【#1】Bột Cần Tây Mật Ong Motree Giảm Cân Có Tốt Không? Giá Bao Nhiêu?

Bột cần tây mật ong Motree giảm cân có tốt không?

Bột cần tây mật ong Motree giảm cân có tốt không? Để có thể trả lời cho câu hỏi này, hãy đi cùng tìm hiểu xem thành phần, công dụng bột cần tây mật ong Motree là như thế nào. Bột cần tây mật ong Motree là một sản phẩm xuất xứ từ Việt Nam và đã được có được đầy đủ giấy phép của Bộ y tế để có thể bày bán.

Thành phần bột cần tây mật ong Motree

Trong bột cần tây mật ong Motree sẽ có các thành phần sau:

– Bột cần tây là sản phẩm được sản xuất từ rau cần tây tươi dựa trên công nghệ sấy lạnh hiện đại và Công nghệ nghiền lạnh siêu mịn giúp quá trình nghiền bột không sinh nhiệt nên có thể giữ lại 99% hương vị màu sắc và cũng như chất dinh dưỡng của cây cần tây.

– Mật ong núi là một trong những thực phẩm vàng chứa nhiều chất dinh dưỡng, tốt cho sức khỏe và làm đẹp hiệu quả.

– Chiết xuất hạt đậu trắng (phase 2): Một thành phần tự nhiên có nguồn gốc từ đậu tây trắng (white kidney bean) làm giảm sự hấp thụ Carbohydrate.

Thành phần bột cần tây mật ong Motree

Công dụng bột cần tây mật ong Motree

Với những thành phần trên của bột cần tây mật ong Motree, sản phẩm có những công dụng như sau:

– cần tây có thể giúp đốt cháy mỡ thừa trong cơ thể, trả lại cho bạn một vóc dáng cân đối, thon gọn. Giảm cân: Ăn cần tây hoặc uống nước ép

Ngăn ngừa ung thư: Một số nghiên cứu chỉ ra rằng chất flavonols, furanocoumarins và acid phenoli trong rau cần tây có thể phòng chống và ngăn chặn sự lan truyền của cấc tế bào ungthư.

Hỗ trợ tiêu hóa: Ăn sống cần tây hoặc uống nước ép cần tây giúp nhuận tràng và tối ưu hoạt động của đường tiêu hóa. Hãy thử uống nước ép cần tay mỗi ngày, bạn sẽ nhận thấy những hiệu quả bất ngờ chỉ sau 1 tuần

Giúp da căng mịn, săn chắc: Theo chuyên gia dinh dưỡng Tamara Rausch, cần tây chứa nhiều chất carotene – một chất có khả năng bảo vệ sức khỏe làn da ở cấp độ phân tử. Không những vậy, chúng còn giúp cân bằng quá trình sản sinh tế bào, tăng cường phục hồi và duy trìcollagen tự nhiên, giúp da săn chắc, mịn màng, đẩy lùi các dấu hiệu lão hóa.

Cho xương chắc khỏe: Người ta tìm thấy trong cần tây có chứa canxi và silic. Đây là hai chất rất quan trọng vớixương, giúp tăng cường độ chắc choxương, tái tạoxương bị hư tổn. Ngoài ra, vitamin K trong cần tây còn có khả năng phòng ngừa loãngxương hiệu quả.

Đẩy lùi virut, vi khuẩn gây bệnh: Với nhiều dưỡng chất và khoáng chất có trong mình, rau cần tây giúp cơ thể thải độc, tăng sức đềkháng, đẩy lùi vikhuẩn xâm nhập từ đó giúp da kh0e mạnh và đẩy lùi mụn một cách hiệuquả.

Nuôi dưỡng hệ thần kinh: Các dưỡng chất trong rau cần tây có tác dụng giảm huyết áp, giảm mức độ căng thẳng, làm dịu cơ thể, từ đó giúp bạn dễ dàng chìm vào giấc ngủ sâu một cách tự nhiên.

Làm tan canxi bị vón cục: polyacetylen và luteolin, có khả năng ức chế enzym gây ra phản ứng viêm trong cơ thể và có lợi cho người bị viêm khớp.

Tăng cường sức khỏe tim mạch: Cần tây được cho là rất tốt với sức khỏe tim mạch nhờ chứa chất Phthalide có tác dụng giúp cơ cơ và mạch máu thư giãn, chất coumarins giúp điều hoà lượng cortisol trong cơ thể, giảm huyết khối.

Kháng viêm, giải đôc tố: Chất luteolin trong cần tây có khả năng ức chế enzym gây ra phản ứng viêm trong cơ thể. Ngoài ra cần tây còn chứa polyacetylen – một chất rất tốt cho người bị viêm khớp.

Công dụng bột cần tây mật ong Motree

Cách sử dụng bột cần tây mật ong Motree hiệu quả

Để có thể sử dụng bột cần tây mật ong Motree đạt hiệu quả cao nhất trong việc giảm cân, hỗ trợ đẹp da đẹp dáng, chúng ta cần dùng bột cần tây mật ong Motree theo cách pha chế sau đây:

+ Bước 1: Lấy 1 thìa bột cần tây khoảng 4-5gram trong gói, cho vào ly. Sau đó cho 300ml nước mát (nếu muốn uống lạnh” hoặc nước ấm (nếu muốn uống nóng)

+ Bước 2: Tiến hành hòa tan bột trong ly, chúng ta có thể thêm đá (nếu muốn) và sau đó bắt đầu sử dụng như một thức uống dinh dưỡng cho cơ thể.

Cách sử dụng bột cần tây mật ong Motree hiệu quả

Sử dụng bột cần tây mật ong Motree mỗi ngày 2 lần, tốt nhất là trước khi ăn khoảng 30 phút để bột phát huy được hiệu quả tốt nhất.

Những ai thích hợp sử dụng bột cần tây mật ong Motree?

Những ai nên sử dụng bột cần tây mật ong Motree

– Những người thừa cân, béo phì đã trải qua nhiều phương pháp giảm cân khác nhau nhưng không có hiệu quả.

– Phụ nữ sau sinh có lượng mỡ thừa lớn và rất khó loại bỏ.

– Những ai đang bị rối loạn nội tiết tố trong cơ thể.

– Phụ nữ muốn làm đẹp da, ngăn chặn quá trình lão hóa.

– Những người bị thiếu canxi, xương không chắc khỏe, cơ thể mệt mỏi và suy giảm.

– Trường hợp khó ngủ, ngủ không ngon giấc, hay tỉnh dậy giữa đêm.

– Những người lười vận động, thường xuyên ngồi văn phòng, ít di chuyển.

Reivew khách hàng đã sử dụng bột cần tây mật ong Motree Reivew khách hàng đã sử dụng bột cần tây mật ong Motree

Review bột cần tây mật ong Motree có tốt không webtretho

Bột cần tây mật ong Motree có giá bao nhiêu?

Bột cần tây mật ong Motree có giá bao nhiêu?

Review Bột Cần Tây Giảm Cân Sitokata Có Tốt Không Webtretho, Giá Bao Nhiêu? Review Bột Cần Tây Sấy Lạnh Có Tốt Không? Giá Bao Nhiêu? Nước Ép Cần Tây Green Beauty Có Tốt Không? Green Beauty Có Giảm Cân Không Webtretho?

Hiện này trên thị trường rất nhiều shop online bán mặt hàng này như facebook, shopee, tiki, … Với mức giá khoảng 125.000 – 150.000/ 1 sản phẩm. Các bạn lưu ý khi mua sản phẩm này nên mua ở những shop uy tín để tránh mua phải hàng kém chất lượng ảnh hưởng tới sức khỏe bản thân.

【#2】Bột Cần Tây Có Tác Dụng Gì? Top 5 Bột Cần Tây Giảm Cân Tốt Nhất

Bột cần tây là gì? Tác dụng của bột cần tây sấy lạnh là gì? Bột cần tây có giảm cân không? Bột cần tây loại nào tốt? Review Top 5 bột cần tây giảm cân tốt nhất được mọi người ưa chuộng.

Bạn nghe nhiều người nói rằng rau cần tây có khả năng giảm cân hiệu quả nhưng không thể nào uống được vì nó có cực kỳ khó uống.

Bột cần tây là giải pháp dành cho bạn bởi nó được chế biến để giảm bớt mùi đặc trưng, dễ uống hơn.

Trên thị trường hiện nay có rất nhiều loại, vậy bột cần tây loại nào tốt? Bài review TOP 5 bột cần tây tốt nhất hiện nay hi vọng sẽ giúp bạn dễ dàng lựa chọn cho mình 1 sản phẩm phù hợp.

Bột cần tây là gì?

Bột cần tây là một loại gia vị được tạo ra bằng cách lấy rau cần tây tươi sấy khô và nghiền thành bột. Thường được sử dụng được để làm gia vị và bảo quản thịt.

Tuy nhiên, uống bột cần tây sấy khô còn giúp bạn detox cơ thể, giảm cân, trị táo bón, đại tràng, đau dạ dày. Chi tiết về công dụng mình sẽ nói tiếp ở phần dưới.

Tác dụng của bột cần tây?

Trong cây cần tây chứa flavonoid (chất dinh dưỡng thực vật mạnh mẽ với đặc tính chống oxy hóa). Nghiên cứu cho thấy trong cần tây có chứa nhiều nước, khoảng 1/3 là chất xơ. Chất xơ sau khi vào trong dạ dày và ruột không thể tiêu hóa, chỉ cung cấp cảm giác “no” chứ không cung cấp calo. Chính vì lý do đó, bột cần tây là sản phẩm bổ sung thích hợp cho mọi chế độ ăn kiêng giảm cân.

Thêm vào đó, trong cần tây còn chứa một lượng vitamin C và K, cũng như là folate và kali. Các nghiên cứu cho thấy rằng, uống cần tây hay bột cần tây đều có thể giúp chống lại ung thư và bệnh gan, tăng cường sức khỏe tim mạch.

Hơn thế, bột cần tây còn có các công dụng khác như:

  • Hỗ trợ bệnh cao huyết áp do bột cần tây có tính hạ đường huyết.
  • Giàu canxi, magie,…giúp xương phát triển chắc khỏe hơn.
  • Detox cơ thể, giúp da trở nên mịn màng hơn.
  • Cải thiện bệnh chàm, vẩy nến.
  • Giúp giảm cholesterol cao.
  • Chữa mụn trứng cá.

Tại sao nên uống bột cần tây thay vì uống nước ép cần tây tươi?

Câu hỏi mà độc giả thường hay hỏi mình rằng: “Có nên uống bột cần tây sấy lạnh không?”. Săn Mỹ Phẩm Tốt sẽ đưa ra 1 vài lý do bạn nên uống bột cần tây thay vì uống nước ép cần tây tươi.

  • Bột cần tây dễ uống hơn vì được thêm các hương liệu từ thiên nhiên như cỏ ngọt, đường ăn kiêng thơm ngon.
  • Thời gian chế biến nhanh, không cần phải ép cần tây tươi như cách thông thường.
  • Một số sản phẩm bột cần tây còn thêm các thành phần như Collagen, Sâm tố nữ, Diệp lục,…nhằm tăng công dụng làm đẹp da, da trắng sáng, mềm mịn, chống lão hóa,…

Review top 5 bột cần tây tốt nhất

1. Bột cần tây sấy lạnh Sitokata

ĐIỂM ĐÁNH GIÁ: 9.5/10

Thành phần

Mỗi gói 5g có chứa:

  • Bột cần tây tươi
  • Mầm đậu nành
  • Mầm đậu xanh
  • Chiết suất Cỏ ngọt
  • Chiết suất Sâm tố nữ

Phụ liệu: Hương thơm (vani, sữa, socola, hoa quả), Natri Benzoate, Sorbat Kali, Polyvinylpyrrolidone, màu thực phẩm vừa đủ 1 gói 5g

Công dụng

– Detox cơ thể, hỗ trợ giảm cân một cách tự nhiên.

– Cải thiện chuyện chăn gối, các tình trạng rối loạn nội tiết tố nữ.

– Chống lão hóa da, giúp da căng mịn, có sức sống hơn.

– Hỗ trợ, ngăn ngừa các bệnh cấp và mãn tính như: viêm tuyến giáp, bệnh chàm, bệnh vẩy nến, mụn trứng cá, táo bón, các vấn đề về đường trong máu, bệnh gút,…

– Hỗ trợ bệnh cao huyết áp vì cần tây có tính hạ đường huyết.

Điểm nổi bật Sitokata so với các sản phẩm khác

  • Thành phần sạch, nguyên liệu được chọn từ những hạt giống tốt nhất và không bị biến đổi gen.
  • Kết hợp thêm Sâm tố nữ, Mầm đậu nành, Mầm đậu xanh rất tốt trong việc chăn gối, giảm bốc hỏa,…
  • Áp dụng thành công công nghệ sấy lạnh từ Nhật Bản nên giữ nguyên được dinh dưỡng và hương vị.
  • Không sử dụng đường, mà thay vào đó là vị ngọt hoàn toàn tự nhiên từ cây cỏ ngọt.
  • Được chuyên gia khuyên dùng, được các hoa hậu, người mẫu, diễn viên tin dùng.
  • Được đưa tin trên các trang báo uy tín, VTV1 đưa tin.
  • Đã được Bộ Y tế kiểm định và cấp giấy phép lưu hành trên toàn quốc.
  • Được tặng kèm chai đựng nước nếu mua tại website chính hãng.

Cách dùng

Đầu tiên, hãy pha 1 gói 50g cùng với 150ml nước ấm hoặc nước sôi để nguội.

Tiếp theo, hãy khuấy đều cho bột tan. Có thể cho thêm chút đá tùy khẩu vị.

Giá bán và nơi mua Sitokata chính hãng

Bột cần tây sấy lạnh Sitokata được bán với giá niêm yết là 499.000đ/hộp 20 gói.

Tuy nhiên, nếu mua combo 2 hộp ưu đãi chỉ còn 399.000đ, combo 3 hộp ưu đãi chỉ còn 360.000đ và còn được tặng chai đựng nước, miễn phí giao hàng nữa.

2. Bột cần tây Keto Slim

ĐIỂM ĐÁNH GIÁ: 9.3/10

Thành phần

100% cần tây tươi nguyên liệu đến từ Nhật Bản.

Công dụng

– Hỗ trợ giảm cảm giác thèm ăn, nhưng vẫn bổ sung đầy đủ chất dinh dưỡng để cơ thể hoạt động, giúp bạn giảm cân dễ dàng hơn.

– Hỗ trợ thải độc, detox cơ thể.

– Giúp chống lão hóa, làm đẹp da.

Điểm nổi bật của bột cần tây Keto Slim so với các sản phẩm khác

  • Thành phần được chiết suất từ cần tây tươi nguyên chất 100%.
  • Hoạt chất Alkalizing được chiết suất một cách tối đa giúp tăng cường chuyển hóa, đào thải chất độc tự nhiên.
  • Hàm lượng chất xơ cao gấp 200 lần so với cần tây tươi giúp no lâu, giảm cảm giác thèm ăn.
  • Sản phẩm đã được Bộ Y tế cấp giấy phép lưu hành trên toàn quốc.

Cách dùng

Pha 1 thìa cà phê bột cần tây Keto Slim cùng với 150ml nước ấm hoặc nước sôi để nguội.

Cho thêm một ít đá viên (tùy khẩu vị mỗi người).

Nên uống từ 2-3 lần/ngày, trước bữa ăn 30 phút hoặc lúc bụng đói để sản phẩm phát huy tối đa công dụng.

Giá bán và nơi mua bột cần tây Keto Sim chính hãng

Tại website chính hãng, bột cần tây giảm cân Keto Slim hiện đang bán với giá 500.000đ/hộp.

Bạn sẽ được ưu đãi hơn nếu mua từ combo 2 trở lên, cụ thể khi mua combo 2 chỉ còn 450.000đ/hộp, combo 3 chỉ còn 400.000đ/hộp.

Để đặt mua bột cần tây Keto Slim, khuyến khích bạn nên đặt hàng tại vì nghe phong phanh là đã xuất hiện hàng giả trên thị trường rồi.

3. Bột cần tây giảm cân Green Beauty

ĐIỂM ĐÁNH GIÁ: 9.3/10

Thành phần

Gồm 5 thành phần chính:

Ngoài ra, còn vô vàn các thành phần khác được kết hợp tạo nên Green Beauty: Alpha Lipoic Acid, Inulin, L-Cystine, Vitamin C, Maltodextrin, Monohydrat, đường Isomalt, hương sữa vừa đủ.

Công dụng

– Detox, thanh lọc cơ thể.

– Hỗ trợ giảm cân hiệu quả.

– Làm trắng da, cải thiện tình trạng da sẫm màu.

– Giảm khô hạn, tăng nội tiết tố nữ.

– …

Điểm nổi bật của Green Beauty so với các sản phẩm khác

  • Thành phần chiết suất 100% từ cây cần tây.
  • Sử dụng đường Isomalt (đường ăn kiêng) nhằm giúp hạn chế tối đa lượng đường nạp vào cơ thể gây tăng cân.
  • Kết hợp thêm nhiều thành phần nổi tiếng trong ngành làm đẹp như Tảo xoắn, Diệp lục, Glutathione, Collagen,…Vì thế, ngoài công dụng làm giảm cân, còn giúp làm đẹp da hiệu quả, cải thiện nội tiết tố nữ.
  • Được VTV1 đưa tin, được các nghệ sĩ đánh giá tốt.

Cách dùng Green Beauty

Hòa tan 1 gói bột cần tây Green Beauty cùng với 500ml nước. Có thể cho thêm đá tùy khẩu vị của mỗi người.

Nên dùng từ 2-3 gói/ngày. Có thể uống vào sáng sớm (khi chưa đánh răng), trưa và chiều tối.

Giá bán và nơi mua Green Beauty chính hãng

Giá bán niêm yết trên thị trường cho Green Beauty Cần tây – Táo xoắn – Diệp lục – Collagen – Glutathione là 360.000đ/hộp 30 gói.

4. Bột cần tây mật ong Jan’s Power

ĐIỂM ĐÁNH GIÁ: 9.0/10

Thành phần

100% từ rau cần tây tươi được trồng tại nông trại Jansfarmmades cao nguyên Đà Lạt ở độ cao 1500m.

Công dụng

– Giảm eo, giảm mỡ bụng hiệu quả.

– Ngăn ngừa ung thư.

– Làm tan canxi vón cục, cho xương trở nên chắc khỏe hơn.

– Chống táo bón.

– Giúp giảm mụn, làm đẹp da, giúp da sáng mịn.

– …

Điểm nổi bật của bột cần tây sấy lạnh Jan’s Power so với các sản phẩm khác

  • Sản xuất bởi công nghệ sấy lạnh nên giữ được 99% NGUYÊN CHẤT, NGUYÊN MÙI, NGUYÊN XƠ từ rau cần tây tươi.
  • Rau cần tây được trực tiếp trồng hữu cơ, thu hoạch trên cao nguyên Đà Lạt.
  • Chứa hợp chất 3-n-butylphthalide với công dụng làm giảm lượng mỡ máu lipit trong cơ thể.
  • Không chứa chất bảo quản, không phẩm màu, không phụ gia, không biến đổi gen.
  • Được á hậu Huyền My tin tưởng sử dụng và cho đánh giá tốt.

Hướng dẫn sử dụng

Pha 1 muống cà phê bột cần tây Jan’s cùng với 150ml nước ấm. Có thể thêm một chút đá tùy khẩu vị của mỗi người.

Giá bán và nơi mua bột cần tây sấy lạnh mật ong Jan’s Power

Bột cần tây sấy lạnh Jan’s Power hiện dao động với giá từ 145.000đ – 195.000đ/hộp 20 gói.

5. Bột cần tây Dalahouse

Thành phần

100% cần tây tươi. Không hóa chất, không hương liệu.

Điểm nổi bật của bột cần tây Dalahouse so với các sản phẩm khác

  • Thiết kế dạng túi zip dễ dàng lấy bột ra bên ngoài.
  • Sử dụng công nghệ sấy lạnh hiện đại bảo toàn được enzyme và chất dinh dưỡng của cần tây.
  • Giá rẻ, dễ mua.

Cách dùng

Cho 1 muỗng cà phê (~2gram bột cần tây) cùng với 100ml nước ấm. Bạn cũng có thể kết hợp với nước trái cây, sinh tố, sữa chua,…để tạo thành một thức uống thơm ngon hơn.

Giá bán và nơi mua bột cần tây Dalahouse

Tham khảo tại website chính hãng chúng tôi giá bán hiện tại của sản phẩm này là 95.000đ/gói 50g. Ngoài 50g ra thì còn có 150g, 200g, 300g, 500g nữa tha hồ cho bạn lựa chọn.

Câu hỏi thường gặp

1. Bột cần tây giá bao nhiêu? Mua ở đâu?

Về giá cả, nơi mua chính hãng, Săn Mỹ Phẩm Tốt đã nêu chi tiết rất rõ trong từng sản phẩm rồi. Vui lòng lướt lại từng sản phẩm để cập nhật.

2. Uống bột cần tây vào lúc nào tốt nhất?

Thời gian uống bột cần tây tốt nhất là vào lúc trước bữa ăn 30 phút và lúc bụng đói. Ngoài ra, bạn cũng có thể uống vào sáng sớm (khi chưa đánh răng) để detox cơ thể hiệu quả.

3. Phụ nữ đang mang thai và cho con bú có sử dụng được bột cần tây?

Về vấn đề này, bạn nên thăm hỏi ý kiến bác sĩ trước khi sử dụng.

4. Bột cần tây có dễ uống không?

Được biết, bột cần tây có phần dễ uống hơn nước ép cần tây tươi nhờ thêm các thành phần từ thiên nhiên khác như Cỏ ngọt, Đường Isomalt (đường ăn kiêng),…

5. Uống bột cần tây có tốt không?

Bột cần tây không chỉ giúp bạn giảm cân một cách an toàn, tự nhiên mà còn làm

6. Cách uống bột cần tây giảm cân

Nghiên cứu cho thấy trong cần tây có chứa nhiều nước, khoảng 1/3 là chất xơ. Chất xơ sau khi vào trong dạ dày và ruột không thể tiêu hóa, chỉ cung cấp cảm giác “no” chứ không cung cấp calo, bởi ông nhận định “Không loại thức ăn nào có thể giảm được cân. Chỉ có loại thức ăn làm giảm lượng calo bạn ăn vào, từ đó trợ giúp nhất định cho việc giảm cân”.

Do đó cách giảm cân bằng bột cần tây là hoàn toàn có lợi cho việc giảm cân.

Lời kết

Hi vọng, qua bài viết Bột cần tây có tác dụng gì? Top 5 bột cần tây giảm cân tốt nhất sẽ giúp bạn dễ dàng chọn được cho mình một sản phẩm phù hợp với bản thân mình.

【#3】Relent By Etro + Venice Photo Essay

Hey there happy huffers,

Fragrantica gives these featured accords:

Top: Lemon, orange, lime, eucalyptus

Heart: Orange blossom, rose, iris

Base: Amber, vanilla, musk (ETRO adds citron in the base)

From the ETRO site: The true Eden is never a pcise location; we need to learn to create it inside ourselves, to carry with us some of the serenity that can be evoked by aromas that brighten the heart. Sparkling citrus fruits and the sweetest flowers, a hint of the sensuality of amber and the languor of rose, a drop of solemn musk.

Since Venice, every shop that has ETRO gets a visit from me but nobody seems to carry Relent anymore, only the newer ones in the lineup. So I went to the internet and recently I found a Relent 150ml Eau Parfumee at Beauty Encounter for only $70 and the 200ml Shower Gel for only $39!! I am extremely happy about it and bought fragrance and a couple of shower gels. It is such a vivid memory for both Jin and I, a happy, wonderful memory that we cherish, so easy to bring back just by fragrance. Fragrantica gives 2010 as this fragrances release but MUA has reviews from 2003.

How does it smell? The opening citrus and eucalyptus combination is fizzzy, dry and interesting, the citrus fizzes like a soda pop drink fresh from the bottle but the eucalyptus holds the sweetness in check giving a very herbal, green dryness. If you told me there was some cumin with coriander/lavender/basil here I would totally believe you because it’s such a vegetative yet sweaty green opening. I also smell some wood notes that are unmentioned. It takes a while for the opening scene to develop properly and it stays for a while before the orange blossom makes her appearance, not as an entrance but she comes in though the side door unannounced, no fanfare but there she is whispering something naughty in your ear and rose is giggling wickedly beside her. Then, as the star of the show is about to be announced, like a wedding everyone quietens down and there is a fragrant hush, a lull, a pause before IRIS stands tall at the top of the stairs in full spotlight. A woody, powder puff of an iris, gentle and soft and cuddly and furry with musks comes down the stairs to be the star of the night. Everyone gets to dance with her, maybe the best analogy would be a round dance where everyone is involved but only a few are near iris for the rest of the evening before the last slow dance and then gone.

I think Relent could be worn anywhere, including frag phobic works, it is soft and ptty enough to be passed of as body lotion but interesting enough to wear. Light, cuddly and to Jin and I joyful. Maybe you will think so too.

My scent hungry skin gets about 3-4 hours before there is only a sweet amber musk that smells like me. Jin says the scent continues but I have lost the ability to smell it.

Nobody else on the first 4 pages of Google has reviewed Relent

Beauty Encounter has the best prices I could find and none of the sample shops carry Relent, though some have other ETRO frags.

I hope you enjoyed our ETRO Relent and Venice Photo Essay. All unattributed photos taken by Jin or myself.

See you tomorrow for more fun and madness,

Portia xx

【#4】Principles Of Microeconomics, 5Th Edition

FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY 13 The Costs of Production 14 Firms in Competitive Markets

The theory of the firm sheds light on the decisions that lie behind supply in competitive markets.

15 Monopoly 16 Monopolistic Competition

Firms with market power can cause market outcomes to be inefficient.

17 Oligopoly

THE ECONOMICS OF LABOR MARKETS 18 The Markets for the Factors of Production 19 Earnings and Discrimination

These chapters examine the special features of labor markets, in which most people earn most of their income.

20 Income Inequality and Poverty

TOPICS FOR FURTHER STUDY 21 The Theory of Consumer Choice 22 Frontiers of Microeconomics

Additional topics in microeconomics include household decision making, asymmetric information, political economy, and behavioral economics.

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PRIN CIPL E S

O F

Microeconomics FIF TH

EDITION

N. GREGORY MANKIW HARVARD UNIVERSITY

Australia * Brazil * Japan * Korea * Mexico * Singapore * Spain * United Kingdom * United States

Principles of Microeconomics, 5e N. Gregory Mankiw Vice President of Editorial, Business: Jack W. Calhoun Vice President/Editor-in-Chief: Alex von Rosenberg

© 2009, 2007 South-Western, a part of Cengage Learning ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means-graphic, electronic, or mechanical, including photocopying, recording, taping, Web distribution, information storage and retrieval systems, or in any other manner-except as may be permitted by the license terms herein.

Executive Editor: Mike Worls Developmental Editor: Jane Tufts Contributing Editors: Jennifer E. Thomas and Katie Yanos Executive Marketing Manager: Brian Joyner Marketing Coordinator: Suellen Ruttkay

For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706 For permission to use material from this text or product, submit all requests online at chúng tôi Further permissions questions can be emailed to early 1990s brought the organization around to the concept. “We now believe that Farmer: (sounding skeptical) That seems like a good deal for me. But I don’t understand why you are offering it. If the deal is so good for me, it can’t be good for you too. Rancher: Oh, but it is! Suppose I spend 6 hours a day raising cattle and 2 hours growing potatoes. Then I can produce 18 ounces of meat and 12 ounces of potatoes. After I give you 5 ounces of my meat in exchange for 15 ounces of your potatoes, I’ll end up with 13 ounces of meat and 27 ounces of potatoes, instead of the 12 ounces of meat and

CHAPTER 3

INTERDEPENDENCE AND THE GAINS FROM TRADE

The proposed trade between the farmer and the rancher offers each of them a combination of meat and potatoes that would be impossible in the absence of trade. In panel (a), the farmer gets to consume at point A* rather than point A. In panel (b), the rancher gets to consume at point B* rather than point B. Trade allows each to consume more meat and more potatoes.

(a) The Farmer’s Production and Consumption Meat (ounces)

F I G U R E

How Trade Expands the Set of Consumption Opportunities

(b) The Rancher’s Production and Consumption Meat (ounces) Rancher’s production with trade

24

Rancher’s consumption with trade

18

8

Farmer’s consumption with trade

A*

5 4

13 Farmer’s production and consumption without trade

A

B* B

12

32 16

17

0

12

Potatoes (ounces)

(c) The Gains from Trade: A Summary

Farmer Meat Without Trade: Production and Consumption With Trade: Production Trade Consumption GAINS FROM TRADE: Increase in Consumption

Farmer: Rancher:

Rancher’s production and consumption without trade

Farmer’s production with trade

0

Farmer: Rancher:

2

Rancher

Potatoes

Meat

Potatoes

4 oz

16 oz

12 oz

24 oz

0 oz Gets 5 oz 5 oz

32 oz Gives 15 oz 17 oz

18 oz Gives 5 oz 13 oz

12 oz Gets 15 oz 27 oz

+1 oz

+1 oz

+1 oz

+3 oz

24 ounces of potatoes that I now get. So I will also consume more of both foods than I do now. (after pausing to study the table) These calculations seem correct, but I am puzzled. How can this deal make us both better off? We can both benefit because trade allows each of us to specialize in doing what we do best. You will spend more time growing potatoes and less time raising cattle. I will spend more time raising cattle and

24 27

48 Potatoes (ounces)

53

54

PART I

INTRODUCTION

less time growing potatoes. As a result of specialization and trade, each of us can consume more meat and more potatoes without working any more hours.

