Microeconomics (from Greek prefix mikro- meaning "small") is a branch of economics that

studies the behavior of individuals andfirms in making decisions regarding the allocation
of limited resources.[1][2][3]
This is in contrast to macroeconomics, which involves "the sum total of economic activity,
dealing with the issues of growth, inflation, and unemployment and with national economic
policies relating to these issues".[2] Microeconomics also deals with the effects of national
economic policies (such as changing taxation levels) on the aforementioned aspects of the
economy.[4] Particularly in the wake of the Lucas critique, much of modern macroeconomic
theory has been built upon 'microfoundations'i.e. based upon basic assumptions about
micro-level behavior.
One goal of microeconomics is to analyze the market mechanisms that establish relative
prices among goods and services and allocate limited resources among alternative uses.
Microeconomics also analyzes market failure, where markets fail to produceefficient results,
and describes the theoretical conditions needed for perfect competition.
Assumptions and definitions[edit]
Microeconomic theory typically begins with the study of a single rational and utility
maximizing individual. To economists, rationality means an individual possesses
stablepreferences that are both complete and transitive. The technical assumption that
preference relations are continuous is needed to ensure the existence of a utility function.
Although microeconomic theory can continue without this assumption, it would
make comparative statics impossible since there is no guarantee that the resulting utility
function would be differentiable.
Microeconomic theory progresses by defining a competitive budget set which is a subset of
the consumption set. It is at this point that economists make the technical assumption that
preferences are locally non-satiated. Without the assumption of LNS (local non-satiation)
there is no guarantee that a rational individual would maximize utility. With the necessary
tools and assumptions in place the utility maximization problem (UMP) is developed.
The utility maximization problem is the heart of consumer theory. The utility maximization
problem attempts to explain the action axiom by imposing rationality axioms on consumer
preferences and then mathematically modeling and analyzing the consequences. The utility
maximization problem serves not only as the mathematical foundation of consumer theory
but as a metaphysical explanation of it as well. That is, the utility maximization problem is
used by economists to not only explain what or how individuals make choices
but why individuals make choices as well.
The utility maximization problem is a constrained optimization problem in which an
individual seeks to maximize utility subject to a budget constraint. Economists use

the extreme value theorem to guarantee that a solution to the utility maximization problem
exists. That is, since the budget constraint is both bounded and closed, a solution to the utility
maximization problem exists. Economists call the solution to the utility maximization
problem a Walrasian demand function or correspondence.
The utility maximization problem has so far been developed by taking consumer tastes (i.e.
consumer utility) as the primitive. However, an alternative way to develop microeconomic
theory is by taking consumer choice as the primitive. This model of microeconomic theory is
referred to as Revealed preference theory. To reconcile these two models, restrictions are
placed on the Walrasian demand function. Specifically, the solution to a utility maximization
problem must satisfy the Weak Axiom of Revealed Preferences (WARP). In order for a
Walrasian demand function to satisfy WARP the Substitution (Slutsky) Matrix must
be negative semi-definite. Put more simply, in order for a Walrasian demand function to be
consistent with WARP its substitution effect must always be non-positive.

The supply and demand model describes how prices vary as a result of a balance between product
availability at each price (supply) and the desires of those with purchasing power at each price (demand).
The graph depicts a right-shift in demand from D 1 to D2along with the consequent increase in price and
quantity required to reach a new market-clearing equilibrium point on the supply curve (S).

The theory of supply and demand usually assumes that markets are perfectly competitive.
This implies that there are many buyers and sellers in the market and none of them have the
capacity to significantly influence prices of goods and services. In many real-life transactions,
the assumption fails because some individual buyers or sellers have the ability to influence
prices. Quite often, a sophisticated analysis is required to understand the demand-supply
equation of a good model. However, the theory works well in situations meeting these
assumptions.
Mainstream economics does not assume a priori that markets are preferable to other forms of
social organization. In fact, much analysis is devoted to cases where market failures lead
to resource allocation that is suboptimal and creates deadweight loss. A classic example of
suboptimal resource allocation is that of a public good. In such cases, economists may
attempt to find policies that avoid waste, either directly by government control, indirectly by
regulation that induces market participants to act in a manner consistent with optimal welfare,

or by creating "missing markets" to enable efficient trading where none had previously
existed.
This is studied in the field of collective action and public choice theory. "Optimal welfare"
usually takes on a Paretian norm, which is a mathematical application of the KaldorHicks
method. This can diverge from the Utilitarian goal of maximizing utility because it does not
consider the distribution of goods between people. Market failure in positive economics
(microeconomics) is limited in implications without mixing the belief of the economist and
their theory.
The demand for various commodities by individuals is generally thought of as the outcome of
a utility-maximizing process, with each individual trying to maximize their own utility under
a budget constraint and a given consumption set.
Microeconomic topics[edit]
The study of microeconomics involves several "key" areas:
Demand, supply, and equilibrium[edit]
Main article: Supply and demand
Supply and demand is an economic model of price determination in a perfectly
competitive market. It concludes that in a perfectly competitive market with
no externalities, per unit taxes, or price controls, the unit price for a particular good is the
price at which the quantity demanded by consumers equals the quantity supplied by
producers. This price results in a stable economic equilibrium.
Measurement of elasticities[edit]
Main article: Elasticity (economics)
Elasticity is the measurement of how responsive an economic variable is to a change in
another variable. Elasticity can be quantified as the ratio of the percentage change in one
variable to the percentage change in another variable, when the later variable has a causal
influence on the former. It is a tool for measuring the responsiveness of a variable, or of the
function that determines it, to changes in causative variables in unitless ways. Frequently
used elasticities include price elasticity of demand, price elasticity of supply,income elasticity
of demand, elasticity of substitution between factors of production and elasticity of
intertemporal substitution.

