Econ 101: An introduction to FIRMS

We have been studying consumer and consumer behavior a LOT lately... well not anymore! It's time for us to turn our attention to the strange and wonderful world of PRODUCERS!

Scary stuff, right?

First-off: The role of the firm.

In economics, we define a firm as any self-contained, profit maximizing entity that produces and sells goods or services (or both)

A firm is an economic construct, and may not necessarily be exactly the same as a "business". There are three main kinds of firms in the economic universe: Single Proprietorships, Partnerships, and Corporations.

Single (Sole) Proprietorship:
In this type of firm, the owner IS the business. For an example, Mr. Wong owns Mr. Wong's Confectionary, so Mr. Wong IS Mr. Wong's Confectionary! What this means is that Mr. Wong is personally liable for all damage done by his business, and will be accordingly held responsible. For an example, if I ate a pie from Mr. Wong's Confectionary and it made me sick, I could sue Mr. Wong's Confectionary for damages and uncleanliness. If I won, Mr. Wong would have to pay me out of his own pocket.
Some other characteristics of proprietorships:
-There is only one owner
-Unlimited liability
-There are obvious incentives for the owner to get the firm to generate profit
-They can be difficult to finance (because the burden of financing proprietorships falls on one individual)
-Transfering ownership is difficult (selling your business can be hard)
-Owners are taxed at the personal rate


Partnership:
In this type of firm, two or more individuals who perform the same kind of work (for an exampple, two laser hair removal specialists) join together under a contract in order to make PROFIT! This partnership is legal and binding. What it entails is that all of the individuals who have entered the partnership are jointly liable for all damage their business causes. For an example if I get laser hair removal from doctor A, and the procedures somehow gives me skin cancer, I can sue A & B hair removal and force Doctor B to pay me for damages out of his own pocket, even though he had nothing to do with me contracting skin cancer. For this reason, it is important to REALLY TRUST anyone you enter a partnership with.
Some other characteristics of partnerships:
-2 or more owners
-Unlimited shared liability
-They can be difficult to finance (because the burden of financing proprietorships falls on only a few individual)
-Transfering ownership is difficult (selling your small business can be hard, especially if you are a group of specialized professionals and there is no one with a similar skill set who is willing to take over your business)
-Owners are taxed at the personal rate

Both of these types of firms can be very risky to own, due to the unlimited liability imposed on all owners. SO, laws were invented to pave the way for...

THE CORPORATION:
These have lots of different names (company, ltd, inc)
http://en.wikipedia.org/wiki/Salomon_v_A_Salomon_&_Co_Ltd
Basically, the corporation is treated as a separate legal entity. Each shareholder (owner) has limited liability equal only to the dollar amount of the company which they own as shares
-Corporations are easier to finance (many different people can become part owners and finance corporations as shareholders without having to assume liability)
-Shareholders can easily buy and sell their partial ownership (this is what trading stocks and selling shares is all about)
-Usually, the shareholders elect a board of directors, who in turn hire the top-ranking employees (the CEO, CFO, and VPs)
-Corporations are taxed twice: once for corporate profits and once for shareholder dividends.

There are also a few hybrid firms, which combine aspects of several different kinds of firms.

A limited partnership is a cross-breed between a partnership and a company. In a limited partnership, there is at least one general partner with unlimited liability. There can be other limited partners, however, who own limited shares of the business, but aren't involved in running it (kind of like shareholders). Limited partnerships are used to get around security legislation and gives limited partners the chance to invest in riskier operations without being held liable for shortcomings

A limited liability partnership is only available for professionals. It is very similar to a limited partnership, but the limited partners can be involved in the business.

A crown corporation is a company in which the controlling shareholder is the government. The business may function as an entity independent from the government, but often they act as a sounding board for government policy (ie CBC).

Not For Profit Corporations try to just break even, not making any excess profit.

TransNational Corporations (TNGs) are the big boys. THINK McDonalds and Wal-Mart


Proprietorship Partnership Corp
Ownership Easy Easy Easy
Liability Unlimited Unlimited Limited (but with conditions)
Transfer Difficult P-ship Agmnt Easy
Finance Difficult Difficult Easier
Mgmt Easy Tough Separate
Taxes Tough Tough Excruciating


3 problems which small businesses face:
- Government Regulation and payroll taxes (Canada Pension Plan, Unemployment Insurance, Workers Compensation Board)
-Financing Problems
-A lack of Qualified Labor

Canadian Federation of Independent Business is a lobby group for small businesses.