Q

Q

UICK UIZ Draw an example of a production possibilities frontier for Robinson Crusoe, a shipwrecked sailor who spends his time gathering coconuts and catching fish. Does this frontier limit Crusoe’s consumption of coconuts and fish if he lives by himself? Does he face the same limits if he can trade with natives on the island?

OPPORTUNITY COST opportunity cost whatever must be given up to obtain some item

AND

COMPARATIVE A DVANTAGE

There is another way to look at the cost of producing potatoes. Rather than comparing inputs required, we can compare the opportunity costs. Recall from Chapter 1 that the opportunity cost of some item is what we give up to get that item. In our example, we assumed that the farmer and the rancher each spend 8 hours a day working. Time spent producing potatoes, therefore, takes away from time available for producing meat. When reallocating time between the two goods, the rancher and farmer give up units of one good to produce units of the other, thereby moving along the production possibilities frontier. The opportunity cost measures the trade-off between the two goods that each producer faces.

CHAPTER 3

INTERDEPENDENCE AND THE GAINS FROM TRADE

COMPARATIVE A DVANTAGE

AND

TRADE

T A B L E

1

Opportunity Cost of: 1 oz of Meat Farmer Rancher

4 oz potatoes 2 oz potatoes

1 oz of Potatoes 1

⁄4 oz meat ⁄2 oz meat

1

The Opportunity Cost of Meat and Potatoes

55

56

PART I

INTRODUCTION

THE PRICE

OF THE

TRADE

CHAPTER 3

INTERDEPENDENCE AND THE GAINS FROM TRADE

PHOTO: © BETTMANN/CORBIS

Economists have long understood the gains from trade. Here is how the great economist Adam Smith put the argument:

QUICK QUIZ

57

PART I

INTRODUCTION

SHOULD TIGER WOODS MOW HIS OWN LAWN? © JOHN AMIS/REUTERS/LANDOV

58

SHOULD THE UNITED STATES TRADE WITH OTHER COUNTRIES?

imports goods produced abroad and sold domestically exports goods produced domestically and sold abroad

CHAPTER 3

INTERDEPENDENCE AND THE GAINS FROM TRADE

When the United States exports food and imports cars, the impact on an American farmer is not the same as the impact on an American autoworker. Yet, contrary to the opinions sometimes voiced by politicians and pundits, international trade is not like war, in which some countries win and others lose. Trade allows all countries to achieve greater prosperity.

Q

Q

UICK UIZ Suppose that a skilled brain surgeon also happens to be the world’s fastest typist. Should she do her own typing or hire a secretary? Explain.

Ogre to Slay? Outsource It to Chinese

PHOTO: © MARK RALSTON/AFP/GETTY IMAGES

By David Barboza Fuzhou, China-One of China’s newest factories operates here in the basement of an old warehouse. Posters of World of Warcraft and Magic Land hang above a corps of young people glued to their computer screens, pounding away at their keyboards in the latest hustle for money. The people working at this clandestine locale are “gold farmers.” Every day, in 12hour shifts, they “play” computer games by killing onscreen monsters and winning battles, harvesting artificial gold coins and other virtual goods as rewards that, as it turns out, can be transformed into real cash. That is because, from Seoul to San Francisco, affluent online gamers who lack the time and patience to work their way up to the higher levels of gamedom are willing to pay the young Chinese here to play the early rounds for them. “For 12 hours a day, 7 days a week, my colleagues and I are killing monsters,” said Source: New York Times, December 9, 2005.

a 23-year-old gamer who works here in this makeshift factory and goes by the online code name Wandering. “I make about $250 a month, which is ptty good compared with the other jobs I’ve had. And I can play games all day.” He and his comrades have created yet another new business out of cheap Chinese labor. They are tapping into the fastgrowing world of “massively multiplayer online games,” which involve role playing and often revolve around fantasy or warfare in medieval kingdoms or distant galaxies. . . . For the Chinese in game-playing factories like these, though, it is not all fun and

59

60

PART I

INTRODUCTION

SUMMARY * Each person consumes goods and services produced by many other people both in the United States and around the world. Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services.

exports, p. 58

CHAPTER 3

INTERDEPENDENCE AND THE GAINS FROM TRADE

61

62

PART I

INTRODUCTION

Boston Chicago

Pairs of Red Socks per Worker per Hour

Pairs of White Socks per Worker per Hour

3 2

3 1

CHAPTER #

THE MARKET FORCES OF SUPPLY AND DEMAND

PART II How Markets Work

63

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4

CHAPTER

The Market Forces of Supply and Demand

W

hen a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country. When the weather turns warm in New England every summer, the price of hotel rooms in the Caribbean plummets. When a war breaks out in the Middle East, the price of gasoline in the United States rises, and the price of a used Cadillac falls. What do these events have in common? They all show the workings of supply and demand. Supply and demand are the two words economists use most often-and for good reason. Supply and demand are the forces that make market economies work. They determine the quantity of each good produced and the price at which it is sold. If you want to know how any event or policy will affect the economy, you must think first about how it will affect supply and demand. This chapter introduces the theory of supply and demand. It considers how buyers and sellers behave and how they interact with one another. It shows how supply and demand determine prices in a market economy and how prices, in turn, allocate the economy’s scarce resources.

65

66

PART II

HOW MARKETS WORK

MARKETS AND COMPETITION The terms supply and demand refer to the behavior of people as they interact with one another in competitive markets. Before discussing how buyers and sellers behave, let’s first consider more fully what we mean by the terms market and competition.

WHAT IS market a group of buyers and sellers of a particular good or service

A

M ARKET?

A market is a group of buyers and sellers of a particular good or service. The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product. Markets take many forms. Sometimes markets are highly organized, such as the markets for many agricultural commodities. In these markets, buyers and sellers meet at a specific time and place, where an auctioneer helps set prices and arrange sales. More often, markets are less organized. For example, consider the market for ice cream in a particular town. Buyers of ice cream do not meet together at any one time. The sellers of ice cream are in different locations and offer somewhat different products. There is no auctioneer calling out the price of ice cream. Each seller posts a price for an ice-cream cone, and each buyer decides how much ice cream to buy at each store. Nonetheless, these consumers and producers of ice cream are closely connected. The ice-cream buyers are choosing from the various ice-cream sellers to satisfy their hunger, and the ice-cream sellers are all trying to appeal to the same ice-cream buyers to make their businesses successful. Even though it is not organized, the group of ice-cream buyers and ice-cream sellers forms a market.

WHAT IS COMPETITION?

competitive market a market in which there are many buyers and many sellers so that each has a negligible impact on the market price

The market for ice cream, like most markets in the economy, is highly competitive. Each buyer knows that there are several sellers from which to choose, and each seller is aware that his or her product is similar to that offered by other sellers. As a result, the price of ice cream and the quantity of ice cream sold are not determined by any single buyer or seller. Rather, price and quantity are determined by all buyers and sellers as they interact in the marketplace. Economists use the term competitive market to describe a market in which there are so many buyers and so many sellers that each has a negligible impact on the market price. Each seller of ice cream has limited control over the price because other sellers are offering similar products. A seller has little reason to charge less than the going price, and if he or she charges more, buyers will make their purchases elsewhere. Similarly, no single buyer of ice cream can influence the price of ice cream because each buyer purchases only a small amount. In this chapter, we assume that markets are perfectly competitive. To reach this highest form of competition, a market must have two characteristics: (1) the goods offered for sale are all exactly the same, and (2) the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. Because buyers and sellers in perfectly competitive markets must accept the price the market determines, they are said to be price takers. At the market price, buyers can buy all they want, and sellers can sell all they want.

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

There are some markets in which the assumption of perfect competition applies perfectly. In the wheat market, for example, there are thousands of farmers who sell wheat and millions of consumers who use wheat and wheat products. Because no single buyer or seller can influence the price of wheat, each takes the price as given. Not all goods and services, however, are sold in perfectly competitive markets. Some markets have only one seller, and this seller sets the price. Such a seller is called a monopoly. Your local cable television company, for instance, may be a monopoly. Residents of your town probably have only one cable company from which to buy this service. Still other markets fall between the extremes of perfect competition and monopoly. Despite the persity of market types we find in the world, assuming perfect competition is a useful simplification and, therefore, a natural place to start. Perfectly competitive markets are the easiest to analyze because everyone participating in the market takes the price as given by market conditions. Moreover, because some degree of competition is psent in most markets, many of the lessons that we learn by studying supply and demand under perfect competition apply in more complicated markets as well.

QUICK QUIZ

What is a market? * What are the characteristics of a perfectly competitive

market?

DEMAND We begin our study of markets by examining the behavior of buyers. To focus our thinking, let’s keep in mind a particular good-ice cream.

THE DEMAND CURVE: THE R ELATIONSHIP PRICE AND QUANTITY DEMANDED

BETWEEN

The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. As we will see, many things determine the quantity demanded of any good, but when analyzing how markets work, one determinant plays a central role-the price of the good. If the price of ice cream rose to $20 per scoop, you would buy less ice cream. You might buy frozen yogurt instead. If the price of ice cream fell to $0.20 per scoop, you would buy more. This relationship between price and quantity demanded is true for most goods in the economy and, in fact, is so pervasive that economists call it the law of demand: Other things equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, the quantity demanded rises. The table in Figure 1 shows how many ice-cream cones Catherine buys each month at different prices of ice cream. If ice cream is free, Catherine eats 12 cones per month. At $0.50 per cone, Catherine buys 10 cones each month. As the price rises further, she buys fewer and fewer cones. When the price reaches $3.00, Catherine doesn’t buy any ice cream at all. This table is a demand schedule, a table that shows the relationship between the price of a good and the quantity demanded, holding constant everything else that influences how much consumers of the good want to buy.

quantity demanded the amount of a good that buyers are willing and able to purchase

law of demand the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises demand schedule a table that shows the relationship between the price of a good and the quantity demanded

67

68

PART II

1

HOW MARKETS WORK

F I G U R E

The demand schedule is a table that shows the quantity demanded at each price. Types of Graphs

Catherine’s Demand Schedule and Demand Curve

demand which graphshow theU.S. demand schedule, thevarious quantity The pie chartcurve, in panel (a) shows national incomeillustrates is derivedhow from demanded ofbar thegraph good in changes as compares its price varies. Becauseincome a lower increases sources. The panel (b) the average in price four countries. the quantity demanded, demand curve downward. The time-series graph in the panel (c) shows theslopes productivity of labor in U.S. businesses from 1950 to 2000.

Price of Ice-Cream Cone

Quantity of Cones Demanded

$0.00 0.50 1.00 1.50 2.00 2.50 3.00

12 cones 10 8 6 4 2 0

Price of Ice-Cream Cone $3.00 2.50 1. A decrease in price . . .

2.00 1.50 1.00 Demand curve 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones 2. . . . increases quantity of cones demanded.

demand curve a graph of the relationship between the price of a good and the quantity demanded

The graph in Figure 1 uses the numbers from the table to illustrate the law of demand. By convention, the price of ice cream is on the vertical axis, and the quantity of ice cream demanded is on the horizontal axis. The downward-sloping line relating price and quantity demanded is called the demand curve.

M ARKET DEMAND

VERSUS

INDIVIDUAL DEMAND

The demand curve in Figure 1 shows an inpidual’s demand for a product. To analyze how markets work, we need to determine the market demand, the sum of all the inpidual demands for a particular good or service. The table in Figure 2 shows the demand schedules for ice cream of the two inpiduals in this market-Catherine and Nicholas. At any price, Catherine’s demand schedule tells us how much ice cream she buys, and Nicholas’s demand schedule tells us how much ice cream he buys. The market demand at each price is the sum of the two inpidual demands. The graph in Figure 2 shows the demand curves that correspond to these demand schedules. Notice that we sum the inpidual demand curves horizontally to obtain the market demand curve. That is, to find the total quantity demanded at any price, we add the inpidual quantities, which are found on the horizontal axis of the inpidual demand curves. Because we are interested in analyzing how markets function, we work most often with the market demand curve. The market demand curve shows how the total quantity demanded of a good varies as the

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

Price of Ice-Cream Cone

Catherine

$0.00 0.50 1.00 1.50 2.00 2.50 3.00

12 10 8 6 4 2 0

Catherine’s Demand

Nicholas +

7 6 5 4 3 2 1

+

=

19 cones 16 13 10 7 4 1

Nicholas’s Demand

=

Market Demand

Price of Ice-Cream Cone

Price of Ice-Cream Cone

$3.00

$3.00

$3.00

2.50

2.50

2.50

2.00

2.00

2.00

1.50

1.50

1.50

1.00

1.00

DCatherine

0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones

1.00 DNicholas

IN THE

DMarket

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones

price of the good varies, while all the other factors that affect how much consumers want to buy are held constant.

SHIFTS

Market Demand as the Sum of Inpidual Demands

Market

Price of Ice-Cream Cone

0.50

2

F I G U R E

The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price. Thus, the market demand curve is found by adding horizontally the inpidual demand curves. At a price of $2.00, Catherine demands 4 ice-cream cones, and Nicholas demands 3 ice-cream cones. The quantity demanded in the market at this price is 7 cones.

DEMAND CURVE

Because the market demand curve holds other things constant, it need not be stable over time. If something happens to alter the quantity demanded at any given price, the demand curve shifts. For example, suppose the American Medical Association discovered that people who regularly eat ice cream live longer, healthier lives. The discovery would raise the demand for ice cream. At any given price, buyers would now want to purchase a larger quantity of ice cream, and the demand curve for ice cream would shift. Figure 3 illustrates shifts in demand. Any change that increases the quantity demanded at every price, such as our imaginary discovery by the American Medical Association, shifts the demand curve to the right and is called an increase in demand. Any change that reduces the quantity demanded at every price shifts the demand curve to the left and is called a decrease in demand. There are many variables that can shift the demand curve. Here are the most important.

0

2

4

6 8 10 12 14 16 18 Quantity of Ice-Cream Cones

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HOW MARKETS WORK

F I G U R E Price of Ice-Cream Cone

Shifts in the Demand Curve Any change that raises the quantity that buyers wish to purchase at any given price shifts the demand curve to the right. Any change that lowers the quantity that buyers wish to purchase at any given price shifts the demand curve to the left.

Increase in demand

Decrease in demand Demand curve, D2 Demand curve, D1 Demand curve, D3 0

Quantity of Ice-Cream Cones

Income What would happen to your demand for ice cream if you lost your job one summer? Most likely, it would fall. A lower income means that you have less to spend in total, so you would have to spend less on some-and probably most-goods. If the demand for a good falls when income falls, the good is called a normal good. Not all goods are normal goods. If the demand for a good rises when income falls, the good is called an inferior good. An example of an inferior good might be bus rides. As your income falls, you are less likely to buy a car or take a cab and more likely to ride a bus. Prices of Related Goods Suppose that the price of frozen yogurt falls. The law of demand says that you will buy more frozen yogurt. At the same time, you will probably buy less ice cream. Because ice cream and frozen yogurt are both cold, sweet, creamy desserts, they satisfy similar desires. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. Substitutes are often pairs of goods that are used in place of each other, such as hot dogs and hamburgers, sweaters and sweatshirts, and movie tickets and video rentals. Now suppose that the price of hot fudge falls. According to the law of demand, you will buy more hot fudge. Yet in this case, you will buy more ice cream as well because ice cream and hot fudge are often used together. When a fall in the price of one good raises the demand for another good, the two goods are called complements. Complements are often pairs of goods that are used together, such as gasoline and automobiles, computers and software, and peanut butter and jelly. Tastes The most obvious determinant of your demand is your tastes. If you like ice cream, you buy more of it. Economists normally do not try to explain people’s tastes because tastes are based on historical and psychological forces that are beyond the realm of economics. Economists do, however, examine what happens when tastes change.

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

T A B L E Variable

A Change in This Variable . . .

Price of the good itself

Repsents a movement along the demand curve Shifts the demand curve Shifts the demand curve Shifts the demand curve Shifts the demand curve Shifts the demand curve

Income Prices of related goods Tastes Expectations Number of buyers

1

Variables That Influence Buyers This table lists the variables that affect how much consumers choose to buy of any good. Notice the special role that the price of the good plays: A change in the good’s price repsents a movement along the demand curve, whereas a change in one of the other variables shifts the demand curve.

Expectations Your expectations about the future may affect your demand for a good or service today. For example, if you expect to earn a higher income next month, you may choose to save less now and spend more of your current income buying ice cream. As another example, if you expect the price of ice cream to fall tomorrow, you may be less willing to buy an ice-cream cone at today’s price. Number of Buyers In addition to the pceding factors, which influence the behavior of inpidual buyers, market demand depends on the number of these buyers. If Peter were to join Catherine and Nicholas as another consumer of ice cream, the quantity demanded in the market would be higher at every price, and market demand would increase.

© ALEXANDER BECHER/DPA/LANDOV

Summary The demand curve shows what happens to the quantity demanded of a good when its price varies, holding constant all the other variables that influence buyers. When one of these other variables changes, the demand curve shifts. Table 1 lists the variables that influence how much consumers choose to buy of a good. If you have trouble remembering whether you need to shift or move along the demand curve, it helps to recall a lesson from the appendix to Chapter 2. A curve shifts when there is a change in a relevant variable that is not measured on either axis. Because the price is on the vertical axis, a change in price repsents a movement along the demand curve. By contrast, income, the prices of related goods, tastes, expectations, and the number of buyers are not measured on either axis, so a change in one of these variables shifts the demand curve.

WHAT IS THE BEST WAY TO STOP THIS?

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F I G U R E

If warnings on cigarette packages convince smokers to smoke less, the demand Types of Graphs curve forchart cigarettes shifts to thehow left. U.S. In panel (a), the demand curve shifts from D1 The pie in panel (a) shows national income is derived from various to D2. At The a price $2.00inper pack, quantity falls from 20 to 10 cigasources. barof graph panel (b) the compares thedemanded average income in four countries. rettes per day, as reflected by the shift from point A to point B. By if a tax The time-series graph in panel (c) shows the productivity of labor in contrast, U.S. businesses raises1950 the price of cigarettes, the demand curve does not shift. Instead, we observe from to 2000. a movement to a different point on the demand curve. In panel (b), when the price rises from $2.00 to $4.00, the quantity demanded falls from 20 to 12 cigarettes per day, as reflected by the movement from point A to point C.

Shifts in the Demand Curve versus Movements along the Demand Curve

(b) A Movement along the Demand Curve

(a) A Shift in the Demand Curve Price of Cigarettes, per Pack

Price of A policy to discourage Cigarettes, smoking shifts the per Pack demand curve to the left. $4.00

B

$2.00

A

C

A tax that raises the price of cigarettes results in a movement along the demand curve.

A

2.00

D1

D1

D2 0

10

20

Number of Cigarettes Smoked per Day

0

12

20

Number of Cigarettes Smoked per Day

Alternatively, policymakers can try to raise the price of cigarettes. If the government taxes the manufacture of cigarettes, for example, cigarette companies pass much of this tax on to consumers in the form of higher prices. A higher price encourages smokers to reduce the numbers of cigarettes they smoke. In this case, the reduced amount of smoking does not repsent a shift in the demand curve. Instead, it repsents a movement along the same demand curve to a point with a higher price and lower quantity, as in panel (b) of Figure 4. How much does the amount of smoking respond to changes in the price of cigarettes? Economists have attempted to answer this question by studying what happens when the tax on cigarettes changes. They have found that a 10 percent increase in the price causes a 4 percent reduction in the quantity demanded. Teenagers are found to be especially sensitive to the price of cigarettes: A 10 percent increase in the price causes a 12 percent drop in teenage smoking. A related question is how the price of cigarettes affects the demand for illicit drugs, such as marijuana. Opponents of cigarette taxes often argue that tobacco and marijuana are substitutes so that high cigarette prices encourage marijuana use. By contrast, many experts on substance abuse view tobacco as a “gateway drug” leading the young to experiment with other harmful substances. Most studies of the data are consistent with this latter view: They find that lower cigarette prices are associated with greater use of marijuana. In other words, tobacco and marijuana appear to be complements rather than substitutes. ●

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

QUICK QUIZ

Make up an example of a monthly demand schedule for pizza and graph the implied demand curve. * Give an example of something that would shift this demand curve, and briefly explain your reasoning. * Would a change in the price of pizza shift this demand curve?

SUPPLY We now turn to the other side of the market and examine the behavior of sellers. Once again, to focus our thinking, let’s consider the market for ice cream.

THE SUPPLY CURVE: THE R ELATIONSHIP PRICE AND QUANTITY SUPPLIED

BETWEEN

The quantity supplied of any good or service is the amount that sellers are willing and able to sell. There are many determinants of quantity supplied, but once again, price plays a special role in our analysis. When the price of ice cream is high, selling ice cream is profitable, and so the quantity supplied is large. Sellers of ice cream work long hours, buy many ice-cream machines, and hire many workers. By contrast, when the price of ice cream is low, the business is less profitable, and so sellers produce less ice cream. At a low price, some sellers may even choose to shut down, and their quantity supplied falls to zero. This relationship between price and quantity supplied is called the law of supply: Other things equal, when the price of a good rises, the quantity supplied of the good also rises, and when the price falls, the quantity supplied falls as well. The table in Figure 5 shows the quantity of ice-cream cones supplied each month by Ben, an ice-cream seller, at various prices of ice cream. At a price below $1.00, Ben does not supply any ice cream at all. As the price rises, he supplies a greater and greater quantity. This is the supply schedule, a table that shows the relationship between the price of a good and the quantity supplied, holding constant everything else that influences how much producers of the good want to sell. The graph in Figure 5 uses the numbers from the table to illustrate the law of supply. The curve relating price and quantity supplied is called the supply curve. The supply curve slopes upward because, other things equal, a higher price means a greater quantity supplied.

M ARKET SUPPLY

VERSUS

INDIVIDUAL SUPPLY

Just as market demand is the sum of the demands of all buyers, market supply is the sum of the supplies of all sellers. The table in Figure 6 shows the supply schedules for the two ice-cream producers in the market-Ben and Jerry. At any price, Ben’s supply schedule tells us the quantity of ice cream Ben supplies, and Jerry’s supply schedule tells us the quantity of ice cream Jerry supplies. The market supply is the sum of the two inpidual supplies. The graph in Figure 6 shows the supply curves that correspond to the supply schedules. As with demand curves, we sum the inpidual supply curves horizontally to obtain the market supply curve. That is, to find the total quantity supplied at any price, we add the inpidual quantities, which are found on the horizontal axis of the inpidual supply curves. The market supply curve shows how the total quantity supplied varies as the price of the good varies, holding constant

quantity supplied the amount of a good that sellers are willing and able to sell

law of supply the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises supply schedule a table that shows the relationship between the price of a good and the quantity supplied supply curve a graph of the relationship between the price of a good and the quantity supplied

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F I G U R E

The supply schedule is a table that shows the quantity supplied at each price. This Types of Graphs

Ben’s Supply Schedule and Supply Curve

supply which graphs the supply schedule, the quantity supplied The piecurve, chart in panel (a) shows how U.S. nationalillustrates income ishow derived from various of the good as in itspanel price (b) varies. Because higher price increases quantity sources. Thechanges bar graph compares theaaverage income in four the countries. supplied, the supply slopes upward. The time-series graphcurve in panel (c) shows the productivity of labor in U.S. businesses from 1950 to 2000.

Price of Ice-Cream Cone

Quantity of Cones Supplied

$0.00 0.50 1.00 1.50 2.00 2.50 3.00

0 cones 0 1 2 3 4 5

Price of Ice-Cream Cone $3.00

Supply curve

2.50 1. An increase in price … 2.00 1.50 1.00 0.50

0

1

2

3

4

5

6

7

8

9 10 11 12 Quantity of Ice-Cream Cones 2. … increases quantity of cones supplied.

all the other factors beyond price that influence producers’ decisions about how much to sell.

SHIFTS

IN THE

SUPPLY CURVE

Because the market supply curve holds other things constant, the curve shifts when one of the factors changes. For example, suppose the price of sugar falls. Sugar is an input into producing ice cream, so the fall in the price of sugar makes selling ice cream more profitable. This raises the supply of ice cream: At any given price, sellers are now willing to produce a larger quantity. The supply curve for ice cream shifts to the right. Figure 7 illustrates shifts in supply. Any change that raises quantity supplied at every price, such as a fall in the price of sugar, shifts the supply curve to the right and is called an increase in supply. Similarly, any change that reduces the quantity supplied at every price shifts the supply curve to the left and is called a decrease in supply. There are many variables that can shift the supply curve. Here are some of the most important. Input Prices To produce their output of ice cream, sellers use various inputs: cream, sugar, flavoring, ice-cream machines, the buildings in which the ice cream is made, and the labor of workers to mix the ingredients and operate the machines.

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

F I G U R E

Price of Ice-Cream Cone

Ben

$0.00 0.50 1.00 1.50 2.00 2.50 3.00

0 0 1 2 3 4 5

Jerry +

+

Ben’s Supply Price of Ice-Cream Cone

0 0 0 2 4 6 8

=

Market

Market Supply as the Sum of Inpidual Supplies

0 cones 0 1 4 7 10 13

The quantity supplied in a market is the sum of the quantities supplied by all the sellers at each price. Thus, the market supply curve is found by adding horizontally the inpidual supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones, and Jerry supplies 4 ice-cream cones. The quantity supplied in the market at this price is 7 cones.

=

Jerry’s Supply

Price of Ice-Cream Cone

S Ben

Market Supply

Price of Ice-Cream Cone

S Jerry

$3.00

$3.00

$3.00

2.50

2.50

2.50

2.00

2.00

2.00

1.50

1.50

1.50

1.00

1.00

1.00

0.50

0.50

0.50 0 1 2 3 4 5 6 7 8 9 10 11 12

0 1 2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

S Market

0 1 2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

Quantity of Ice-Cream Cones

F I G U R E Price of Ice-Cream Cone

Supply curve, S3 Supply curve, S1 Decrease in supply

Supply curve, S2

Increase in supply

0

6

Quantity of Ice-Cream Cones

Shifts in the Supply Curve Any change that raises the quantity that sellers wish to produce at any given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at any given price shifts the supply curve to the left.

7

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QUICK QUIZ

Make up an example of a monthly supply schedule for pizza and graph the implied supply curve. * Give an example of something that would shift this supply curve, and briefly explain your reasoning. * Would a change in the price of pizza shift this supply curve?

2

T A B L E

Variables That Influence Sellers This table lists the variables that affect how much producers choose to sell of any good. Notice the special role that the price of the good plays: A change in the good’s price repsents a movement along the supply curve, whereas a change in one of the other variables shifts the supply curve.

Variable

A Change in This Variable . . .

Price of the good itself Input prices Technology Expectations Number of sellers

Repsents a movement along the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

SUPPLY AND DEMAND TOGETHER Having analyzed supply and demand separately, we now combine them to see how they determine the price and quantity of a good sold in a market.

EQUILIBRIUM Figure 8 shows the market supply curve and market demand curve together. Notice that there is one point at which the supply and demand curves intersect. This point is called the market’s equilibrium. The price at this intersection is called the equilibrium price, and the quantity is called the equilibrium quantity. Here the equilibrium price is $2.00 per cone, and the equilibrium quantity is 7 icecream cones. The dictionary defines the word equilibrium as a situation in which various forces are in balance-and this also describes a market’s equilibrium. At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell. The equilibrium price is sometimes called the market-clearing price because, at this price, everyone in the market has been satisfied: Buyers have bought all they want to buy, and sellers have sold all they want to sell. The actions of buyers and sellers naturally move markets toward the equilibrium of supply and demand. To see why, consider what happens when the market price is not equal to the equilibrium price. Suppose first that the market price is above the equilibrium price, as in panel (a) of Figure 9. At a price of $2.50 per cone, the quantity of the good supplied (10 cones) exceeds the quantity demanded (4 cones). There is a surplus of the good: Suppliers are unable to sell all they want at the going price. A surplus is sometimes called a situation of excess supply. When there is a surplus in the ice-cream market,

equilibrium a situation in which the market price has reached the level at which quantity supplied equals quantity demanded equilibrium price the price that balances quantity supplied and quantity demanded equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price surplus a situation in which quantity supplied is greater than quantity demanded

F I G U R E Price of Ice-Cream Cone

Equilibrium price

Supply

Equilibrium $2.00

Demand

0

1

2

3

4

5

6

7

Equilibrium quantity

8

9 10 11 12 13 Quantity of Ice-Cream Cones

The Equilibrium of Supply and Demand The equilibrium is found where the supply and demand curves intersect. At the equilibrium price, the quantity supplied equals the quantity demanded. Here the equilibrium price is $2.00: At this price, 7 icecream cones are supplied, and 7 ice-cream cones are demanded.

8

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HOW MARKETS WORK

F I G U R E

Markets Not in Equilibrium

(b) Excess Demand

(a) Excess Supply Price of Ice-Cream Cone

Supply Surplus

Price of Ice-Cream Cone

Supply

$2.50 $2.00

2.00

1.50 Shortage Demand

Demand

0

4 Quantity demanded

shortage a situation in which quantity demanded is greater than quantity supplied

law of supply and demand the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance

7

10

Quantity supplied

Quantity of Ice-Cream Cones

0

4

Quantity supplied

7

10

Quantity demanded

Quantity of Ice-Cream Cones

sellers of ice cream find their freezers increasingly full of ice cream they would like to sell but cannot. They respond to the surplus by cutting their prices. Falling prices, in turn, increase the quantity demanded and decrease the quantity supplied. Prices continue to fall until the market reaches the equilibrium. Suppose now that the market price is below the equilibrium price, as in panel (b) of Figure 9. In this case, the price is $1.50 per cone, and the quantity of the good demanded exceeds the quantity supplied. There is a shortage of the good: Demanders are unable to buy all they want at the going price. A shortage is sometimes called a situation of excess demand. When a shortage occurs in the ice-cream market, buyers have to wait in long lines for a chance to buy one of the few cones available. With too many buyers chasing too few goods, sellers can respond to the shortage by raising their prices without losing sales. As the price rises, the quantity demanded falls, the quantity supplied rises, and the market once again moves toward the equilibrium. Thus, the activities of the many buyers and sellers automatically push the market price toward the equilibrium price. Once the market reaches its equilibrium, all buyers and sellers are satisfied, and there is no upward or downward pssure on the price. How quickly equilibrium is reached varies from market to market depending on how quickly prices adjust. In most free markets, surpluses and shortages are only temporary because prices eventually move toward their equilibrium levels. Indeed, this phenomenon is so pervasive that it is called the law of supply and demand: The price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance.