Consumer demand theory[edit]

Main article: Consumer choice
Consumer demand theory relates preferences for the consumption of both goods and services
to the consumption expenditures; ultimately, this relationship between preferences and
consumption expenditures is used to relate preferences to consumer demand curves. The link
between personal preferences, consumption and the demand curve is one of the most closely

studied relations in economics. It is a way of analyzing how consumers may

achieve equilibrium between preferences and expenditures by maximizing utilitysubject to
consumer budget constraints.
Theory of production[edit]
Main article: Production theory
Production theory is the study of production, or the economic process of converting inputs
into outputs. Production uses resources to create a good or service that is suitable for
use, gift-giving in a gift economy, or exchange in a market economy. This can
include manufacturing, storing, shipping, and packaging. Some economists define production
broadly as all economic activity other than consumption. They see every commercial activity
other than the final purchase as some form of production.
Costs of production[edit]
Main article: Cost-of-production theory of value
The cost-of-production theory of value states that the price of an object or condition is
determined by the sum of the cost of the resources that went into making it. The cost can
comprise any of the factors of production: labour, capital, land. Technology can be viewed
either as a form of fixed capital (ex:plant) or circulating capital (ex:intermediate goods).
Perfect competition[edit]
Main article: Perfect competition
Perfect competition describes markets such that no participants are large enough to have
the market power to set the price of a homogeneous product. A good example would be that
of digital marketplaces, such as eBay, on which many different sellers sell similar products to
many different buyers.
Monopoly[edit]
Main article: monopoly
A monopoly (from Greek monos (alone or single) + polein (to sell)) exists
when a single company is the only supplier of a particular commodity.
Oligopoly[edit]
Main article: Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number
of sellers (oligopolists). Oligopolies can create the incentive for firms to engage
incollusion and form cartels that reduce competition leading to higher prices for consumers
and less overall market output.[5]
Market structure[edit]
The market structure can have several types of interacting market systems. Different forms of
markets is a feature of capitalism and advocates of socialism often criticize markets and aim
to substitute markets with economic planning to varying degrees. Competition is the
regulatory mechanism of the market system.

Monopolistic competition, also called competitive market, where there is a large

number of firms, each having a small proportion of the market share and slightly
differentiated products.

Oligopoly, in which a market is run by a small number of firms that together control
the majority of the market share.

Duopoly, a special case of an oligopoly with two firms. Game theory tends to govern
duopoly and oligopoly behavior.[6]

Monopsony, when there is only one buyer in a market.

Oligopsony, a market where many sellers can be present but meet only a few buyers.

Monopoly, where there is only one provider of a product or service.

Natural monopoly, a monopoly in which economies of scale cause efficiency to

increase continuously with the size of the firm. A firm is a natural monopoly if it is able
to serve the entire market demand at a lower cost than any combination of two or more
smaller, more specialized firms.

Perfect competition, a theoretical market structure that features no barriers to entry, an

unlimited number of producers and consumers, and a perfectly elastic demand curve.

Examples of markets include but are not limited to: commodity markets, insurance
markets, bond markets, energy markets, flea markets, debt markets, stock markets, online
auctions, media exchange markets, real estate market.
Game theory[edit]
Main article: Game theory
Game theory is a major method used in mathematical economics and business
for modeling competing behaviors of interacting agents. The term "game" here implies the
study of any strategic interaction between people. Applications include a wide array of
economic phenomena and approaches, such as auctions, bargaining, mergers &
acquisitionspricing, fair division, duopolies, oligopolies, social network formation, agentbased computational economics, general equilibrium, mechanism design,and voting systems,
and across such broad areas as experimental economics, behavioral economics, information
economics, industrial organization, and political economy.
Labour economics[edit]
Main article: Labour economics
Labour economics seeks to understand the functioning and dynamics of the markets for wage
labour. Labour markets function through the interaction of workers and employers. Labour
economics looks at the suppliers of labour services (workers), the demands of labour services

(employers), and attempts to understand the resulting pattern of wages, employment, and
income. In economics, labour is a measure of the work done by human beings. It is
conventionally contrasted with such other factors of productionas land and capital. There are
theories which have developed a concept called human capital (referring to the skills that
workers possess, not necessarily their actual work), although there are also counter posing
macro-economic system theories that think human capital is a contradiction in terms.
Welfare economics[edit]
Main article: Welfare economics
Welfare economics is a branch of economics that uses microeconomic techniques to
evaluate well-being from allocation of productive factors as to desirability and economic
efficiency within an economy, often relative to competitive general equilibrium.[7] It
analyzes social welfare, however measured, in terms of economic activities of the individuals
that compose the theoretical society considered. Accordingly, individuals, with associated
economic activities, are the basic units for aggregating to social welfare, whether of a group,
a community, or a society, and there is no "social welfare" apart from the "welfare" associated
with its individual units.
Economics of information[edit]
Main article: Information economics
Information economics or the economics of information is a branch of microeconomic
theory that studies how information and information systems affect an economy and
economic decisions. Information has special characteristics. It is easy to create but hard to
trust. It is easy to spread but hard to control. It influences many decisions. These special
characteristics (as compared with other types of goods) complicate many standard economic
theories.[8]
OPPORTUNITY COST.
Opportunity cost of an activity (or goods) is equal to the best next alternative uses/foregone.
Although opportunity cost can be hard to quantify, the effect of opportunity cost is universal
and very real on the individual level. In fact, this principle applies to all decisions, not just
economic ones.
Opportunity cost is one way to measure the cost of something. Rather than merely identifying
and adding the costs of a project, one may also identify the next best alternative way to spend
the same amount of money. The forgone profit of this next best alternative is the opportunity
cost of the original choice. A common example is a farmer that chooses to farm their land
rather than rent it to neighbors, wherein the opportunity cost is the forgone profit from
renting. In this case, the farmer may expect to generate more profit alone. This kind of
reasoning is a very important part of the calculation of discount rates in discounted cash
flow investment valuation methodologies. Similarly, the opportunity cost of
attending university is the lost wages a student could have earned in the workforce, rather