A shelf company is just a piece of paper created by company lawyers. After it is created, a firm needs to raise financial capital (money) to carry on their business.

There are 2 ways most firms do this:

1: Equity Financing: Firms grant others a share of control of their company in return for a gift of money. Investor, however, expect a divident- a return on their investment. It should be noted that this return is completely DISCRETIONARY (firms can withhold it). Capital gain is an increase in the market value of the share (the share becomes more valuable, eg: a stock goes from $12 to $16). If a company pumps profits back into the company instead of distributing them to the shareholders, this is called undistributed profit.

2: Debt Financing: Firms borrow money from external lenders (usually banks)
Debtor = Borrower
Creditor = Lender
Principal = Originally Borrowed Amount
Interest = Extra money paid as a return on the loan
Redemption Date = The date the loan must be repaid
Term = The period between the date of the loan and the redemption date.

There are 3 Kinds of debt instruments!

1: Loans
-Short Terms
-Principal must be repaid
-Interest must be paid

2: Bill and Notes (ie you loan $90 and expect $100 back)
-Short Term
-Principal Guaranteed
-No interest, but sold by debtors to creditors for less than their real worth

3: Bonds and Debentures
-Long term
-Principal must be paid
-Interest payments must be made

Debentures:
If they are unsecured, there is no charge on specific assets
If they are secured all assets which are no specifically secured can be charged
Assets are taken by the creditor in the case of bankruptcies
This lets you use your assets as a credit (ie- you can use your house as a line of credit if it is paid for)

BIG IDEA: We assume that firms want to maximize profit!

This may not happen in corporations where management is hired by the owners. Management may be more focused on increasing their own salaries in this case. Here, they will maximize sales sometimes at the expense of profit.

There IS a range of profit which companies can work within which can be adjusted for different situations while still keeping the owners reasonably happy.

In the end, the companies that make profits are the one which survive. it's evolutionary.

Econ 101: Income, and Substituion with Indifference curves

HEY, Before anything else happens, we should all ask our TAs why indifference curves are convex to the origin (I think it has something to do with diminishing marginal rates of substitution- basically, a combination of goods with a major defficiency in one product requires a LOT of compensation in terms of the other product in order to get the same total utility as you would with a balanced combination of goods).

Alright: It's a shorter lecture today.

We know that we can use the budget line and the indifference curves for any two products to predict a different quantiy which will be purchased at each price.


Now we're going to look at how to graphically represent the substitution and income effects using budget lines and marginal utility analysis.

Remember: whenever the price of one good drops, our real income (purchasing power) rises. For theory's sake, in order to isolate the substitution effect, we must change the budget line to reflect changing price ratios while keeping real income constant. In order to do this, we take the budget line and rotate it around the point where it originally intersects with it's original indifference curve.

We look at where this new, streched budget line is tangent to a greater indifference curve. The change in the quantity of product A is caused by the substituion effect: consumers substituting into the cheaper good to maximize total utility (reach a greater indifference curve).

Now let's look at income effect: If total income increases when the price of a NORMAL GOOD decreases, that will also cause us to purchase more of that good. In order to look at the income effect, we take the restricted budget line (with the new price ratio) and shift it up and to the right to reflect the increase in real income.

The point where this new, inflated budget line is tangent to the highest indifference curve represents the new quantity purchased as a result of both substitution AND income effect.


Remember:
-The total effect is the substitution effect + the income effect
-The substitution is a change in quantity purchased due to a change in relative prices. It is always negative (except for conspicious consumption goods), which means that price and quantity purchased change in opposite directions
-Income effect is a change in quantity purchased due to a change in purchasing power.
It can be positive (for normal goods) or negative (for inferior goods)

If the income effect is greater than the substitution effect, the product in question is a Giffen Good


NOW: let's put it all together!

Indifference curve analysis yields the same conditions for total utility maximization as marginal utility analysis!

We know that for Utility to be maximized in indifference curve analysis, the budget line must be tangent to the indifference curve.