THE MARKET FORCES OF SUPPLY AND DEMAND

CARTOON: NON-SEQUITUR © WILEY MILLER. DIST. BY UNIVERSAL PRESS SYNDICATE. REPRINTED WITH PERMISSION. ALL RIGHTS RESERVED.

CHAPTER 4

THREE STEPS

TO

ANALYZING CHANGES

IN

EQUILIBRIUM

So far, we have seen how supply and demand together determine a market’s equilibrium, which in turn determines the price and quantity of the good that buyers purchase and sellers produce. The equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts one of these curves, the equilibrium in the market changes, resulting in a new price and a new quantity exchanged between buyers and sellers. When analyzing how some event affects the equilibrium in a market, we proceed in three steps. First, we decide whether the event shifts the supply curve, the demand curve, or, in some cases, both curves. Second, we decide whether the curve shifts to the right or to the left. Third, we use the supply-and-demand diagram to compare the initial and the new equilibrium, which shows how the shift affects the equilibrium price and quantity. Table 3 summarizes these three steps. To see how this recipe is used, let’s consider various events that might affect the market for ice cream. Example: A Change in Market Equilibrium Due to a Shift in Demand Suppose that one summer the weather is very hot. How does this event affect the market for ice cream? To answer this question, let’s follow our three steps. 1.

2.

3.

The hot weather affects the demand curve by changing people’s taste for ice cream. That is, the weather changes the amount of ice cream that people want to buy at any given price. The supply curve is unchanged because the weather does not directly affect the firms that sell ice cream. Because hot weather makes people want to eat more ice cream, the demand curve shifts to the right. Figure 10 shows this increase in demand as the shift in the demand curve from D1 to D2. This shift indicates that the quantity of ice cream demanded is higher at every price. As Figure 10 shows, the increase in demand raises the equilibrium price from $2.00 to $2.50 and the equilibrium quantity from 7 to 10 cones. In other words, the hot weather increases the price of ice cream and the quantity of ice cream sold.

Shifts in Curves versus Movements along Curves Notice that when hot weather increases the demand for ice cream and drives up the price, the quantity of ice cream that firms supply rises, even though the supply curve remains the same. In this case, economists say there has been an increase in “quantity supplied” but no change in “supply.”

3

T A B L E

Three Steps for Analyzing Changes in Equilibrium 1. Decide whether the event shifts the supply or demand curve (or perhaps both). 2. Decide in which direction the curve shifts. 3. Use the supply-anddemand diagram to see how the shift changes the equilibrium price and quantity.

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F I G U R E Price of Ice-Cream Cone

How an Increase in Demand Affects the Equilibrium An event that raises quantity demanded at any given price shifts the demand curve to the right. The equilibrium price and the equilibrium quantity both rise. Here an abnormally hot summer causes buyers to demand more ice cream. The demand curve shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to rise from 7 to 10 cones.

1. Hot weather increases the demand for ice cream . . .

Supply $2.50

New equilibrium

2.00 2. . . . resulting in a higher price . . .

Initial equilibrium D2 D1 0

7 3. . . . and a higher quantity sold.

10

Quantity of Ice-Cream Cones

Supply refers to the position of the supply curve, whereas the quantity supplied refers to the amount suppliers wish to sell. In this example, supply does not change because the weather does not alter firms’ desire to sell at any given price. Instead, the hot weather alters consumers’ desire to buy at any given price and thereby shifts the demand curve to the right. The increase in demand causes the equilibrium price to rise. When the price rises, the quantity supplied rises. This increase in quantity supplied is repsented by the movement along the supply curve. To summarize, a shift in the supply curve is called a “change in supply,” and a shift in the demand curve is called a “change in demand.” A movement along a fixed supply curve is called a “change in the quantity supplied,” and a movement along a fixed demand curve is called a “change in the quantity demanded.” Example: A Change in Market Equilibrium Due to a Shift in Supply Suppose that during another summer, a hurricane destroys part of the sugarcane crop and drives up the price of sugar. How does this event affect the market for ice cream? Once again, to answer this question, we follow our three steps. 1.

2.

The change in the price of sugar, an input into making ice cream, affects the supply curve. By raising the costs of production, it reduces the amount of ice cream that firms produce and sell at any given price. The demand curve does not change because the higher cost of inputs does not directly affect the amount of ice cream households wish to buy. The supply curve shifts to the left because, at every price, the total amount that firms are willing and able to sell is reduced. Figure 11 illustrates this decrease in supply as a shift in the supply curve from S1 to S2.

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

F I G U R E Price of Ice-Cream Cone S2

1. An increase in the price of sugar reduces the supply of ice cream. . . S1

New equilibrium

$2.50

Initial equilibrium

2.00 2. . . . resulting in a higher price of ice cream . . .

Demand

0

4

7 3. . . . and a lower quantity sold.

3.

Quantity of Ice-Cream Cones

As Figure 11 shows, the shift in the supply curve raises the equilibrium price from $2.00 to $2.50 and lowers the equilibrium quantity from 7 to 4 cones. As a result of the sugar price increase, the price of ice cream rises, and the quantity of ice cream sold falls.

Example: Shifts in Both Supply and Demand Now suppose that a heat wave and a hurricane occur during the same summer. To analyze this combination of events, we again follow our three steps. 1.

2.

3.

We determine that both curves must shift. The hot weather affects the demand curve because it alters the amount of ice cream that households want to buy at any given price. At the same time, when the hurricane drives up sugar prices, it alters the supply curve for ice cream because it changes the amount of ice cream that firms want to sell at any given price. The curves shift in the same directions as they did in our pvious analysis: The demand curve shifts to the right, and the supply curve shifts to the left. Figure 12 illustrates these shifts. As Figure 12 shows, two possible outcomes might result depending on the relative size of the demand and supply shifts. In both cases, the equilibrium price rises. In panel (a), where demand increases substantially while supply falls just a little, the equilibrium quantity also rises. By contrast, in panel (b), where supply falls substantially while demand rises just a little, the equilibrium quantity falls. Thus, these events certainly raise the price of ice cream, but their impact on the amount of ice cream sold is ambiguous (that is, it could go either way).

11

How a Decrease in Supply Affects the Equilibrium An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises, and the equilibrium quantity falls. Here an increase in the price of sugar (an input) causes sellers to supply less ice cream. The supply curve shifts from S1 to S2, which causes the equilibrium price of ice cream to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 cones.

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HOW MARKETS WORK

F I G U R E

Here weofobserve Types Graphsa simultaneous increase in demand and decrease in supply. Two outcomes are in possible. panel how (a), the price rises from Pfrom The pie chart panel (a)Inshows U.S.equilibrium national income is derived various 1 to P 2, and the equilibrium rises Q2. In panel the equilibrium pricecountries. again rises sources. Thequantity bar graph in from panelQ(b) compares the (b), average income in four 1 to fromtime-series P1 to P2, but the equilibrium quantity falls from Q1 toofQlabor The graph in panel (c) shows the productivity in U.S. businesses 2. from 1950 to 2000.

A Shift in Both Supply and Demand

(b) Price Rises, Quantity Falls

(a) Price Rises, Quantity Rises Price of Ice-Cream Large Cone increase in demand

Price of Ice-Cream Cone New equilibrium

S2

S2

Small increase in demand

S1

S1 P2

New equilibrium

P2

P1

D2

Small decrease in supply

Large decrease in supply

P1 Initial equilibrium

Initial equilibrium

D2 D1

D1 0

Q1

Q2

Quantity of Ice-Cream Cones

0

Q2

Q1

Quantity of Ice-Cream Cones

Summary We have just seen three examples of how to use supply and demand curves to analyze a change in equilibrium. Whenever an event shifts the supply curve, the demand curve, or perhaps both curves, you can use these tools to pdict how the event will alter the amount sold in equilibrium and the price at which the good is sold. Table 4 shows the pdicted outcome for any combination of shifts in the two curves. To make sure you understand how to use the tools of supply and demand, pick a few entries in this table and make sure you can explain to yourself why the table contains the pdiction it does.

QUICK QUIZ

On the appropriate diagram, show what happens to the market for pizza if the price of tomatoes rises. * On a separate diagram, show what happens to the market for pizza if the price of hamburgers falls.

4

T A B L E

What Happens to Price and Quantity When Supply or Demand Shifts? As a quick quiz, make sure you can explain at least a few of the entries in this table using a supply-anddemand diagram.

No Change in Supply

An Increase in Supply

A Decrease in Supply

No Change in Demand

P same Q same

P down Q up

P up Q down

An Increase in Demand

P up Q up

P ambiguous Q up

P up Q ambiguous

A Decrease in Demand

P down Q down

P down Q ambiguous

P ambiguous Q down

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

The Helium Market This analysis illustrates how supply and demand interact.

As Demand Balloons, Helium Is in Short Supply

PHOTO: © LOUIE PSIHOYOS/SCIENCE FACTION/GETTY IMAGES

By Ana Campoy Syracuse University physicist Gianfranco Vidali spends most of his time studying how molecules are made in outer space, but a couple of months ago he abruptly dropped his interstellar research to address an earthly issue: the global shortage of helium. The airy element best known for floating party balloons and the Goodyear blimp is also the lifeblood of a widening world of scientific research. Mr. Vidali uses the gas, which becomes the coldest liquid on earth when pssurized, to recreate conditions similar to outer space. Without it, he can’t work. So when his helium supplier informed him it was cutting deliveries to his lab, Mr. Vidali said, “it sent us into a panic mode.” Helium is found in varying concentrations in the world’s natural-gas deposits, and is separated out in a special refining process. As with oil and natural gas, the easiest-to-get helium supplies have been tapped and are declining. It is needed to make computer microchips, flat-panel displays, fiber optics and to operate magnetic resonance imaging, or MRI, scans and welding machines. . . . Glitches at some of the world’s biggest helium-producing plants have put a further pinch on supplies in the past year. The upshot: Helium users-from party planners to welding shops-are having to

do with less. which have produced important research over the years, and slow down work at bigger research centers. Helium is used in research to find cures to deadly diseases, create new sources of energy and answer questions about how the universe was formed. . . . Experts pdict this situation will eventually price out many helium users, who will find substitutes or modify their technology. Some party balloon businesses are filling balloons with mixtures that contain less helium. Some welders are using argon. Industrial users are installing recovery systems. . . . Reem Jaafar, a researcher at CUNY, says she will go into another area of physics if helium prices stay at their current levels. “If you have a fixed amount in a grant, and you have to spend it all on helium, you don’t have anything left over,” she says.

Source: The Wall Street Journal, December 5, 2007.

CONCLUSION: HOW PRICES ALLOCATE RESOURCES This chapter has analyzed supply and demand in a single market. Although our discussion has centered on the market for ice cream, the lessons learned here apply in most other markets as well. Whenever you go to a store to buy something,

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Price Increases after Natural Disasters When a natural disaster such as a hurricane hits a region, basic commodities such as gasoline and bottled water experience increasing demand and shrinking supply. These shifts in demand and supply curves cause prices to rise, leading some people to complain about “price gouging.” But, as journalist John Stossel argues in this opinion piece, there is an upside to higher prices after a disaster strikes.

tradesmen to go to New Orleans. But in a free society, those tradesmen must be persuaded to leave their homes and families, leave their employers and customers, and drive from say, Wisconsin, to take work in New Orleans. If they can’t make more money in Louisiana than Wisconsin, why would they make the trip? Some may be motivated by a desire to be heroic, but we can’t expect enough heroes to fill the need, week after week; most will travel there for the same reason most Americans go to work: to make money. Any tradesman who treks to a disaster area must get higher pay than he would get in his hometown, or he won’t do the trek. Limit him to what his New Orleans colleagues charged before the storm, and even a would-be hero may say, “the heck with it.” If he charges enough to justify his venture, he’s likely to be condemned morally or legally by the very people he’s trying to help. But they just don’t understand basic economics. Force prices down, and you keep suppliers out. Let the market work, suppliers come-and competition brings prices as low as the challenges of the disaster allow. Goods that were in short supply become available, even to the poor. It’s the price “gougers” who bring the water, ship the gasoline, fix the roof, and rebuild the cities. The price “gougers” save lives.

CARTOON: © 2002 THE NEW YORKER COLLECTION FROM chúng tôi ALL RIGHTS RESERVED.

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

you are contributing to the demand for that item. Whenever you look for a job, you are contributing to the supply of labor services. Because supply and demand are such pervasive economic phenomena, the model of supply and demand is a powerful tool for analysis. We will be using this model repeatedly in the following chapters. One of the Ten Principles of Economics discussed in Chapter 1 is that markets are usually a good way to organize economic activity. Although it is still too early to judge whether market outcomes are good or bad, in this chapter we have begun to see how markets work. In any economic system, scarce resources have to be allocated among competing uses. Market economies harness the forces of supply and demand to serve that end. Supply and demand together determine the prices of the economy’s many different goods and services; prices in turn are the signals that guide the allocation of resources. For example, consider the allocation of beachfront land. Because the amount of this land is limited, not everyone can enjoy the luxury of living by the beach. Who gets this resource? The answer is whoever is willing and able to pay the price. The price of beachfront land adjusts until the quantity of land demanded exactly balances the quantity supplied. Thus, in market economies, prices are the mechanism for rationing scarce resources. Similarly, prices determine who produces each good and how much is produced. For instance, consider farming. Because we need food to survive, it is crucial that some people work on farms. What determines who is a farmer and who is not? In a free society, there is no government planning agency making this decision and ensuring an adequate supply of food. Instead, the allocation of workers to farms is based on the job decisions of millions of workers. This decentralized system works well because these decisions depend on prices. The prices of food and the wages of farmworkers (the price of their labor) adjust to ensure that enough people choose to be farmers. If a person had never seen a market economy in action, the whole idea might seem pposterous. Economies are enormous groups of people engaged in a multitude of interdependent activities. What pvents decentralized decision making from degenerating into chaos? What coordinates the actions of the millions of people with their varying abilities and desires? What ensures that what needs to be done is in fact done? The answer, in a word, is prices. If an invisible hand guides market economies, as Adam Smith famously suggested, then the price system is the baton that the invisible hand uses to conduct the economic orchestra.

“Two dollars”

“-and seventy-five cents.”

SUMMARY * Economists use the model of supply and demand to analyze competitive markets. In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price.

* The demand curve shows how the quantity of a good demanded depends on the price. According to the law of demand, as the price of a good

falls, the quantity demanded rises. Therefore, the demand curve slopes downward.

* In addition to price, other determinants of how much consumers want to buy include income, the prices of substitutes and complements, tastes, expectations, and the number of buyers. If one of these factors changes, the demand curve shifts.

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* The supply curve shows how the quantity of a good supplied depends on the price. According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward.

* In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers. If one of these factors changes, the supply curve shifts.

* The intersection of the supply and demand curves determines the market equilibrium. At the equilibrium price, the quantity demanded equals the quantity supplied.

* The behavior of buyers and sellers naturally drives markets toward their equilibrium. When the market price is above the equilibrium price, there is a surplus of the good, which causes the market price to fall. When the market price is

below the equilibrium price, there is a shortage, which causes the market price to rise.

* To analyze how any event influences a market, we use the supply-and-demand diagram to examine how the event affects the equilibrium price and quantity. To do this, we follow three steps. First, we decide whether the event shifts the supply curve or the demand curve (or both). Second, we decide in which direction the curve shifts. Third, we compare the new equilibrium with the initial equilibrium.

* In market economies, prices are the signals that guide economic decisions and thereby allocate scarce resources. For every good in the economy, the price ensures that supply and demand are in balance. The equilibrium price then determines how much of the good buyers choose to consume and how much sellers choose to produce.

KEY CONCEPTS market, p. 66 competitive market, p. 66 quantity demanded, p. 67 law of demand, p. 67 demand schedule, p. 67 demand curve, p. 68 normal good, p. 70

inferior good, p. 70 substitutes, p. 70 complements, p. 70 quantity supplied, p. 73 law of supply, p. 73 supply schedule, p. 73 supply curve, p. 73

equilibrium, p. 77 equilibrium price, p. 77 equilibrium quantity, p. 77 surplus, p. 77 shortage, p. 78 law of supply and demand, p. 78

QUESTIONS FOR REVIEW 1. What is a competitive market? Briefly describe a type of market that is not perfectly competitive. 2. What are the demand schedule and the demand curve and how are they related? Why does the demand curve slope downward? 3. Does a change in consumers’ tastes lead to a movement along the demand curve or a shift in the demand curve? Does a change in price lead to a movement along the demand curve or a shift in the demand curve? 4. Popeye’s income declines, and as a result, he buys more spinach. Is spinach an inferior or

a normal good? What happens to Popeye’s demand curve for spinach? 5. What are the supply schedule and the supply curve and how are they related? Why does the supply curve slope upward? 6. Does a change in producers’ technology lead to a movement along the supply curve or a shift in the supply curve? Does a change in price lead to a movement along the supply curve or a shift in the supply curve? 7. Define the equilibrium of a market. Describe the forces that move a market toward its equilibrium.

CHAPTER 4

8. Beer and pizza are complements because they are often enjoyed together. When the price of beer rises, what happens to the supply, demand,

THE MARKET FORCES OF SUPPLY AND DEMAND

quantity supplied, quantity demanded, and the price in the market for pizza? 9. Describe the role of prices in market economies.

PROBLEMS AND APPLICATIONS 1. Explain each of the following statements using supply-and-demand diagrams. a. “When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country.” b. “When the weather turns warm in New England every summer, the price of hotel rooms in Caribbean resorts plummets.” c. “When a war breaks out in the Middle East, the price of gasoline rises, and the price of a used Cadillac falls.” 2. “An increase in the demand for notebooks raises the quantity of notebooks demanded but not the quantity supplied.” Is this statement true or false? Explain. 3. Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans. a. People decide to have more children. b. A strike by steelworkers raises steel prices. c. Engineers develop new automated machinery for the production of minivans. d. The price of sports utility vehicles rises. e. A stock-market crash lowers people’s wealth. 4. Identify the flaw in this analysis: “If more Americans go on a low-carb diet, the demand for bread will fall. The decrease in the demand for bread will cause the price of bread to fall. The lower price, however, will then increase the demand. In the new equilibrium, Americans might end up consuming more bread than they did initially.” 5. Consider the markets for DVD movies, TV screens, and tickets at movie theaters. a. For each pair, identify whether they are complements or substitutes: * DVDs and TV screens * DVDs and movie tickets * TV screens and movie tickets

6.

7.

8.

9.

10.

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11. The market for pizza has the following demand and supply schedules:

Currently, the demand and supply schedules are as follows:

Price

Quantity Demanded

Quantity Supplied

Price

$4 5 6 7 8 9

135 pizzas 104 81 68 53 39

26 pizzas 53 81 98 110 121

$ 4 8 12 16 20

a. Graph the demand and supply curves. What is the equilibrium price and quantity in this market? b. If the actual price in this market were above the equilibrium price, what would drive the market toward the equilibrium? c. If the actual price in this market were below the equilibrium price, what would drive the market toward the equilibrium? 12. Consider the following events: Scientists reveal that consumption of oranges decreases the risk of diabetes and, at the same time, farmers use a new fertilizer that makes orange trees more productive. Illustrate and explain what effect these changes have on the equilibrium price and quantity of oranges. 13. Because bagels and cream cheese are often eaten together, they are complements. a. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. What could be responsible for this pattern-a fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer. b. Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen. What could be responsible for this pattern-a rise in the price of flour or a rise in the price of milk? Illustrate and explain your answer. 14. Suppose that the price of basketball tickets at your college is determined by market forces.

Quantity Demanded

Quantity Supplied

10,000 tickets 8,000 6,000 4,000 2,000

8,000 tickets 8,000 8,000 8,000 8,000

a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true? b. What are the equilibrium price and quantity of tickets? c. Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule: Price $ 4 8 12 16 20

Quantity Demanded 4,000 tickets 3,000 2,000 1,000 0

Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity? 15. Market research has revealed the following information about the market for chocolate bars: The demand schedule can be repsented by the equation QD = 1,600 – 300P, where QD is the quantity demanded and P is the price. The supply schedule can be repsented by the equation QS = 1,400 + 700P, where QS is the quantity supplied. Calculate the equilibrium price and quantity in the market for chocolate bars.

5

CHAPTER

Elasticity and Its Application

I

magine that some event drives up the price of gasoline in the United States. It could be a war in the Middle East that disrupts the world supply of oil, a booming Chinese economy that boosts the world demand for oil, or a new tax on gasoline passed by Congress. How would U.S. consumers respond to the higher price? It is easy to answer this question in broad fashion: Consumers would buy less. That is simply the law of demand we learned in the pvious chapter. But you might want a pcise answer. By how much would consumption of gasoline fall? This question can be answered using a concept called elasticity, which we develop in this chapter. Elasticity is a measure of how much buyers and sellers respond to changes in market conditions. When studying how some event or policy affects a market, we can discuss not only the direction of the effects but their magnitude as well. Elasticity is useful in many applications, as we will see toward the end of this chapter. Before proceeding, however, you might be curious about the answer to the gasoline question. Many studies have examined consumers’ response to gasoline prices, and they typically find that the quantity demanded responds more in the

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long run than it does in the short run. A 10 percent increase in gasoline prices reduces gasoline consumption by about 2.5 percent after a year and about 6 percent after five years. About half of the long-run reduction in quantity demanded arises because people drive less and half because they switch to more fuel-efficient cars. Both responses are reflected in the demand curve and its elasticity.

THE ELASTICITY OF DEMAND

elasticity a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants price elasticity of demand a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded pided by the percentage change in price

When we introduced demand in Chapter 4, we noted that consumers usually buy more of a good when its price is lower, when their incomes are higher, when the prices of substitutes for the good are higher, or when the prices of complements of the good are lower. Our discussion of demand was qualitative, not quantitative. That is, we discussed the direction in which quantity demanded moves but not the size of the change. To measure how much consumers respond to changes in these variables, economists use the concept of elasticity.

THE PRICE ELASTICITY OF DEMAND AND ITS DETERMINANTS The law of demand states that a fall in the price of a good raises the quantity demanded. The price elasticity of demand measures how much the quantity demanded responds to a change in price. Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price. The price elasticity of demand for any good measures how willing consumers are to buy less of the good as its price rises. Thus, the elasticity reflects the many economic, social, and psychological forces that shape consumer pferences. Based on experience, however, we can state some general rules about what determines the price elasticity of demand. Availability of Close Substitutes Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. For example, butter and margarine are easily substitutable. A small increase in the price of butter, assuming the price of margarine is held fixed, causes the quantity of butter sold to fall by a large amount. By contrast, because eggs are a food without a close substitute, the demand for eggs is less elastic than the demand for butter. Necessities versus Luxuries Necessities tend to have inelastic demands, whereas luxuries have elastic demands. When the price of a doctor’s visit rises, people will not dramatically reduce the number of times they go to the doctor, although they might go somewhat less often. By contrast, when the price of sailboats rises, the quantity of sailboats demanded falls substantially. The reason is that most people view doctor visits as a necessity and sailboats as a luxury. Of course, whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but on the pferences of the buyer. For avid sailors with little concern over their health, sailboats might be a necessity with inelastic demand and doctor visits a luxury with elastic demand.

CHAPTER 5

ELASTICITY AND ITS APPLICATION

Definition of the Market The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. For example, food, a broad category, has a fairly inelastic demand because there are no good substitutes for food. Ice cream, a narrower category, has a more elastic demand because it is easy to substitute other desserts for ice cream. Vanilla ice cream, a very narrow category, has a very elastic demand because other flavors of ice cream are almost perfect substitutes for vanilla. Time Horizon Goods tend to have more elastic demand over longer time horizons. When the price of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months. Over time, however, people buy more fuelefficient cars, switch to public transportation, and move closer to where they work. Within several years, the quantity of gasoline demanded falls more substantially.

COMPUTING

THE

PRICE ELASTICITY

OF

DEMAND

Now that we have discussed the price elasticity of demand in general terms, let’s be more pcise about how it is measured. Economists compute the price elasticity of demand as the percentage change in the quantity demanded pided by the percentage change in the price. That is, Price elasticity of demand =

Percentage change in quantity demanded . Percentage change in price

For example, suppose that a 10 percent increase in the price of an ice-cream cone causes the amount of ice cream you buy to fall by 20 percent. We calculate your elasticity of demand as Price elasticity of demand =

20 percent = 2. 10 percent

In this example, the elasticity is 2, reflecting that the change in the quantity demanded is proportionately twice as large as the change in the price. Because the quantity demanded of a good is negatively related to its price, the percentage change in quantity will always have the opposite sign as the percentage change in price. In this example, the percentage change in price is a positive 10 percent (reflecting an increase), and the percentage change in quantity demanded is a negative 20 percent (reflecting a decrease). For this reason, price elasticities of demand are sometimes reported as negative numbers. In this book, we follow the common practice of dropping the minus sign and reporting all price elasticities of demand as positive numbers. (Mathematicians call this the absolute value.) With this convention, a larger price elasticity implies a greater responsiveness of quantity demanded to price.

THE MIDPOINT M ETHOD: A BETTER WAY PERCENTAGE CHANGES AND ELASTICITIES

TO

CALCULATE

If you try calculating the price elasticity of demand between two points on a demand curve, you will quickly notice an annoying problem: The elasticity from

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point A to point B seems different from the elasticity from point B to point A. For example, consider these numbers: Point A: Point B:

Price = $4 Price = $6

Quantity = 120 Quantity = 80

Going from point A to point B, the price rises by 50 percent, and the quantity falls by 33 percent, indicating that the price elasticity of demand is 33/50, or 0.66. By contrast, going from point B to point A, the price falls by 33 percent, and the quantity rises by 50 percent, indicating that the price elasticity of demand is 50/33, or 1.5. This difference arises because the percentage changes are calculated from a different base. One way to avoid this problem is to use the midpoint method for calculating elasticities. The standard procedure for computing a percentage change is to pide the change by the initial level. By contrast, the midpoint method computes a percentage change by piding the change by the midpoint (or average) of the initial and final levels. For instance, $5 is the midpoint between $4 and $6. Therefore, according to the midpoint method, a change from $4 to $6 is considered a 40 percent rise because (6 – 4) / 5 × 100 = 40. Similarly, a change from $6 to $4 is considered a 40 percent fall. Because the midpoint method gives the same answer regardless of the direction of change, it is often used when calculating the price elasticity of demand between two points. In our example, the midpoint between point A and point B is: Midpoint:

Price = $5

Quantity = 100

According to the midpoint method, when going from point A to point B, the price rises by 40 percent, and the quantity falls by 40 percent. Similarly, when going from point B to point A, the price falls by 40 percent, and the quantity rises by 40 percent. In both directions, the price elasticity of demand equals 1. The following formula expsses the midpoint method for calculating the price elasticity of demand between two points, denoted (Q1, P1) and (Q2, P2): Price elasticity of demand =

(Q2 – Q1) /

The numerator is the percentage change in quantity computed using the midpoint method, and the denominator is the percentage change in price computed using the midpoint method. If you ever need to calculate elasticities, you should use this formula. In this book, however, we rarely perform such calculations. For most of our purposes, what elasticity repsents-the responsiveness of quantity demanded to a change in price-is more important than how it is calculated.

THE VARIETY

OF

DEMAND CURVES

Economists classify demand curves according to their elasticity. Demand is considered elastic when the elasticity is greater than 1, which means the quantity moves proportionately more than the price. Demand is considered inelastic when the elasticity is less than 1, which means the quantity moves proportionately less

CHAPTER 5

ELASTICITY AND ITS APPLICATION

F I G U R E

The price elasticity of demand determines whether the demand curve is steep or flat. Note that all percentage changes are calculated using the midpoint method.

1

The Price Elasticity of Demand (b) Inelastic Demand: Elasticity Is Less Than 1

(a) Perfectly Inelastic Demand: Elasticity Equals 0 Price

Price Demand

$5

$5

4

4

1. An increase in price . . .

1. A 22% increase in price . . .

0

100

Demand

90 100

0

Quantity

2. . . . leaves the quantity demanded unchanged.

Quantity

(c) Unit Elastic Demand: Elasticity Equals 1 Price

$5 4 Demand

1. A 22% increase in price . . .

0

80

100

Quantity

(e) Perfectly Elastic Demand: Elasticity Equals Infinity Price 1. At any price above $4, quantity demanded is zero.

$5 4

Demand

$4

1. A 22% increase in price . . .

Demand 2. At exactly $4, consumers will buy any quantity.

0

50

100

Quantity

0 3. At a price below $4, quantity demanded is infinite.

Quantity

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than the price. If the elasticity is exactly 1, the quantity moves the same amount proportionately as the price, and demand is said to have unit elasticity. Because the price elasticity of demand measures how much quantity demanded responds to changes in the price, it is closely related to the slope of the demand curve. The following rule of thumb is a useful guide: The flatter the demand curve that passes through a given point, the greater the price elasticity of demand. The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand. Figure 1 on the pvious page shows five cases. In the extreme case of a zero elasticity, shown in panel (a), demand is perfectly inelastic, and the demand curve is vertical. In this case, regardless of the price, the quantity demanded stays the same. As the elasticity rises, the demand curve gets flatter and flatter, as shown in panels (b), (c), and (d). At the opposite extreme, shown in panel (e), demand is perfectly elastic. This occurs as the price elasticity of demand approaches infinity and the demand curve becomes horizontal, reflecting the fact that very small changes in the price lead to huge changes in the quantity demanded. Finally, if you have trouble keeping straight the terms elastic and inelastic, here’s a memory trick for you: Inelastic curves, such as in panel (a) of Figure 1, look like the letter I. This is not a deep insight, but it might help on your next exam.