than the cost of tuition, books, and other requisite items (whose sum makes up the total cost
of attendance).
Note that opportunity cost is not the sum of the available alternatives, but rather the benefit of
the single, best alternative. Possible opportunity costs of a city's decision to build a hospital
on its vacant land are the loss of the land for a sporting center, or the inability to use the land
for a parking lot, or the money that could have been made from selling the land, or the loss of
any of the various other possible uses but not all of these in aggregate. The true
opportunity cost would be the forgone profit of the most lucrative of those listed.
One question that arises here is how to determine a money value for each alternative to
facilitate comparison and assess opportunity cost, which may be more or less difficult
depending on the things we are trying to compare. For example, many decisions involve
environmental impacts whose monetary value is difficult to assess because of scientific
uncertainty. Valuing a human life or the economic impact of an Arctic oil spill involves
making subjective choices with ethical implications.
It is imperative to understand that no decision on allocating time is free. No matter what one
chooses to do, they are always giving something up in return. An example of opportunity cost
is deciding between going to a concert and doing homework. If one decides to go the concert,
then they are giving up valuable time to study, but if they choose to do homework then the
cost is giving up the concert. Any decision in allocating capital is likewise: there is an
opportunity cost of capital, or a hurdle rate, defined as the expected rate one could get by
investing in similar projects on the open market. Opportunity cost is vital in understanding
microeconomics and decisions that are made.
Applied microeconomics[edit]
Applied microeconomics includes a range of specialized areas of study, many of which draw
on methods from other fields. Industrial organization examines topics such as the entry and
exit of firms, innovation, and the role of trademarks. Labor economics examines wages,
employment, and labor market dynamics. Financial economics examines topics such as the
structure of optimal portfolios, the rate of return to capital, econometric analysis of security
returns, and corporate financial behavior. Public economics examines the design of
government tax and expenditure policies and economic effects of these policies (e.g., social
insurance programs). Political economyexamines the role of political institutions in
determining policy outcomes. Health economics examines the organization of health care
systems, including the role of the health care workforce and health insurance
programs. Urban economics, which examines the challenges faced by cities, such as sprawl,
air and water pollution, traffic congestion, and poverty, draws on the fields of urban
geography and sociology. Law and economics applies microeconomic principles to the
selection and enforcement of competing legal regimes and their relative
efficiencies. Economic history examines the evolution of the economy and economic

institutions, using methods and techniques from the fields of economics, history, geography,
sociology, psychology, and political science.

MACROECONOMICS
Macroeconomics (from the Greek prefix makro- meaning "large" and economics) is a branch
of economics dealing with the performance, structure, behavior, and decision-making of
an economy as a whole rather than individual markets. This includes national, regional, and
global economies.[1][2] Along with microeconomics, macroeconomics is one of the two most
general fields ineconomics.
Macroeconomists study aggregated indicators such as GDP, unemployment rates, national
income, price indices, and the interrelations among the different sectors of the economy to
better understand how the whole economy functions. Macroeconomists develop models that
explain the relationship between such factors as national
income, output, consumption, unemployment, inflation,savings, investment, international
trade and international finance. In contrast, microeconomics is primarily focused on the
actions of individual agents, such as firms and consumers, and how their behavior
determines prices and quantities in specific markets.
While macroeconomics is a broad field of study, there are two areas of research that are
emblematic of the discipline: the attempt to understand the causes and consequences of shortrun fluctuations in national income (the business cycle), and the attempt tounderstand the
determinants of long-run economic growth (increases in national income). Macroeconomic
models and their forecasts are used by governments to assist in the development and
evaluation of economic policy.

Basic macroeconomic concepts[edit]

Macroeconomics encompasses a variety of concepts and variables, but there are three central
topics for macroeconomic research.[3] Macroeconomic theories usually relate the phenomena
of output, unemployment, and inflation. Outside of macroeconomic theory, these topics are
also important to all economic agents including workers, consumers, and producers.

Circulation in macroeconomics.
Output and income[edit]
National output is the total amount of everything a country produces in a given period of
time. Everything that is produced and sold generates an equal amount of income. Therefore,
output and income are usually considered equivalent and the two terms are often used
interchangeably. Output can be measured as total income, or it can be viewed from the
production side and measured as the total value of final goods and services or the sum of
all value added in the economy.[4]
Macroeconomic output is usually measured by gross domestic product (GDP) or one of the
other national accounts. Economists interested in long-run increases in output study economic
growth. Advances in technology, accumulation of machinery and other capital, and better
education and human capital all lead to increased economic output over time. However,
output does not always increase consistently. Business cycles can cause short-term drops in
output called recessions. Economists look for macroeconomic policies that prevent
economies from slipping into recessions and that lead to faster long-term growth.
Unemployment[edit]
Main article: Unemployment
The amount of unemployment in an economy is measured by the unemployment rate, i.e. the
percentage of workers without jobs in thelabor force. The unemployment rate in the labor
force only includes workers actively looking for jobs. People who are retired, pursuing
education, or discouraged from seeking work by a lack of job prospects are excluded.
Unemployment can be generally broken down into several types that are related to different
causes.

Classical unemployment theory suggests that unemployment occurs when wages are
too high for employers to be willing to hire more workers.[citation needed] Other more modern
economic theories[which?] suggest that increased wages actually decrease unemployment by
creating more consumer demand. According to these more recent theories, unemployment
results from reduced demand for the goods and services produced through labor and
suggest that only in markets where profit margins are very low, and in which the market

will not bear a price increase of product or service, will higher wages result in
unemployment.

Consistent with classical unemployment theory, frictional unemployment occurs when

appropriate job vacancies exist for a worker, but the length of time needed to search for
and find the job leads to a period of unemployment.[5]

Structural unemployment covers a variety of possible causes of unemployment

including a mismatch between workers' skills and the skills required for open jobs.
[6]
Large amounts of structural unemployment can occur when an economy is
transitioning industries and workers find their previous set of skills are no longer in
demand. Structural unemployment is similar to frictional unemployment as both reflect
the problem of matching workers with job vacancies, but structural unemployment also
covers the time needed to acquire new skills in addition to the short term search process.
[7]

While some types of unemployment may occur regardless of the condition of the
economy, cyclical unemployment occurs when growth stagnates. Okun's law represents
the empirical relationship between unemployment and economic growth.[8] The original
version of Okun's law states that a 3% increase in output would lead to a 1% decrease in
unemployment.[9]
Inflation and deflation[edit]
A general price increase across the entire economy is called inflation. When prices decrease,
there is deflation. Economists measure these changes in prices with price indexes. Inflation
can occur when an economy becomes overheated and grows too quickly. Similarly, a
declining economy can lead to deflation.
Central bankers, who manage a country's money supply, try to avoid changes in price level by
using monetary policy. Raising interest rates or reducing the supply of money in an economy
will reduce inflation. Inflation can lead to increased uncertainty and other negative
consequences. Deflation can lower economic output. Central bankers try to stabilize prices to
protect economies from the negative consequences of price changes.
Changes in price level may be the result of several factors. The quantity theory of
money holds that changes in price level are directly related to changes in the money supply.
Most economists believe that this relationship explains long-run changes in the price level.
[10]
Short-run fluctuations may also be related to monetary factors, but changes in aggregate
demand and aggregate supply can also influence price level. For example, a decrease in
demand due to a recession can lead to lower price levels and deflation. A negative supply
shock, such as an oil crisis, lowers aggregate supply and can cause inflation.
Macroeconomic models[edit]
Aggregate demandaggregate supply[edit]