BUDGET LINE EQUATION: PxQx +PyQy = Income
BUDGET LINE SLOPE: -Px/Py (Marginal rate of tranformation)

INDIFFERENCE CURVE EQUATION: /\Qx(MUx) + /\Qy(MUy) = 0
INDIFFERENCE CURVE SLOPE: -MUx/MUy (Marginal rate of substitution)

Maximazation condition: The budget line must be tangent to the indifference curve

or

the slope of the budget line must equal the slope of the indifference curve

or

-Px/Py must = -MUx/MUy

or

MUx/Px = MUy/Py WHICH IS MARGINAL UTILITY ANALYSIS

Brilliant, non?

Econ 101 Indifference Curves:

Indifference curves are graphs which incorporate the idea of tastes or preferences.


We assume that consumers are rational thinkers, and that they can rank their preferences. There are three parts to this 'rationality':

1- COMPLETE the consumer must either prefer good A to good B, good B to good A, or be indifferent
2- REFLEXIVE A is always as good as A. Preferences don't change based on exogenous variables
3- TRANSITIVE If A > B and B > C, then A > C

THESE SUBJECTIVE PREFERENCES ARE INDEPENDANT (EXOGENOUS).
-We cannot make comparisons between different people (because you can't compare my happiness to yours)
-We cannot make comparisons between different times
-This shows us that psychology is the basis of microeconomics!

HOKAY! Now that the background stuff is out of the way, let's actually look at one of these again.

FUNCTION OF A UTILITY CURVE: U = U(x,y) higher number = higher utility...

All of the different points on one indifference curve show different combined quantities of 2 goods (x and y) which yield a constant total utility.
Because the utility derived from any product is different for different people, the indifference curve shows PERSONAL PREFERENCES.

CHARACTERISTICS:
For any two products, there are an infinite number of indifference curves expanding outward. The total utility for each progressive curve is higher than the last one, because each progressive curve represents a greater combined quantity of goods x and y, and in most cases, we prefer to have MORE (more goods = greater total utility).

Two indifference curves for the same product cannot cross, because that would suggest that we can achieve the same total utility with a set combination of x and y as we could with the same quantity of x, but fewer of y. Also the point of intersection would imply two different total utilities for the same combination of goods. That's illogical.

EQUATION: Change in X (Marginal utility of X) + Change in Y (Marginal utility of Y) = 0

Why? Because if two points are on the same indifference curve, the utility lost on one axis is gained on the other axis.

utility lost = Change in X (Marginal utility of X)
utility gained = Change in Y (Marginal utility of Y)

The slope of the indifference curve = change in X/change in Y

OR

negative marginal utility of X/marginal utility of Y

OR

the marginal rate of substitution!

COMBINING BUDGET LINES AND INDIFFERENCE CURVES:
both budget lines and indifference curves have the same axes: quantities of different products. Budget lines show us possible combinations of different products, and indifference curve show us desired combinations of different products!

REMEMBER, price changes are represented as rotations or stretches of the budget line. SO, if the price of soda falls, the budget line for soda stretches out further along the x-axis, and the possible quantity of soda increases. Consumers want to maximize total utility, so places where the indifference line meets the budget line represent the demanded combinations of goods, given the prices of both products. As the prices of a good falls, consumers substitute into that good in order to reach higher indifference curves with the stretched budget line.
.
In this way, we can see the formation of a demand curve- consumers buy greater quantities of a product as the price decreases in order to maximize total utility (intersect with the highest indifference curve). This results in a negatively sloped demand curve.

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ECON 101: The beginning of consumer behavior

WE ARE STARTING TO LOOK AT CONSUMER BEHAVIOR!

Isn't it exciting!? In order to nicely coordinate with the way the midterm is working out, we are going to spread this unit out over a period of two weeks. The online test won't pop up until the 16th.

An interesting note: Prof Gateman thinks that population growth is the reason behind all of the world's problems.

OKAY! For this unit, we are going BEHIND the demand curve to discover what the psychological link is between consumer behavior and HAPPINESS

For instance, we will discover why the demand of a Louis Vitton Purse increases when the price increases. Sounds crazy? It might be, but it works, and we're going to find out why!

