Market Interventions and Their Consequences

Market Intervention

Market Efficiency

Competitive markets lead to an efficient allocation of resources.
In equilibrium, quantity demanded equals quantity supplied.
Resources are allocated to their highest valued uses, described as "Pareto Optimal."

Why Markets are Efficient

Division of Labor, Specialization, Trade: Maximizes the production of goods and services for given resources.
Competition: Forces producers to offer the best products and services, adopt low-cost methods and technologies, and sell at the lowest prices.
The Price System: Prices coordinate the separate actions of individuals, even without direct interaction, utilizing dispersed knowledge.
Profits and Losses: Profits enable successful companies to expand and innovate, while losses redirect resources away from unsuccessful ones.

The Invisible Hand

Adam Smith, The Wealth of Nations, 1776, highlights that individuals acting in their own self-interest unintentionally promote broader societal benefits.
The system doesn't require altruism or specialized knowledge.
Quote: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest…"
Quote: "… by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention."

Competitive Markets

Competitive markets allocate resources to create the highest standard of living for the largest number of people.

Scarcity

Thomas Sowell: "The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics."

Government Intervention

Governments intervene when the market is perceived to deliver an inefficient outcome.
Methods of intervention:
- Price Controls
- Output Controls
- Taxes, Subsidies
- Regulations

Example: Credit Card Interest Rate Cap

Proposed legislation to cap credit card interest rates at 10%.
Banks borrow at a federal interest rate of 4.25%, while credit card interest rates are around 23.8%.
Previous attempts include the Loan Shark Prevention Act, which proposed a 15% federal cap.

Price Controls: Floors

Price floors create a surplus.
Minimum wages create unemployment.
Effects of minimum wage:
- Some people get a higher price.
- Fewer people are employed.
- Prices increase elsewhere.
- Employers may replace employees with automation.
Example: Maryland's minimum wage at $15/hour.

Example: Minimum Wage Impact on Delivery Services

New York City's minimum wage hike leads to reduced hours and tips for food delivery workers.
Companies limit the number of couriers to control payroll costs.
Uber's new scheduling system restricts when couriers can go online.

Example: California Fast-Food Wage Increase

California fast-food workers set to receive a nearly 30% pay bump to $20/hour.
Chipotle and other chains plan to raise prices to offset higher labor costs.
Pizza Hut franchisees laying off over 1,200 delivery drivers in California.

Price Floors: Increased Prices Elsewhere

When labor costs increase, the price of goods and services using labor also increase (e.g., Big Macs, Starbucks lattes, Uber rides).
Increased factor costs decrease supply, raising prices.
Even workers earning higher wages lose some benefits due to increased prices.

The Question of Minimum Wage

Why isn't the minimum wage $100 per hour?

Technology and Automation

Robots are being introduced to automate tasks (e.g., burger chefs making $3/hour).
Examples:
- Flippy the robot at Miso Robotics.
- Waiterless restaurants with tablet orders and conveyor belt food delivery.
- Walmart using robots for shelf inventory checks (e.g., Tally).
- Loyola University using Just Walk Out technology in its store.
- Canvas using robots for drywalling.

Robots in Various Industries

Robots are automating tasks in accounting, merging purchase orders, and transferring customer data.

Price Controls: Ceilings

Price ceilings create a shortage.
Some buyers get a lower price.
Sellers reduce supply, decreasing quantity.
Some resell products at a higher "black market" price (PBM) to buyers with higher valued uses.
Example: Rent control can lead to products not going to their highest-value uses.

Quantity Controls: Limits

Limits on quantity or production raise prices.
The price increases for the lesser quantity.
Example: No offshore oil drilling can lead to lost production.

Quantity Controls: Mandates

Quantity mandates raise prices.
Quantity increases to the new mandate (Qm).
Prices rise to $Ps@Qm$ so suppliers produce $Qm$ , but buyers will only pay $PD@Q_m$ .
Subsidies are required to close the difference between $PD@Qm$ and $Ps@Qm$ .
This is a transfer from taxpayers to original buyers.
Example: Affordable Care Act (ACA), where everyone must have health insurance, needing a 3rd party subsidy.