A traditional ASAD diagram showing a shift in AD and the AS curve becoming inelastic
beyond potential output.
The AD-AS model has become the standard textbook model for explaining the
macroeconomy.[11] This model shows the price level and level of real output given the
equilibrium in aggregate demand and aggregate supply. The aggregate demand curve's
downward slope means that more output is demanded at lower price levels.[12] The downward
slope is the result of three effects: the Pigou or real balance effect, which states that as real
prices fall, real wealth increases, resulting in higher consumer demand of goods; the Keynes
or interest rate effect, which states that as prices fall, the demand for money decreases,
causing interest rates to decline and borrowing for investment and consumption to increase;
and the net export effect, which states that as prices rise, domestic goods become
comparatively more expensive to foreign consumers, leading to a decline in exports.[12]
In the conventional Keynesian use of the AS-AD model, the aggregate supply curve is
horizontal at low levels of output and becomes inelastic near the point of potential output,
which corresponds with full employment.[11] Since the economy cannot produce beyond the
potential output, any AD expansion will lead to higher price levels instead of higher output.
The ADAS diagram can model a variety of macroeconomic phenomena, including inflation.
Changes in the non-price level factors or determinants cause changes in aggregate demand
and shifts of the entire aggregate demand (AD) curve. When demand for goods exceeds
supply there is an inflationary gap where demand-pull inflation occurs and the AD curve
shifts upward to a higher price level. When the economy faces higher costs,cost-push
inflation occurs and the AS curve shifts upward to higher price levels.[13] The ASAD
diagram is also widely used as a pedagogical tool to model the effects of various
macroeconomic policies.[14]
ISLM[edit]

In this example of an IS/LM chart, the IS curve moves to the right, causing higher interest
rates (i) and expansion in the "real" economy (real GDP, or Y).
The ISLM model represents all the combinations of interest rates and output that ensure the
equilibrium in the goods and money markets.[15] The goods market is represented by the
equilibrium in investment and saving (IS), and the money market is represented by the
equilibrium between the money supply and liquidity preference.[16] The IS curve consists of
the points where investment, given the interest rate, is equal to savings, given output.[17]
The IS curve is downward sloping because output and interest rate have an inverse
relationship in the goods market: as output increases, more money is saved, which means
interest rates must be lower to spur enough investment to match savings.[17] The LM curve is
upward sloping because interest rate and output have a positive relationship in the money
market: as output increases, the demand for money increases, resulting in a rise in interest
rate.[18]
The IS/LM model is often used to demonstrate the effects of monetary and fiscal policy.
[15]
Textbooks frequently use the IS/LM model, but it does not feature the complexities of
most modern macroeconomic models.[15] Nevertheless, these models still feature similar
relationships to those in IS/LM.[15]
Growth models[edit]
The neoclassical growth model of Robert Solow has become a common textbook model for
explaining economic growth in the long-run.[citation needed] The model begins with a production
function where national output is the product of two inputs: capital and labor. The Solow
model assumes that labor and capital are used at constant rates without the fluctuations in
unemployment and capital utilization commonly seen in business cycles.[19]
An increase in output, or economic growth, can only occur because of an increase in the
capital stock, a larger population, or technological advancements that lead to higher
productivity (total factor productivity). An increase in the savings rate leads to a temporary
increase as the economy creates more capital, which adds to output. However, eventually the
depreciation rate will limit the expansion of capital: savings will be used up replacing
depreciated capital, and no savings will remain to pay for an additional expansion in capital.

Solow's model suggests that economic growth in terms of output per capita depends solely on
technological advances that enhance productivity.[20]
In the 1980s and 1990s endogenous growth theory arose to challenge neoclassical growth
theory. This group of models explains economic growth through other factors, such as
increasing returns to scale for capital and learning-by-doing, that are endogenously
determined instead of the exogenous technological improvement used to explain growth in
Solow's model.[21]
Macroeconomic policy[edit]
Macroeconomic policy is usually implemented through two sets of tools: fiscal and monetary
policy. Both forms of policy are used to stabilize the economy, which can mean boosting the
economy to the level of GDP consistent with full employment.[22] Macroeconomic policy
focuses on limiting the effects of the business cycle to achieve the economic goals of price
stability, full employment, and growth. [23]
Monetary policy[edit]
Further information: Monetary policy
Central banks implement monetary policy by controlling the money supply through several
mechanisms. Typically, central banks take action by issuing money to buy bonds (or other
assets), which boosts the supply of money and lowers interest rates, or, in the case of
contractionary monetary policy, banks sell bonds and take money out of circulation. Usually
policy is not implemented by directly targeting the supply of money.
Central banks continuously shift the money supply to maintain a targeted fixed interest rate.
Some of them allow the interest rate to fluctuate and focus on targeting inflation ratesinstead.
Central banks generally try to achieve high output without letting loose monetary policy that
create large amounts of inflation.
Conventional monetary policy can be ineffective in situations such as a liquidity trap. When
interest rates and inflation are near zero, the central bank cannot loosen monetary policy
through conventional means.

An example of intervention strategy under different conditions

Central banks can use unconventional monetary policy such as quantitative easing to help
increase output. Instead of buying government bonds, central banks can implement
quantitative easing by buying not only government bonds, but also other assets such as
corporate bonds, stocks, and other securities. This allows lower interest rates for a broader
class of assets beyond government bonds. In another example of unconventional monetary
policy, the United States Federal Reserve recently made an attempt at such a policy
with Operation Twist. Unable to lower current interest rates, the Federal Reserve lowered
long-term interest rates by buying long-term bonds and selling short-term bonds to create a
flat yield curve.
Fiscal policy[edit]
Further information: Fiscal policy
Fiscal policy is the use of government's revenue and expenditure as instruments to influence
the economy. Examples of such tools are expenditure, taxes, debt.
For example, if the economy is producing less than potential output, government spending
can be used to employ idle resources and boost output. Government spending does not have
to make up for the entire output gap. There is a multiplier effect that boosts the impact of
government spending. For instance, when the government pays for a bridge, the project not
only adds the value of the bridge to output, but also allows the bridge workers to increase
their consumption and investment, which helps to close the output gap.
The effects of fiscal policy can be limited by crowding out. When the government takes on
spending projects, it limits the amount of resources available for the private sector to use.
Crowding out occurs when government spending simply replaces private sector output
instead of adding additional output to the economy. Crowding out also occurs when
government spending raises interest rates, which limits investment. Defenders of fiscal
stimulus argue that crowding out is not a concern when the economy is depressed, plenty of
resources are left idle, and interest rates are low.[citation needed]