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WE'RE STARTING WITH MARGINAL UTILITY ANALYSIS

In order to add up total demand for any specific product, we set the price for the product and then add up the quantity each individual consumer demands at that price (ceteris paribus) to find the total. The total market demand is the sum of each individual household's demand for the product!

Super-easy, right?

Total demand + total supply = An economy, but we don't get to total supply until next chapter...

See, there is a chain of 'bigness'

Individual consumer preferences make up household demand
Total household demand makes up market demand
Market demand plus market supply makes up an economy
An economy is awesome and interesting

In the mean while, we need to come to understand the basis for that demand at the individual consumer level.

HOKAY, now for the juicy stuff: MARGINAL UTILITY THEORY

Utility: We define utility as satisfaction, happiness, fulfillment of a want. Sometimes utility is also used as a method ranking products, or illustrating personal preferences.

Utility is an ORDINAL MEASURE (which means that we can rank utility, but unlike a cardinal measure, we cannot assign specific numeric value to it)

TOTAL UTILITY is the total satisfaction derived from consuming all units of the good (for instance, the total amount of satisfaction I derive from chugging 10 bottles of beer)

MARGINAL (extra, or incremental) UTILITY is the change in total utility which occurs as a result of consuming one additional unit of the good (ie, the amount of satisfaction I derive from chugging the 10th bottle of beer)

There is this thing in economics, and it is known as the
LAW OF DIMINISHING MARGINAL UTILITY
What it means is that marginal utility decreases as we continue to consume a certain product AFTER A CERTAIN POINT (ceteris paribus)

SEE!?

Why does this happen?
Well, it's because of opportunity cost. Usually, consumers are willing to give up more for the first quantity of a product than the for the 39th quantity of a product. A good example here is water. We would give up a LOT in order to have use of at least 1 litre of water per day. We would give up a significantly smaller amount to have use of 390 litres of water per day.

The FORMULAS:
Marginal Utility = (Change in Total Utility)/(Change in Quantity)
Marginal Utility is a derivative of total utility with regard to quantity

Total utility = The sum of the marginal utilities
Total utility is an integral of marginal utility

Let's review:
-Total utilty increases as a decreasing rate after a certain point (ceteris paribus)
-Marginal utility is the change in total utility divided by the change in quantity
-The slope of a line between two points on a total utility curve is the marginal utility of that product for that change in quantity
-Generally, total utility curve is S-shaped

The point where marginal utility stops increasing and begins to decrease is the inflexion point.
The reason why marginal utlity rises up to the inflexion point is that usually, the first bit of a product makes you crave or require even more of it (it's psychological).

After the inflexion point, total utility can still increase, but at a decreasing rate.

So... what can we do with this knowledge?

WELL we can try and maximize our utility, given two different products at different prices.

IN ECONOMICS, WE ALWAYS ASSUME THAT INDIVIDUALS SEEK TO MAXIMIZE THEIR TOTAL UTILITY. (We call this maximization principle). Individuals prefer happiness to unhappiness.

We will prove that individuals allocate income such that the utilty gained from the last dollar spent on each good is equal. In other words, that marginal utility per price on each good is equal. This can be expressed as an equation.

(marginal utility of product 1)/(Price of Product 1) = (Marginal utility of product 2)/(Price of product 2)

WE MAXIMIZE THE TOTAL UTILITY BY EQUATING THE MARGINAL UTILITIES.

Why do we use 'per dollar' utility? Because utility gained from one very expensive product is going to be much higher than utility gained from one cheap product, so we have to accomodate for that.
In these equations, we always assume that there is no utility gained by holding on to money (unless the money is considered a good, like in currency exchange scenarios)

So just think about that for a little while...

ECON 101 - Currency exchange, and excise taxes

Today, we're looking at two different applications of supply and demand: Currency Exchange, and Excise Taxes!

CURRENCY EXCHANGE:

The exchange rate is the price of a foreign currency in terms of a domestic currency. For an example, if 1 Canadian Dollar is Worth 2 British Pounds, the exchange rate of the British Pound is 2 Canadian Dollars.

The external value is the price of a domestic currency in terms of a foreign currency. For an example, if 1 Canadian Dollar is Worth 2 British Pounds, the external value of the Canadian Dollar is half a British Pound.

A good way to remember this is to remember that external value is 'all about me', so it's all about how much MY money is worth.