TOTAL R EVENUE AND THE PRICE ELASTICITY OF DEMAND total revenue the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold

When studying changes in supply or demand in a market, one variable we often want to study is total revenue, the amount paid by buyers and received by sellers of the good. In any market, total revenue is P × Q, the price of the good times the quantity of the good sold. We can show total revenue graphically, as in Figure 2. The height of the box under the demand curve is P, and the width is Q. The area of this box, P × Q, equals the total revenue in this market. In Figure 2, where P = $4 and Q = 100, total revenue is $4 × 100, or $400. How does total revenue change as one moves along the demand curve? The answer depends on the price elasticity of demand. If demand is inelastic, as in panel (a) of Figure 3, then an increase in the price causes an increase in total revenue. Here an increase in price from $1 to $3 causes the quantity demanded to fall from 100 to 80, so total revenue rises from $100 to $240. An increase in price raises P × Q because the fall in Q is proportionately smaller than the rise in P. We obtain the opposite result if demand is elastic: An increase in the price causes a decrease in total revenue. In panel (b) of Figure 3, for instance, when the price rises from $4 to $5, the quantity demanded falls from 50 to 20, so total revenue falls from $200 to $100. Because demand is elastic, the reduction in the quantity demanded is so great that it more than offsets the increase in the price. That is, an increase in price reduces P × Q because the fall in Q is proportionately greater than the rise in P. Although the examples in this p are extreme, they illustrate some general rules:

* When demand is inelastic (a price elasticity less than 1), price and total revenue move in the same direction.

* When demand is elastic (a price elasticity greater than 1), price and total revenue move in opposite directions.

CHAPTER 5

ELASTICITY AND ITS APPLICATION

F I G U R E Price

Total Revenue The total amount paid by buyers, and received as revenue by sellers, equals the area of the box under the demand curve, P × Q. Here, at a price of $4, the quantity demanded is 100, and total revenue is $400.

$4

P Q $400 (revenue)

P

Demand

100

0

Quantity

Q

* If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains constant when the price changes.

ELASTICITY AND TOTAL R EVENUE A LINEAR DEMAND CURVE

ALONG

Let’s examine how elasticity varies along a linear demand curve, as shown in Figure 4. We know that a straight line has a constant slope. Slope is defined as “rise over run,” which here is the ratio of the change in price (“rise”) to the change in quantity (“run”). This particular demand curve’s slope is constant because each $1 increase in price causes the same two-unit decrease in the quantity demanded. Even though the slope of a linear demand curve is constant, the elasticity is not. This is true because the slope is the ratio of changes in the two variables, whereas the elasticity is the ratio of percentage changes in the two variables. You can see this by looking at the table in Figure 4, which shows the demand schedule for the linear demand curve in the graph. The table uses the midpoint method to calculate the price elasticity of demand. At points with a low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic. The table also psents total revenue at each point on the demand curve. These numbers illustrate the relationship between total revenue and elasticity. When the price is $1, for instance, demand is inelastic, and a price increase to $2 raises total revenue. When the price is $5, demand is elastic, and a price increase to $6 reduces total revenue. Between $3 and $4, demand is exactly unit elastic, and total revenue is the same at these two prices. The linear demand curve illustrates that the price elasticity of demand need not be the same at all points on a demand curve. A constant elasticity is possible, but it is not always the case.

2

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3

HOW MARKETS WORK

F I G U R E

How Total Revenue Changes When Price Changes

(a) The Case of Inelastic Demand Price

Price

$3

Revenue $240 $1 Revenue $100

100

0

Demand

Demand 80

0

Quantity

Quantity

(b) The Case of Elastic Demand Price

Price

$5 $4 Demand

Demand Revenue $200

0

50

Revenue $100

Quantity

0

20

Quantity

CHAPTER 5

ELASTICITY AND ITS APPLICATION

F I G U R E Price Elasticity is larger than 1.

$7 6

Elasticity of a Linear Demand Curve

5 Elasticity is smaller than 1.

4 3

4

The slope of a linear demand curve is constant, but its elasticity is not. The demand schedule in the table was used to calculate the price elasticity of demand by the midpoint method. At points with a low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic.

2 1 0

2

4

6

8

10

12 14 Quantity

Price

Quantity

Total Revenue (Price × Quantity)

$7 6 5 4 3 2 1 0

0 2 4 6 8 10 12 14

$ 0 12 20 24 24 20 12 0

Percentage Change in Price

Percentage Change in Quantity

Elasticity

Description

15 18 22 29 40 67 200

200 67 40 29 22 18 15

13.0 3.7 1.8 1.0 0.6 0.3 0.1

Elastic Elastic Elastic Unit elastic Inelastic Inelastic Inelastic

OTHER DEMAND ELASTICITIES In addition to the price elasticity of demand, economists use other elasticities to describe the behavior of buyers in a market. The Income Elasticity of Demand The income elasticity of demand measures how the quantity demanded changes as consumer income changes. It is calculated as the percentage change in quantity demanded pided by the percentage change in income. That is, Income elasticity of demand =

Percentage change in quantity demanded . Percentage change in income

As we discussed in Chapter 4, most goods are normal goods: Higher income raises the quantity demanded. Because quantity demanded and income move in the same direction, normal goods have positive income elasticities. A few goods, such as bus rides, are inferior goods: Higher income lowers the quantity demanded. Because quantity demanded and income move in opposite directions, inferior goods have negative income elasticities.

income elasticity of demand a measure of how much the quantity demanded of a good responds to a change in consumers’ income, computed as the percentage change in quantity demanded pided by the percentage change in income

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Energy Demand What would induce consumers to use less gasoline and electricity?

Real Energy Savers Don’t Wear Cardigans. Or Do They?

PHOTO: © DENNIS BRACK/LANDOV

By Anna Bernasek When oil and gas prices surged after Hurricanes Katrina and Rita, President Bush appealed to Americans to conserve energy. He asked people to cut back on nonessential travel, for example, and to carpool to work. Then, in October, the White House started a campaign for energy conservation in American homes, dusting off some old ideas like switching to fluorescent light bulbs and installing better insulation in attics. Some critics derided the program as a bizarre flashback from the 1970’s-a collection of worn-out ideas that evoked feelings of deprivation and gloom. It will be a pity, though, if an effective energy policy never gets off the ground. Much has been learned since the 70’s about what works and what doesn’t. . . . There are reasons for optimism. One is that market forces can help provide solutions: higher prices, on their own, can make people cut back. Just how responsive consumers are to price changes-what economists call the elasticity of demand-has been the focus of much research. Today, economists believe that they have developed a ptty good rule of thumb for energy use. In the case of electricity, which is relatively easy to measure, they have found that

Source: New York Times, November 13, 2005.

That kind of drop requires a big change in behavior. The authors found that households had turned off air-conditioners in the middle of summer and had invested in new energyefficient appliances, among other things. High costs aren’t the only force that will influence consumers to cut back. Although public appeals to save energy may be ridiculed by comedians on late-night television-recall President Jimmy Carter’s cardigan sweater-the efforts can have a substantial impact. Professors Reiss and White found that to be true in San Diego. In February 2001, with electricity prices capped, the state of California began a campaign to have households conserve electricity. It worked. “It was clear by about six months into 2001 that public appeals were having a big impact,” Professor White said. Such campaigns can have significant effects on consumer behavior, he said, if they offer a clear explanation of what people can do and how it will make a difference. Perhaps the most important reason for optimism is technology’s role in promoting energy savings. From 1979 to 1985, in the aftermath of energy shortages, Americans reduced their oil consumption by 15 percent. The single biggest factor was a shift in car-buying habits. Americans found that driving fuel-efficient cars, instead of gas guzzlers, didn’t stop them from going where they wanted to go.

CHAPTER 5

ELASTICITY AND ITS APPLICATION

Even among normal goods, income elasticities vary substantially in size. Necessities, such as food and clothing, tend to have small income elasticities because consumers choose to buy some of these goods even when their incomes are low. Luxuries, such as caviar and diamonds, tend to have large income elasticities because consumers feel that they can do without these goods altogether if their incomes are too low. The Cross-Price Elasticity of Demand The cross-price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good. It is calculated as the percentage change in quantity demanded of good 1 pided by the percentage change in the price of good 2. That is, Cross-price elasticity of demand =

Percentage change in quantity demanded of good 1 . Percentage change in the price of good 2

Whether the cross-price elasticity is a positive or negative number depends on whether the two goods are substitutes or complements. As we discussed in Chapter 4, substitutes are goods that are typically used in place of one another, such as hamburgers and hot dogs. An increase in hot dog prices induces people to grill hamburgers instead. Because the price of hot dogs and the quantity of hamburgers demanded move in the same direction, the cross-price elasticity is positive. Conversely, complements are goods that are typically used together, such as computers and software. In this case, the cross-price elasticity is negative, indicating that an increase in the price of computers reduces the quantity of software demanded.

Q

Q

UICK UIZ Define the price elasticity of demand. total revenue and the price elasticity of demand.

cross-price elasticity of demand a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good pided by the percentage change in the price of the second good

* Explain the relationship between

THE ELASTICITY OF SUPPLY When we introduced supply in Chapter 4, we noted that producers of a good offer to sell more of it when the price of the good rises. To turn from qualitative to quantitative statements about quantity supplied, we once again use the concept of elasticity.

THE PRICE ELASTICITY ITS DETERMINANTS

OF

SUPPLY

AND

The law of supply states that higher prices raise the quantity supplied. The price elasticity of supply measures how much the quantity supplied responds to changes in the price. Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price. The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce. For example, beachfront land has an inelastic supply because it is almost impossible to produce more of it. By contrast, manufactured goods, such as books, cars, and televisions, have elastic supplies because

price elasticity of supply a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied pided by the percentage change in price

99

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HOW MARKETS WORK

firms that produce them can run their factories longer in response to a higher price. In most markets, a key determinant of the price elasticity of supply is the time period being considered. Supply is usually more elastic in the long run than in the short run. Over short periods of time, firms cannot easily change the size of their factories to make more or less of a good. Thus, in the short run, the quantity supplied is not very responsive to the price. By contrast, over longer periods, firms can build new factories or close old ones. In addition, new firms can enter a market, and old firms can shut down. Thus, in the long run, the quantity supplied can respond substantially to price changes.

COMPUTING

THE

PRICE ELASTICITY

OF

SUPPLY

Now that we have a general understanding about the price elasticity of supply, let’s be more pcise. Economists compute the price elasticity of supply as the percentage change in the quantity supplied pided by the percentage change in the price. That is, Price elasticity of supply =

Percentage change in quantity supplied . Percentage change in price

For example, suppose that an increase in the price of milk from $2.85 to $3.15 a gallon raises the amount that dairy farmers produce from 9,000 to 11,000 gallons per month. Using the midpoint method, we calculate the percentage change in price as Percentage change in price = (3.15 – 2.85) / 3.00 × 100 = 10 percent.

Similarly, we calculate the percentage change in quantity supplied as Percentage change in quantity supplied = (11,000 – 9,000) / 10,000 × 100 = 20 percent.

In this case, the price elasticity of supply is Price elasticity of supply =

20 percent = 2.0. 10 percent

In this example, the elasticity of 2 indicates that the quantity supplied changes proportionately twice as much as the price.

THE VARIETY

OF

SUPPLY CURVES

Because the price elasticity of supply measures the responsiveness of quantity supplied to the price, it is reflected in the appearance of the supply curve. Figure 5 shows five cases. In the extreme case of a zero elasticity, as shown in panel (a), supply is perfectly inelastic, and the supply curve is vertical. In this case, the quantity supplied is the same regardless of the price. As the elasticity rises, the supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price. At the opposite extreme, shown in panel (e), supply is perfectly elastic. This occurs as the price elasticity of supply approaches infinity and the supply curve becomes horizontal, meaning that very small changes in the price lead to very large changes in the quantity supplied.

CHAPTER 5

ELASTICITY AND ITS APPLICATION

F I G U R E

The price elasticity of supply determines whether the supply curve is steep or flat. Note that all percentage changes are calculated using the midpoint method.

101

5

The Price Elasticity of Supply (a) Perfectly Inelastic Supply: Elasticity Equals 0 Price

(b) Inelastic Supply: Elasticity Is Less Than 1 Price

Supply Supply $5

$5

4

4

1. An increase in price . . .

1. A 22% increase in price . . .

0

100

0

Quantity

2. . . . leaves the quantity supplied unchanged.

100

110

Quantity

(c) Unit Elastic Supply: Elasticity Equals 1 Price Supply $5 4 1. A 22% increase in price . . .

0

100

125

Quantity

(e) Perfectly Elastic Supply: Elasticity Equals Infinity Price

Price

1. At any price above $4, quantity supplied is infinite.

Supply $5 $4

4 1. A 22% increase in price . . .

0

Supply 2. At exactly $4, producers will supply any quantity.

100

200

Quantity

0 3. At a price below $4, quantity supplied is zero.

Quantity

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HOW MARKETS WORK

In some markets, the elasticity of supply is not constant but varies over the supply curve. Figure 6 shows a typical case for an industry in which firms have factories with a limited capacity for production. For low levels of quantity supplied, the elasticity of supply is high, indicating that firms respond substantially to changes in the price. In this region, firms have capacity for production that is not being used, such as plants and equipment idle for all or part of the day. Small increases in price make it profitable for firms to begin using this idle capacity. As the quantity supplied rises, firms begin to reach capacity. Once capacity is fully used, increasing production further requires the construction of new plants. To induce firms to incur this extra expense, the price must rise substantially, so supply becomes less elastic. Figure 6 psents a numerical example of this phenomenon. When the price rises from $3 to $4 (a 29 percent increase, according to the midpoint method), the quantity supplied rises from 100 to 200 (a 67 percent increase). Because quantity supplied changes proportionately more than the price, the supply curve has elasticity greater than 1. By contrast, when the price rises from $12 to $15 (a 22 percent increase), the quantity supplied rises from 500 to 525 (a 5 percent increase). In this case, quantity supplied moves proportionately less than the price, so the elasticity is less than 1.

Q

Q

UICK UIZ Define the price elasticity of supply. * Explain why the price elasticity of supply might be different in the long run and in the short run.

THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY Can good news for farming be bad news for farmers? Why did OPEC fail to keep the price of oil high? Does drug interdiction increase or decrease drug-related crime? At first, these questions might seem to have little in common. Yet all three

6

F I G U R E Price $15 Elasticity is small (less than 1).

How the Price Elasticity of Supply Can Vary Because firms often have a maximum capacity for production, the elasticity of supply may be very high at low levels of quantity supplied and very low at high levels of quantity supplied. Here an increase in price from $3 to $4 increases the quantity supplied from 100 to 200. Because the 67 percent increase in quantity supplied (computed using the midpoint method) is larger than the 29 percent increase in price, the supply curve is elastic in this range. By contrast, when the price rises from $12 to $15, the quantity supplied rises only from 500 to 525. Because the 5 percent increase in quantity supplied is smaller than the 22 percent increase in price, the supply curve is inelastic in this range.

12

Elasticity is large (greater than 1). 4 3

0

100

200

500 525

Quantity

CHAPTER 5

ELASTICITY AND ITS APPLICATION

103

questions are about markets, and all markets are subject to the forces of supply and demand. Here we apply the versatile tools of supply, demand, and elasticity to answer these seemingly complex questions.

1. When demand is inelastic, an increase in supply . . . S1

S2

$3 2

Demand 0

100

Quantity of Wheat 3. . . . and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220. 110

7

PART II

HOW MARKETS WORK

CARTOON: DOONESBURY © 1972 G. B. TRUDEAU. REPRINTED WITH PERMISSION OF UNIVERSAL PRESS SYNDICATE. ALL RIGHTS RESERVED.

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ELASTICITY AND ITS APPLICATION

This analysis of the market for farm products also helps to explain a seeming paradox of public policy: Certain farm programs try to help farmers by inducing them not to plant crops on all of their land. The purpose of these programs is to reduce the supply of farm products and thereby raise prices. With inelastic demand for their products, farmers as a group receive greater total revenue if they supply a smaller crop to the market. No single farmer would choose to leave his land fallow on his own because each takes the market price as given. But if all farmers do so together, each of them can be better off. When analyzing the effects of farm technology or farm policy, it is important to keep in mind that what is good for farmers is not necessarily good for society as a whole. Improvement in farm technology can be bad for farmers because it makes farmers increasingly unnecessary, but it is surely good for consumers who pay less for food. Similarly, a policy aimed at reducing the supply of farm products may raise the incomes of farmers, but it does so at the expense of consumers.

WHY DID OPEC FAIL TO K EEP THE P RICE OF OIL H IGH? Many of the most disruptive events for the world’s economies over the past several decades have originated in the world market for oil. In the 1970s, members of the Organization of Petroleum Exporting Countries (OPEC) decided to raise the world price of oil to increase their incomes. These countries accomplished this goal by jointly reducing the amount of oil they supplied. From 1973 to 1974, the price of oil (adjusted for overall inflation) rose more than 50 percent. Then, a few years later, OPEC did the same thing again. From 1979 to 1981, the price of oil approximately doubled. Yet OPEC found it difficult to maintain a high price. From 1982 to 1985, the price of oil steadily declined about 10 percent per year. Dissatisfaction and disarray soon pvailed among the OPEC countries. In 1986, cooperation among OPEC members completely broke down, and the price of oil plunged 45 percent. In 1990, the price of oil (adjusted for overall inflation) was back to where it began in 1970, and it stayed at that low level throughout most of the 1990s. (In the first decade of the 21st century, the price of oil rose again, but the main driving force was not OPEC supply restrictions but, rather, increased world demand, in part from a large and rapidly growing Chinese economy.) This OPEC episode of the 1970s and 1980s shows how supply and demand can behave differently in the short run and in the long run. In the short run, both the supply and demand for oil are relatively inelastic. Supply is inelastic because the quantity of known oil reserves and the capacity for oil extraction cannot be changed quickly. Demand is inelastic because buying habits do not respond immediately to changes in price. Thus, as panel (a) of Figure 8 shows, the shortrun supply and demand curves are steep. When the supply of oil shifts from S1 to S2, the price increase from P1 to P2 is large. The situation is very different in the long run. Over long periods of time, producers of oil outside OPEC respond to high prices by increasing oil exploration and by building new extraction capacity. Consumers respond with greater conservation, for instance by replacing old inefficient cars with newer efficient ones. Thus, as panel (b) of Figure 8 shows, the long-run supply and demand curves are more elastic. In the long run, the shift in the supply curve from S1 to S2 causes a much smaller increase in the price.

105

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PART II

8

HOW MARKETS WORK

F I G U R E

When the of oil falls, the response depends on the time horizon. In the short Types of supply Graphs

A Reduction in Supply in the World Market for Oil

run, pie supply and relatively inelastic, as income in panelis(a). Thus, from whenvarious the supply The chart in demand panel (a) are shows how U.S. national derived curve shifts S1 to Sin price rises substantially. By contrast, infour the long run, sources. Thefrom bar graph panel (b) compares the average income in countries. 2, the supply and demand are as in panel (b). Inofthis case, the same size The time-series graph inrelatively panel (c) elastic, shows the productivity labor in U.S. businesses shift the to supply from in 1950 2000.curve (S1 to S2) causes a smaller increase in the price.

(a) The Oil Market in the Short Run

(b) The Oil Market in the Long Run Price of Oil

Price of Oil 1. In the short run, when supply and demand are inelastic, a shift in supply . . . S2

1. In the long run, when supply and demand are elastic, a shift in supply . . .

S1

S2 S1

Demand Demand 0

Quantity of Oil

0

Quantity of Oil

This analysis shows why OPEC succeeded in maintaining a high price of oil only in the short run. When OPEC countries agreed to reduce their production of oil, they shifted the supply curve to the left. Even though each OPEC member sold less oil, the price rose by so much in the short run that OPEC incomes rose. By contrast, in the long run, when supply and demand are more elastic, the same reduction in supply, measured by the horizontal shift in the supply curve, caused a smaller increase in the price. Thus, OPEC’s coordinated reduction in supply proved less profitable in the long run. The cartel learned that raising prices is easier in the short run than in the long run.

DOES DRUG INTERDICTION INCREASE DECREASE DRUG-R ELATED CRIME?

OR

CHAPTER 5

ELASTICITY AND ITS APPLICATION

107

Suppose the government increases the number of federal agents devoted to the war on drugs. What happens in the market for illegal drugs? As is usual, we answer this question in three steps. First, we consider whether the supply or demand curve shifts. Second, we consider the direction of the shift. Third, we see how the shift affects the equilibrium price and quantity. Although the purpose of drug interdiction is to reduce drug use, its direct impact is on the sellers of drugs rather than the buyers. When the government stops some drugs from entering the country and arrests more smugglers, it raises the cost of selling drugs and, therefore, reduces the quantity of drugs supplied at any given price. The demand for drugs-the amount buyers want at any given price-is not changed. As panel (a) of Figure 9 shows, interdiction shifts the supply curve to the left from S1 to S2 and leaves the demand curve the same. The equilibrium price of drugs rises from P1 to P2, and the equilibrium quantity falls from Q1 to Q2. The fall in the equilibrium quantity shows that drug interdiction does reduce drug use. But what about the amount of drug-related crime? To answer this question, consider the total amount that drug users pay for the drugs they buy. Because few drug addicts are likely to break their destructive habits in response to a higher price, it is likely that the demand for drugs is inelastic, as it is drawn in the p.

F I G U R E

Drug interdiction reduces the supply of drugs from S1 to S2, as in panel (a). If the demand for drugs is inelastic, then the total amount paid by drug users rises, even as the amount of drug use falls. By contrast, drug education reduces the demand for drugs from D1 to D2, as in panel (b). Because both price and quantity fall, the amount paid by drug users falls.

(a) Drug Interdiction Price of Drugs

9

Policies to Reduce the Use of Illegal Drugs (b) Drug Education

1. Drug interdiction reduces the supply of drugs . . .

Price of Drugs

1. Drug education reduces the demand for drugs . . .

S2

Supply S1

P2

P1

P1

P2

2. . . . which raises the price . . .

2. . . . which reduces the price . . .

0

Demand

Q2

Q1

Quantity of Drugs

3. . . . and reduces the quantity sold.

D1 D2

0

Q2

Q1

Quantity of Drugs

3. . . . and reduces the quantity sold.

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HOW MARKETS WORK

Q

Q

UICK UIZ How might a drought that destroys half of all farm crops be good for farmers? If such a drought is good for farmers, why don’t farmers destroy their own crops in the absence of a drought?

CONCLUSION According to an old quip, even a parrot can become an economist simply by learning to say “supply and demand.” These last two chapters should have convinced you that there is much truth in this statement. The tools of supply and demand allow you to analyze many of the most important events and policies that shape the economy. You are now well on your way to becoming an economist (or at least a well-educated parrot).

SUMMARY * The price elasticity of demand measures how * The price elasticity of demand is calculated as much the quantity demanded responds to changes in the price. Demand tends to be more elastic if close substitutes are available, if the good is a luxury rather than a necessity, if the market is narrowly defined, or if buyers have substantial time to react to a price change.

the percentage change in quantity demanded pided by the percentage change in price. If quantity demanded moves proportionately less than the price, then the elasticity is less than 1, and demand is said to be inelastic. If quantity demanded moves proportionately more than the

CHAPTER 5

price, then the elasticity is greater than 1, and demand is said to be elastic.

* Total revenue, the total amount paid for a good, equals the price of the good times the quantity sold. For inelastic demand curves, total revenue rises as price rises. For elastic demand curves, total revenue falls as price rises.

* The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. The cross-price elasticity of demand measures how much the quantity demanded of one good responds to changes in the price of another good.

* The price elasticity of supply measures how much the quantity supplied responds to changes in the price. This elasticity often depends on the

ELASTICITY AND ITS APPLICATION

time horizon under consideration. In most markets, supply is more elastic in the long run than in the short run.

* The price elasticity of supply is calculated as the percentage change in quantity supplied pided by the percentage change in price. If quantity supplied moves proportionately less than the price, then the elasticity is less than 1, and supply is said to be inelastic. If quantity supplied moves proportionately more than the price, then the elasticity is greater than 1, and supply is said to be elastic.

* The tools of supply and demand can be applied in many different kinds of markets. This chapter uses them to analyze the market for wheat, the market for oil, and the market for illegal drugs.

KEY CONCEPTS elasticity, p. 90 price elasticity of demand, p. 90 total revenue, p. 93

income elasticity of demand, p. 97 cross-price elasticity of demand, p. 99

price elasticity of supply, p. 99

6. If demand is elastic, how will an increase in price change total revenue? Explain. 7. What do we call a good whose income elasticity is less than 0? 8. How is the price elasticity of supply calculated? Explain what it measures. 9. What is the price elasticity of supply of Picasso paintings? 10. Is the price elasticity of supply usually larger in the short run or in the long run? Why? 11. How did elasticity help explain why drug interdiction could reduce the supply of drugs, yet possibly increase drug-related crime?

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PROBLEMS AND APPLICATIONS 1. For each of the following pairs of goods, which good would you expect to have more elastic demand and why? a. required textbooks or mystery novels b. Beethoven recordings or classical music recordings in general c. subway rides during the next 6 months or subway rides during the next 5 years d. root beer or water 2. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston: Price

Quantity Demanded (business travelers)

Quantity Demanded (vacationers)

$150 200 250 300

2,100 tickets 2,000 1,900 1,800

1,000 tickets 800 600 400

a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? (Use the midpoint method in your calculations.) b. Why might vacationers have a different elasticity from business travelers? 3. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run. a. If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the quantity of heating oil demanded in the short run? In the long run? (Use the midpoint method in your calculations.) b. Why might this elasticity depend on the time horizon? 4. A price change causes the quantity demanded of a good to decrease by 30 percent, while the total revenue of that good increases by 15 percent. Is the demand curve elastic or inelastic? Explain. 5. The equilibrium price of coffee mugs rose sharply last month, but the equilibrium quantity was the same as ever. Three people tried to explain the situation. Which explanations could be right? Explain your logic.

Billy: Demand increased, but supply was totally inelastic. Marian: Supply increased, but so did demand. Valerie: Supply decreased, but demand was totally inelastic. 6. Suppose that your demand schedule for compact discs is as follows: Price

Quantity Demanded (income = $10,000)

Quantity Demanded (income = $12,000)

$ 8 10 12 14 16

40 CDs 32 24 16 8

50 CDs 45 30 20 12

a. Use the midpoint method to calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income is $10,000 and (ii) your income is $12,000. b. Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12 and (ii) the price is $16. 7. You have the following information about good X and good Y: * Income elasticity of demand for good X: -3 * Cross-price elasticity of demand for good X with respect to the price of good Y: 2 Would an increase in income and a decrease in the price of good Y unambiguously decrease the demand for good X? Why or why not? 8. Maria has decided always to spend one-third of her income on clothing. a. What is her income elasticity of clothing demand? b. What is her price elasticity of clothing demand? c. If Maria’s tastes change and she decides to spend only one-fourth of her income on clothing, how does her demand curve change? What is her income elasticity and price elasticity now?

CHAPTER 5

14.

15.

16.

17.

ELASTICITY AND ITS APPLICATION

a. What happens to the equilibrium price and quantity in each market? b. Which product experiences a larger change in price? c. Which product experiences a larger change in quantity? d. What happens to total consumer spending on each product? Beachfront resorts have an inelastic supply, and automobiles have an elastic supply. Suppose that a rise in population doubles the demand for both products (that is, the quantity demanded at each price is twice what it was). a. What happens to the equilibrium price and quantity in each market? b. Which product experiences a larger change in price? c. Which product experiences a larger change in quantity? d. What happens to total consumer spending on each product? Several years ago, flooding along the Missouri and the Mississippi rivers destroyed thousands of acres of wheat. a. Farmers whose crops were destroyed by the floods were much worse off, but farmers whose crops were not destroyed benefited from the floods. Why? b. What information would you need about the market for wheat to assess whether farmers as a group were hurt or helped by the floods? Explain why the following might be true: A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drought only in Kansas reduces the total revenue that Kansas farmers receive. Suppose the demand curve for a product is Q = 60/P. Compute the quantity demanded at prices of $1, $2, $3, $4, $5, and $6. Graph the demand curve. Use the midpoint method to calculate the price elasticity of demand between $1 and $2 and between $5 and $6. How does this demand curve compare to the linear demand curve?

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CHAPTER

Supply, Demand, and Government Policies

E

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After discussing price controls, we consider the impact of taxes. Policymakers use taxes to raise revenue for public purposes and to influence market outcomes. Although the pvalence of taxes in our economy is obvious, their effects are not. For example, when the government levies a tax on the amount that firms pay their workers, do the firms or the workers bear the burden of the tax? The answer is not at all clear-until we apply the powerful tools of supply and demand.

CONTROLS ON PRICES

price ceiling a legal maximum on the price at which a good can be sold price floor a legal minimum on the price at which a good can be sold

To see how price controls affect market outcomes, let’s look once again at the market for ice cream. As we saw in Chapter 4, if ice cream is sold in a competitive market free of government regulation, the price of ice cream adjusts to balance supply and demand: At the equilibrium price, the quantity of ice cream that buyers want to buy exactly equals the quantity that sellers want to sell. To be concrete, suppose the equilibrium price is $3 per cone. Not everyone may be happy with the outcome of this free-market process. Let’s say the American Association of Ice-Cream Eaters complains that the $3 price is too high for everyone to enjoy a cone a day (their recommended diet). Meanwhile, the National Organization of Ice-Cream Makers complains that the $3 price-the result of “cutthroat competition”-is too low and is depssing the incomes of its members. Each of these groups lobbies the government to pass laws that alter the market outcome by directly controlling the price of an ice-cream cone. Because buyers of any good always want a lower price while sellers want a higher price, the interests of the two groups conflict. If the Ice-Cream Eaters are successful in their lobbying, the government imposes a legal maximum on the price at which ice cream can be sold. Because the price is not allowed to rise above this level, the legislated maximum is called a price ceiling. By contrast, if the IceCream Makers are successful, the government imposes a legal minimum on the price. Because the price cannot fall below this level, the legislated minimum is called a price floor. Let us consider the effects of these policies in turn.