Fiscal policy can be implemented through automatic stabilizers. Automatic stabilizers do not
suffer from the policy lags of discretionary fiscal policy. Automatic stabilizers use
conventional fiscal mechanisms but take effect as soon as the economy takes a downturn:
spending on unemployment benefits automatically increases when unemployment rises and,
in a progressive income tax system, the effective tax rate automatically falls when incomes
decline.
Comparison[edit]
Economists usually favor monetary over fiscal policy because it has two major advantages.
First, monetary policy is generally implemented by independent central banks instead of the
political institutions that control fiscal policy. Independent central banks are less likely to
make decisions based on political motives.[22] Second, monetary policy suffers shorter inside
lags and outside lags than fiscal policy. Central banks can quickly make and implement
decisions while discretionary fiscal policy may take time to pass and even longer to carry out.
[22]

Development[edit]
Main article: History of macroeconomic thought
Origins[edit]
Macroeconomics descended from the once divided fields of business cycle
theory and monetary theory.[24] The quantity theory of money was particularly influential
prior to World War II. It took many forms, including the version based on the work of Irving
Fisher:
In the typical view of the quantity theory, money velocity (V) and the quantity of goods
produced (Q) would be constant, so any increase in money supply (M) would lead to a
direct increase in price level (P). The quantity theory of money was a central part of the
classical theory of the economy that prevailed in the early twentieth century.
Austrian School[edit]
Ludwig Von Mises's work Theory of Money and Credit, published in 1912, was one of
the first books from the Austrian School to deal with macroeconomic topics.
Keynes and his followers[edit]
Macroeconomics, at least in its modern form,[25] began with the publication of John
Maynard Keynes's General Theory of Employment, Interest and Money.[24][26] When the
Great Depression struck, classical economists had difficulty explaining how goods could
go unsold and workers could be left unemployed. In classical theory, prices and wages
would drop until the market cleared, and all goods and labor were sold. Keynes offered a
new theory of economics that explained why markets might not clear, which would
evolve (later in the 20th century) into a group of macroeconomic schools of thought
known as Keynesian economics also called Keynesianism or Keynesian theory.

In Keynes's theory, the quantity theory broke down because people and businesses tend to
hold on to their cash in tough economic timesa phenomenon he described in terms
of liquidity preferences. Keynes also explained how the multiplier effect would magnify a
small decrease in consumption or investment and cause declines throughout the economy.
Keynes also noted the role uncertainty and animal spirits can play in the economy.[25]
The generation following Keynes combined the macroeconomics of the General
Theory with neoclassical microeconomics to create the neoclassical synthesis. By the
1950s, most economists had accepted the synthesis view of the macroeconomy.
[25]
Economists like Paul Samuelson, Franco Modigliani, James Tobin, and Robert
Solow developed formal Keynesian models and contributed formal theories of
consumption, investment, and money demand that fleshed out the Keynesian framework.
[27]

Monetarism[edit]
Milton Friedman updated the quantity theory of money to include a role for money
demand. He argued that the role of money in the economy was sufficient to explain
the Great Depression, and that aggregate demand oriented explanations were not
necessary. Friedman also argued that monetary policy was more effective than fiscal
policy; however, Friedman doubted the government's ability to "fine-tune" the economy
with monetary policy. He generally favored a policy of steady growth in money supply
instead of frequent intervention.[28]
Friedman also challenged the Phillips curve relationship between inflation and
unemployment. Friedman and Edmund Phelps (who was not a monetarist) proposed an
"augmented" version of the Phillips curve that excluded the possibility of a stable, longrun tradeoff between inflation and unemployment.[citation needed] When the oil shocks of the
1970s created a high unemployment and high inflation, Friedman and Phelps were
vindicated. Monetarism was particularly influential in the early 1980s. Monetarism fell
out of favor when central banks found it difficult to target money supply instead of
interest rates as monetarists recommended. Monetarism also became politically
unpopular when the central banks created recessions in order to slow inflation.
New classical[edit]
New classical macroeconomics further challenged the Keynesian school. A central
development in new classical thought came when Robert Lucas introduced rational
expectations to macroeconomics. Prior to Lucas, economists had generally used adaptive
expectations where agents were assumed to look at the recent past to make expectations
about the future. Under rational expectations, agents are assumed to be more
sophisticated. A consumer will not simply assume a 2% inflation rate just because that
has been the average the past few years; she will look at current monetary policy and
economic conditions to make an informed forecast. When new classical economists

introduced rational expectations into their models, they showed that monetary policy
could only have a limited impact.
Lucas also made an influential critique of Keynesian empirical models. He argued that
forecasting models based on empirical relationships would keep producing the same
predictions even as the underlying model generating the data changed. He advocated
models based on fundamental economic theory that would, in principle, be structurally
accurate as economies changed. Following Lucas's critique, new classical economists, led
by Edward C. Prescott and Finn E. Kydland, created real business cycle (RBC) models of
the macroeconomy.[29]
RBC models were created by combining fundamental equations from neo-classical
microeconomics. In order to generate macroeconomic fluctuations, RBC models
explained recessions and unemployment with changes in technology instead of changes
in the markets for goods or money. Critics of RBC models argue that money clearly plays
an important role in the economy, and the idea that technological regress can explain
recent recessions is implausible.[29] However, technological shocks are only the more
prominent of a myriad of possible shocks to the system that can be modeled. Despite
questions about the theory behind RBC models, they have clearly been influential in
economic methodology.[citation needed]
New Keynesian response[edit]
New Keynesian economists responded to the new classical school by adopting rational
expectations and focusing on developing micro-founded models that are immune to the
Lucas critique. Stanley Fischer and John B. Taylor produced early work in this area by
showing that monetary policy could be effective even in models with rational
expectations when contracts locked in wages for workers. Other new Keynesian
economists expanded on this work and demonstrated other cases where inflexible prices
and wages led to monetary and fiscal policy having real effects.
Like classical models, new classical models had assumed that prices would be able to
adjust perfectly and monetary policy would only lead to price changes. New Keynesian
models investigated sources of sticky prices and wages due to imperfect competition,
[30]
which would not adjust, allowing monetary policy to impact quantities instead of
prices.
By the late 1990s economists had reached a rough consensus. The nominal rigidity of
new Keynesian theory was combined with rational expectations and the RBC
methodology to produce dynamic stochastic general equilibrium (DSGE) models. The
fusion of elements from different schools of thought has been dubbed the new
neoclassical synthesis. These models are now used by many central banks and are a core
part of contemporary macroeconomics.[31]

New Keynesian economics, which developed partly in response to new classical

economics, strives to provide microeconomic foundations to Keynesian economics by
showing how imperfect markets can justify demand management.