It's important to note that many major news sources don't always use these terms correctly.

OKAY! So why would people want to exchange currencies in the first place???

WELL, there two reasons.
1: They have a demand for foreign goods (so they need to convert their own currency into foreign currency in order to purchase them)
2: They want to make investments in foreign markets

SO...

Because of this, demand and supply of certain currencies depend on two factors.

DEMAND for a domestic currency depends on:
1- Demand for domestic exports
2- Foreign investment in domestic markets (K inflow)

SUPPLY of a domestic currency depends on:
1- Demand for foreign imports
2- Domestic investment in foreign markets (K outflow)

Let's say we're exchanging Canadian dollars for any kind of foreign currency. If the demand for Canadian dollars = the supply of Canadian dollars, we have EQUILIBRIUM

Things that can effect our dollar value:
-An increase in demand for Canadian goods
-A decrease in our own demand for foreign goods (in other words, a decrease in the supply of the Canadian dollar).

In this way, trade affects the currency market.

EXCISE TAXES: Basically, a sales tax which only applies to a specific item (carbon taxes, or sin taxes are examples of excise taxes)

There are two different kinds of excise taxes!
1: "AD VALOREM" ---> A percentage of the value of the product (like jewelry, slot machines, and matches)
2: "SPECIFIC" -------> A per-unit tax (quantity based) (like beer and cigarettes)

Also governments are considering creating an excise tax for fast food or trans fats... which could be interesting. The question is, does this tax serve as an effective disincentive?

TAX INCIDENCE is on whom the ultimate burden of a tax lies (aka: what percentage of the tax is paid for by consumers in the form of increased prices, and what percentage is paid for by the producer in the form of lost profits)

Basically, if you want to graphically introduce an excise tax, make a new supply curve above the original supply curve by the number of price units equal to the excise tax. Using this new curve, find the new equilibrium (where it intersects with demand at this new price). At this new quantity, the difference between the equilibrium price and the consumer price determines the consumer tax incidence, and the difference between the equilibrium price and the producer price determines the consumer tax incidence.

You can also manipulate the formulas for the curves using simple addition on the supply curve equal to the tax increase.

As a good rule of thumb, whichever curve (supply or demand) which is more inelastic will bear the majority of the tax incidence.

HOKAY! WHAT HAVE WE LEARNED SO FAR!?

Government intervention has a cost! It requires alternative allocation mechanisms, and generally the free market is much more efficient.

The free market can be a cruel cruel place...

but goddammit, it works!


An excise tax functions like an effect cost increase, and as such, it shifts the supply curve left for any product.
The consumer price = the producer price + the tax

Econ 101: A Jarring Look at Agriculture Markets

Hokay!

Farmers basically experience two kinds of problems which make their lives miserables.

THE LONG TERM PROBLEM is that farmer's incomes fall, relative to the incomes of urban workers. There are three reasons for this.
1: Increasing domestic supply: as time moves on and technologies improve in farming, the domestic supply of farmed products shifts to the right (increases). This wouldn't be necessarily such a bad thing if demand would also shift to the right... however...
2: The is a lagging domestic demand for farm products: Because farm products are necessities (food), they have low income elasticity. As such, increases in income do not cause consumers to purchase much more farm products.

also

3: The is a decreased demand for exported farm goods: There is less of a demand now for Canadian farm products on the global market because countries which we have sold to in the past now produce their own farmed goods domestically.

So basically, demand for farm products remains relatively stagnant, while the supply of farm products increases. This means that the price of farm products inevitally drops, as do farmer incomes.

AGRICULTURE SUPPORT: RAISING INCOME

Government argicultural policy often aims to raise farmer's incomes above what they would make selling goods at equilibrium prices (in addition to stabilizing incomes).

There are two ways to maintain an effective price floor above the equilibrium price
1: PRICE SUPPORT

In price support, the government legislates an effectual price floor, by buying all of a farmer's output at a set price higher than the equilibrium price. By doing this, the government creates a situation where demand is perfectly elastic (and prices will not change regardless of quantity supplied).

The price and quantity exchanged both rise from the orginal equilibrium level. There is, however, an excess in supply (the farmers produce more than customers will actually buy at that set price). Excess supply is stockpiled each year.

