Reading Essentials and Study Guide

NAME ________________________________________ DATE _______________ CLASS _________ Reading Essentials and Study Guide Chapter 6: Prices Lesson 3 Soci...
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Reading Essentials and Study Guide Chapter 6: Prices Lesson 3 Social Goals, Prices, and Market Efficiency ESSENTIAL QUESTION What factors affect prices?

Reading HELP DESK Academic Vocabulary stabilize to make steady or unchanging arbitrarily randomly or by chance

Content Vocabulary price ceiling the highest legal price that can be charged for a product price floor the lowest legal price that can be paid for a product target price price floor for agricultural products set by the government to stabilize farm prices nonrecourse loan loan that does not have a penalty or further obligation to repay

TAKING NOTES: Key Ideas and Details ACTIVITY Use a graphic organizer like the one below to identify the goals or objectives of price ceilings and price floors. Goal Copyright © McGraw-Hill Education. Permission is granted to reproduce for classroom use.

Price ceiling

Price floor

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Reading Essentials and Study Guide Chapter 6: Prices Lesson 3 Social Goals, Prices, and Market Efficiency, cont. Controlling Prices Guiding Question What are the costs and benefits of economic policies aimed at creating equity and security? In a 100 percent competitive-free enterprise system, buyers and sellers determine prices. But the free enterprise economy of the United States is a little different. This means that the government sometimes interferes in the market in order to achieve a goal for the benefit of the people in a society. One way the government does this is by setting prices for certain goods and services below or above the equilibrium price. Equilibrium price is the price of a product when the demand for it equals its supply. Attempts to fix, or permanently set, prices are not new. During World War I and World War II, the federal government fixed the prices of certain foods to make sure that everyone could get affordable meals. President Nixon fought inflation, or rising prices, in the early 1970s by trying to fix some prices. But his efforts mostly did not work. Today the government uses a combination of price ceilings and price floors to fix prices on many products.

Price Ceilings

Price Floors At other times, lawmakers may think that the market clearing price is too low. So they try to raise it by setting a price floor, the minimum legal price that a seller can charge. A price floor means a seller can’t set a price below a certain dollar amount. The result of the price floor is shown in Panel B of Figure 6.4. With a price floor of $25, 2 units are demanded but 11 units are supplied. This leaves a surplus of 9. A surplus is too much of something. Usually the surplus of 9 would push the price toward its equilibrium level of $15, but not in the case of a price floor. Instead, the surplus becomes permanent and will remain as long as the price floor stays above the market’s equilibrium price. A change in either demand or supply could cause the surplus to increase or decrease. But a surplus will always be there as long as the price floor remains above the equilibrium price.

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Copyright © McGraw-Hill Education. Permission is granted to reproduce for classroom use.

When a price is set below its equilibrium level, it is called a price ceiling. This is the maximum legal price that can be charged for a product. The case of a price ceiling is shown in Panel A of Figure 6.4 where the price ceiling of $10 is set below the one that clears the market. The result of the price ceiling in the figure is clear. With a price ceiling of $10, there are 10 units demanded but only 4 units are supplied, which means that 6 are missing. Missing 6 units would usually push the price toward its equilibrium level of $15, but not with a price ceiling. Instead, the shortage becomes permanent. It will stay as long as the price ceiling stays below its equilibrium price. A change in demand or supply could cause the shortage to increase or decrease. But a shortage will always be there as long as the price ceiling stays below the equilibrium price.

NAME ________________________________________ DATE _______________ CLASS _________

Reading Essentials and Study Guide Chapter 6: Prices Lesson 3

Social Goals, Prices, and Market Efficiency, cont.

Progress Check Analyzing What are the negative and positive aspects of price ceilings and price floors?

Examples of Fixed Price Policies Guiding Question Whom do price supports help and whom do they hurt? Price fixing is not just something that happened in the middle of a war. There is a surprising amount of it happening today. Minimum wage, farm subsidies (money that the government gives to farms), and rent controls are major examples of price controls used today. More information about minimum wage is in Chapter 9.

Copyright © McGraw-Hill Education. Permission is granted to reproduce for classroom use.

