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Economics/Gov Intervention


For each of the following scenarios which of the actions listed would apply?  
Price the buyer pay decreases? price the buyer pays increase? Quantity demanded
will ultimately equal quantity supplied? Quantity both bought and sold will
increase? Quantity successfully purchased decreases?  Actions: Price Floor;
price ceiling; Quantity Restrictions; Excise Tax; 3rd party payer system;

Price the buyer pays decreases
The only time prices decrease is in response to extremely bad economic conditions.  For example, when a company is desperate to sell surplus inventories in order to reduce their operating costs.

Price the buyer pays increases
Quantity Restrictions – Since buyers must rely on alternatives which have less utility or higher price in order to meet demand, a high price is paid than otherwise would have been available.
Excise Tax – Companies will respond to a new tax by increasing price, and that price jump will become a permanent fixation of market price.  Take away the tax and prices do not then decrease.
Subsidies – As much as companies will try to convince you that subsidies make goods cheaper for end consumers, it’s not generally true.  The money producers receive in the form of subsidies increase profitability, and prices – being sticky – tend to remain stagnant, as determined by demand, competition, and available substitutes.  Since buyers are now paying price, plus paying additional by being taxed to fund those subsidies, they are paying an overall higher price.

Quantity demanded will ultimately equal quantity supplied
This is true of all things.  When supply is higher than demand, companies will reduce their production capacity to eliminate extraneous costs.  When demand is higher than supply, companies will increase production capacity in order to generate more profits.  A company will continue to produce so long as they make money, and they will not spend more than they need to in order to meet that demand regardless of government action.  Guaranteed.

Quantity both bought and sold will increase
3rd Party Payer – When something in funded indirectly and by the population as a whole through taxation and government expenditures, two things happen.  First, it allows for people who otherwise would not contribute to demand due to an inability to afford a given good or service, to suddenly gain access, increasing demand.  As with anything else, producers will continue to sell so long as it is profitable to do so.  Second, this creates a cognitive dissociation, wherein people will consume without consciously considering the price, since it is paid for through taxes, or “personal overhead”.  When people are directly paying for something, they frequently tend to be more concerned with the financial impact of it, just as people more carefully consider their purchases when asked to keep a log of their spending behavior.  This is eliminated when the cost is paid for with tax money, because there is no direct per-unit cost by which consumers can evaluate the amount of perceived value of their marginal rates of consumption.

Quantity successfully purchased decreases
Quantity Restrictions – Unlike with taxes, there is no monetary response in the long run that will shift supply or demand curves.  So, a shortage is maintained as long as the restrictions are in place.  These quotas are generally placed used on imports, resulting in the remaining demand being met by domestic firms who consumer greater value in the factors of production to meet that demand.  This resource inefficiency causes higher prices being paid, and misallocates resources which could otherwise be used to create value by producing things in which the nation has a comparative advantage (those things which can be produced more efficiently).  This minimizes the gains from trade that nation can experience, making them generally less competitive in the international market.

Price Floor
Price ceiling
These two are not associated with any of the above.  It is a common misconception among introductory economics courses to believe that these cause shortages or surpluses, but the market has an adjustment mechanism to account for this.  In the short term, each of these cause a shift to the producer and/or consumer surpluses experiences in the exchange.  In the long run, these value surpluses return to their original position as a result of shifts in the value of the money being used to measure the exchange.  For example, an increase in minimum wages will cause a decrease in profitability in the short run, since prices are sticky and will not respond immediately to the increased cost, but as demand increases as a result of higher average disposable income, overall price levels will increase, creating a market correction.  That’s why minimum wages function as short-term stimulus, but average real wages have remained stagnant for decades, regardless of what happens with the minimum wage.  This tends to be particularly true for those things on which the government places price controls - wages, housing, and so forth; things that are extremely price inelastic and which influence the price of just about everything else.

These will likely drive economics undergrad students crazy, but when you first begin learning about economics, you hold many variables constant.  You use the assumption of "ceteris paribus", meaning "all other things held constant", in order to help explain things easily.  Economics does not occur in a vacuum, though, so these assumptions are often false, causing a lot of confusion and misconception among would-be economists.


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Michael Taillard


Accepts most economic questions


Consulting with major corporations, government agencies, political organizations, small businesses, non-profits, start-ups, and even individual people. Teaching at universities around the world, and developing original coursework. Performing original research and analysis. Writing books and scientific studies.

American Economics Association

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PhD (Financial Economics; honors) -- MBA (International Business Finance; honors) -- Grad School Certificate (International Business Management; honors) -- BS (International Business Economics; honors) -- AA (Business Administration; honors) -- Certificate (Chinese Language and Culture) -- Trade School (Transportation Logistics; honors)

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