The government is subidizing an amount equal to (the artificially inflated price) X (The excess in demand)
The consumer is subsidizing an amount equal to (quantity demanded at inflated prices) X (The difference between the equilibrium price, and the inflated price)
BASICALLY, this method allows farmers to make more money by rellocating money from the consumer and from the taxpayer.

2: QUOTAS

In a quota scenario, the government sets a limit on the quantity of a farm good that is supplied (like a quantity wall). The quota quantity is less than the equilibrium quantity, and as such, the price at the quota quantity is higher than the equilibrium price.
The effect is that quota holders get extra revenue equal to (the difference between the price demanded at the quota quantity and the price supplied at quota quantities)
Because demand is inelastic if for whatever reason quantity falls, farmer's total renevues increase! And quantity cannot rise above the quota level.
Pe X Qe < Pq X Qq BECAUSE OF INELASTIC DEMAND

Advantages: Farmer's income is stabilized without stockpiling
Disadvantages: The consumer pays more for less, and the cost of purchasing quota rights effectually allows quota licenses to become a market in and of themselves.

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THE SHORT TERM PROBLEM is that the prices of farm products fluctuate tremendously, and as a result, the farmer has a difficult time securing a steady income. These fluctuations can happen on a few levels.

INTERNATION MARKETS- changes in world prices cause changes in export prices. When the world market goes up or down, farmers make more or less money off of exports.
Basically, the demand in the world market is perfectly elastic, because Canada's contributions to international farm product markets are so small, they are practically insignificant. As a result, whatever quantities Canadian producers put on the international market do not affect the price determined for the product. FARMERS HAVE NO CONTROL OVER FLUCTUATIONS IN WORLD PRICE. Because prices are uncontrollable, farmers incomes increase in the same direction as supply (if the weather is good for some reason and a large crop is harvested, they make more money) and vice versa. Farmer incomes also increase when world prices arbitrarily rise, and fall when world prices fall.

The big complaint for farmers is that they have very little control over their incomes due to these uncontrollable changes in both the world market and their own supply. As a result, the government will often step in and try and fix things.

STABILIZATION POLICIES FOR INTERNATIONAL MARKETS (in order to adjust for fluctuations)

1: Stabilize Quantity!
How? Stockpile farm products when there are too many being produced (a good year), and then dip into this stockpile when there is not enough being produced (a bad year)
Problems: This won't work for perishable items, and also, there are extra costs farmers will have to pay to stockpile their products.
GATEMAN'S AWESOME SUGGESTION: Why not just save extra money made during good years and borrow money lost during bad years (like the rest of us)

2: Stabilize Price!
How? Create a system of 'guarunteed price' where the government subsidizes farmers when world prices are too low, and farmers pay the government when the prices are too high.
Major Problem: How do you determine what prices are too high and which are too low? If the government sets the 'ideal' price at a rate which does not correspond to acceptable world prices, either the government or the farmers will be getting a bad deal.
GATEMAN'S AWESOME SUGGESTION: Why not just save extra money made during good years and borrow money lost during bad years (like the rest of us)

DOMESTIC MARKETS- Basically, supply is inelastic from year to year (farmers can't substitute inputs and change production mid-growing season without much difficulty), and unplanned changes can occur to this inelastic supply due to changes in weather or other uncontrollable factors.

Domestic demand for farm products is very inelastic (there isn't a whole lot of substitution people can make for food). Because price is so inelastic, farmers can ACTUALLY LOSE OVERALL PROFIT by supplied a LARGER QUANTITY THAN EXPECTED (because, remember, total revenue is price X quantity, and for inelastic demand, total revenue increases when you lower quantity exchanged and increase the price). In other words, farmers incomes will fluctuate in the same direction as the price, and in the opposite direction to supply (the higher the price of wheat, the more money wheat farmers will make), and exogenous factors can raise or lower the price of wheat (by changing the quantity supplied)

HOKAY! Farmers hate this because again, they have no control over their own incomes.

THIS IS WHAT THE GOVERNMENT DOES!