What is 'Consumer Surplus'

Consumer surplus is an economic measure of consumer benefit, which is calculated by
analyzing the difference between what consumers are willing and able to pay for a good or
service relative to its market price, or what they actually do spend on the good or service. A
consumer surplus occurs when the consumer is willing to pay more for a given product than
the current market price.

BREAKING DOWN 'Consumer Surplus'

The concept of consumer surplus was developed in 1844 to measure the social benefits
of public goods such as national highways, canals and bridges. It has been an important tool
in the field of welfare economics and in the formulation of tax policies by governments.
Consumer surplus is based on the economic theory of marginal utility, which states the price
an individual is willing to spend on a particular good or service reflects the amount of utility
he receives from that good or service. The utility a good or service provides varies from
individual to individual based on his own personal preference. Economic law holds that the
more a consumer has of a good the less he is willing to spend for more due to the diminishing
marginal utility he receives.
Measuring Consumer Surplus With a Demand Curve
The demand curve is a graphic representation used to calculate consumer surplus. It shows
the relationship between the price of a product and the quantity of the product demanded at
that price, with price drawn on the y-axis of the graph and quantity demanded drawn on the
x-axis. Because of the law of diminishing marginal utility, the demand curve is downward
sloping.
Consumer surplus is measured as the area below the downward-sloping demand curve, or the
amount a consumer is willing to spend for given quantities of a good, and above the actual
market price of the good, depicted with a horizontal line drawn between the y-axis and
demand curve. Consumer surplus can be calculated on either an individual or aggregate basis,
depending on if the demand curve is individual or aggregated. Consumer surplus always
increases as the price of a good falls and decreases as the price of a good rises.
To illustrate, suppose an individual or economy is willing to pay $50 for the first unit of
product A and $20 for the 50th unit. If 50 of the units are sold at $20 each, then 49 of the
units were sold at a consumer surplus, assuming the demand curve is constant. Consumer
surplus is depicted as the triangle that forms between the following points on a graph: (0,50),
(0,20) and (50,20). The numerical value is calculated as half, or 0.50, multiplied by the base
of the triangle multiplied by the height of the triangle, or 0.50*30*50.
Trading Center
A surplus is the amount of an asset or resource that exceeds the portion that is utilized. A
surplus is used to describe many excess assets including income, profits,capital and goods. A
surplus often occurs in abudget, when expenses are less than the income taken in or in
inventory when fewer supplies are used than were retained. Economic surplus is related
to supply and demand.
BREAKING DOWN 'Surplus'

A surplus isn't always a positive outcome. In some cases, when a manufacturer anticipates a
high demand for a product that it produces and makes more than it sells during that time
period, it can have a surplus inventory which may, if it's deep enough, create a financial loss
for that quarter or year. When the surplus is of a perishable commodity, such as grain, it could
result in a permanentloss, or a write-down as the inventory becomes bad.
Producer Surplus
Producer surplus is an economic measure of the difference between the amount a producer of
a good receives and the minimum amount the producer is willing to accept for the good. The
difference, or surplus amount, is the benefit the producer receives for selling the good in the
market. Producer surplus is generated by market prices in excess of the lowest price
producers would otherwise be willing to accept for their goods.
BREAKING DOWN 'Producer Surplus'
Producer surplus is shown graphically below as the area above the producer's supply curve
that it receives at the price point (P(i)), forming a triangular area on the graph. The size of the
producer surplus and its triangular depiction on the graph increases as the market price for the
good increases, and decreases as the market price for the good decreases.

Producer surplus combined with consumer surplus equals overall economic surplus or the
benefit provided by producers and consumers interacting in a free market as opposed to one
with price controls or quotas. If a producer had the ability to price discriminate perfectly, or
rather charge every consumer the maximum price the consumer is willing to pay, then the
producer could capture the entire economic surplus. In other words, producer surplus would
equal overall economic surplus.
Example of Producer Surplus

Say a producer is willing to sell 500 widgets at $5 each and consumers are willing to
purchase these widgets for $8 each. If the producer sells all of the widgets to consumers for
$8, it receives $4,000. To calculate the producer surplus, subtract the amount the producer
received by the minimal amount it was willing to accept, in this case $2,500. The producer
surplus is $1,500, or $4,000 - $2,500. It is not static and may increase or decrease as the
market price increases or decreases.
Impact on Producer Surplus
Producers would not sell products if they could not get at least the marginal cost to produce
those products. The supply curve as depicted on the graph above represents the marginal cost
curve for the producer. As such, producer surplus is the difference between the price received
for a product and the marginal cost to produce it. From an economics standpoint, marginal
cost includes opportunity cost. In essence, opportunity cost is the cost of not doing something
different such as producing a different item.
The existence of producer surplus does not mean there is an absence of consumer surplus.
The idea behind a free market that sets a price for a good is that both consumers and
producers can benefit, with consumer surplus and producer surplus generating greater overall
economic welfare. Market prices can change materially due to consumers, producers, a
combination of the two or other outside forces. As a result, profits and producer surplus may
change materially due to market prices.
What is Producer Surplus
Producer surplus can be described as the difference between what producers are willing and
able to supply for a particular good and the price that they actually receive. Producer surplus
is generated when the producer is willing to sell their goods at a lower price, and the buyers
are willing to accept goods for a higher price. This creates an excess welfare and is identified
as an excess demand.
Producer surplus can be graphically represented as follows. The surplus is the area below the
market price and above the supply curve. ABO is the producer surplus, and CBO is called the
consumer surplus. Both producer surplus and consumer surpluses equal overall economic
surplus or the benefit provided by producers and consumers act together in a free market. If a
producer has the ability to sell goods at the maximum price or if he can price discriminate
perfectly and the consumer is willing to pay that amount for the good, then the producer can
capture the entire economic surplus. In other words, producer surplus would be equal to

overall

economic

surplus.