HOW PRICE CEILINGS AFFECT M ARKET OUTCOMES When the government, moved by the complaints and campaign contributions of the Ice-Cream Eaters, imposes a price ceiling on the market for ice cream, two outcomes are possible. In panel (a) of Figure 1, the government imposes a price ceiling of $4 per cone. In this case, because the price that balances supply and demand ($3) is below the ceiling, the price ceiling is not binding. Market forces naturally move the economy to the equilibrium, and the price ceiling has no effect on the price or the quantity sold. Panel (b) of Figure 1 shows the other, more interesting, possibility. In this case, the government imposes a price ceiling of $2 per cone. Because the equilibrium price of $3 is above the price ceiling, the ceiling is a binding constraint on the market. The forces of supply and demand tend to move the price toward the equilibrium price, but when the market price hits the ceiling, it can, by law, rise no further. Thus, the market price equals the price ceiling. At this price, the quantity of ice cream demanded (125 cones in the p) exceeds the quantity supplied (75 cones). There is a shortage of ice cream: 50 people who want to buy ice cream at the going price are unable to do so.

CHAPTER 6

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

F I G U R E

In panel (a), the government imposes a price ceiling of $4. Because the price ceiling is above the equilibrium price of $3, the price ceiling has no effect, and the market can reach the equilibrium of supply and demand. In this equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price ceiling of $2. Because the price ceiling is below the equilibrium price of $3, the market price equals $2. At this price, 125 cones are demanded and only 75 are supplied, so there is a shortage of 50 cones. (a) A Price Ceiling That Is Not Binding Price of Ice-Cream Cone

Supply

$4

Price ceiling

(b) A Price Ceiling That Is Binding

Supply

Equilibrium price

3

$3

Equilibrium price

2 Shortage

100 Equilibrium quantity

Quantity of Ice-Cream Cones

Price ceiling Demand

Demand 0

1

A Market with a Price Ceiling

Price of Ice-Cream Cone

0

75 Quantity supplied

When a shortage of ice cream develops because of this price ceiling, some mechanism for rationing ice cream will naturally develop. The mechanism could be long lines: Buyers who are willing to arrive early and wait in line get a cone, but those unwilling to wait do not. Alternatively, sellers could ration ice cream according to their own personal biases, selling it only to friends, relatives, or members of their own racial or ethnic group. Notice that even though the price ceiling was motivated by a desire to help buyers of ice cream, not all buyers benefit from the policy. Some buyers do get to pay a lower price, although they may have to wait in line to do so, but other buyers cannot get any ice cream at all. This example in the market for ice cream shows a general result: When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers. The rationing mechanisms that develop under price ceilings are rarely desirable. Long lines are inefficient because they waste buyers’ time. Discrimination according to seller bias is both inefficient (because the good does not necessarily go to the buyer who values it most highly) and potentially unfair. By contrast, the rationing mechanism in a free, competitive market is both efficient and impersonal. When the market for ice cream reaches its equilibrium, anyone who wants to pay the market price can get a cone. Free markets ration goods with prices.

125 Quantity demanded

115

Quantity of Ice-Cream Cones

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LINES AT THE GAS PUMP As we discussed in the pceding chapter, in 1973 the Organization of Petroleum Exporting Countries (OPEC) raised the price of crude oil in world oil markets. Because crude oil is the major input used to make gasoline, the higher oil prices reduced the supply of gasoline. Long lines at gas stations became commonplace, and motorists often had to wait for hours to buy only a few gallons of gas. What was responsible for the long gas lines? Most people blame OPEC. Surely, if OPEC had not raised the price of crude oil, the shortage of gasoline would not have occurred. Yet economists blame U.S. government regulations that limited the price oil companies could charge for gasoline. Figure 2 shows what happened. As shown in panel (a), before OPEC raised the price of crude oil, the equilibrium price of gasoline, P1, was below the price ceiling. The price regulation, therefore, had no effect. When the price of crude oil rose, however, the situation changed. The increase in the price of crude oil raised the cost of producing gasoline, and this reduced the supply of gasoline. As panel (b) shows, the supply curve shifted to the left from S1 to S2. In an unregulated market, this shift in supply would have raised the equilibrium price of gasoline from P1 to P2, and no shortage would have resulted. Instead, the price ceiling pvented the price from rising to the equilibrium level. At the price ceiling, producers were willing to sell QS, and consumers were willing to buy QD. Thus, the shift in supply caused a severe shortage at the regulated price.

2

F I G U R E

The Market for Gasoline with a Price Ceiling

Panel (a)ofshows the gasoline market when the price ceiling is not binding because Types Graphs the below theU.S. ceiling. Panelincome (b) shows the gasoline market The equilibrium pie chart in price, panel P(a) shows how national is derived from various 1, is after an increase in the price of crude oil (an input into making gasoline) the sources. The bar graph in panel (b) compares the average income in fourshifts countries. supply curve to graph the leftinfrom toshows S2. In an pricebusinesses would have The time-series panelS1(c) theunregulated productivitymarket, of laborthe in U.S. risen from P P2. The price ceiling, however, pvents this from happening. At the from 1950 to1 to 2000. binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS. The difference between quantity demanded and quantity supplied, QD – QS, measures the gasoline shortage.

(a) The Price Ceiling on Gasoline Is Not Binding Price of Gasoline

(b) The Price Ceiling on Gasoline Is Binding Price of Gasoline

S2 2. . . . but when supply falls . . . S1

Supply, S1 1. Initially, the price ceiling is not binding . . .

P2

Price ceiling

Price ceiling

P1

P1

Demand 0

3. . . . the price ceiling becomes binding . . .

Q1

Quantity of Gasoline

4. . . . resulting in a shortage.

Demand 0

QS

QD

Q1

Quantity of Gasoline

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SUPPLY, DEMAND, AND GOVERNMENT POLICIES

117

Eventually, the laws regulating the price of gasoline were repealed. Lawmakers came to understand that they were partly responsible for the many hours Americans lost waiting in line to buy gasoline. Today, when the price of crude oil changes, the price of gasoline can adjust to bring supply and demand into equilibrium. ●

Panel (a) shows the short-run effects of rent control: Because the supply and demand for apartments are relatively inelastic, the price ceiling imposed by a rent-control law causes only a small shortage of housing. Panel (b) shows the long-run effects of rent control: Because the supply and demand for apartments are more elastic, rent control causes a large shortage.

(a) Rent Control in the Short Run (supply and demand are inelastic) Rental Price of Apartment

F I G U R E

Rent Control in the Short Run and in the Long Run

(b) Rent Control in the Long Run (supply and demand are elastic) Rental Price of Apartment

Supply

Supply

Controlled rent

Controlled rent Shortage

Demand

Shortage Demand 0

Quantity of Apartments

0

Quantity of Apartments

3

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HOW MARKETS WORK

because supply and demand are inelastic in the short run, the initial shortage caused by rent control is small. The primary effect in the short run is to reduce rents. The long-run story is very different because the buyers and sellers of rental housing respond more to market conditions as time passes. On the supply side, landlords respond to low rents by not building new apartments and by failing to maintain existing ones. On the demand side, low rents encourage people to find their own apartments (rather than living with their parents or sharing apartments with roommates) and induce more people to move into a city. Therefore, both supply and demand are more elastic in the long run. Panel (b) of Figure 3 illustrates the housing market in the long run. When rent control depsses rents below the equilibrium level, the quantity of apartments supplied falls substantially, and the quantity of apartments demanded rises substantially. The result is a large shortage of housing. In cities with rent control, landlords use various mechanisms to ration housing. Some landlords keep long waiting lists. Others give a pference to tenants without children. Still others discriminate on the basis of race. Sometimes apartments are allocated to those willing to offer under-the-table payments to building superintendents. In essence, these bribes bring the total price of an apartment (including the bribe) closer to the equilibrium price. To understand fully the effects of rent control, we have to remember one of the Ten Principles of Economics from Chapter 1: People respond to incentives. In free markets, landlords try to keep their buildings clean and safe because desirable apartments command higher prices. By contrast, when rent control creates shortages and waiting lists, landlords lose their incentive to respond to tenants’ concerns. Why should a landlord spend money to maintain and improve the property when people are waiting to get in as it is? In the end, tenants get lower rents, but they also get lower-quality housing. Policymakers often react to the effects of rent control by imposing additional regulations. For example, there are laws that make racial discrimination in housing illegal and require landlords to provide minimally adequate living conditions. These laws, however, are difficult and costly to enforce. By contrast, when rent control is eliminated and a market for housing is regulated by the forces of competition, such laws are less necessary. In a free market, the price of housing adjusts to eliminate the shortages that give rise to undesirable landlord behavior. ●

HOW PRICE FLOORS AFFECT M ARKET OUTCOMES To examine the effects of another kind of government price control, let’s return to the market for ice cream. Imagine now that the government is persuaded by the pleas of the National Organization of Ice-Cream Makers. In this case, the government might institute a price floor. Price floors, like price ceilings, are an attempt by the government to maintain prices at other than equilibrium levels. Whereas a price ceiling places a legal maximum on prices, a price floor places a legal minimum. When the government imposes a price floor on the ice-cream market, two outcomes are possible. If the government imposes a price floor of $2 per cone when the equilibrium price is $3, we obtain the outcome in panel (a) of Figure 4. In this case, because the equilibrium price is above the floor, the price floor is not binding. Market forces naturally move the economy to the equilibrium, and the price floor has no effect.

CHAPTER 6

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and only 80 are demanded, there is a surplus of 40 cones.

Supply

A Market with a Price Floor

Price of Ice-Cream Cone

Supply Surplus

Equilibrium price

$4

$3

Price floor

2

3

100 Equilibrium quantity

Quantity of Ice-Cream Cones

Price floor

Equilibrium price Demand

Demand 0

4

(b) A Price Floor That Is Binding

(a) A Price Floor That Is Not Binding Price of Ice-Cream Cone

F I G U R E

0

Panel (b) of Figure 4 shows what happens when the government imposes a price floor of $4 per cone. In this case, because the equilibrium price of $3 is below the floor, the price floor is a binding constraint on the market. The forces of supply and demand tend to move the price toward the equilibrium price, but when the market price hits the floor, it can fall no further. The market price equals the price floor. At this floor, the quantity of ice cream supplied (120 cones) exceeds the quantity demanded (80 cones). Some people who want to sell ice cream at the going price are unable to. Thus, a binding price floor causes a surplus. Just as the shortages resulting from price ceilings can lead to undesirable rationing mechanisms, so can the surpluses resulting from price floors. In the case of a price floor, some sellers are unable to sell all they want at the market price. The sellers who appeal to the personal biases of the buyers, perhaps due to racial or familial ties, are better able to sell their goods than those who do not. By contrast, in a free market, the price serves as the rationing mechanism, and sellers can sell all they want at the equilibrium price.

THE MINIMUM WAGE An important example of a price floor is the minimum wage. Minimum-wage laws dictate the lowest price for labor that any employer may pay. The U.S. Congress first instituted a minimum wage with the Fair Labor Standards Act of 1938 to ensure workers a minimally adequate standard of living. In 2007, the minimum

119

80 120 Quantity of Quantity Quantity Ice-Cream Cones demanded supplied

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wage according to federal law was $5.15 per hour, and it was scheduled to increase to $7.25 by 2010. (Some states mandate minimum wages above the federal level.) Most European nations have minimum-wage laws as well; some, such as France and the United Kingdom, have significantly higher minimums than the United States. To examine the effects of a minimum wage, we must consider the market for labor. Panel (a) of Figure 5 shows the labor market, which, like all markets, is subject to the forces of supply and demand. Workers determine the supply of labor, and firms determine the demand. If the government doesn’t intervene, the wage normally adjusts to balance labor supply and labor demand. Panel (b) of Figure 5 shows the labor market with a minimum wage. If the minimum wage is above the equilibrium level, as it is here, the quantity of labor supplied exceeds the quantity demanded. The result is unemployment. Thus, the minimum wage raises the incomes of those workers who have jobs, but it lowers the incomes of workers who cannot find jobs. To fully understand the minimum wage, keep in mind that the economy contains not a single labor market but many labor markets for different types of workers. The impact of the minimum wage depends on the skill and experience of the worker. Workers with high skills and much experience are not affected because their equilibrium wages are well above the minimum. For these workers, the minimum wage is not binding. The minimum wage has its greatest impact on the market for teenage labor. The equilibrium wages of teenagers are low because teenagers are among the least skilled and least experienced members of the labor force. In addition, teenagers are often willing to accept a lower wage in exchange for on-the-job training. (Some

5

F I G U R E

How the Minimum Wage Affects the Labor Market

Panel (a)ofshows a labor market in which the wage adjusts to balance labor supply Types Graphs and labor demand. Panel (b) shows impact of aincome bindingis minimum wage. Because The pie chart in panel (a) shows howthe U.S. national derived from various the minimum wage is a price floor, causes a the surplus: Theincome quantityinof labor supplied sources. The bar graph in panel (b) it compares average four countries. exceeds the quantity result unemployment. The time-series graphdemanded. in panel (c) The shows the is productivity of labor in U.S. businesses from 1950 to 2000.

(a) A Free Labor Market

(b) A Labor Market with a Binding Minimum Wage

Wage

Wage

Labor supply

Labor supply Minimum wage

Labor surplus (unemployment)

Equilibrium wage Labor demand 0

Equilibrium employment

Quantity of Labor

Labor demand 0

Quantity demanded

Quantity supplied

Quantity of Labor

CHAPTER 6

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

EVALUATING PRICE CONTROLS One of the Ten Principles of Economics discussed in Chapter 1 is that markets are usually a good way to organize economic activity. This principle explains why economists usually oppose price ceilings and price floors. To economists, prices

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President Chavez versus the Market Venezuela’s psident has tried to replace market prices with his own.

are not the outcome of some haphazard process. Prices, they contend, are the result of the millions of business and consumer decisions that lie behind the supply and demand curves. Prices have the crucial job of balancing supply and demand and, thereby, coordinating economic activity. When policymakers set prices by legal decree, they obscure the signals that normally guide the allocation of society’s resources. Another one of the Ten Principles of Economics is that governments can sometimes improve market outcomes. Indeed, policymakers are led to control prices because they view the market’s outcome as unfair. Price controls are often aimed at helping the poor. For instance, rent-control laws try to make housing affordable for everyone, and minimum-wage laws try to help people escape poverty. Yet price controls often hurt those they are trying to help. Rent control may keep rents low, but it also discourages landlords from maintaining their buildings and makes housing hard to find. Minimum-wage laws may raise the incomes of some workers, but they also cause other workers to be unemployed. Helping those in need can be accomplished in ways other than controlling prices. For instance, the government can make housing more affordable by paying a fraction of the rent for poor families. Unlike rent control, such rent subsidies do not reduce the quantity of housing supplied and, therefore, do not lead to housing

CHAPTER 6

decent price, processors are refusing to buy the corn because they can’t sell it at what they consider an acceptable markup. The country’s largest food company, Alimentos Polar, has warned it may have to halt production of corn flour for such reasons. In early December, coffee producers challenged the new price ceilings, paralyzing deliveries and causing an acute coffee shortage for weeks. As the world’s fifth-largest oil exporter- the state-run oil company supplies about 15% of U.S. petroleum imports-Venezuela has amassed a hoard of cash that has allowed it to import goods and sell them at a loss through the state-run Mercal supermarket chain, subsidizing Mr. Chávez’s pricing policies. Enforcement of price controls is being stepped up as Mr. Chávez readies a December re-election bid. had once been on the Laffer curve himself. “I came into the Big Money making pictures during World War II,” he would always say. At that time the wartime income surtax hit 90 percent. “You could only make four pictures and then you were in the top bracket,” he would continue. “So we all quit working after four pictures and went off to the country.” High tax rates caused less work. Low tax rates caused more. His experience proved it. When Reagan ran for psident in 1980, he made cutting taxes part of his platform. Reagan argued that taxes were so high that they were discouraging hard work. He argued that lower taxes would give people the proper incentive to work, which would raise economic well-being and perhaps even tax revenue. Because the cut in tax rates was intended to encourage people to increase the quantity of labor they supplied, the views of Laffer and Reagan became known as supply-side economics. Economists continue to debate Laffer’s argument. Many believe that subsequent history refuted Laffer’s conjecture that lower tax rates would raise tax revenue. Yet because history is open to alternative interptations, other economists view the events of the 1980s as more favorable to the supply-siders. To evaluate Laffer’s hypothesis definitively, we would need to rerun history without the Reagan tax cuts and see if tax revenues were higher or lower. Unfortunately, that experiment is impossible. Some economists take an intermediate position on this issue. They believe that while an overall cut in tax rates normally reduces revenue, some taxpayers at some times may find themselves on the wrong side of the Laffer curve. Other things equal, a tax cut is more likely to raise tax revenue if the cut applies to those taxpayers facing the highest tax rates. In addition, Laffer’s argument may be more compelling when considering countries with much higher tax rates than the United States. In Sweden in the early 1980s, for instance, the typical worker faced a marginal tax rate of about 80 percent. Such a high tax rate provides a substantial disincentive to work. Studies have suggested that Sweden would indeed have raised more tax revenue if it had lowered its tax rates. Economists disagree about these issues in part because there is no consensus about the size of the relevant elasticities. The more elastic that supply and demand are in any market, the more taxes in that market distort behavior, and the more likely it is that a tax cut will raise tax revenue. There is no debate, however, about the general lesson: How much revenue the government gains or loses from a tax change cannot be computed just by looking at tax rates. It also depends on how the tax change affects people’s behavior. ●

Q

Q

UICK UIZ If the government doubles the tax on gasoline, can you be sure that revenue from the gasoline tax will rise? Can you be sure that the deadweight loss from the gasoline tax will rise? Explain.

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CONCLUSION In this chapter we have used the tools developed in the pvious chapter to further our understanding of taxes. One of the Ten Principles of Economics discussed in Chapter 1 is that markets are usually a good way to organize economic activity. In Chapter 7, we used the concepts of producer and consumer surplus to make this principle more pcise. Here we have seen that when the government imposes taxes on buyers or sellers of a good, society loses some of the benefits of market efficiency. Taxes are costly to market participants not only because taxes transfer resources from those participants to the government but also because they alter incentives and distort market outcomes. The analysis psented here and in Chapter 6 should give you a good basis for understanding the economic impact of taxes, but this is not the end of the story. Microeconomists study how best to design a tax system, including how to strike the right balance between equality and efficiency. Macroeconomists study how taxes influence the overall economy and how policymakers can use the tax system to stabilize economic activity and to achieve more rapid economic growth. So don’t be surprised that, as you continue your study of economics, the subject of taxation comes up yet again.

SUMMARY * A tax on a good reduces the welfare of buyers and sellers of the good, and the reduction in consumer and producer surplus usually exceeds the revenue raised by the government. The fall in total surplus-the sum of consumer surplus, producer surplus, and tax revenue-is called the deadweight loss of the tax.

* Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less, and these changes in behavior shrink the size of the market below the level that maxi-

mizes total surplus. Because the elasticities of supply and demand measure how much market participants respond to market conditions, larger elasticities imply larger deadweight losses.

* As a tax grows larger, it distorts incentives more, and its deadweight loss grows larger. Because a tax reduces the size of the market, however, tax revenue does not continually increase. It first rises with the size of a tax, but if a tax gets large enough, tax revenue starts to fall.

CHAPTER 8

APPLICATION: THE COSTS OF TAXATION

KEY CONCEPT deadweight loss, p. 163

QUESTIONS FOR REVIEW 1. What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue? Explain. 2. Draw a supply-and-demand diagram with a tax on the sale of the good. Show the deadweight loss. Show the tax revenue.

3. How do the elasticities of supply and demand affect the deadweight loss of a tax? Why do they have this effect? 4. Why do experts disagree about whether labor taxes have small or large deadweight losses? 5. What happens to the deadweight loss and tax revenue when a tax is increased?

PROBLEMS AND APPLICATIONS 1. The market for pizza is characterized by a downward-sloping demand curve and an upward-sloping supply curve. a. Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and producer surplus. Is there any deadweight loss? Explain. b. Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold. Illustrate the effect of this tax on the pizza market, being sure to label the consumer surplus, producer surplus, government revenue, and deadweight loss. How does each area compare to the p-tax case? c. If the tax were removed, pizza eaters and sellers would be better off, but the government would lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their gains to the government. Could all parties (including the government) be better off than they were with a tax? Explain using the labeled areas in your graph. 2. Evaluate the following two statements. Do you agree? Why or why not? a. “A tax that has no deadweight loss cannot raise any revenue for the government.”

b. “A tax that raises no revenue for the government cannot have any deadweight loss.” 3. Consider the market for rubber bands. a. If this market has very elastic supply and very inelastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Use the tools of consumer surplus and producer surplus in your answer. b. If this market has very inelastic supply and very elastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Contrast your answer with your answer to part (a). 4. The 19th-century economist Henry George argued that the government should levy a sizable tax on land, the supply of which he took to be completely inelastic. a. George believed that economic growth increased the demand for land and made rich landowners richer at the expense of the tenants who made up the demand side of the market. Show this argument on an appropriately labeled diagram. b. Who bears the burden of a tax on land-the owners of land or the tenants on the land? Explain.

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5.

6.

7.

8.

MARKETS AND WELFARE

c. Is the deadweight loss of this tax large or small? Explain. d. Many cities and towns today levy taxes on the value of real estate. Why might the above analysis of George’s land tax not apply to this modern tax? Suppose that the government imposes a tax on heating oil. a. Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain. b. Would the revenue collected from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain. After economics class one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. In what sense is taxing food a “good” way to raise revenue? In what sense is it not a “good” way to raise revenue? Daniel Patrick Moynihan, the late senator from New York, once introduced a bill that would levy a 10,000 percent tax on certain hollowtipped bullets. a. Do you expect that this tax would raise much revenue? Why or why not? b. Even if the tax would raise no revenue, why might Senator Moynihan have proposed it? The government places a tax on the purchase of socks. a. Illustrate the effect of this tax on equilibrium price and quantity in the sock market. Identify the following areas both before and after the imposition of the tax: total spending by consumers, total revenue for producers, and government tax revenue. b. Does the price received by producers rise or fall? Can you tell whether total receipts for producers rise or fall? Explain. c. Does the price paid by consumers rise or fall? Can you tell whether total spending by consumers rises or falls? Explain carefully. (Hint: Think about elasticity.) If total consumer spending falls, does consumer surplus rise? Explain.

9. Suppose the government currently raises $100 million through a 1-cent tax on widgets, and another $100 million through a 10-cent tax on gadgets. If the government doubled the tax rate on widgets and eliminated the tax on gadgets, would it raise more money than today, less money, or the same amount of money? Explain. 10. This chapter analyzed the welfare effects of a tax on a good. Consider now the opposite policy. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain. 11. Hotel rooms in Smalltown go for $100, and 1,000 rooms are rented on a typical day. a. To raise revenue, the mayor decides to charge hotels a tax of $10 per rented room. After the tax is imposed, the going rate for hotel rooms rises to $108, and the number of rooms rented falls to 900. Calculate the amount of revenue this tax raises for Smalltown and the deadweight loss of the tax. (Hint: The area of a triangle is 1⁄2 × base × height.) b. The mayor now doubles the tax to $20. The price rises to $116, and the number of rooms rented falls to 800. Calculate tax revenue and deadweight loss with this larger tax. Do they double, more than double, or less than double? Explain. 12. Suppose that a market is described by the following supply and demand equations: QS = 2P QD = 300 – P a. Solve for the equilibrium price and the equilibrium quantity. b. Suppose that a tax of T is placed on buyers, so the new demand equation is QD = 300 – (P + T). Solve for the new equilibrium. What happens to the price received by sellers, the price paid by buyers, and the quantity sold?

CHAPTER 8

c. Tax revenue is T × Q. Use your answer to part (b) to solve for tax revenue as a function of T. Graph this relationship for T between 0 and 300. d. The deadweight loss of a tax is the area of the triangle between the supply and demand curves. Recalling that the area of a triangle is 1⁄2 × base × height, solve for deadweight loss as a function of T. Graph this relation-

APPLICATION: THE COSTS OF TAXATION

ship for T between 0 and 300. (Hint: Looking sideways, the base of the deadweight loss triangle is T, and the height is the difference between the quantity sold with the tax and the quantity sold without the tax.) e. The government now levies a tax on this good of $200 per unit. Is this a good policy? Why or why not? Can you propose a better policy?

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9

CHAPTER

Application: International Trade

I

177

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MARKETS AND WELFARE

explain how the international marketplace achieves these gains from trade or how the gains are distributed among various economic participants. We now return to the study of international trade and take up these questions. Over the past several chapters, we have developed many tools for analyzing how markets work: supply, demand, equilibrium, consumer surplus, producer surplus, and so on. With these tools, we can learn more about how international trade affects economic well-being.

THE DETERMINANTS OF TRADE Consider the market for textiles. The textile market is well suited to examining the gains and losses from international trade: Textiles are made in many countries around the world, and there is much world trade in textiles. Moreover, the textile market is one in which policymakers often consider (and sometimes implement) trade restrictions to protect domestic producers from foreign competitors. We examine here the textile market in the imaginary country of Isoland.

THE EQUILIBRIUM

WITHOUT

TRADE

As our story begins, the Isolandian textile market is isolated from the rest of the world. By government decree, no one in Isoland is allowed to import or export textiles, and the penalty for violating the decree is so large that no one dares try. Because there is no international trade, the market for textiles in Isoland consists solely of Isolandian buyers and sellers. As Figure 1 shows, the domestic price adjusts to balance the quantity supplied by domestic sellers and the quantity demanded by domestic buyers. The p shows the consumer and producer surplus in the equilibrium without trade. The sum of consumer and producer surplus

1

F I G U R E Price of Textiles

The Equilibrium without International Trade When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. This p shows consumer and producer surplus in an equilibrium without international trade for the textile market in the imaginary country of Isoland.

Domestic supply Consumer surplus Equilibrium price

Producer surplus Domestic demand

0

Equilibrium quantity

Quantity of Textiles

CHAPTER 9

APPLICATION: INTERNATIONAL TRADE

measures the total benefits that buyers and sellers receive from participating in the textile market. Now suppose that, in an election upset, Isoland elects a new psident. The psident campaigned on a platform of “change” and promised the voters bold new ideas. Her first act is to assemble a team of economists to evaluate Isolandian trade policy. She asks them to report on three questions:

* If the government allows Isolandians to import and export textiles, what will * *

happen to the price of textiles and the quantity of textiles sold in the domestic textile market? Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses? Should a tariff (a tax on textile imports) be part of the new trade policy?

After reviewing supply and demand in their favorite textbook (this one, of course), the Isolandian economics team begins its analysis.

THE WORLD PRICE

AND

COMPARATIVE A DVANTAGE

Q

Q

UICK UIZ The country Autarka does not allow international trade. In Autarka, you can buy a wool suit for 3 ounces of gold. Meanwhile, in neighboring countries, you can buy the same suit for 2 ounces of gold. If Autarka were to allow free trade, would it import or export wool suits? Why?

world price the price of a good that pvails in the world market for that good

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THE WINNERS AND LOSERS FROM TRADE To analyze the welfare effects of free trade, the Isolandian economists begin with the assumption that Isoland is a small economy compared to the rest of the world. This small-economy assumption means that Isoland’s actions have little effect on world markets. Specifically, any change in Isoland’s trade policy will not affect the world price of textiles. The Isolandians are said to be price takers in the world economy. That is, they take the world price of textiles as given. Isoland can be an exporting country by selling textiles at this price or an importing country by buying textiles at this price. The small-economy assumption is not necessary to analyze the gains and losses from international trade. But the Isolandian economists know from experience (and from reading Chapter 2 of this book) that making simplifying assumptions is a key part of building a useful economic model. The assumption that Isoland is a small economy simplifies the analysis, and the basic lessons do not change in the more complicated case of a large economy.

THE GAINS

AND

L OSSES

OF AN

EXPORTING COUNTRY

Figure 2 shows the Isolandian textile market when the domestic equilibrium price before trade is below the world price. Once trade is allowed, the domestic price rises to equal the world price. No seller of textiles would accept less than the world price, and no buyer would pay more than the world price.

2

F I G U R E

International Trade in an Exporting Country Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of textiles produced domestically, and the demand curve shows the quantity consumed domestically. Exports from Isoland equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. Sellers are better off (producer surplus rises from C to B + C + D), and buyers are worse off (consumer surplus falls from A + B to A). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole.