1: Stabilize Quantity!
How? Stockpile farm products when there are too many being produced (a good year), and then dip into this stockpile when there is not enough being produced (a bad year)
Problems: This won't work for perishable items, and also, there are extra costs farmers will have to pay to stockpile their products.
GATEMAN'S AWESOME SUGGESTION: Why not just save extra money made during good years and borrow money lost during bad years (like the rest of us)

2: Stabilize Price!
How? Create a system of 'guarunteed price' where the government subsidizes farmers when world prices are too low, and farmers pay the government when the prices are too high.
Major Problem: How do you determine a good average price? Also, farm income will still vary with the quantity supplied.
GATEMAN'S AWESOME SUGGESTION: Why not just save extra money made during good years and borrow money lost during bad years (like the rest of us)

3: Suggestions for income stabilization in domestic markets:
-With too little government intervention, farmer incomes will vary inversely with supply. (The artificial demand curve is too inelastic)
-With too much government intervention, farmer incomes will vary directly with supply. (The artificial demand curve is too elastic)
-So in order to be most effective, the government tries to intervene in an intermediate fashion by providing unit elasticity. In other words, the government's 'guaranteed' price for farm products will vary in an inverse proportion to the quantity.
FOR EXAMPLE: If output rises 10%, the government allows the 'guaranteed price' to fall 10%, so total revenue remains unchanged.

Agricultural Policies in CANADA:

1: DIFFERENT KINDS OF MARKETING BOARDS

a) Supply Management (which is a marketing board)
-sets quotas
-used for milk, eggs, cheese, butter, and poultry
-they are provincial bodies
-they allow for huge profits for farmers... at the expense of the consumer
-Food processor (who buy farm products as inputs) also incur high costs
-In 1995, the quotas were replaced tariff equivalents in order to conform with the World Trade Organization. The tariffs were set as high at 300% though, so our farmers are still making a lot of money

b) Marketing Agents
-The Canadian Wheat Board in an example of this
-Every farmer is required to sell all of their wheat to the Canadian wheat board
-The wheat board pays the farmer the world price for their wheat

2: INCOME SUPPLEMENTS
"Farm safety net programs"
-Crop failure insurance
-Income stabilization
-Bailouts

Farms are pretty big businesses... small farmers are pretty much a thing of the past. =(

ISN'T IT DEPRESSING!?

ECON 101 - Markets in Action

Important Announcement: The Midterm is one week away! Here's a quick review of what we've been doing.

Chapter 1: What is economics?
Chapter 2: What is a social science/how do research and statistics work?
Chapter 3: What are demand and supply curves?
Chapter 4: We describe demand and supply curves
Chapter 5: We apply demand and supply curves

STUDY ECONOMICS! Your Marks depend on it!

If you hit the ground running, you will do well!
It really doesn't matter how you study as long as you understand the material.

Okay!
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Examples/Applications of supply and demand
-Interaction among markets
-Government controlled prices
-Market Efficiency

INTERACTION AMONG MARKETS
-Basically, changes in one market will affect other markets. There is also a degree of feedback, so changes in a market can cause it to change again.

For an example, if a technology develops which makes it much cheaper and faster to extract oil, the supply of oil will move to the right (oil's supply will rise). This in turn causes all markets which use oil as an input (such as plastics or transportation) in turn to experience and increase in supply. At the same time, as supply of oil increases, equilibrium price of oil will fall, which in turn will effect the demand of oil substitutes such as natural gas or wind power.... you get the point?

There are two ways of looking at markets

PARTIAL EQUILIBRIUM- analysis of a market in isolation (other markets aren't taken into account)

GENERAL EQUILIBRIUM- All of the markets are taken into account

In this course, we are considering markets almost exclusively from a partial equilibrium standpoint.
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GOVERNMENT CONTROLLED PRICES

When the price is in disequilibrium, the ACTUAL AMOUNT exchanged is always the LESSER/SMALLER of the quantity supply or the quantity demanded. This is the small numbers rule!


PRICE FLOORS: A minimum price. Prices are not allowed to fall below a set amount.

They have no effect UNLESS they are set above the equilibrium price. Otherwise, the market will simply fall into equilibrium, like it regularly does.

A binding price floor creates an excess supply!


PRICE CEILING: A maximum price. Prices are not allowed to rise above a set amount.

They have no effect unless UNLESS they are set below the equilibrium price.

In most cases with price ceilings, a shortage is created (an excess of demand). Those who are able to get their hands on the product get it for a cheap price, but everyone else is simply denied the product.