Using Price Floors to Support Sugar Prices Over time, prices on almost all agricultural, or farm, products have risen and fallen much more widely than prices on other goods and services. This is because farmers often have times of prosperity or difficulty. When crops are good, the extra production pushes prices down. In years of drought or flooding, the reduced crops push prices up. Because of this, the government tries to stabilize, or make steady, agricultural prices. The government does this by using price floors to help farmers and processors of farm products. The sugar business is one example of how the government can stabilize farm prices with floor prices. The government set target prices on sugar that comes from sugarcane. It did this in 1981, and approved it again with the 2008 Farm Act. A target price is a floor price that the government thinks is fair for a product. The government has a loan system to make sure that farmers get the target price for their products. For example, in 2013 the government set a loan rate of 18.75 cents per pound on cane sugar. A sugarcane processor could get a loan from the United States Department of Agriculture (USDA) at this rate if it promised its sugar as collateral, or security, for the loan. After processing the sugar, the processor had two choices: (1) The processor could sell the sugar on the open market at a higher price than the target price. Then the processor could use the money from the sale to pay back the USDA loan. (2) Or, if the market price of sugar fell below target price, the processor could keep the profits of the loan and let the USDA take the sugar. The loan is called a nonrecourse loan because it does not have to be paid back. Also, the loan does not have a penalty or duty, extra money that must be paid back when a person does not pay back a loan, to pay back. Either way, the processor is sure to get at least 18.75 cents per pound for the processed sugar. This is how a price floor helps to stabilize farm income. Price supports not only stabilize agricultural profits, but they have also helped U.S. sugar producers compete with foreign sugar producers. The price supports have also saved jobs in the sugar production business.

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Reading Essentials and Study Guide Chapter 6: Prices Lesson 3 Social Goals, Prices, and Market Efficiency, cont. Unfortunately, the sugar support policies, or a plan of action, have also raised the price of sugar for American buyers. Since the first Farm Act that introduced this type of policy in 1981, U.S. sugar prices have been about twice as high as world sugar prices. This has cost Americans billions of dollars, and the higher cost of U.S. sugar has also been a problem for American industries that use sugar, like makers of candy, sweets, and drinks. These American industries have lost jobs as a result of higher prices. Agricultural price supports are just one example of a nation trying to reach one economic goal (economic security) at the price of another (economic efficiency). As you can see, there are consequences to setting a legal price too high in order to reach a goal for the social good.

Using Price Ceilings to Control Rents

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Rent control is an example of a price ceiling because it sets the highest price that can be charged for certain types of housing. Some cities, like New York City, used rent controls during World War II. Cities did this to free up resources for the war. Today New York City uses rent controls to make housing less expensive for many middle- and low-income renters. Figure 6.5 shows how rent control works. Let us suppose that without rent controls, the free market sets rents at $1,500 a month. There is an equilibrium number of two million apartments at this rate. If the government wants to support the social goals of fairness and security for people who do not have the money to pay these rents, it can arbitrarily, or randomly, set a price ceiling at $1,000 a month. Of course, possible renters would like the $1,000 price. Let us suppose they demand 2.4 million apartments. But landlords , people who rents property, want to supply fewer apartments at that price—let’s say 1.6 million units. This would leave a shortage of 0.8 million, or 800,000 apartments. This shortage would stay as long as the ceiling price remains below the equilibrium price. Would more people have a better life if this price ceiling were in place? Maybe not. Clearly the 800,000 possible renters who could not get apartments would not be happy. Also, landlords would be unhappy because they would have to accept a lower price for their rental units. Because of this, the landlords would want to rent fewer units than they would under free market conditions. More than likely, they would convert some of the nicer apartments to high-priced condos (apartments that are sold, not rented) or offices—leaving the less wanted ones to be rented. They would also cut back on basic repairs on the units they rent. This would let the buildings deteriorate, or get worse. The only people who are better off are the 1.6 million renters who were able to get the apartments for $1,000 a month. But in time, even they would become unhappy when they found out that their landlords were not maintaining their buildings. At the same time, there would be long lines of people waiting to get the low-cost rental units. All of this results in a situation where prices no longer affect apartment choice. Instead, landlords deal with the shortage by using long waiting lists or by using nonprice reasons such as keeping out renters with children and pets. Is the landlord’s behavior unfair? After all, what would you do if you owned rental units in a city with rent controls? If you could not increase rents to keep up with repairs and city building taxes, you might do what other landlords do. That means lowering your costs by only doing the absolute minimum repairs. You may even tear down some buildings to make way for more profitable shopping centers, factories, parking garages, or high-rise office buildings. All of this adds up to the slow movement of productive resources out of the rental market and into other activities. This is just one example of how rent controls twist the economy’s distribution of useful assets. In the end, government tries to reach two of our seven economic goals: economic equity and economic security. But these conflict with another goal—economic efficiency. Are equity and security