Before Trade

After Trade

Change

A+B C A+B+C

A B+C+D A+B+C+D

-B +(B + D) +D

Consumer Surplus Producer Surplus Total Surplus

The area D shows the increase in total surplus and repsents the gains from trade. Price of Textiles

Price after trade

Domestic supply Exports

A

Price before trade

World price

D

B C

Exports 0

Domestic quantity demanded

Domestic quantity supplied

Domestic demand Quantity of Textiles

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APPLICATION: INTERNATIONAL TRADE

After the domestic price has risen to equal the world price, the domestic quantity supplied differs from the domestic quantity demanded. The supply curve shows the quantity of textiles supplied by Isolandian sellers. The demand curve shows the quantity of textiles demanded by Isolandian buyers. Because the domestic quantity supplied is greater than the domestic quantity demanded, Isoland sells textiles to other countries. Thus, Isoland becomes a textile exporter. Although domestic quantity supplied and domestic quantity demanded differ, the textile market is still in equilibrium because there is now another participant in the market: the rest of the world. One can view the horizontal line at the world price as repsenting the rest of the world’s demand for textiles. This demand curve is perfectly elastic because Isoland, as a small economy, can sell as many textiles as it wants at the world price. Now consider the gains and losses from opening up trade. Clearly, not everyone benefits. Trade forces the domestic price to rise to the world price. Domestic producers of textiles are better off because they can now sell textiles at a higher price, but domestic consumers of textiles are worse off because they have to buy textiles at a higher price. To measure these gains and losses, we look at the changes in consumer and producer surplus. Before trade is allowed, the price of textiles adjusts to balance domestic supply and domestic demand. Consumer surplus, the area between the demand curve and the before-trade price, is area A + B. Producer surplus, the area between the supply curve and the before-trade price, is area C. Total surplus before trade, the sum of consumer and producer surplus, is area A + B + C. After trade is allowed, the domestic price rises to the world price. Consumer surplus is reduced to area A (the area between the demand curve and the world price). Producer surplus is increased to area B + C + D (the area between the supply curve and the world price). Thus, total surplus with trade is area A + B + C + D. These welfare calculations show who wins and who loses from trade in an exporting country. Sellers benefit because producer surplus increases by the area B + D. Buyers are worse off because consumer surplus decreases by the area B. Because the gains of sellers exceed the losses of buyers by the area D, total surplus in Isoland increases. This analysis of an exporting country yields two conclusions:

* When a country allows trade and becomes an exporter of a good, domestic *

producers of the good are better off, and domestic consumers of the good are worse off. Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.

THE GAINS

AND

L OSSES

OF AN

IMPORTING COUNTRY

Now suppose that the domestic price before trade is above the world price. Once again, after trade is allowed, the domestic price must equal the world price. As Figure 3 shows, the domestic quantity supplied is less than the domestic quantity demanded. The difference between the domestic quantity demanded and the domestic quantity supplied is bought from other countries, and Isoland becomes a textile importer. In this case, the horizontal line at the world price repsents the supply of the rest of the world. This supply curve is perfectly elastic because Isoland is a small economy and, therefore, can buy as many textiles as it wants at the world price.

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International Trade in an Importing Country Once trade is allowed, the domestic price falls to equal the world price. The supply curve shows the amount produced domestically, and the demand curve shows the amount consumed domestically. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off (consumer surplus rises from A to A + B + D), and sellers are worse off (producer surplus falls from B + C to C). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole.

Consumer Surplus Producer Surplus Total Surplus

Before Trade

After Trade

Change

A B+C A+B+C

A+B+D C A+B+C+D

+(B + D) -B +D

The area D shows the increase in total surplus and repsents the gains from trade. Price of Textiles Domestic supply A Price before trade Price after trade

B

D World price

C Imports

0

Domestic quantity supplied

Domestic quantity demanded

Domestic demand Quantity of Textiles

Now consider the gains and losses from trade. Once again, not everyone benefits. When trade forces the domestic price to fall, domestic consumers are better off (they can now buy textiles at a lower price), and domestic producers are worse off (they now have to sell textiles at a lower price). Changes in consumer and producer surplus measure the size of the gains and losses. Before trade, consumer surplus is area A, producer surplus is area B + C, and total surplus is area A + B + C. After trade is allowed, consumer surplus is area A + B + D, producer surplus is area C, and total surplus is area A + B + C + D. These welfare calculations show who wins and who loses from trade in an importing country. Buyers benefit because consumer surplus increases by the area B + D. Sellers are worse off because producer surplus falls by the area B. The gains of buyers exceed the losses of sellers, and total surplus increases by the area D. This analysis of an importing country yields two conclusions parallel to those for an exporting country:

* When a country allows trade and becomes an importer of a good, domestic *

consumers of the good are better off, and domestic producers of the good are worse off. Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.

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Having completed our analysis of trade, we can better understand one of the Ten Principles of Economics in Chapter 1: Trade can make everyone better off. If Isoland opens its textile market to international trade, the change will create winners and losers, regardless of whether Isoland ends up exporting or importing textiles. In either case, however, the gains of the winners exceed the losses of the losers, so the winners could compensate the losers and still be better off. In this sense, trade can make everyone better off. But will trade make everyone better off? Probably not. In practice, compensation for the losers from international trade is rare. Without such compensation, opening an economy to international trade is a policy that expands the size of the economic pie, while perhaps leaving some participants in the economy with a smaller slice. We can now see why the debate over trade policy is often contentious. Whenever a policy creates winners and losers, the stage is set for a political battle. Nations sometimes fail to enjoy the gains from trade because the losers from free trade are better organized than the winners. The losers may turn their cohesiveness into political clout, lobbying for trade restrictions such as tariffs or import quotas.

THE EFFECTS

OF A

TARIFF

The Isolandian economists next consider the effects of a tariff-a tax on imported goods. The economists quickly realize that a tariff on textiles will have no effect if Isoland becomes a textile exporter. If no one in Isoland is interested in importing textiles, a tax on textile imports is irrelevant. The tariff matters only if Isoland becomes a textile importer. Concentrating their attention on this case, the economists compare welfare with and without the tariff. Figure 4 shows the Isolandian market for textiles. Under free trade, the domestic price equals the world price. A tariff raises the price of imported textiles above the world price by the amount of the tariff. Domestic suppliers of textiles, who compete with suppliers of imported textiles, can now sell their textiles for the world price plus the amount of the tariff. Thus, the price of textiles-both imported and domestic-rises by the amount of the tariff and is, therefore, closer to the price that would pvail without trade. The change in price affects the behavior of domestic buyers and sellers. Because the tariff raises the price of textiles, it reduces the domestic quantity demanded from Q D1 to Q D2 and raises the domestic quantity supplied from Q S1 to Q S2. Thus, the tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. Now consider the gains and losses from the tariff. Because the tariff raises the domestic price, domestic sellers are better off, and domestic buyers are worse off. In addition, the government raises revenue. To measure these gains and losses, we look at the changes in consumer surplus, producer surplus, and government revenue. These changes are summarized in the table in Figure 4. Before the tariff, the domestic price equals the world price. Consumer surplus, the area between the demand curve and the world price, is area A + B + C + D + E + F. Producer surplus, the area between the supply curve and the world price, is area G. Government revenue equals zero. Total surplus, the sum of consumer surplus, producer surplus, and government revenue, is area A + B + C + D + E + F + G. Once the government imposes a tariff, the domestic price exceeds the world price by the amount of the tariff. Consumer surplus is now area A + B. Producer

tariff a tax on goods produced abroad and sold domestically

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A tariff of reduces the quantity of imports and moves a market closer to the equilibrium Types Graphs that pie would exist without surplus falls by an amount equalfrom to area D + F. The chart in panel (a) trade. showsTotal how U.S. national income is derived various These two triangles repsent lossaverage from the tariff. in four countries. sources. The bar graph in panelthe (b)deadweight compares the income The time-series graph in panel (c) shows the productivity of labor in U.S. businesses from 1950 to 2000.

The Effects of a Tariff

Consumer Surplus Producer Surplus Government Revenue Total Surplus

Before Tariff

After Tariff

Change

A+B+C+D+E+F G None A+B+C+D+E+F+G

A+B C+G E A+B+C+E+G

-(C + D + E + F) +C +E -(D + F)

The area D + F shows the fall in total surplus and repsents the deadweight loss of the tariff. Price of Textiles

Domestic supply

A

Equilibrium without trade B

Price with tariff Price without tariff

0

Tariff

C

D

E

G

F

Imports with tariff Q1S

Q2S

Domestic demand Q2D

Q1D

World price

Quantity of Textiles

Imports without tariff

surplus is area C + G. Government revenue, which is the quantity of after-tariff imports times the size of the tariff, is the area E. Thus, total surplus with the tariff is area A + B + C + E + G. To determine the total welfare effects of the tariff, we add the change in consumer surplus (which is negative), the change in producer surplus (positive), and the change in government revenue (positive). We find that total surplus in the market decreases by the area D + F. This fall in total surplus is called the deadweight loss of the tariff. A tariff causes a deadweight loss simply because a tariff is a type of tax. Like most taxes, it distorts incentives and pushes the allocation of scarce resources

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Import Quotas: Another Way to Restrict Trade Beyond tariffs, another way that nations sometimes restrict international trade is by putting limits on how much of a good can be imported. In this book, we will not analyze such a policy, other than to point out the conclusion: Import quotas are much like tariffs. Both tariffs and import quotas reduce the quantity of imports, raise the domestic price of the good, decrease the welfare of domestic consumers, increase the welfare of domestic producers, and cause deadweight losses. There is only one difference between these two types of trade restriction: A tariff raises revenue for the government, whereas an import quota creates surplus for those who obtain the licenses to import. The profit for the holder of an import license is the difference between the domestic price (at which he sells the imported good) and the world price (at which he buys it). Tariffs and import quotas are even more similar if the government charges a fee for the import licenses. Suppose the government

sets the license fee equal to the difference between the domestic price and the world price. In this case, all the profit of license holders is paid to the government in license fees, and the import quota works exactly like a tariff. Consumer surplus, producer surplus, and government revenue are pcisely the same under the two policies. In practice, however, countries that restrict trade with import quotas rarely do so by selling the import licenses. For example, the U.S. government has at times pssured Japan to “voluntarily” limit the sale of Japanese cars in the United States. In this case, the Japanese government allocates the import licenses to Japanese firms, and the surplus from these licenses accrues to those firms. From the standpoint of U.S. welfare, this kind of import quota is worse than a U.S. tariff on imported cars. Both a tariff and an import quota raise prices, restrict trade, and cause deadweight losses, but at least the tariff produces revenue for the U.S. government rather than profit for foreign producers.

away from the optimum. In this case, we can identify two effects. First, when the tariff raises the domestic price of textiles above the world price, it encourages domestic producers to increase production from Q S1 to Q S2. Even though the cost of making these incremental units exceeds the cost of buying them at the world price, the tariff makes it profitable for domestic producers to manufacture them nonetheless. Second, when the tariff raises the price that domestic textile consumers have to pay, it encourages them to reduce consumption of textiles from Q D1 to Q D2 . Even though domestic consumers value these incremental units at more than the world price, the tariff induces them to cut back their purchases. Area D repsents the deadweight loss from the overproduction of textiles, and area F repsents the deadweight loss from the underconsumption. The total deadweight loss of the tariff is the sum of these two triangles.

THE LESSONS

FOR

TRADE POLICY

The team of Isolandian economists can now write to the new psident: Dear Madame President, You asked us three questions about opening up trade. After much hard work, we have the answers.

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OTHER BENEFITS

OF

INTERNATIONAL TRADE

The conclusions of the Isolandian economics team are based on the standard analysis of international trade. Their analysis uses the most fundamental tools in the economist’s toolbox: supply, demand, and producer and consumer surplus. It shows that there are winners and losers when a nation opens itself up to trade, but the gains to the winners exceed the losses of the losers. The case for free trade can be made even stronger, however, because there are several other economic benefits of trade beyond those emphasized in the standard analysis. Here, in a nutshell, are some of these other benefits:

* Increased variety of goods. Goods produced in different countries are not exactly the same. German beer, for instance, is not the same as American beer. Free trade gives consumers in all countries greater variety from which to choose.

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APPLICATION: INTERNATIONAL TRADE

Should the Winners from Free Trade Compensate the Losers? Political candidates often say that the government should help those made worse off by international trade. In this opinion piece, an economist makes the opposite case.

What to Expect When You’re Free Trading By Steven E. Landsburg In the days before Tuesday’s Republican psidential primary in Michigan, Mitt Romney and John McCain battled over what the government owes to workers who lose their jobs because of the foreign competition unleashed by free trade. Their rhetoric differed-Mr. Romney said he would “fight for every single job,” while Mr. McCain said some jobs “are not coming back”-but their proposed policies were remarkably similar: educate and retrain the workers for new jobs. All economists know that when American jobs are outsourced, Americans as a group are net winners. What we lose through lower wages is more than offset by what we gain through lower prices. In other words, the winners can more than afford to compensate the losers. Does that mean they ought to? Does it create a moral mandate for the taxpayer-subsidized retraining programs proposed by Mr. McCain and Mr. Romney? Um, no. Even if you’ve just lost your job, there’s something fundamentally churlish about blaming the very phenomenon that’s elevated you above the subsistence level since the day you were born. If the world owes you compensation for enduring the downside of trade, what do you owe the world for enjoying the upside? Source: New York Times, January 16, 2008.

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* Lower costs through economies of scale. Some goods can be produced at

*

*

QUICK QUIZ

Draw a supply and demand diagram for wool suits in the country of Autarka. When trade is allowed, the price of a suit falls from 3 to 2 ounces of gold. In your diagram, show the change in consumer surplus, the change in producer surplus, and the change in total surplus. How would a tariff on suit imports alter these effects?

THE JOBS A RGUMENT “YOU LIKE PROTECTIONISM AS A ‘WORKING MAN.’ HOW ABOUT AS A CONSUMER?”

Opponents of free trade often argue that trade with other countries destroys domestic jobs. In our example, free trade in textiles would cause the price of textiles to fall, reducing the quantity of textiles produced in Isoland and thus reducing employment in the Isolandian textile industry. Some Isolandian textile workers would lose their jobs.

CARTOON: © BERRY’S WORLD REPRINTED BY PERMISSION OF UNITED FEATURE SYNDICATE, INC.

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health of U.S. airlines, and the security of the jobs and pensions of most airline employees, should he not applaud Delta for saving $25 million a year by sending some reservation services to India? Does Kerry really want to restrain the rise of health care costs? Does he oppose having X-rays analyzed in India at a fraction of the U.S. cost? In November, Indiana Gov. Joseph Kernan canceled a $15 million contract with a firm in India to process state unemployment claims. The contract was given to a U.S. firm that will charge $23 million. Because of this 53 percent price increase, there will be 8 million fewer state dollars for schools, hospitals, law enforcement, etc. And the benefit to Indiana is . . . what? When Kernan made this gesture he probably was wearing something that was wholly or partly imported and that at one time, before offshoring, would have been entirely made here. Such potential embarrassments are among the perils of making moral grandstanding into an economic policy.

Source: The Washington Post, Friday, February 20, 2004. Page A25. Copyright © 2004, The Washington Post Writers Group. Reprinted with permission.

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THE NATIONAL-SECURITY A RGUMENT When an industry is threatened with competition from other countries, opponents of free trade often argue that the industry is vital for national security. For example, if Isoland were considering free trade in steel, domestic steel companies might point out that steel is used to make guns and tanks. Free trade would allow Isoland to become dependent on foreign countries to supply steel. If a war later broke out and the foreign supply was interrupted, Isoland might be unable to produce enough steel and weapons to defend itself. Economists acknowledge that protecting key industries may be appropriate when there are legitimate concerns over national security. Yet they fear that this argument may be used too quickly by producers eager to gain at consumers’ expense. One should be wary of the national-security argument when it is made by repsentatives of industry rather than the defense establishment. Companies have an incentive to exaggerate their role in national defense to obtain protection from foreign competition. A nation’s generals may see things very differently. Indeed, when the military is a consumer of an industry’s output, it would benefit from imports. Cheaper steel in Isoland, for example, would allow the Isolandian military to accumulate a stockpile of weapons at lower cost.

THE INFANT-INDUSTRY A RGUMENT New industries sometimes argue for temporary trade restrictions to help them get started. After a period of protection, the argument goes, these industries will mature and be able to compete with foreign firms. Similarly, older industries sometimes argue that they need temporary protection to help them adjust to new conditions. For example, in 2002, President Bush imposed temporary tariffs on imported steel. He said, “I decided that imports were severely affecting our industry, an important industry.” The tariff, which lasted 20 months, offered “temporary relief so that the industry could restructure itself.” Economists are often skeptical about such claims, largely because the infantindustry argument is difficult to implement in practice. To apply protection suc-

CHAPTER 9

APPLICATION: INTERNATIONAL TRADE

cessfully, the government would need to decide which industries will eventually be profitable and decide whether the benefits of establishing these industries exceed the costs of this protection to consumers. Yet “picking winners” is extraordinarily difficult. It is made even more difficult by the political process, which often awards protection to those industries that are politically powerful. And once a powerful industry is protected from foreign competition, the “temporary” policy is sometimes hard to remove. In addition, many economists are skeptical about the infant-industry argument in principle. Suppose, for instance, that an industry is young and unable to compete profitably against foreign rivals, but there is reason to believe that the industry can be profitable in the long run. In this case, firm owners should be willing to incur temporary losses to obtain the eventual profits. Protection is not necessary for an infant industry to grow. History shows that start-up firms often incur temporary losses and succeed in the long run, even without protection from competition.

THE UNFAIR-COMPETITION A RGUMENT A common argument is that free trade is desirable only if all countries play by the same rules. If firms in different countries are subject to different laws and regulations, then it is unfair (the argument goes) to expect the firms to compete in the international marketplace. For instance, suppose that the government of Neighborland subsidizes its textile industry by giving textile companies large tax breaks. The Isolandian textile industry might argue that it should be protected from this foreign competition because Neighborland is not competing fairly. Would it, in fact, hurt Isoland to buy textiles from another country at a subsidized price? Certainly, Isolandian textile producers would suffer, but Isolandian textile consumers would benefit from the low price. The case for free trade is no different: The gains of the consumers from buying at the low price would exceed the losses of the producers. Neighborland’s subsidy to its textile industry may be a bad policy, but it is the taxpayers of Neighborland who bear the burden. Isoland can benefit from the opportunity to buy textiles at a subsidized price.

THE PROTECTION-AS-A-BARGAINING-CHIP A RGUMENT Another argument for trade restrictions concerns the strategy of bargaining. Many policymakers claim to support free trade but, at the same time, argue that trade restrictions can be useful when we bargain with our trading partners. They claim that the threat of a trade restriction can help remove a trade restriction already imposed by a foreign government. For example, Isoland might threaten to impose a tariff on textiles unless Neighborland removes its tariff on wheat. If Neighborland responds to this threat by removing its tariff, the result can be freer trade. The problem with this bargaining strategy is that the threat may not work. If it doesn’t work, the country faces a choice between two bad options. It can carry out its threat and implement the trade restriction, which would reduce its own economic welfare. Or it can back down from its threat, which would cause it to lose pstige in international affairs. Faced with this choice, the country would probably wish that it had never made the threat in the first place.

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Second Thoughts about Free Trade Some economists worry about the impact of trade on the distribution of income. Even if free trade enhances efficiency, it may reduce equality.

countries is a very good thing. Above all, it offers backward economies their best hope of moving up the income ladder. But for American workers the story is much less positive. In fact, it’s hard to avoid the conclusion that growing U.S. trade with third-world countries reduces the real wages of many and perhaps most workers in this country. And that reality makes the politics of trade very difficult. Let’s talk for a moment about the economics. Trade between high-wage countries tends to be a modest win for all, or almost all, concerned. When a free-trade pact made it possible to integrate the U.S. and Canadian auto industries in the 1960s, each country’s industry concentrated on producing a nar-

rower range of products at larger scale. The result was an all-round, broadly shared rise in productivity and wages. By contrast, trade between countries at very different levels of economic development tends to create large classes of losers as well as winners. Although the outsourcing of some hightech jobs to India has made headlines, on balance, highly educated workers in the United States benefit from higher wages and expanded job opportunities because of trade. For example, ThinkPad notebook computers are now made by a Chinese company, Lenovo, but a lot of Lenovo’s research and development is conducted in North Carolina. But workers with less formal education either see their jobs shipped overseas or

TRADE AGREEMENTS AND THE WORLD TRADE ORGANIZATION A country can take one of two approaches to achieving free trade. It can take a unilateral approach and remove its trade restrictions on its own. This is the approach that Great Britain took in the 19th century and that Chile and South Korea have taken in recent years. Alternatively, a country can take a multilateral approach and reduce its trade restrictions while other countries do the same. In other words, it can bargain with its trading partners in an attempt to reduce trade restrictions around the world. One important example of the multilateral approach is the North American Free Trade Agreement (NAFTA), which in 1993 lowered trade barriers among the United States, Mexico, and Canada. Another is the General Agreement on Tariffs and Trade (GATT), which is a continuing series of negotiations among many of the world’s countries with the goal of promoting free trade. The United States

CHAPTER 9

find their wages driven down by the ripple effect as other workers with similar qualifications crowd into their industries and look for employment to replace the jobs they lost to foreign competition. And lower prices at Wal-Mart aren’t sufficient compensation. All this is textbook international economics: contrary to what people sometimes assert, economic theory says that free trade normally makes a country richer, but it doesn’t say that it’s normally good for everyone. Still, when the effects of third-world exports on U.S. wages first became an issue in the 1990s, a number of economists- myself included-looked at the data and concluded that any negative effects on U.S. wages were modest. The trouble now is that these effects may no longer be as modest as they were, because imports of manufactured goods from the third world have grown dramatically-from just 2.5 percent of G.D.P. in 1990 to 6 percent in 2006. And the biggest growth in imports has come from countries with very low wages.

The original “newly industrializing economies” exporting manufactured goods- South Korea, Taiwan, Hong Kong and Singapore-paid wages that were about 25 percent of U.S. levels in 1990. Since then, however, the sources of our imports have shifted to Mexico, where wages are only 11 percent of the U.S. level, and China, where they’re only about 3 percent or 4 percent. There are some qualifying aspects to this story. For example, many of those madein-China goods contain components made in Japan and other high-wage economies. Still, there’s little doubt that the pssure of globalization on American wages has increased. So am I arguing for protectionism? No. Those who think that globalization is always and everywhere a bad thing are wrong. On the contrary, keeping world markets relatively open is crucial to the hopes of billions of people. But I am arguing for an end to the finger-wagging, the accusation either of not understanding economics or of kowtow-

APPLICATION: INTERNATIONAL TRADE

ing to special interests that tends to be the editorial response to politicians who expss skepticism about the benefits of free-trade agreements. It’s often claimed that limits on trade benefit only a small number of Americans, while hurting the vast majority. That’s still true of things like the import quota on sugar. But when it comes to manufactured goods, it’s at least arguable that the reverse is true. The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose. As I said, I’m not a protectionist. For the sake of the world as a whole, I hope that we respond to the trouble with trade not by shutting trade down, but by doing things like strengthening the social safety net. But those who are worried about trade have a point, and deserve some respect.

Source: New York Times, December 28, 2007.

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Q

Q

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APPLICATION: INTERNATIONAL TRADE

farmers and grow the wheat that the inventor turns into textiles. Others enter new industries that emerge as a result of higher Isolandian living standards. Everyone understands that the displacement of workers in outmoded industries is an inevitable part of technological progress and economic growth. After several years, a newspaper reporter decides to investigate this mysterious new textiles process. She sneaks into the inventor’s factory and learns that the inventor is a fraud. The inventor has not been making textiles at all. Instead, he has been smuggling wheat abroad in exchange for textiles from other countries. The only thing that the inventor had discovered was the gains from international trade. When the truth is revealed, the government shuts down the inventor’s operation. The price of textiles rises, and workers return to jobs in textile factories. Living standards in Isoland fall back to their former levels. The inventor is jailed and held up to public ridicule. After all, he was no inventor. He was just an economist.

* When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off. When a country allows trade and becomes an importer of a good, consumers are better off, and producers are worse off. In both cases, the gains from trade exceed the losses.

closer to the equilibrium that would exist without trade and, therefore, reduces the gains from trade. Although domestic producers are better off and the government raises revenue, the losses to consumers exceed these gains.

* There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, pventing unfair competition, and responding to foreign trade restrictions. Although some of these arguments have some merit in some cases, economists believe that free trade is usually the better policy.

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KEY CONCEPTS world price, p. 179

tariff, p. 183

plus with free trade? What is the change in total surplus? 4. Describe what a tariff is and its economic effects. 5. List five arguments often given to support trade restrictions. How do economists respond to these arguments? 6. What is the difference between the unilateral and multilateral approaches to achieving free trade? Give an example of each.

PROBLEMS AND APPLICATIONS 1. Mexico repsents a small part of the world orange market. a. Draw a diagram depicting the equilibrium in the Mexican orange market without international trade. Identify the equilibrium price, equilibrium quantity, consumer surplus, and producer surplus. b. Suppose that the world orange price is below the Mexican price before trade and that the Mexican orange market is now opened to trade. Identify the new equilibrium price, quantity consumed, quantity produced domestically, and quantity imported. Also show the change in the surplus of domestic consumers and producers. Has total surplus increased or decreased?

CHAPTER 9

plus, and total surplus in Canada. Who are the winners and losers? Is Canada as a whole better or worse off? 3. Suppose that Congress imposes a tariff on imported autos to protect the U.S. auto industry from foreign competition. Assuming that the United States is a price taker in the world auto market, show on a diagram: the change in the quantity of imports, the loss to U.S. consumers, the gain to U.S. manufacturers, government revenue, and the deadweight loss associated with the tariff. The loss to consumers can be decomposed into three pieces: a gain to domestic producers, revenue for the government, and a deadweight loss. Use your diagram to identify these three pieces. 4. When China’s clothing industry expands, the increase in world supply lowers the world price of clothing. a. Draw an appropriate diagram to analyze how this change in price affects consumer surplus, producer surplus, and total surplus in a nation that imports clothing, such as the United States. b. Now draw an appropriate diagram to show how this change in price affects consumer surplus, producer surplus, and total surplus in a nation that exports clothing, such as the Dominican Republic. c. Compare your answers to parts (a) and (b). What are the similarities and what are the differences? Which country should be concerned about the expansion of the Chinese textile industry? Which country should be applauding it? Explain. 5. Imagine that winemakers in the state of Washington petitioned the state government to tax wines imported from California. They argue that this tax would both raise tax revenue for the state government and raise employment in the Washington State wine industry. Do you agree with these claims? Is it a good policy?

APPLICATION: INTERNATIONAL TRADE

6. Consider the arguments for restricting trade. a. Assume you are a lobbyist for timber, an established industry suffering from lowpriced foreign competition. Which two or three of the five arguments do you think would be most persuasive to the average member of Congress as to why he or she should support trade restrictions? Explain your reasoning. b. Now assume you are an astute student of economics (hopefully not a hard assumption). Although all the arguments for restricting trade have their shortcomings, name the two or three arguments that seem to make the most economic sense to you. For each, describe the economic rationale for and against these arguments for trade restrictions. 7. Senator Ernest Hollings once wrote that “consumers do not benefit from lower-priced imports. Glance through some mail-order catalogs and you’ll see that consumers pay exactly the same price for clothing whether it is chúng tôi or imported.” Comment. 8. The nation of Textilia does not allow imports of clothing. In its equilibrium without trade, a T-shirt costs $20, and the equilibrium quantity is 3 million T-shirts. One day, after reading Adam Smith’s The Wealth of Nations while on vacation, the psident decides to open the Textilian market to international trade. The market price of a T-shirt falls to the world price of $16. The number of T-shirts consumed in Textilia rises to 4 million, while the number of T-shirts produced declines to 1 million. a. Illustrate the situation just described in a graph. Your graph should show all the numbers. b. Calculate the change in consumer surplus, producer surplus, and total surplus that results from opening up trade. (Hint: Recall that the area of a triangle is 1⁄2 × base × height.)

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9. China is a major producer of grains, such as wheat, corn, and rice. In 2008 the Chinese government, concerned that grain exports were driving up food prices for domestic consumers, imposed a tax on grain exports. a. Draw the graph that describes the market for grain in an exporting country. Use this graph as the starting point to answer the following questions. b. How does an export tax affect domestic grain prices? c. How does it affect the welfare of domestic consumers, the welfare of domestic producers, and government revenue? d. What happens to total welfare in China, as measured by the sum of consumer surplus, producer surplus, and tax revenue? 10. Consider a country that imports a good from abroad. For each of following statements, say whether it is true or false. Explain your answer. a. “The greater the elasticity of demand, the greater the gains from trade.” b. “If demand is perfectly inelastic, there are no gains from trade.” c. “If demand is perfectly inelastic, consumers do not benefit from trade.” 11. Kawmin is a small country that produces and consumes jelly beans. The world price of jelly beans is $1 per bag, and Kawmin’s domestic demand and supply for jelly beans are governed by the following equations: Demand: QD = 8 – P Supply: QS = P, where P is in dollars per bag and Q is in bags of jelly beans. a. Draw a well-labeled graph of the situation in Kawmin if the nation does not allow trade. Calculate the following (recalling that the area of a triangle is 1⁄2 × base × height): the equilibrium price and quantity, consumer surplus, producer surplus, and total surplus.

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APPLICATION: INTERNATIONAL TRADE

steel, the quantity of steel produced, the quantity of steel consumed, and the quantity of steel exported? How does it affect consumer surplus, producer surplus, government revenue, and total surplus? Is it a good policy from the standpoint of economic efficiency? (Hint: The analysis of an export subsidy is similar to the analysis of a tariff.)

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Externalities

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externality the uncompensated impact of one person’s actions on the well-being of a bystander

* The exhaust from automobiles is a negative externality because it creates

*

*

*

smog that other people have to breathe. As a result of this externality, drivers tend to pollute too much. The federal government attempts to solve this problem by setting emission standards for cars. It also taxes gasoline to reduce the amount that people drive. Restored historic buildings convey a positive externality because people who walk or ride by them can enjoy the beauty and the sense of history that these buildings provide. Building owners do not get the full benefit of restoration and, therefore, tend to discard older buildings too quickly. Many local governments respond to this problem by regulating the destruction of historic buildings and by providing tax breaks to owners who restore them. Barking dogs create a negative externality because neighbors are disturbed by the noise. Dog owners do not bear the full cost of the noise and, therefore, tend to take too few pcautions to pvent their dogs from barking. Local governments address this problem by making it illegal to “disturb the peace.” Research into new technologies provides a positive externality because it creates knowledge that other people can use. Because inventors cannot capture the full benefits of their inventions, they tend to devote too few resources to research. The federal government addresses this problem partially through the patent system, which gives inventors exclusive use of their inventions for a limited time.