IF YOU SCREW WITH MARKETS, THERE IS ALWAYS A COST! DUN DUN DUN...

Basically, if price controls prevent markets from allocating goods, other allocation methods will spring up.
-Black Markets (illegal markets in which black marketeers buy products at controlled prices, and then sell them at the prices which consumers are willing to pay for them, making personal and illegal profits off of the difference)
-First come, first served (so people will cue up to get products. Think UBC BBQs)
-Rationing (the government decides how much each consumer gets to purchase. This happens during wars usually)
-Seller Preferences (Under the counter deals for favorite customers or family)

Okay!

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RENT CONTROL
(otherwise known as an effective price ceiling)

Basically, supply is inelastic in the short run, because it takes time to build new apartments, or to let existing apartments go to ruins.

Rent controls cause excess demand equal to the difference between the quantity which would actually be demanded at the rent control price (a large quantity. if pricing is cheap, people want more of it) and the quantity supplied at that price range. This may not be a large excess of demand initially, but as time passes and the housing market becomes more elastic, buildings will not be kept up, and as a result, they will become uninhabitable. This means that supply will actually decrease over time, creating a larger excess of demand (housing shortage).

The moral of the story: Those who get tenancy before the price controls are adopted WIN, because they have cheap rent forever (but on the other hand, their building may not be kept well if the owner is making a loss on it due to artificially cheapened rent). Landlords and prospective future tenants both lose. Landlords lose because they don't get the expected returns on their investment in real estate, and potential tenants lose because there aren't enough available buildings for them to find a place to rent from.

As a result...
-Black Market (This is the rent... and then you also have to pay a $1600 key deposit. HAHAHAHA)
-First come first served
-Rationing
-Seller preference (I only rent to my relatives)

MINIMUM WAGES
these are effective price floors for labor. They create an excess of supplied labor, which is otherwise known as unemployment.

The moral: Workers who can keep their jobs win (but not entirely, because they will be expected to perform the duties normally performed by a slightly larger staff). Producers and prospective employees lose. Producers have to pay more, and potential employees can't find a job.

ALTERNATIVES TO PRICE CONTROLS
1: Let the market work
2:
-Subsidized housing
-Public housing
-Income assistance
in other words, just directly give people the money. These are nonmarket solutions. They do not, however, change the fact that opportunity cost for certain goods (such as houses) is high.

How do you balance everything off? There are benefits and downfalls to every scenario where prices are controlled. Do the benefits to those who receive them outweigh the costs to those who incur them in every price control scenario? How do we figure this all out?

MARKET EFFICIENCY: Let's us see if the market is maximizing social welfare.

In order to understand market efficiency, we first need to come to a new understanding of supply and demand. Basically, we morph the demand curve into a benefit curve, and the supply curve into a cost curve.

DEMAND is the maximum price a consumer is willing to pay for any given quantity. If there is less supplied, the consumer is willing to pay more.
in this sense, MAXIMUM PRICE = value, or benefit to you, the consumer.

SUPPLY is the minimum price a producer is willing to accept for the sale of a good. The less they are selling, the less they are willing to sell for.

ECONOMIC SURPLUS = BENEFIT - COST

Let's say I am willing to buy a can of coke for $1, and a company is willing to sell it for ten cents! Well... then basically, when we buy and sell at equilibrium price, the consumers are getting bonus profit, and consumers are getting a lower price than the maximum they are willing to pay, so there is an economic surplus spread through the market to both consumers and producers. The dollar amount of this surplus can be determined by finding the area of the triangle which represents the surplus on a market graph.

The producer surplus is the part of the triangle above the equilibrium price point
The consumer surplus is the part of the triangle below the equilibrium price point

Economic surplus is FREE HAPPINESS!

We don't want to cut that surplus, because that creates losses... however some create total losses, but net benefits for either producers or suppliers

PRICE CEILINGS create losses in the producer surplus, losses in the total surplus, and increases in the consumer surplus.
PRICE FLOORS create losses in the consumer surplus, losses in the total surplus, and increases in the producer surplus.

The chunk which is taken out of the triangle (to the right of the price control quantity exchanged) represents the net loss in economic surplus. That is the cost of intervention.