Changes in Producer Surplus

The amount of producer surplus will increase with the increases in market price and decrease
with the decreases in market price when other factors remain unchanged.
Supply curve shifts are directly related with producer surplus. If supply increases, producer
surplus will increase and vice versa. As per the following graph, supply has decreased, and
equilibrium has shifted from O to O1. At 1 st equilibrium, (O) producer receive a large surplus
than equilibrium 2 (O1). It can be clearly seen in the highlighted areas.
S>S1
Red color area > O1BC

Hence, Supply and producer surplus have a positive relationship.

Shifts in the demand curve are directly related to producer surplus. If demand increases,
producer surplus increases. If demand decreases, producer surplus decreases. This can be
easily understood by the below graph.
D2>D1
O1AB > Highlighted area

Hence Demand and producer surplus also have a positive relationship.

How to Calculate Producer Surplus

Producer surplus is the excess amount the buyer received. It can be calculated in two ways:
using a graph or using an equation.

Calculating Producer Surplus Using Graph

Calculating Producer Surplus Using Equations

A producer is willing to sell 500 toys at $5 each, and consumers are willing to purchase these
toys for $7 each. If the producer sells all of the toys to consumers for $7, he receives $3500.
To calculate the producer surplus, subtract the amount the producer received by the minimal
amount it was willing to accept.
Producer surplus = the actual amount the producer received minimal amount producer was
willing to accept
= $7 * 500 $5 * 500
= $3500 $2500
= $1000
In this case producer surplus is $1000. We can find producer surplus in both ways for any
case.
Conclusion

Companies differ greatly in terms of their missions, strategic goals, and product offerings, but every
business has the essential goal of making a surplus. The surplus is a concept that describes the amount
of utility or value that consumers and producers receive when making transactions. Every producer
and consumer in an economy want to gain utility by increasing the surplus.

MARKET EFFICIENCY - DEFINITION AND TESTS

What is an efficient market?
Efficient market is one where the market price is an unbiased estimate of
the true value of the investment.
Implicit in this derivation are several key concepts (a) Market efficiency does not require that the market price be equal to true
value at every point in time. All it requires is that errors in the market price be
unbiased, i.e., that prices can be greater than or less than true value, as long as
these deviations are random.
(b) The fact that the deviations from true value are random implies, in a rough
sense, that there is an equal chance that stocks are under or over valued at any
point in time, and that these deviations are uncorrelated with any observable
variable. For instance, in an efficient market, stocks with lower PE ratios should be
no more or less likely to under valued than stocks with high PE ratios.
(c) If the deviations of market price from true value are random, it follows that no
group of investors should be able to consistently find under or over valued
stocks using any investment strategy.
Market Efficiency for Investor Groups
Definitions of market efficiency have to be specific not only about the
market that is being considered but also the investor group that is covered.
o It is extremely unlikely that all markets are efficient to all investors,
but it is entirely possible that a particular market (for instance, the
New York Stock Exchange) is efficient with respect to the average
investor.
o It is also possible that some markets are efficient while others are
not, and that a market is efficient with respect to some investors and
not to others. This is a direct consequence of differential tax rates and

transactions costs, which confer advantages on some investors

relative to others.
Definitions of market efficiency are also linked up with assumptions about
what information is available to investors and reflected in the price. For
instance, a strict definition of market efficiency that assumes that all
information, public as well as private, is reflected in market prices would
imply that even investors with precise inside information will be unable to
beat the market.
Classifications
Strong versus Weak Form Efficiency:
- Under weak form efficiency, the current price reflects the information contained
in all past prices, suggesting that charts and technical analyses that use past
prices alone would not be useful in finding under valued stocks.
- Under semi-strong form efficiency, the current price reflects the information
contained not only in past prices but all public information (including financial
statements and news reports) and no approach that was predicated on using and
massaging this information would be useful in finding under valued stocks.
- Under strong form efficiency, the current price reflects all information, public as
well as private, and no investors will be able to consistently find under valued
stocks.
Implications of market efficiency
An immediate and direct implication of an efficient market is that no group
of investors should be able to consistently beat the market using a
common investment strategy.
An efficient market would also carry very negative implications for many
investment strategies and actions that are taken for granted (a) In an efficient market, equity research and valuation would be a costly task that
provided no benefits. The odds of finding an undervalued stock should be
random (50/50). At best, the benefits from information collection and equity
research would cover the costs of doing the research.
(b) In an efficient market, a strategy of randomly diversifying across
stocks or indexing to the market, carrying little or no information cost and
minimal execution costs, would be superior to any other strategy, that created

larger information and execution costs. There would be no value added by portfolio
managers and investment strategists.
(c) In an efficient market, a strategy of minimizing trading, i.e., creating a
portfolio and not trading unless cash was needed, would be superior to a strategy
that required frequent trading.
What market efficiency does not imply:
An efficient market does not imply that (a) stock prices cannot deviate from true value; in fact, there can be large
deviations from true value. The only requirement is that the deviations be random.
(b) no investor will 'beat' the market in any time period. To the contrary,
approximately half of all investors, prior to transactions costs, should beat the
market in any period.
(c) no group of investors will beat the market in the long term. Given the
number of investors in financial markets, the laws of probability would suggest
that a fairly large number are going to beat the market consistently over long
periods, not because of their investment strategies but because they are lucky. It
would not, however, be consistent if a disproportionately large number of these
investors used the same investment strategy.
In an efficient market, the expected returns from any investment will
be consistent with the risk of that investment over the long term, though
there may be deviations from these expected returns in the short term.
Necessary conditions for market efficiency
Markets do not become efficient automatically. It is the actions of
investors, sensing bargains and putting into effect schemes to beat the
market, that make markets efficient.
The necessary conditions for a market inefficiency to be eliminated are as
follows (1) The market inefficiency should provide the basis for a scheme to beat the
market and earn excess returns. For this to hold true (a) The asset (or assets) which is the source of the inefficiency has to be traded.
(b) The transactions costs of executing the scheme have to be smaller than the
expected profits from the scheme.