In each of these cases, some decision maker fails to take account of the external effects of his or her behavior. The government responds by trying to influence this behavior to protect the interests of bystanders.

EXTERNALITIES AND MARKET INEFFICIENCY In this section, we use the tools of welfare economics developed in Chapter 7 to examine how externalities affect economic well-being. The analysis shows pcisely why externalities cause markets to allocate resources inefficiently. Later in

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the chapter, we examine various ways in which private inpiduals and public policymakers may remedy this type of market failure.

WELFARE ECONOMICS: A R ECAP We begin by recalling the key lessons of welfare economics from Chapter 7. To make our analysis concrete, we consider a specific market-the market for aluminum. Figure 1 shows the supply and demand curves in the market for aluminum. As you should recall from Chapter 7, the supply and demand curves contain important information about costs and benefits. The demand curve for aluminum reflects the value of aluminum to consumers, as measured by the prices they are willing to pay. At any given quantity, the height of the demand curve shows the willingness to pay of the marginal buyer. In other words, it shows the value to the consumer of the last unit of aluminum bought. Similarly, the supply curve reflects the costs of producing aluminum. At any given quantity, the height of the supply curve shows the cost of the marginal seller. In other words, it shows the cost to the producer of the last unit of aluminum sold. In the absence of government intervention, the price adjusts to balance the supply and demand for aluminum. The quantity produced and consumed in the market equilibrium, shown as QMARKET in Figure 1, is efficient in the sense that it maximizes the sum of producer and consumer surplus. That is, the market allocates resources in a way that maximizes the total value to the consumers who buy and use aluminum minus the total costs to the producers who make and sell aluminum.

NEGATIVE EXTERNALITIES Now let’s suppose that aluminum factories emit pollution: For each unit of aluminum produced, a certain amount of smoke enters the atmosphere. Because this

F I G U R E Price of Aluminum

Supply (private cost)

The demand curve reflects the value to buyers, and the supply curve reflects the costs of sellers. The equilibrium quantity, QMARKET, maximizes the total value to buyers minus the total costs of sellers. In the absence of externalities, therefore, the market equilibrium is efficient.

Equilibrium

Demand (private value) 0

QMARKET

The Market for Aluminum

Quantity of Aluminum

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“ALL I CAN SAY IS THAT IF BEING A LEADING MANUFACTURER MEANS BEING A LEADING POLLUTER, SO BE IT.”

2

F I G U R E Price of Aluminum

Social cost (private cost and external cost)

Pollution and the Social Optimum

External Cost

In the psence of a negative externality, such as pollution, the social cost of the good exceeds the private cost. The optimal quantity, QOPTIMUM, is therefore smaller than the equilibrium quantity, QMARKET.

Supply (private cost)

Optimum Equilibrium

Demand (private value) 0

QOPTIMUM QMARKET

Quantity of Aluminum

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rium, the marginal consumer values aluminum at less than the social cost of producing it. That is, at QMARKET, the demand curve lies below the social-cost curve. Thus, reducing aluminum production and consumption below the market equilibrium level raises total economic well-being. How can the social planner achieve the optimal outcome? One way would be to tax aluminum producers for each ton of aluminum sold. The tax would shift the supply curve for aluminum upward by the size of the tax. If the tax accurately reflected the external cost of smoke released into the atmosphere, the new supply curve would coincide with the social-cost curve. In the new market equilibrium, aluminum producers would produce the socially optimal quantity of aluminum. The use of such a tax is called internalizing the externality because it gives buyers and sellers in the market an incentive to take into account the external effects of their actions. Aluminum producers would, in essence, take the costs of pollution into account when deciding how much aluminum to supply because the tax would make them pay for these external costs. And, because the market price would reflect the tax on producers, consumers of aluminum would have an incentive to use a smaller quantity. The policy is based on one of the Ten Principles of Economics: People respond to incentives. Later in this chapter, we consider in more detail how policymakers can deal with externalities.

EXTERNALITIES

internalizing the externality altering incentives so that people take account of the external effects of their actions

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F I G U R E Price of Education Supply (private cost)

Education and the Social Optimum In the psence of a positive externality, the social value of the good exceeds the private value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity, QMARKET.

External benefit

Optimum Equilibrium

Social value (private value and external benefit) Demand (private value) 0

QMARKET

QOPTIMUM

Quantity of Education

is socially desirable. To remedy the problem, the government can internalize the externality by taxing goods that have negative externalities and subsidizing goods that have positive externalities.

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QUICK QUIZ

Give an example of a negative externality and a positive externality. Explain why market outcomes are inefficient in the psence of these externalities.

PUBLIC POLICIES TOWARD EXTERNALITIES We have discussed why externalities lead markets to allocate resources inefficiently but have mentioned only briefly how this inefficiency can be remedied. In practice, both public policymakers and private inpiduals respond to externalities in various ways. All of the remedies share the goal of moving the allocation of resources closer to the social optimum. This section considers governmental solutions. As a general matter, the government can respond to externalities in one of two ways. Command-and-control policies regulate behavior directly. Market-based policies provide incentives so that private decision makers will choose to solve the problem on their own.

COMMAND-AND-CONTROL POLICIES: R EGULATION The government can remedy an externality by making certain behaviors either required or forbidden. For example, it is a crime to dump poisonous chemicals into the water supply. In this case, the external costs to society far exceed the benefits to the polluter. The government therefore institutes a command-and-control policy that prohibits this act altogether. In most cases of pollution, however, the situation is not this simple. Despite the stated goals of some environmentalists, it would be impossible to prohibit all polluting activity. For example, virtually all forms of transportation-even

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the horse-produce some undesirable polluting by-products. But it would not be sensible for the government to ban all transportation. Thus, instead of trying to eradicate pollution entirely, society has to weigh the costs and benefits to decide the kinds and quantities of pollution it will allow. In the United States, the Environmental Protection Agency (EPA) is the government agency with the task of developing and enforcing regulations aimed at protecting the environment. Environmental regulations can take many forms. Sometimes the EPA dictates a maximum level of pollution that a factory may emit. Other times the EPA requires that firms adopt a particular technology to reduce emissions. In all cases, to design good rules, the government regulators need to know the details about specific industries and about the alternative technologies that those industries could adopt. This information is often difficult for government regulators to obtain.

M ARKET-BASED POLICY 1: CORRECTIVE TAXES AND SUBSIDIES

corrective tax a tax designed to induce private decision makers to take account of the social costs that arise from a negative externality

* Regulation: The EPA could tell each factory to reduce its pollution to 300 tons of glop per year.

* Corrective tax: The EPA could levy a tax on each factory of $50,000 for each ton of glop it emits. The regulation would dictate a level of pollution, whereas the tax would give factory owners an economic incentive to reduce pollution. Which solution do you think is better? Most economists pfer the tax. To explain this pference, they would first point out that a tax is just as effective as a regulation in reducing the overall level of pollution. The EPA can achieve whatever level of pollution it wants by setting the tax at the appropriate level. The higher the tax, the larger the reduction in pollution. If the tax is high enough, the factories will close down altogether, reducing pollution to zero. Although regulation and corrective taxes are both capable of reducing pollution, the tax accomplishes this goal more efficiently. The regulation requires each factory to reduce pollution by the same amount. An equal reduction, however, is not necessarily the least expensive way to clean up the water. It is possible that the paper

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mill can reduce pollution at lower cost than the steel mill. If so, the paper mill would respond to the tax by reducing pollution substantially to avoid the tax, whereas the steel mill would respond by reducing pollution less and paying the tax. In essence, the corrective tax places a price on the right to pollute. Just as markets allocate goods to those buyers who value them most highly, a corrective tax allocates pollution to those factories that face the highest cost of reducing it. Whatever the level of pollution the EPA chooses, it can achieve this goal at the lowest total cost using a tax. Economists also argue that corrective taxes are better for the environment. Under the command-and-control policy of regulation, the factories have no reason to reduce emission further once they have reached the target of 300 tons of glop. By contrast, the tax gives the factories an incentive to develop cleaner technologies because a cleaner technology would reduce the amount of tax the factory has to pay. Corrective taxes are unlike most other taxes. As we discussed in Chapter 8, most taxes distort incentives and move the allocation of resources away from the social optimum. The reduction in economic well-being-that is, in consumer and producer surplus-exceeds the amount of revenue the government raises, resulting in a deadweight loss. By contrast, when externalities are psent, society also cares about the well-being of the bystanders who are affected. Corrective taxes alter incentives to account for the psence of externalities and thereby move the allocation of resources closer to the social optimum. Thus, while corrective taxes raise revenue for the government, they also enhance economic efficiency.

WHY IS GASOLINE TAXED SO HEAVILY? In many nations, gasoline is among the most heavily taxed goods. The gas tax can be viewed as a corrective tax aimed at three negative externalities associated with driving:

* Congestion: If you have ever been stuck in bumper-to-bumper traffic, you

*

*

have probably wished that there were fewer cars on the road. A gasoline tax keeps congestion down by encouraging people to take public transportation, carpool more often, and live closer to work. Accidents: Whenever people buy large cars or sport-utility vehicles, they may make themselves safer but they certainly put their neighbors at risk. According to the National Highway Traffic Safety Administration, a person driving a typical car is five times as likely to die if hit by a sport-utility vehicle than if hit by another car. The gas tax is an indirect way of making people pay when their large, gas-guzzling vehicles impose risk on others, which in turn makes them take this risk into account when choosing what vehicle to purchase. Pollution: The burning of fossil fuels such as gasoline is widely believed to be the cause of global warming. Experts disagree about how dangerous this threat is, but there is no doubt that the gas tax reduces the threat by reducing the use of gasoline.

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How high should the tax on gasoline be? Most European countries impose gasoline taxes that are much higher than those in the United States. Many observers have suggested that the United States also should tax gasoline more heavily. A 2007 study published in the Journal of Economic Literature summarized the research on the size of the various externalities associated with driving. It concluded that the optimal corrective tax on gasoline was $2.10 per gallon, compared to the actual tax in the United States of 40 cents. The tax revenue from a gasoline tax could be used to lower taxes that distort incentives and cause deadweight losses. In addition, some of the burdensome government regulations that require automakers to produce more fuel-efficient cars would prove unnecessary. This idea, however, has never proven politically popular. ●

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F I G U R E

The Equivalence of Corrective Taxes and Pollution Permits

In panelof (a),Graphs the EPA sets a price on pollution by levying a corrective tax, and the Types demand curveindetermines the quantity ofnational pollution. In panel (b), the from EPA limits the The pie chart panel (a) shows how U.S. income is derived various quantity by in limiting number ofthe pollution permits, the countries. demand sources. of Thepollution bar graph panel the (b) compares average incomeand in four curve determines the price of pollution. price and quantity of in pollution are the The time-series graph in panel (c) shows The the productivity of labor U.S. businesses same in thetotwo cases. from 1950 2000.

(a) Corrective Tax

(b) Pollution Permits Price of Pollution

Price of Pollution

Corrective tax

P 1. A corrective tax sets the price of pollution . . . 0

Supply of pollution permits

P

Demand for pollution rights Q 2. . . . which, together with the demand curve, determines the quantity of pollution.

Quantity of Pollution

Demand for pollution rights 0 2. . . . which, together with the demand curve, determines the price of pollution.

Quantity of Pollution

Q

1. Pollution permits set the quantity of pollution . . .

leading cause of acid rain. In 1990, amendments to the Clean Air Act required power plants to reduce SO2 emissions substantially. At the same time, the amendments set up a system that allowed plants to trade their SO2 allowances. Although initially both industry repsentatives and environmentalists were skeptical of the proposal, over time the system has proved that it can reduce pollution with minimal disruption. Pollution permits, like corrective taxes, are now widely viewed as a cost-effective way to keep the environment clean.

OBJECTIONS

TO THE

ECONOMIC ANALYSIS

OF

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willing to accept poor nutrition, inadequate medical care, or shoddy housing to make the environment as clean as possible. Economists argue that some environmental activists hurt their own cause by not thinking in economic terms. A clean environment is a good like other goods. Like all normal goods, it has a positive income elasticity: Rich countries can afford a cleaner environment than poor ones and, therefore, usually have more rigorous environmental protection. In addition, like most other goods, clean air and clean water obey the law of demand: The lower the price of environmental protection, the more the public will want. The economic approach of using pollution permits and corrective taxes reduces the cost of environmental protection and should, therefore, increase the public’s demand for a clean environment.

QUICK QUIZ

A glue factory and a steel mill emit smoke containing a chemical that is harmful if inhaled in large amounts. Describe three ways the town government might respond to this externality. What are the pros and cons of each solution?

PRIVATE SOLUTIONS TO EXTERNALITIES Although externalities tend to cause markets to be inefficient, government action is not always needed to solve the problem. In some circumstances, people can develop private solutions.

THE TYPES

OF

PRIVATE SOLUTIONS

Sometimes the problem of externalities is solved with moral codes and social sanctions. Consider, for instance, why most people do not litter. Although there are laws against littering, these laws are not vigorously enforced. Most people do not litter just because it is the wrong thing to do. The Golden Rule taught to most children says, “Do unto others as you would have them do unto you.” This moral injunction tells us to take account of how our actions affect other people. In economic terms, it tells us to internalize externalities. Another private solution to externalities is charities, many of which are established to deal with externalities. For example, the Sierra Club, whose goal is to protect the environment, is a nonprofit organization funded with private donations. As another example, colleges and universities receive gifts from alumni, corporations, and foundations in part because education has positive externalities for society. The government encourages this private solution to externalities through the tax system by allowing an income tax deduction for charitable donations. The private market can often solve the problem of externalities by relying on the self-interest of the relevant parties. Sometimes the solution takes the form of integrating different types of businesses. For example, consider an apple grower and a beekeeper who are located next to each other. Each business confers a positive externality on the other: By pollinating the flowers on the trees, the bees help the orchard produce apples. At the same time, the bees use the nectar they get from the apple trees to produce honey. Nonetheless, when the apple grower is deciding how many trees to plant and the beekeeper is deciding how many bees to keep, they neglect the positive externality. As a result, the apple grower plants too few trees and the beekeeper keeps too few bees. These externalities could be internalized if the beekeeper bought the apple orchard or if the apple grower

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The Case for Taxing Carbon An obscure economist proposes a way to deal with global climate change.

a carbon tax would raise the tax burden on anyone who drives a car or uses electricity produced with fossil fuels, which means just about everybody. Some might fear this would be particularly hard on the poor and middle class. But Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged. He proposes a tax of $15 per metric ton of carbon dioxide, together with a rebate of the federal payroll tax on the first $3,660 of earnings for each worker. The case for a carbon tax looks even stronger after an examination of the other options on the table. Lawmakers in both political parties want to require carmakers to increase the fuel efficiency of the cars they sell. Passing the buck to auto companies has a lot of popular appeal. Increased fuel efficiency, however, is not free. Like a tax, the cost of complying with

bought the beehives: Both activities would then take place within the same firm, and this single firm could choose the optimal number of trees and bees. Internalizing externalities is one reason that some firms are involved in different types of businesses. Another way for the private market to deal with external effects is for the interested parties to enter into a contract. In the foregoing example, a contract between the apple grower and the beekeeper can solve the problem of too few trees and too few bees. The contract can specify the number of trees, the number of bees, and perhaps a payment from one party to the other. By setting the right number of trees and bees, the contract can solve the inefficiency that normally arises from these externalities and make both parties better off.

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more stringent regulation will be passed on to consumers in the form of higher car prices. But the government will not raise any revenue that it can use to cut other taxes to compensate for these higher prices. (And don’t expect savings on gas to compensate consumers in a meaningful way: Any truly cost-effective increase in fuel efficiency would already have been made.) More important, enhancing fuel efficiency by itself is not the best way to reduce energy consumption. Fuel use depends not only on the efficiency of the car fleet but also on the daily decisions that people make-how far from work they choose to live and how often they carpool or use public transportation. A carbon tax would provide incentives for people to use less fuel in a multitude of ways. By contrast, merely having more efficient cars encourages more driving. Increased driving not only produces more carbon but also exacerbates other problems, like accidents and road congestion. Another popular proposal to limit carbon emissions is a cap-and-trade system, under which carbon emissions are limited and allowances are bought and sold in the marketplace. The effect of such a system depends on how the carbon allowances are

allocated. If the government auctions them off, then the price of a carbon allowance is effectively a carbon tax. But the history of cap-and-trade systems suggests that the allowances would probably be handed out to power companies and other carbon emitters, which would then be free to use them or sell them at market prices. In this case, the prices of energy products would rise as they would under a carbon tax, but the government would collect no revenue to reduce other taxes and compensate consumers. The international dimension of the problem also suggests the superiority of a carbon tax over cap-and-trade. Any longterm approach to global climate change will have to deal with the emerging economies of China and India. By some reports, China is now the world’s leading emitter of carbon, in large part simply because it has so many people. The failure of the Kyoto treaty to include these emerging economies is one reason that, in 1997, the United States Senate passed a resolution rejecting the Kyoto approach by a vote of 95 to zero. Agreement on a truly global cap-andtrade system, however, is hard to imagine. China is unlikely to be persuaded to accept fewer carbon allowances per person than

EXTERNALITIES

the United States. Using a historical baseline to allocate allowances, as is often proposed, would reward the United States for having been a leading cause of the problem. But allocating carbon allowances based on population alone would create a system in which the United States, with its higher standard of living, would buy allowances from China. American voters are not going to embrace a system of higher energy prices, coupled with a large transfer of national income to the Chinese. It would amount to a massive foreign aid program to one of the world’s most rapidly growing economies. A global carbon tax would be easier to negotiate. All governments require revenue for public purposes. The world’s nations could agree to use a carbon tax as one instrument to raise some of that revenue. No money needs to change hands across national borders. Each government could keep the revenue from its tax and use it to finance spending or whatever form of tax relief it considered best. Convincing China of the virtues of a carbon tax, however, may prove to be the easy part. The first and more difficult step is to convince American voters, and therefore political consultants, that “tax” is not a fourletter word.

Source: New York Times, September 16, 2007.

THE COASE THEOREM How effective is the private market in dealing with externalities? A famous result, called the Coase theorem after economist Ronald Coase, suggests that it can be very effective in some circumstances. According to the Coase theorem, if private parties can bargain over the allocation of resources at no cost, then the private market will always solve the problem of externalities and allocate resources efficiently. To see how the Coase theorem works, consider an example. Suppose that Dick owns a dog named Spot. Spot barks and disturbs Jane, Dick’s neighbor. Dick gets a benefit from owning the dog, but the dog confers a negative externality on Jane.

Coase theorem the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own

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WHY PRIVATE SOLUTIONS DO NOT A LWAYS WORK Despite the appealing logic of the Coase theorem, private inpiduals on their own often fail to resolve the problems caused by externalities. The Coase theorem applies only when the interested parties have no trouble reaching and enforcing

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an agreement. In the real world, however, bargaining does not always work, even when a mutually beneficial agreement is possible. Sometimes the interested parties fail to solve an externality problem because of transaction costs, the costs that parties incur in the process of agreeing to and following through on a bargain. In our example, imagine that Dick and Jane speak different languages so that, to reach an agreement, they need to hire a translator. If the benefit of solving the barking problem is less than the cost of the translator, Dick and Jane might choose to leave the problem unsolved. In more realistic examples, the transaction costs are the expenses not of translators but of the lawyers required to draft and enforce contracts. At other times, bargaining simply breaks down. The recurrence of wars and labor strikes shows that reaching agreement can be difficult and that failing to reach agreement can be costly. The problem is often that each party tries to hold out for a better deal. For example, suppose that Dick gets a $500 benefit from the dog, and Jane bears an $800 cost from the barking. Although it is efficient for Jane to pay Dick to get rid of the dog, there are many prices that could lead to this outcome. Dick might demand $750, and Jane might offer only $550. As they haggle over the price, the inefficient outcome with the barking dog persists. Reaching an efficient bargain is especially difficult when the number of interested parties is large because coordinating everyone is costly. For example, consider a factory that pollutes the water of a nearby lake. The pollution confers a negative externality on the local fishermen. According to the Coase theorem, if the pollution is inefficient, then the factory and the fishermen could reach a bargain in which the fishermen pay the factory not to pollute. If there are many fishermen, however, trying to coordinate them all to bargain with the factory may be almost impossible. When private bargaining does not work, the government can sometimes play a role. The government is an institution designed for collective action. In this example, the government can act on behalf of the fishermen, even when it is impractical for the fishermen to act for themselves.

Q

Q

UICK UIZ Give an example of a private solution to an externality. * What is the Coase theorem? * Why are private economic participants sometimes unable to solve the problems caused by an externality?

CONCLUSION The invisible hand is powerful but not omnipotent. A market’s equilibrium maximizes the sum of producer and consumer surplus. When the buyers and sellers in the market are the only interested parties, this outcome is efficient from the standpoint of society as a whole. But when there are external effects, such as pollution, evaluating a market outcome requires taking into account the well-being of third parties as well. In this case, the invisible hand of the marketplace may fail to allocate resources efficiently. In some cases, people can solve the problem of externalities on their own. The Coase theorem suggests that the interested parties can bargain among themselves and agree on an efficient solution. Sometimes, however, an efficient outcome cannot be reached, perhaps because the large number of interested parties makes bargaining difficult.

EXTERNALITIES

transaction costs the costs that parties incur in the process of agreeing to and following through on a bargain

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When people cannot solve the problem of externalities privately, the government often steps in. Yet even with government intervention, society should not abandon market forces entirely. Rather, the government can address the problem by requiring decision makers to bear the full costs of their actions. Corrective taxes on emissions and pollution permits, for instance, are designed to internalize the externality of pollution. More and more, these are the policies of choice for those interested in protecting the environment. Market forces, properly redirected, are often the best remedy for market failure.

SUMMARY * When a transaction between a buyer and seller directly affects a third party, the effect is called an externality. If an activity yields negative externalities, such as pollution, the socially optimal quantity in a market is less than the equilibrium quantity. If an activity yields positive externalities, such as technology spillovers, the socially optimal quantity is greater than the equilibrium quantity.

* Governments pursue various policies to remedy the inefficiencies caused by externalities. Sometimes the government pvents socially inefficient activity by regulating behavior. Other times it internalizes an externality using corrective taxes. Another public policy is to issue permits. For example, the government could protect the environment by issuing a limited number

of pollution permits. The result of this policy is largely the same as imposing corrective taxes on polluters.

* Those affected by externalities can sometimes solve the problem privately. For instance, when one business imposes an externality on another business, the two businesses can internalize the externality by merging. Alternatively, the interested parties can solve the problem by negotiating a contract. According to the Coase theorem, if people can bargain without cost, then they can always reach an agreement in which resources are allocated efficiently. In many cases, however, reaching a bargain among the many interested parties is difficult, so the Coase theorem does not apply.

KEY CONCEPTS externality, p. 204 internalizing the externality, p. 207

corrective tax, p. 210 Coase theorem, p. 217 transaction costs, p. 219

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EXTERNALITIES

QUESTIONS FOR REVIEW 1. Give an example of a negative externality and an example of a positive externality. 2. Draw a supply-and-demand diagram to explain the effect of a negative externality that occurs as a result of a firm’s production process. 3. In what way does the patent system help society solve an externality problem? 4. What are corrective taxes? Why do economists pfer them to regulations as a way to protect the environment from pollution?

5. List some of the ways that the problems caused by externalities can be solved without government intervention. 6. Imagine that you are a nonsmoker sharing a room with a smoker. According to the Coase theorem, what determines whether your roommate smokes in the room? Is this outcome efficient? How do you and your roommate reach this solution?

PROBLEMS AND APPLICATIONS 1. There are two ways to protect your car from theft. The Club makes it difficult for a car thief to take your car. Lojack makes it easier for the police to catch the car thief who has stolen it. Which of these types of protection conveys a negative externality on other car owners? Which conveys a positive externality? Do you think there are any policy implications of your analysis? 2. Do you agree with the following statements? Why or why not? a. “The benefits of corrective taxes as a way to reduce pollution have to be weighed against the deadweight losses that these taxes cause.” b. “When deciding whether to levy a corrective tax on consumers or producers, the government should be careful to levy the tax on the side of the market generating the externality.” 3. Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities? b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve. c. Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ. d. If the external benefit is $10 per extinguisher, describe a government policy that would yield the efficient outcome.

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theorem, how might Ringo and Luciano reach an efficient outcome on their own? What might pvent them from reaching an efficient outcome? 9. The Pristine River has two polluting firms on its banks. Acme Industrial and Creative Chemicals each dump 100 tons of glop into the river each year. The cost of reducing glop emissions per ton equals $10 for Acme and $100 for Creative. The local government wants to reduce overall pollution from 200 tons to 50 tons. a. If the government knows the cost of reduction for each firm, what reductions will it impose to reach its overall goal? What will be the cost to each firm and the total cost to the firms together? b. In a more typical situation, the government does not know the cost of pollution reduction for each firm. If the government decides to reach its overall goal by imposing uniform reductions on the firms, calculate the reduction made by each firm, the cost to each firm, and the total cost to the firms together. c. Compare the total cost of pollution reduction in parts (a) and (b). If the government does not know the cost of reduction for each firm, is there still some way for it to reduce pollution to 50 tons at the total cost you calculated in part (a)? Explain. 10. Figure 4 shows that for any given demand curve for the right to pollute, the government can achieve the same outcome either by setting a price with a corrective tax or by setting a quantity with pollution permits. Suppose there is a sharp improvement in the technology for controlling pollution. a. Using graphs similar to those in Figure 4, illustrate the effect of this development on the demand for pollution rights. b. What is the effect on the price and quantity of pollution under each regulatory system? Explain. 11. Suppose that the government decides to issue tradable permits for a certain form of pollution. a. Does it matter for economic efficiency whether the government distributes or auctions the permits? b. If the government chooses to distribute the permits, does the allocation of permits among firms matter for efficiency?

CHAPTER 10

12. There are three industrial firms in Happy Valley. Firm A B C

Initial Pollution Level

Cost of Reducing Pollution by 1 Unit

70 units 80 units 50 units

$20 $25 $10

The government wants to reduce pollution to 120 units, so it gives each firm 40 tradable pollution permits. a. Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation? b. How much higher would the costs of pollution reduction be if the permits could not be traded? 13. The market for a particular chemical, called Negext, is described by the following equations. Demand is given by: QD = 100 – 5P Supply is given by: QS = 5P where Q is measured as units of Negext and P is price in dollars per unit. a. Find the equilibrium price and quantity. Compute consumer surplus, producer surplus, and total surplus in the market equilibrium.

EXTERNALITIES

b. For each unit of Negext produced, 4 units of pollution are emitted, and each unit of pollution imposes a cost on society of $1. Compute the total cost of pollution when the market for Negext is in equilibrium. What is total surplus from this market after taking into account the cost of pollution? c. Would banning Negext increase or decrease welfare? Why? d. Suppose that the government restricts emissions to 100 units of pollution. Graph the Negext market under this constraint. Find the new equilibrium price and quantity and show them on your graph. Compute how this policy affects consumer surplus, producer surplus, and the cost of pollution. Would you recommend this policy? Why? e. Suppose that instead of restricting pollution, the government imposes a tax on producers equal to $4 for each unit of chemical produced. Calculate the new equilibrium price and quantity, as well as consumer surplus, producer surplus, tax revenue, and the cost of pollution. What is total surplus now? Would you recommend this policy? Why? f. New research finds the social cost of pollution is really higher than $1. How would that change the optimal policy response? Is there some cost of pollution that would make it sensible to ban Negext? If so, what is it?

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Public Goods and Common Resources

A

n old song lyric maintains that “the best things in life are free.” A moment’s thought reveals a long list of goods that the songwriter could have had in mind. Nature provides some of them, such as rivers, mountains, beaches, lakes, and oceans. The government provides others, such as playgrounds, parks, and parades. In each case, people do not pay a fee when they choose to enjoy the benefit of the good. Goods without prices provide a special challenge for economic analysis. Most goods in our economy are allocated in markets, where buyers pay for what they receive and sellers are paid for what they provide. For these goods, prices are the signals that guide the decisions of buyers and sellers, and these decisions lead to an efficient allocation of resources. When goods are available free of charge, however, the market forces that normally allocate resources in our economy are absent. In this chapter, we examine the problems that arise for the allocation of resources when there are goods without market prices. Our analysis will shed light on one of the Ten Principles of Economics in Chapter 1: Governments can sometimes improve market outcomes. When a good does not have a price attached to it, private markets cannot ensure that the good is produced and consumed in the proper amounts. In such cases, government policy can potentially remedy the market failure and raise economic well-being. 225

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THE DIFFERENT KINDS OF GOODS How well do markets work in providing the goods that people want? The answer to this question depends on the good being considered. As we discussed in Chapter 7, a market can provide the efficient number of ice-cream cones: The price of ice-cream cones adjusts to balance supply and demand, and this equilibrium maximizes the sum of producer and consumer surplus. Yet as we discussed in Chapter 10, the market cannot be counted on to pvent aluminum manufacturers from polluting the air we breathe: Buyers and sellers in a market typically do not take into account the external effects of their decisions. Thus, markets work well when the good is ice cream, but they work badly when the good is clean air. In thinking about the various goods in the economy, it is useful to group them according to two characteristics: excludability the property of a good whereby a person can be pvented from using it

* Is the good excludable? That is, can people be pvented from using the

rivalry in consumption the property of a good whereby one person’s use diminishes other people’s use

Using these two characteristics, Figure 1 pides goods into four categories:

good?

* Is the good rival in consumption? That is, does one person’s use of the good reduce another person’s ability to use it?

1.

private goods goods that are both excludable and rival in consumption public goods goods that are neither excludable nor rival in consumption

1

2.