NAME ________________________________________ DATE _______________ CLASS _________

Reading Essentials and Study Guide Chapter 6: Prices Lesson 3

Social Goals, Prices, and Market Efficiency, cont.

worth more than efficiency? This depends on how voters view the costs and benefits of the action, and how they express their satisfaction or frustration when they vote.

Government and Social Goals

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The American free enterprise system has seven broad economic and social goals that most people seem to share. These goals are economic freedom, economic efficiency, economic equity, economic security, full employment, price stability, and economic growth. But we also know that these goals often conflict with one another. As a result, laws to reach any one goal almost always conflict with other economic goals. This makes effective government policy-making difficult. So, how does government decide which of the seven economic goals to promote? And how does government evaluate the costs and benefits of a specific policy to see if it should be supported over another? The answer is that government does neither. Instead, extreme conditions usually must exist before all political parties and the president agree to support any one goal. For example, the minimum wage was set during the Great Depression when nearly one in four people in search of work could not find a job. And many of those who were working earned as little as a nickel an hour. Price floors were also widely used in agriculture during that time because farm incomes were so low. Rent and other price controls came into use during World War I and World War II to save resources for the war effort and to prevent price gouging, or overcharging for scarce, or hard to find, goods. So why do we still have price ceilings and floors today when economic conditions are much better than they were during the Great Depression or the world wars? The answer is that once price supports are put in place, they often have enough political support to keep them there. Or, as in the case of sugar support prices, so few people know about them that there is no overt opposition.

Progress Check Summarizing What has been the effect of price floors in the U.S. sugar industry?

When Markets Talk Guiding Question How do markets “talk”? Markets are impersonal tools that bring buyers and sellers together. Although markets do not talk in the usual meaning of the word, they do send signals. These signals represent the actions of buyers and sellers who trade in the markets. Markets “talk” when prices move up or down greatly in reaction to a related event. •

Gold Prices Rise A rising price of gold is usually not a good sign for the economy. This is because people usually think of gold as a hedge, or protection, against a possible economic or social disaster. Sharp rises in the price of gold would get the attention of other investors and perhaps

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Reading Essentials and Study Guide Chapter 6: Prices Lesson 3

Social Goals, Prices, and Market Efficiency, cont.

even encourage some of them to buy gold as well, driving up the price of gold even more. Gold prices usually come down slowly when the economic news is good, so sharp rises in the price of gold gets the most attention. •

Stock Prices Fall Falling stock prices generally reflect a lack of confidence in business conditions or in government policy. Suppose the federal government announced that it would raise taxes to pay off some of the federal debt. If investors thought that this policy would not work, or that other policies might be better, they might sell some of their stocks, causing stock market prices to fall. In a sense, then, we could say that the market has “talked” by showing its disapproval of a new government policy or some other event whenever stock prices go down. But if stock market prices had gone up, it would be a sign that investors had a more positive view of the policy or event.



Oil Prices Rise Investors watch the price of oil closely. This is because it is a commodity (a product or service) used around the world. Also, it has very fixed supply and demand curves. Because of this, even slight changes in the supply or demand for oil can have a dramatic impact on the price of oil. A sharp rise in the price of oil could mean that supply has decreased a little, something the market sees as a possible difficult time ahead for the economy.

We can think of each of these market price changes as a shared effort by markets to “tell” us that something is wrong or is about to happen. This is why we can say that markets “talk.” And, as the world’s economies become increasingly interconnected, we find that markets talk not just in response to local events, but to global events as well. Today, international policy decisions, wars, and other major events around the world can affect the prices of products in the United States. Likewise, events in the United States can have far-reaching effects on prices throughout the world.

Examining Can you think of any other examples of markets “talking”? Explain.

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Progress Check

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