(2) There should be profit maximizing investors who

(a) recognize the 'potential for excess return'
(b) can replicate the beat the market scheme that earns the excess return
(c) have the resources to trade on the stock until the inefficiency disappears
Efficient Markets and Profit-seeking investors: The Internal Contradiction
There is an internal contradiction in claiming that there is no possibility of
beating the market in an efficient market and then requiring profitmaximizing investors to constantly seek out ways of beating the market and
thus making it efficient.
If markets were, in fact, efficient, investors would stop looking for
inefficiencies, which would lead to markets becoming inefficient again.
It makes sense to think about an efficient market as a self-correcting
mechanism, where inefficiencies appear at regular intervals but disappear
almost instantaneously as investors find them and trade on them.
Propositions about market efficiency
Proposition 1: The probability of finding inefficiencies in an asset
market decreases as the ease of trading on the asset increases. To the extent that
investors have difficulty trading on a stock, either because open markets do not
exist or there are significant barriers to trading, inefficiencies in pricing can
continue for long periods.
Example:
Stocks versus real estate
NYSE vs NASDAQ

Proposition 2: The probability of finding an inefficiency in an asset market

increases as the transactions and information cost of exploiting the
inefficiency increases. The cost of collecting information and trading varies
widely across markets and even across investments in the same markets. As these
costs increase, it pays less and less to try to exploit these inefficiencies.

Example:
Initial Public Offerings: IPOs supposedly make excess returns, on average.
Emerging Market Stocks: Do they make excess returns?
Investing in 'loser' stocks, i.e., stocks that have done very badly in some prior
time period should yields excess returns. Transactions costs are likely to be much
higher for these stocks since(a) they then to be low priced stocks, leading to higher brokerage commissions and
expenses
(b) the bid-ask becomes a much higher fraction of the total price paid.
(c) trading is often thin on these stocks, and small trades can cause prices to move.

Corollary 1: Investors who can estabish a cost advantage (either in information

collection or transactions costs) will be more able to exploit small
inefficiencies than other investors who do not possess this advantage.

Example: Block trades effect on stock prices & specialists on the Floor of
the Exchange
Establishing a cost advantage, especially in relation to information, may
be able to generate excess returns on the basis of these advantages. Thus
a John Templeton, who started investing in Japanese and othe Asian markets
well before other portfolio managers, might have been able to exploit the
informational advantages he had over his peers to make excess returns on
his portfolio.

Proposition 3: The speed with which an inefficiency is resolved will be directly

related to how easily the scheme to exploit the ineffficiency can be replicated
by other investors. The ease with which a scheme can be replicated itselft is
inversely related to the time, resouces and information needed to execute it. Since
very few investors single-handedly possess the resources to eliminate an
inefficiency through trading, it is much more likely that an inefficiency will
disappear quickly if the scheme used to exploit the inefficiency is transparent and
can be copied by other investors.

 Example: Investing on stock splits versus Index Arbitrage

Market Inefficiency
Market inefficiency occurs when goods within the market are either overvalued or
undervalued. While certain members of society may benefit from the imbalance, others
suffer consequences in regards to their welfare.
For example, overvalued prices may lead to higher profit margins but negatively affect
consumers of the product. For inelastic goods, the increased cost may prevent
consumers from making purchases in other market sectors or result in some consumers
purchasing a lower quantity of the item when possible. For elastic goods, consumers
may reduce spending in the category to compensate or be priced out of the market
entirely.
Undervalued products may be desirable for consumers but may prevent a producer from
recuperating production costs. If the product remains undervalued for a substantial
period, some producers may be forced out of the market.

What is 'Deadweight Loss'

A deadweight loss is a cost to society created by market inefficiency. Mainly used in

economics, deadweight loss can be applied to any deficiency caused by an inefficient
allocation of resources. Price ceilings, such as price controls and rent controls; price
floors, such as minimum wage and living wage laws; and taxation are all said to
create deadweight losses.

BREAKING DOWN 'Deadweight Loss'

Deadweight loss occurs when supply and demand are not in equilibrium. When
consumers do not feel the price of a good or service is justified when compared to the
perceived utility, they are less likely to purchase the item. With the reduced level of
trade, the allocation of resources may become inefficient, which can lead to a
reduction in overall welfare within a society.

Examples of Deadweight Losses

Minimum wage and living wage laws can create a deadweight loss by causing
employers to overpay for employees and preventing low-skilled workers from
securing jobs. Price ceilings and rent controls can also create deadweight losses by
discouraging production and decreasing the supply of goods, services or housing
below what consumers truly demand. Consumers experience shortages and producers
earn less than they would otherwise.

Taxes are also said to create a deadweight loss because they prevent people from
engaging in purchases they would otherwise make because the final price of the
product is above the equilibrium market price.

For example, if taxes on an item rise, the burden is often split between the producer
and the consumer, leading to the producer receiving less profit from the item and the
customer paying a higher price. This results in lower consumption of the item than
previously, which reduces the overall benefits the consumer market could have
received while simultaneously reducing the benefit the company may see in regards to
profits.

Price Ceilings
If the price ceiling is above the market price, then there is no direct effect. If the price ceiling is set
below the market price, then a "shortage" is created; the quantity demanded will exceed the
quantity supplied. The shortage may be resolved in many ways. One way is "queuing"; people
have to wait in line for the product, and only those willing to wait in line for the product will
actually get it. Sellers might provide the product only to family and friends, or those willing to pay
extra "under the table". Another effect may be that sellers will lower the quality of the good sold.
"Black markets" tend to be created by price ceilings.
Economic Efficiency: Black Vs. Legal Markets
Legal systems provide various benefits to economic systems.
Economic efficiency may be said to occur when an action creates more benefits than costs. Legal
systems help economic systems become more efficient by reducing risks to economics
participants. Risk represents a cost that must be compensated for by higher charges.
One risk reduced by government regulation is theft. Government protects the property rights of
owners so that they can benefit from the assets they own and use them in an efficient, economic
manner. Participants in a "black market system" face a high risk of theft in their transactions as
well as exposure to other forms of violence.
Governments often also provide a regulatory framework for the safety of products. In a market
operating within a legal system, purchasers of drugs have a reasonable expectation about the
quality of the drugs and the expected benefits of the drugs. Participants in a black market for
drugs will have incomplete information about the quality of drugs purchased and, therefore,
appropriate decisions are more difficult to make.
Price Floors
When a "price floor" is set, a certain minimum amount must be paid for a good or service. If the
price floor is below a market price, no direct effect occurs. If the market price is lower than the

price floor, then a surplus will be generated. Minimum wage laws are good examples of price
floors. In many states, the U.S. minimum wage law has no effect, as market wage rates for lowskilled workers are above the U.S. minimum wage rate. In states where the minimum wage is
above the market wage rate, the law will increase unemployment for low-skilled workers.
Although some low-skilled workers will get higher pay, others will lose their jobs.