3.5 — Introduction to Political Economy

# 3.5 — Introduction to Political Economy

## ECON 306 • Microeconomic Analysis • Spring 2023

### Ryan Safner<br> Associate Professor of Economics <br> <a href="mailto:safner@hood.edu"><i class="fa fa-paper-plane fa-fw"></i>safner@hood.edu</a> <br> <a href="https://github.com/ryansafner/microS23"><i class="fa fa-github fa-fw"></i>ryansafner/microS23</a><br> <a href="https://microS23.classes.ryansafner.com"> <i class="fa fa-globe fa-fw"></i>microS23.classes.ryansafner.com</a><br>

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# Outline

### [Policies That Raise Transaction Costs & Prevent Equilibrium](#3)
### [An Example: *Some* Economic Impacts of Covid](#9)
### [Making Fair Comparison](#37)

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# Welfare Economics, Reminder

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.smallest[
- **Markets are great when:**
  1. They are .hi-purple[Competitive]: many buyers and many sellers
  2. They reach .hi-purple[equilibrium] (.hi-purple[prices are free to adjust]): absence of transactions costs or policies *preventing prices from adjusting* to meet supply and demand
  3. .hi-purple[There are no externalities]<sup>.magenta[†]</sup>: costs & benefits are fully internalized by the parties to transactions

- .hi[Market failure]: if these conditions are not met
  - May be role for governments, other institutions, or entrepreneurs to fix

]

.footnote[<sup>.magenta[†]</sup> Or public goods, or asymmetric information. But I treat these as special cases of more common externalities.]

]

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# Policies That Raise Transaction Costs & Prevent Equilibrium

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# Dis-equilibrated Markets

.smallest[
- The .hi-purple[static benefits] of markets all come from markets .hi-purple[being in *equilibrium*] ([class 3.3](/content/3.3-content)):
  - allocative efficiency (.blue[CS]+.red[PS])
  - Pareto efficiency
  - productive efficiency

- But don’t forget the .hi-purple[dynamic benefits] of markets as a .hi-purple[discovery *process*]! ([class 3.4](/content/3.4-content))
  - *discovery* of better allocations of resources
  - creation & elimination of profit opportunities
  - entrepreneurship & innovation
]
]
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<img src="3.5-slides_files/figure-html/unnamed-chunk-1-1.png" width="504" style="display: block; margin: auto;" />
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# Dis-equilibrated Markets

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.smaller[
- To *reach* equilibrium, market prices need to be able to adjust
  - **Shortage** `$(\color{red}{Q_s}<\color{blue}{Q_d})$`: price needs to rise
  - **Surplus** `$(\color{red}{Q_s}>\color{blue}{Q_d})$`: price needs to fall

- There are .b[*unrealized* gains from trade] that exist in disequilibrium (shaded)
  - .blue[Buyers] & .red[sellers] both can be made better off if they can adjust the price
]
]

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<img src="3.5-slides_files/figure-html/unnamed-chunk-2-1.png" width="504" style="display: block; margin: auto;" />
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# Dis-equilibrated Markets

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.quitesmall[
- If market prices are *prevented* from adjusting, shortage/surplus becomes *permanent*

- Lost .blue[CS] and/or .red[PS]: .b[Deadweight loss (DWL)]
  - **inefficiency** created by (permanent) diseq.

- Various government policies can prevent markets from equilibrating & create DWL:
  - .hi-purple[Price regulations] (price ceiling like rent control, price floor like minimum wage)
  - .hi-purple[Taxes, subsidies, tariffs, quotas]<sup>.magenta[†]</sup>
  - These should have been covered in Principles (see my [slides](https://publics20.classes.ryansafner.com/slides/4.4-slides#1) on taxation from ECON 410)
]

.tiny[<sup>.magenta[†]</sup> Some may be necessary (taxes fund government), but create market inefficiencies.]
]

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# An Example: *Some* Economic Impacts of Covid

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# An Example: *Some* Economic Impacts of Covid

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.center[
![:scale 65%](https://www.dropbox.com/s/vd1v40faubhbq81/Screen%20Shot%202020-04-29%20at%202.20.01%20PM.png?raw=1)

- Where did all of the ... go?
  - Toilet paper
  - Hand sanitizer
  - Masks
  - PPE
  - Ventilators

- Three major issues:
  - price elasticity of supply
  - price gouging laws
  - restrictions & regulations on supply
]

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# Increase in Demand

]

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# Increase in Demand

- Demand *increases*, becomes *less elastic*
]
]

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# Increase in Demand

- Demand *increases*, becomes *less elastic*

- At the original market price, a .hi-purple[shortage!] `$(\color{blue}{q_D} > \color{red}{q_S})$`
]
]

]

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# Increase in Demand

- Demand *increases*, becomes *less elastic*

- At the original market price, a .hi-purple[shortage!] `$(\color{blue}{q_D} > \color{red}{q_S})$`

- .red[Sellers] are supplying `$Q_1$`, but some .blue[buyers] willing to pay more for `$Q_1$`
]
]
.pull-right[

]

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# Increase in Demand

- Demand *increases*, becomes *less elastic*

- At the original market price, a .hi-purple[shortage!] `$(\color{blue}{q_D} > \color{red}{q_S})$`

- .red[Sellers] are supplying `$Q_1$`, but some .blue[buyers] willing to pay more for `$Q_1$`

- .blue[Buyers] raise bids, inducing .red[sellers] to sell more

- Reach new equilibrium with:
  - **higher market-clearing price** `$(P_2)$`
  - **larger market-clearing q. exchanged** `$(Q_2)$`
]
]
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]