The Affordable Care Act (ACA) Objectives

Expand medical insurance coverage to 30 million uninsured people.
Lower the cost of health insurance and healthcare.

The Affordable Care Act (ACA) Analysis

Market for Health Insurance:
- Before ACA: $Q_e = 285$ million
- After ACA: $Q_e = 315$ million
- Increased insurance coverage but higher insurance prices.
Market for Health Care:
- Increased healthcare consumption but higher healthcare prices.

Obamacare Premiums

Obamacare premiums jumped 25% on Healthcare.gov in 2017.

Consumer Price Index (CPI) Components

Breaking down the Consumer Price Index shows changes in subcomponents since 2000 (Medical Care, Housing, Food & Beverage, Transportation, etc.).

Taxes and Subsidies

Tax: Money taken from you [-]
Subsidy: Money given to you [+]
Effects depend on where they fall:
- Tax on Transactions: Increases price of goods, decreases Quantity demanded ( $Q_d$ )
- Tax on Income: Reduces income, decreases demand
- Subsidy to Buyers: Additional income, increases demand
- Tax on Seller: Increased price of factor production, decreases supply
- Subsidy to Seller: Decreased price of factor production, increases supply

Tax on Transactions: Sales Taxes

Price increases to consumers.
Quantity declines after tax.
Example: Sales tax rates in Maryland (6.00%), New York (8.53%), New Jersey (6.60%), Pennsylvania (6.34%), Delaware (0.00%).

Tax on Income: Income Tax

Reduces income, decreasing demand.
Price decreases after tax.
Quantity decreases after tax.
Example: If you earn $50,000 a year, you pay $9,075 in federal income taxes.

Subsidy to Buyers

Subsidy = Increased Income, Demand Increases
Quantity Increases After Subsidy
Price Increase After Subsidy
Approximately Equal to the Subsidy
When you Subsidize anything you get more of it at higher prices
Example: Financial Aid, where the government pays $10,000 towards college tuition

Consumer Price Index: College Tuition

Breaking down the Consumer Price Index: College Tuition demonstrates the Inflation Nightmare

Moral Hazard

An incentive that causes people to do something bad or harmful.
Subsidized home insurance encourages building homes too close to the ocean.

Tax on Sellers

Tax = Increased Price Factor of Production, Supply Decreases
Price Increases After Tax
Quantity decreases After Tax
Taxes on producers/sellers increase costs - are passed on to consumers

Subsidy to Sellers

Subsidy = Lower Price Factor of Production, Supply Increases
Price decreases After Subsidy
Quantity Increases After Subsidy
Subsidization increases production by less efficient producers

Summary of Market Interventions: Consequences

Setting minimum price results in lower quantity [surplus]
Setting maximum price results in lower quantity [shortage]
Limiting the quantity results in higher prices
Quantity mandates result in higher prices
Taxes : Decrease demand, lower quantity
Subsidies : more, higher quantity at higher prices
Market Interventions Create Unintended Consequences

Non-Price Interventions

NOT ALL interventions involve prices, quantities, taxes, or subsidies
SOME interventions involve laws, regulations, administrative rulings, interest rates, licensing, permits, codes, rules, zoning, fees
Market Interventions Create Unintended Consequences

Market Interventions: Resources Allocation

In competitive free markets, voluntary exchange creates mutual benefit. Buyers and sellers each weigh costs and benefits. Resources are used efficiently because they go to their highest valued uses.
Market Interventions Resources are not always allocated efficiently.
Market interventions interrupt voluntary exchanges. Costs and benefits are uncoupled from transactions, and can be transferred to others. Resources do not always go to their highest valued uses.

The Price System's Role

Prices act to coordinate the separate actions of countless individuals who never meet each other
Prices Allow Markets to Adjust to Changing Conditions
"The economic problem of society is thus not merely a problem of how to allocate “given” resources— it is a problem of the utilization of knowledge which is not given to anyone in its totality."
Friedrich Hayek