Private goods are both excludable and rival in consumption. Consider an ice-cream cone, for example. An ice-cream cone is excludable because it is possible to pvent someone from eating an ice-cream cone-you just don’t give it to him. An ice-cream cone is rival in consumption because if one person eats an ice-cream cone, another person cannot eat the same cone. Most goods in the economy are private goods like ice-cream cones: You don’t get one unless you pay, and once you have it, you are the only person who benefits. When we analyzed supply and demand in Chapters 4, 5, and 6 and the efficiency of markets in Chapters 7, 8, and 9, we implicitly assumed that goods were both excludable and rival in consumption. Public goods are neither excludable nor rival in consumption. That is, people cannot be pvented from using a public good, and one person’s use of a public good does not reduce another person’s ability to use it. For example,

F I G U R E Rival in consumption? Yes

Four Types of Goods Goods can be grouped into four categories according to two characteristics: (1) A good is excludable if people can be pvented from using it. (2) A good is rival in consumption if one person’s use of the good diminishes other people’s use of it. This diagram gives examples of goods in each category.

Yes

No

Private Goods

Natural Monopolies

Common Resources

Public Goods

Excludable?

No

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3.

4.

PUBLIC GOODS AND COMMON RESOURCES

a tornado siren in a small town is a public good. Once the siren sounds, it is impossible to pvent any single person from hearing it (so it is not excludable). Moreover, when one person gets the benefit of the warning, she does not reduce the benefit to anyone else (so it is not rival in consumption). Common resources are rival in consumption but not excludable. For example, fish in the ocean are rival in consumption: When one person catches fish, there are fewer fish for the next person to catch. Yet these fish are not an excludable good because, given the vast size of an ocean, it is difficult to stop fishermen from taking fish out of it. When a good is excludable but not rival in consumption, it is an example of a good produced by a natural monopoly. For instance, consider fire protection in a small town. It is easy to exclude someone from using this good: The fire department can just let his house burn down. Yet fire protection is not rival in consumption: Once a town has paid for the fire department, the additional cost of protecting one more house is small. (In Chapter 15, we give a more complete definition of natural monopolies and study them in some detail.)

Although Figure 1 offers a clean separation of goods into four categories, the boundary between the categories is sometimes fuzzy. Whether goods are excludable or rival in consumption is often a matter of degree. Fish in an ocean may not be excludable because monitoring fishing is so difficult, but a large enough coast guard could make fish at least partly excludable. Similarly, although fish are generally rival in consumption, this would be less true if the population of fishermen were small relative to the population of fish. (Think of North American fishing waters before the arrival of European settlers.) For purposes of our analysis, however, it will be helpful to group goods into these four categories. In this chapter, we examine goods that are not excludable: public goods and common resources. Because people cannot be pvented from using these goods, they are available to everyone free of charge. The study of public goods and common resources is closely related to the study of externalities. For both of these types of goods, externalities arise because something of value has no price attached to it. If one person were to provide a public good, such as a tornado siren, other people would be better off. They would receive a benefit without paying for it-a positive externality. Similarly, when one person uses a common resource such as the fish in the ocean, other people are worse off because there are fewer fish to catch. They suffer a loss but are not compensated for it-a negative externality. Because of these external effects, private decisions about consumption and production can lead to an inefficient allocation of resources, and government intervention can potentially raise economic well-being.

QUICK QUIZ

Define public goods and common resources and give an example of each.

PUBLIC GOODS To understand how public goods differ from other goods and the problems they psent for society, let’s consider an example: a fireworks display. This good is not excludable because it is impossible to pvent someone from seeing fireworks, and it is not rival in consumption because one person’s enjoyment of fireworks does not reduce anyone else’s enjoyment of them.

common resources goods that are rival in consumption but not excludable

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THE FREE-R IDER PROBLEM

free rider a person who receives the benefit of a good but avoids paying for it

The citizens of Smalltown, U.S.A., like seeing fireworks on the Fourth of July. Each of the town’s 500 residents places a $10 value on the experience for a total benefit of $5,000. The cost of putting on a fireworks display is $1,000. Because the $5,000 benefit exceeds the $1,000 cost, it is efficient for Smalltown to have a fireworks display on the Fourth of July. Would the private market produce the efficient outcome? Probably not. Imagine that Ellen, a Smalltown entrepneur, decided to put on a fireworks display. Ellen would surely have trouble selling tickets to the event because her potential customers would quickly p out that they could see the fireworks even without a ticket. Because fireworks are not excludable, people have an incentive to be free riders. A free rider is a person who receives the benefit of a good but does not pay for it. Because people would have an incentive to be free riders rather than ticket buyers, the market would fail to provide the efficient outcome. One way to view this market failure is that it arises because of an externality. If Ellen puts on the fireworks display, she confers an external benefit on those who see the display without paying for it. When deciding whether to put on the display, however, Ellen does not take the external benefits into account. Even though the fireworks display is socially desirable, it is not profitable. As a result, Ellen makes the privately rational but socially inefficient decision not to put on the display. Although the private market fails to supply the fireworks display demanded by Smalltown residents, the solution to Smalltown’s problem is obvious: The local government can sponsor a Fourth of July celebration. The town council can raise everyone’s taxes by $2 and use the revenue to hire Ellen to produce the fireworks. Everyone in Smalltown is better off by $8-the $10 in value from the fireworks minus the $2 tax bill. Ellen can help Smalltown reach the efficient outcome as a public employee even though she could not do so as a private entrepneur. The story of Smalltown is simplified but realistic. In fact, many local governments in the United States pay for fireworks on the Fourth of July. Moreover, the story shows a general lesson about public goods: Because public goods are not excludable, the free-rider problem pvents the private market from supplying them. The government, however, can potentially remedy the problem. If the government decides that the total benefits of a public good exceed its costs, it can provide the public good, pay for it with tax revenue, and make everyone better off.

SOME IMPORTANT PUBLIC GOODS There are many examples of public goods. Here we consider three of the most important. National Defense The defense of a country from foreign aggressors is a classic example of a public good. Once the country is defended, it is impossible to pvent any single person from enjoying the benefit of this defense. Moreover, when one person enjoys the benefit of national defense, he does not reduce the benefit to anyone else. Thus, national defense is neither excludable nor rival in consumption. National defense is also one of the most expensive public goods. In 2007, the U.S. federal government spent a total of $553 billion on national defense, more than $1,800 per person. People disagree about whether this amount is too small or

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PUBLIC GOODS AND COMMON RESOURCES

CARTOON: © 2002 THE NEW YORKER COLLECTION FROM chúng tôi ALL RIGHTS RESERVED.

Basic Research Knowledge is created through research. In evaluating the appropriate public policy toward knowledge creation, it is important to distinguish general knowledge from specific technological knowledge. Specific technological knowledge, such as the invention of a longer-lasting battery, a smaller microchip, or a better digital music player, can be patented. The patent gives the inventor the exclusive right to the knowledge he or she has created for a period of time. Anyone else who wants to use the patented information must pay the inventor for the right to do so. In other words, the patent makes the knowledge created by the inventor excludable. By contrast, general knowledge is a public good. For example, a mathematician cannot patent a theorem. Once a theorem is proved, the knowledge is not excludable: The theorem enters society’s general pool of knowledge that anyone can use without charge. The theorem is also not rival in consumption: One person’s use of the theorem does not pvent any other person from using the theorem. Profit-seeking firms spend a lot on research trying to develop new products that they can patent and sell, but they do not spend much on basic research. Their incentive, instead, is to free ride on the general knowledge created by others. As a result, in the absence of any public policy, society would devote too few resources to creating new knowledge. The government tries to provide the public good of general knowledge in various ways. Government agencies, such as the National Institutes of Health and the National Science Foundation, subsidize basic research in medicine, mathematics, physics, chemistry, biology, and even economics. Some people justify government funding of the space program on the grounds that it adds to society’s pool of knowledge (although many scientists are skeptical of the scientific value of manned space travel). Determining the appropriate level of government support for these endeavors is difficult because the benefits are hard to measure. Moreover, the members of Congress who appropriate funds for research usually have little expertise in science and, therefore, are not in the best position to judge what lines of research will produce the largest benefits. So, while basic research is surely a public good, we should not be surprised if the public sector fails to pay for the right amount and the right kinds. Fighting Poverty Many government programs are aimed at helping the poor. The welfare system (officially called Temporary Assistance for Needy Families) provides a small income for some poor families. Similarly, the Food Stamp program subsidizes the purchase of food for those with low incomes, and various government housing programs make shelter more affordable. These antipoverty programs are financed by taxes paid by families that are financially more successful. Economists disagree among themselves about what role the government should play in fighting poverty. Although we discuss this debate more fully in Chapter 20, here we note one important argument: Advocates of antipoverty programs claim that fighting poverty is a public good. Even if everyone pfers living in a society without poverty, fighting poverty is not a “good” that private actions will adequately provide.

“I LIKE THE CONCEPT IF WE CAN DO IT WITH NO NEW TAXES.”

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To see why, suppose someone tried to organize a group of wealthy inpiduals to try to eliminate poverty. They would be providing a public good. This good would not be rival in consumption: One person’s enjoyment of living in a society without poverty would not reduce anyone else’s enjoyment of it. The good would not be excludable: Once poverty is eliminated, no one can be pvented from taking pleasure in this fact. As a result, there would be a tendency for people to free ride on the generosity of others, enjoying the benefits of poverty elimination without contributing to the cause. Because of the free-rider problem, eliminating poverty through private charity will probably not work. Yet government action can solve this problem. Taxing the wealthy to raise the living standards of the poor can potentially make everyone better off. The poor are better off because they now enjoy a higher standard of living, and those paying the taxes are better off because they enjoy living in a society with less poverty.

ARE LIGHTHOUSES PUBLIC GOODS?

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WHAT KIND OF GOOD IS THIS?

Some goods can switch between being public goods and being private goods depending on the circumstances. For example, a fireworks display is a public good if performed in a town with many residents. Yet if performed at a private amusement park, such as Walt Disney World, a fireworks display is more like a private good because visitors to the park pay for admission. Another example is a lighthouse. Economists have long used lighthouses as an example of a public good. Lighthouses mark specific locations so that passing ships can avoid treacherous waters. The benefit that the lighthouse provides to the ship captain is neither excludable nor rival in consumption, so each captain has an incentive to free ride by using the lighthouse to navigate without paying for the service. Because of this free-rider problem, private markets usually fail to provide the lighthouses that ship captains need. As a result, most lighthouses today are operated by the government. In some cases, however, lighthouses have been closer to private goods. On the coast of England in the 19th century, for example, some lighthouses were privately owned and operated. Instead of trying to charge ship captains for the service, however, the owner of the lighthouse charged the owner of the nearby port. If the port owner did not pay, the lighthouse owner turned off the light, and ships avoided that port. In deciding whether something is a public good, one must determine who the beneficiaries are and whether these beneficiaries can be excluded from using the good. A free-rider problem arises when the number of beneficiaries is large and exclusion of any one of them is impossible. If a lighthouse benefits many ship captains, it is a public good. Yet if it primarily benefits a single port owner, it is more like a private good. ●

THE DIFFICULT JOB

OF

COST-BENEFIT ANALYSIS

So far we have seen that the government provides public goods because the private market on its own will not produce an efficient quantity. Yet deciding that the government must play a role is only the first step. The government must then determine what kinds of public goods to provide and in what quantities.

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Suppose that the government is considering a public project, such as building a new highway. To judge whether to build the highway, it must compare the total benefits of all those who would use it to the costs of building and maintaining it. To make this decision, the government might hire a team of economists and engineers to conduct a study, called a cost-benefit analysis, the goal of which is to estimate the total costs and benefits of the project to society as a whole. Cost-benefit analysts have a tough job. Because the highway will be available to everyone free of charge, there is no price with which to judge the value of the highway. Simply asking people how much they would value the highway is not reliable: Quantifying benefits is difficult using the results from a questionnaire, and respondents have little incentive to tell the truth. Those who would use the highway have an incentive to exaggerate the benefit they receive to get the highway built. Those who would be harmed by the highway have an incentive to exaggerate the costs to them to pvent the highway from being built. The efficient provision of public goods is, therefore, intrinsically more difficult than the efficient provision of private goods. When buyers of a private good enter a market, they reveal the value they place on it through the prices they are willing to pay. At the same time, sellers reveal their costs with the prices they are willing to accept. The equilibrium is an efficient allocation of resources because it reflects all this information. By contrast, cost-benefit analysts do not have any price signals to observe when evaluating whether the government should provide a public good and how much to provide. Their findings on the costs and benefits of public projects are rough approximations at best.

cost-benefit analysis a study that compares the costs and benefits to society of providing a public good

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Once we have accepted the idea that a person’s life has an implicit dollar value, how can we determine what that value is? One approach, sometimes used by courts to award damages in wrongful-death suits, is to look at the total amount of money a person would have earned if he or she had lived. Economists are often critical of this approach because it ignores other opportunity costs of losing one’s life. It thus has the bizarre implication that the life of a retired or disabled person has no value. A better way to value human life is to look at the risks that people are voluntarily willing to take and how much they must be paid for taking them. Mortality risk varies across jobs, for example. Construction workers in high-rise buildings face greater risk of death on the job than office workers do. By comparing wages in risky and less risky occupations, controlling for education, experience, and other determinants of wages, economists can get some sense about what value people put on their own lives. Studies using this approach conclude that the value of a human life is about $10 million. We can now return to our original example and respond to the town engineer. The traffic light reduces the risk of fatality by 0.5 percentage points. Thus, the expected benefit from installing the traffic light is 0.005 × $10 million, or $50,000. This estimate of the benefit well exceeds the cost of $10,000, so you should approve the project. ●

Q

Q

UICK UIZ What is the free-rider problem? Why does the free-rider problem induce the government to provide public goods? * How should the government decide whether to provide a public good?

COMMON RESOURCES

Tragedy of the Commons a parable that illustrates why common resources are used more than is desirable from the standpoint of society as a whole

Common resources, like public goods, are not excludable: They are available free of charge to anyone who wants to use them. Common resources are, however, rival in consumption: One person’s use of the common resource reduces other people’s ability to use it. Thus, common resources give rise to a new problem. Once the good is provided, policymakers need to be concerned about how much it is used. This problem is best understood from the classic parable called the Tragedy of the Commons.

THE TRAGEDY

OF THE

COMMONS

Consider life in a small medieval town. Of the many economic activities that take place in the town, one of the most important is raising sheep. Many of the town’s families own flocks of sheep and support themselves by selling the sheep’s wool, which is used to make clothing. As our story begins, the sheep spend much of their time grazing on the land surrounding the town, called the Town Common. No family owns the land. Instead, the town residents own the land collectively, and all the residents are allowed to graze their sheep on it. Collective ownership works well because land is plentiful. As long as everyone can get all the good grazing land they want, the Town Common is not rival in consumption, and allowing residents’ sheep to graze for free causes no problems. Everyone in town is happy.

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As the years pass, the population of the town grows, and so does the number of sheep grazing on the Town Common. With a growing number of sheep and a fixed amount of land, the land starts to lose its ability to replenish itself. Eventually, the land is grazed so heavily that it becomes barren. With no grass left on the Town Common, raising sheep is impossible, and the town’s once prosperous wool industry disappears. Many families lose their source of livelihood. What causes the tragedy? Why do the shepherds allow the sheep population to grow so large that it destroys the Town Common? The reason is that social and private incentives differ. Avoiding the destruction of the grazing land depends on the collective action of the shepherds. If the shepherds acted together, they could reduce the sheep population to a size that the Town Common can support. Yet no single family has an incentive to reduce the size of its own flock because each flock repsents only a small part of the problem. In essence, the Tragedy of the Commons arises because of an externality. When one family’s flock grazes on the common land, it reduces the quality of the land available for other families. Because people neglect this negative externality when deciding how many sheep to own, the result is an excessive number of sheep. If the tragedy had been foreseen, the town could have solved the problem in various ways. It could have regulated the number of sheep in each family’s flock, internalized the externality by taxing sheep, or auctioned off a limited number of sheep-grazing permits. That is, the medieval town could have dealt with the problem of overgrazing in the way that modern society deals with the problem of pollution. In the case of land, however, there is a simpler solution. The town can pide the land among town families. Each family can enclose its parcel of land with a fence and then protect it from excessive grazing. In this way, the land becomes a private good rather than a common resource. This outcome in fact occurred during the enclosure movement in England in the 17th century. The Tragedy of the Commons is a story with a general lesson: When one person uses a common resource, he or she diminishes other people’s enjoyment of it. Because of this negative externality, common resources tend to be used excessively. The government can solve the problem by using regulation or taxes to reduce consumption of the common resource. Alternatively, the government can sometimes turn the common resource into a private good. This lesson has been known for thousands of years. The ancient Greek philosopher Aristotle pointed out the problem with common resources: “What is common to many is taken least care of, for all men have greater regard for what is their own than for what they possess in common with others.”

SOME IMPORTANT COMMON R ESOURCES There are many examples of common resources. In almost all cases, the same problem arises as in the Tragedy of the Commons: Private decision makers use the common resource too much. Governments often regulate behavior or impose fees to mitigate the problem of overuse. Clean Air and Water As we discussed in Chapter 10, markets do not adequately protect the environment. Pollution is a negative externality that can be remedied with regulations or with corrective taxes on polluting activities. One can view this market failure as an example of a common-resource problem. Clean air and clean

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Don’t Drive, He Said By Elizabeth Kolbert Michael Bloomberg has always favored grand schemes. Last week, on Earth Day, the Mayor stood in the American Museum of Natural History’s Hall of Ocean Life, beneath the blue whale, to lay out his vision for the city’s future. In an expansive speech, Bloomberg described a New York that would, in 2030, be both “greater” and “greener,” a city with nearly a million more residents, as well as cleaner water, new open space, and zippier transportation. This bigger, better metropolis would be a leader in combatting global warming; despite its increased population, the New York of the future would produce thirty percent less CO2, resulting, as the Mayor put it, in “the most dramatic reduction in greenhouse gases ever achieved by any American city.” The printed version of Bloomberg’s plan ran to a hundred and fifty-five fullcolor pages and contained a hundred and twenty-seven new initiatives. Just one of

them-congestion pricing-got almost all the attention, much of it negative. The Mayor anticipated this-he referred to the pricing proposal as “the elephant in the room”-and his decision to include it anyway is perhaps the best reason to take the plan seriously. The basic idea behind congestion pricing is simple: make motorists pay to use the busiest streets. Under the Mayor’s proposal, an invisible line would be drawn around Manhattan from Eighty-sixth Street south to the Battery. Vehicles crossing this line on weekdays between 6 A.M. and 6 P.M. would be charged a fee-eight dollars for cars, twenty-one dollars for trucks. (Those travelling only within the congestion zone would pay half price, while taxis and livery cabs would be exempt.) The fees would be assessed electronically and could be paid either with a toll pass or over the phone or the Internet. Driving crosstown for lunch is an easy, if maddening, way to appciate the scheme’s logic. The impssion that one could walk-

or at least trot-just as quickly is borne out by the numbers; according to data collected by the New York Metropolitan Transportation Council and analyzed by Bruce Schaller, a Brooklyn-based consultant, the average speed achieved by a vehicle travelling along Forty-second Street between the hours of 10 A.M. and 4 P.M. is 4.7 miles per hour. On Thirty-fourth Street approaching the entrance to the Queens Midtown Tunnel, the average speed drops to 2.5 miles per hour. A few cities have tried congestion pricing, most notably Stockholm and London, and in most cases it has been a success. Stockholm imposed congestion pricing on a trial basis last year; the program worked so well that voters opted to reinstitute it. Since the London plan was introduced, in 2003, vehicle speeds in the city’s central business district have increased by thirty-seven percent and carbon-dioxide emissions from cars and trucks have dropped by fifteen percent. The plan, which the newspapers initially derided as “Kengestion”-after its main supporter,

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London’s mayor, Ken Livingstone-has grown increasingly popular; in 2004, Livingstone was easily reelected, and now nearly two-thirds of Londoners say that they back the scheme. Just three months ago, the congestion zone was expanded westward to include most of the boroughs of Kensington and Chelsea and Westminster. The case against congestion pricing is often posed in egalitarian terms. “The middle class and the poor will not be able to pay these fees and the rich will,” State Assemblyman Richard Brodsky, of Westchester County, declared after listening to the Mayor’s speech. In fact, the poor don’t, as a rule, drive in and out of Manhattan: compare the cost of buying, insuring, and parking a car with the seventy-six dollars a month the M.T.A. charges for an unlimitedride MetroCard. For those who do use cars to commute, eight dollars a day would, it’s true, quickly add up. And that is pcisely the point. Congestion pricing works only to the extent that it makes other choices- changing the hours of one’s daily drive or, better yet, using mass transit-more attractive. One of the Mayor’s proposals is to put the money raised by congestion pricing- an estimated four hundred million dollars a year-toward improving subway and bus service.

PUBLIC GOODS AND COMMON RESOURCES

Mayor Bloomberg Meanwhile, it’s naïve to suppose that congestion isn’t itself costly. Sitting in traffic, a plumber can’t plumb and a deliveryman can’t deliver. The value of time lost to congestion delays in the city has been put at five billion dollars annually. When expenses like wasted fuel, lost revenue, and the increased cost of doing business are added in, that p rises to thirteen billion dollars. The question, Bloomberg observed, is “not whether we want to pay but how do we want to pay?” Many elements of the Mayor’s plan, including congestion pricing, will require approval by the state legislature, which is too bad, since, as a recent Times editorial put it, Albany is a place where good policies generally “go to die.” Even Governor Eliot Spitzer, who, as state attorney general,

sued the country’s largest carbon emitters, offered what can only be described as a tepid endorsement of the Mayor’s proposal, saying, “We look forward to reviewing the plan.” As a matter of city planning, congestion pricing is a compelling idea; in the context of climate change, it is much more than that. Any meaningful effort to address the problem will have to include incentives for low-emitting activities (walking, biking, riding the subway) and costs for high-emitting ones (flying, driving, sitting at home and cranking up the A.C.). These costs will inconvenience some people-perhaps most people-and the burden will not always be distributed with perfect fairness. But, as the Mayor pointed out, New York, a flood-prone coastal city, is vulnerable to one of global warming’s most destructive-and most certain-consequences: rising sea levels. If New Yorkers won’t change their behavior, then it’s hard to see why anyone in the rest of the country or, for that matter, the world should, either. The congestion problem will, in that case, find a different resolution. Who, after all, wants to drive into a city that’s under water?

Source: New Yorker, May 7, 2007.

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“WILL THE MARKET PROTECT ME?”

WHY THE COW IS NOT EXTINCT Throughout history, many species of animals have been threatened with extinction. When Europeans first arrived in North America, more than 60 million buffalo roamed the continent. Yet hunting the buffalo was so popular during the 19th century that by 1900 the animal’s population had fallen to about 400 before the government stepped in to protect the species. In some African countries today, the elephant faces a similar challenge, as poachers kill the animals for the ivory in their tusks. Yet not all animals with commercial value face this threat. The cow, for example, is a valuable source of food, but no one worries that the cow will soon be extinct. Indeed, the great demand for beef seems to ensure that the species will continue to thrive. Why is the commercial value of ivory a threat to the elephant, while the commercial value of beef is a guardian of the cow? The reason is that elephants are a common resource, whereas cows are a private good. Elephants roam freely with-

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out any owners. Each poacher has a strong incentive to kill as many elephants as he can find. Because poachers are numerous, each poacher has only a slight incentive to pserve the elephant population. By contrast, cattle live on ranches that are privately owned. Each rancher makes great effort to maintain the cattle population on his ranch because he reaps the benefit of these efforts. Governments have tried to solve the elephant’s problem in two ways. Some countries, such as Kenya, Tanzania, and Uganda, have made it illegal to kill elephants and sell their ivory. Yet these laws have been hard to enforce, and elephant populations have continued to dwindle. By contrast, other countries, such as Botswana, Malawi, Namibia, and Zimbabwe, have made elephants a private good by allowing people to kill elephants, but only those on their own property. Landowners now have an incentive to pserve the species on their own land, and as a result, elephant populations have started to rise. With private ownership and the profit motive now on its side, the African elephant might someday be as safe from extinction as the cow. ●

QUICK QUIZ

Why do governments try to limit the use of common resources?

CONCLUSION: THE IMPORTANCE OF PROPERTY RIGHTS In this and the pvious chapter, we have seen there are some “goods” that the market does not provide adequately. Markets do not ensure that the air we breathe is clean or that our country is defended from foreign aggressors. Instead, societies rely on the government to protect the environment and to provide for the national defense. Although the problems we considered in these chapters arise in many different markets, they share a common theme. In all cases, the market fails to allocate resources efficiently because property rights are not well established. That is, some item of value does not have an owner with the legal authority to control it. For example, although no one doubts that the “good” of clean air or national defense is valuable, no one has the right to attach a price to it and profit from its use. A factory pollutes too much because no one charges the factory for the pollution it emits. The market does not provide for national defense because no one can charge those who are defended for the benefit they receive. When the absence of property rights causes a market failure, the government can potentially solve the problem. Sometimes, as in the sale of pollution permits, the solution is for the government to help define property rights and thereby unleash market forces. Other times, as in restricted hunting seasons, the solution is for the government to regulate private behavior. Still other times, as in the provision of national defense, the solution is for the government to use tax revenue to supply a good that the market fails to supply. In all cases, if the policy is well planned and well run, it can make the allocation of resources more efficient and thus raise economic well-being.

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SUMMARY are not charged for their use of the public good, they have an incentive to free ride when the good is provided privately. Therefore, governments provide public goods, making their decision about the quantity of each good based on cost-benefit analysis.

* Goods differ in whether they are excludable and whether they are rival in consumption. A good is excludable if it is possible to pvent someone from using it. A good is rival in consumption if one person’s use of the good reduces other people’s ability to use the same unit of the good. Markets work best for private goods, which are both excludable and rival in consumption. Markets do not work as well for other types of goods.

* Public goods are neither rival in consumption nor excludable. Examples of public goods include fireworks displays, national defense, and the creation of fundamental knowledge. Because people

KEY CONCEPTS excludability, p. 226 rivalry in consumption, p. 226 private goods, p. 226

public goods, p. 226 common resources, p. 227 free rider, p. 228

cost-benefit analysis, p. 231 Tragedy of the Commons, p. 232

QUESTIONS FOR REVIEW 1. Explain what is meant by a good being “excludable.” Explain what is meant by a good being “rival in consumption.” Is a slice of pizza excludable? Is it rival in consumption? 2. Define and give an example of a public good. Can the private market provide this good on its own? Explain.

3. What is cost-benefit analysis of public goods? Why is it important? Why is it hard? 4. Define and give an example of a common resource. Without government intervention, will people use this good too much or too little? Why?

PROBLEMS AND APPLICATIONS 1. Think about the goods and services provided by your local government. a. Using the classification in Figure 1, explain which category each of the following goods falls into: * police protection * snow plowing

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a. Are the externalities associated with public goods generally positive or negative? Use examples in your answer. Is the free-market quantity of public goods generally greater or less than the efficient quantity? b. Are the externalities associated with common resources generally positive or negative? Use examples in your answer. Is the free-market use of common resources generally greater or less than the efficient use? 3. Charlie loves watching Teletubbies on his local public TV station, but he never sends any money to support the station during its fundraising drives. a. What name do economists have for Charlie? b. How can the government solve the problem caused by people like Charlie? c. Can you think of ways the private market can solve this problem? How does the existence of cable TV alter the situation? 4. Four roommates are planning to spend the weekend in their dorm room watching old movies, and they are debating how many to watch. Here is their willingness to pay for each film:

First film Second film Third film Fourth film Fifth film

Orson

Alfred

Woody

Ingmar

$7 6 5 4 3

$5 4 3 2 1

$3 2 1 0 0

$2 1 0 0 0

PUBLIC GOODS AND COMMON RESOURCES

f. What does this example teach you about the optimal provision of public goods? 5. Some economists argue that private firms will not undertake the efficient amount of basic scientific research. a. Explain why this might be so. In your answer, classify basic research in one of the categories shown in Figure 1. b. What sort of policy has the United States adopted in response to this problem? c. It is often argued that this policy increases the technological capability of American producers relative to that of foreign firms. Is this argument consistent with your classification of basic research in part (a)? (Hint: Can excludability apply to some potential beneficiaries of a public good and not others?) 6. There is often litter along highways but rarely in people’s yards. Provide an economic explanation for this fact. 7. The village of Ectenia has ten residents. Villagers can earn income by either weaving baskets or fishing. Because the lake has a limited number of fish, the more villagers fish, the less each catches. In particular, if n households fish in the lake, then each fishing household makes an amount: If = 12 – 2n

where If is daily income measured in dollars. The income that a household makes by weaving baskets is $2 a day. a. Assume that each household makes the decision of whether to weave baskets or fish in the lake independently. How many households do you expect to see fishing each day? How many households do you expect to see weaving baskets? (Hint: Think about opportunity cost.) Calculate the total income of the village in this equilibrium. b. Show that, when 3 households fish in the lake, the total income of the village is larger than the one you found in part (a). What pvented the villagers from reaching this higher-income allocation of resources when they acted independently? c. If the villagers together decided to achieve the allocation in part (b), what kinds of rules would they need to institute? If they wanted

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everyone to benefit equally in the new system, what kind of tax and transfer system would they need? d. What type of good is the fishery? What characteristics make it that type of good? 8. The Washington, D.C., Metro (subway) system charges higher fares during rush hours than during the rest of the day. Why might it do this? 9. Timber companies in the United States cut down many trees on publicly owned land and many trees on privately owned land. Discuss the likely efficiency of logging on each type of land in the absence of government regulation. How do you think the government should regulate logging on publicly owned lands? Should similar regulations apply to privately owned land?

10. The federal government tests the safety of car models and provides the test results free of charge to the public. Do you think this information qualifies as a public good? Why or why not? 11. High-income people are willing to pay more than lower-income people to avoid the risk of death. For example, they are more likely to pay for safety features on cars. Do you think cost-benefit analysts should take this fact into account when evaluating public projec

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