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# One Possibility: Inelastic Supply

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.smallest[
- It might that .red[supply] is very *inelastic*
  - Here: *perfectly* inelastic (for convenience)

- Suppliers can’t produce and sell more units even if they want to at very high price demanded
  - sudden shock to inventories (short run)
  - rising production costs
  - government regulations & restrictions

- Thus, the new high price is an equilibrium that will persist for a while
  - no “inefficiency,” just a fixed supply of goods we cannot easily change
]
]

]

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# One Possibility: Inelastic Supply

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.center[
[![](../images/masksshortage.png)](https://www.flexport.com/blog/why-there-arent-enough-masks-and-how-to-get-more/)
]

]

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# Price Gouging Laws

- Additionally, government has .hi-purple[anti-price-gouging laws], a .hi-purple[price ceiling] at the original price, `$P_1$`

- `$\color{blue}{Q_d}>\color{red}{Q_s}$`: .hi-purple[excess demand], a .hi-purple[shortage]!

- Sellers will not supply more than `$Q_1$` at price `$\bar{P_1}$`

]

]

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# Price Gouging Laws

- Additionally, government has .hi-purple[anti-price-gouging laws], a .hi-purple[price ceiling] at the original price, `$P_1$`

- `$\color{blue}{Q_d}>\color{red}{Q_s}$`: .hi-purple[excess demand], a .hi-purple[shortage]!

- Sellers will not supply more than `$Q_1$` at price `$\bar{P_1}$`

- For `$Q_1$` units, buyers are willing to pay `$P_D$`!

]

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<img src="3.5-slides_files/figure-html/unnamed-chunk-12-1.png" width="504" style="display: block; margin: auto;" />
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# Price Gouging Laws

- .hi-purple[If prices were allowed to adjust]: buyers would bid higher prices to get the scarce `$Q_s$` goods

- Sellers would respond to rising willingness to pay, and produce and sell more

- .hi-purple[But the price is not allowed to rise above `\$\bar{P_1}\$`]!

]

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<img src="3.5-slides_files/figure-html/unnamed-chunk-13-1.png" width="504" style="display: block; margin: auto;" />
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# Price Gouging Laws

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# Price Gouging Laws

- Competition exists between buyers to obtain scarce `$Q_s$` goods
  - Buyers willing to pay `$P_D$` *unofficially*

- Goods are distributed by non-market means:
  - Queuing
  - Black markets
  - Political connections, favors, corruption

- **Economic rents**: excess returns (above opp. cost) to those who own the scarce goods
]
]

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# Forms of Rents

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.center[
[![](https://www.dropbox.com/s/9x5joizms3onvig/hoarding_hand_sanitizer.png?raw=1)](https://www.nytimes.com/2020/03/14/technology/coronavirus-purell-wipes-amazon-sellers.html)
]
]

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.center[
[![](https://www.dropbox.com/s/djttw0gez55ct2r/corona_lines.png?raw=1)](https://www.washingtonpost.com/nation/2020/04/26/long-lines-coronavirus/?arc404=true)
]
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# (Temporarily) Raising Prices Can Solve the Shortage

- .hi-purple[Conveys information]: good is relatively scarce

- .hi-purple[Creates incentives for]:
  - **Buyers**: conserve use of this good, seek substitites
  - **Sellers**: produce more of this good
  - **Entrepreneurs**: find substitutes and innovations to satisfy this unmet need
]
]

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# (Temporarily) Raising Prices Can Solve the Shortage

.pull-left[
.center[
[![](https://www.dropbox.com/s/2hcbs03asm1au3w/corona_canada_no_shortages.png?raw=1)](https://www.aier.org/article/why-no-shortages-in-canada-as-compared-with-the-u-s/)
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"The *Canadian National Post*, citing the Canadian Food Inspection Agency, says that 'There are no shortages or disruptions to [food] production, importation or export,' and that 'the shelves remain stocked.' ... 'A price surge as a result of natural market forces is not something that is regulated by Canadian competition laws or otherwise. Canada’s competition laws generally don’t interfere with the free market.' ... Canadians will have enough food to eat. But it will be more expensive.

]
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# (Temporarily) Raising Prices Can Solve the Shortage

.center[
<blockquote class="twitter-tweet"><p lang="en" dir="ltr">A supermarket in Denmark got tired of people hoarding hand sanitizer, so came up with their own way of stopping it.<br><br>1 bottle kr40 (€5.50)<br>2 bottles kr1000 (€134.00) each bottle.<br><br>Hoarding stopped!<a href="https://twitter.com/hashtag/COVID19?src=hash&amp;ref_src=twsrc%5Etfw">#COVID19</a> <a href="https://twitter.com/hashtag/Hoarding?src=hash&amp;ref_src=twsrc%5Etfw">#Hoarding</a> <a href="https://t.co/eKTabEjScc">pic.twitter.com/eKTabEjScc</a> (via <a href="https://twitter.com/_schuermann?ref_src=twsrc%5Etfw">@_schuermann</a>) cc <a href="https://twitter.com/svenseele?ref_src=twsrc%5Etfw">@svenseele</a></p>&mdash; Birger (@Birger_s) <a href="https://twitter.com/Birger_s/status/1240163073928953856?ref_src=twsrc%5Etfw">March 18, 2020</a></blockquote> <script async src="https://platform.twitter.com/widgets.js" charset="utf-8"></script> 
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