Transcript Chapter 6 Notes

CHAPTER
6
Government Actions
in Markets
Learning Objectives
 Explain how price ceilings create
shortages and inefficiency (example,
rent control)
 Explain how price floors create
surpluses and inefficiency (example,
minimum wage)
Price Ceilings
A Regulated Housing
Market
 Price ceilings are regulations that
make it illegal to charge a price
higher than a specified level.
 Rent ceilings (sometimes called rent
control) are price ceilings applied to
housing markets.
How does a rent ceiling affect
the housing market?
A Regulated Housing
Market
 Rent ceilings set above equilibrium
have no effect.
 Rent ceilings set below equilibrium
prevents price from regulating the
quantities supplied and demanded.
Rent (dollars per unit per month)
No Rent Ceiling
S
2400
2000
1600
D
1200
0
36
72
100
150
Quantity (thousands of units per month)
Rent Ceiling
 Instead of letting the housing market
adjust normally (P*=2000, Q*=72),
suppose a rent ceiling of $1600 per
month was imposed.
Rent (dollars per unit per month)
A Rent Ceiling
S
2400
2000
Rent
ceiling
1600
D
1200
0
36
72
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
A Rent Ceiling
S
2400
2000
Rent
ceiling
1600
Housing
shortage
1200
0
36
72
D
100
150
Quantity (thousands of units per month)
Effects of a Rent Ceiling
 Because of the housing shortage, black
markets develop. The maximum black
market rent would be $2400.
Rent (dollars per unit per month)
A Rent Ceiling
Maximum black
market rent
S
2400
2000
Rent
ceiling
1600
Housing
shortage
1200
0
36
72
D
100
150
Quantity (thousands of units per month)
Effects of a Rent Ceiling
 For those who abide by the rent ceiling
law, there is no incentive to maintain the
existing housing stock. As a result,
housing quality falls.
 There is also no incentive to build new
housing. Thus, a permanent shortage of
housing could exist.
Rent (dollars per unit per month)
No Rent Ceiling
2800
S
2400
No Regulation Efficient
2000
1600
D
1200
0
36
72
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
No Rent Ceiling
Consumer
Surplus = .5(72x800)=28800
S
2800
2400
2000
1600
D
1200
0
36
72
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
No Rent Ceiling
Consumer
Surplus = .5(72x800)=28800
S
28
24
20
16
Producer
D
Surplus=.5(72x800)=28800
12
0
36
72
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
No Rent Ceiling
Consumer
Surplus = .5(72x800)=28800
S
28
24
No Regulation Efficient
Consumer Surplus
+Producer Surplus =57600
20
16
Producer
D
Surplus=.5(72x800)=28800
12
0
36
72
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
Inefficiency of Rent Ceiling
2800
Supply at rent ceiling
S
2400
2000
Rent
ceiling
1600
D
1200
0
Rent Ceiling
at $1600
36
72
100
150
Quantity (thousands of units per month)
Rent Ceilings
 100,000 units will be demanded.
 A shortage of 64,000 units will be
created.
Rent (dollars per unit per month)
Inefficiency of Rent Ceiling
2800
Consumer Surplus
=.5(36X400)+(36x800)=36000
2400
S
2000
Rent
ceiling
1600
D
1200
0
36
72
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
Inefficiency of Rent Ceiling
Consumer Surplus
=.5(36X400)+(36x800)=36000
2800
S
2400
2000
Rent
ceiling
1600
1200
0
Producer
surplus=.5(36x400)=7200
36
72
D
100
150
Quantity (thousands of units per month)
Rent (dollars per unit per month)
Inefficiency of Rent Ceiling
Consumer Surplus
=.5(36X400)+(36x800)=36000
2800
S
2400
Deadweight
loss=.5(800x36)=14400
2000
Rent
ceiling
1600
1200
0
Producer
surplus=.5(36x400)=7200
36
72
D
100
150
Quantity (thousands of units per month)
Effects of a Shortage
 When quantity demanded exceeds
quantity supplied, the smaller
quantity will be the one actually
bought and sold, many suppliers
have nothing to sell, and many
buyers find there is nothing to buy.
 36,000 units are available.
 Demand for the additional 64,000
units is unsatisfied.
A Housing Market with a
Rent Ceiling
 Are Rent Ceilings Fair?
According to the fair rules view, a rent ceiling is
unfair because it blocks voluntary exchange.
According to the fair results view, a rent ceiling
is unfair because it does not generally benefit the
poor.
A rent ceiling decreases the quantity of housing
and the scarce housing is allocated by
 Lottery
 First-come, first-served
 Discrimination
A Housing Market with a
Rent Ceiling
A lottery gives scarce housing to the
lucky.
A first-come, first served gives scarce
housing to those who have the greatest
foresight and get their names on the list
first.
Discrimination gives scarce housing to
friends, family members, or those of the
selected race or sex.
None of these methods leads to a fair
outcome.
Price Floors
Labor Markets and
Minimum Wages
 The interaction of demand and
supply in the labor market influences
the jobs we get and the wages we
earn.
 Firms make decisions about the
quantity of labor to demand.
 Households make decisions about
the quantity of labor to supply.
An Unregulated
Labor Market
 The wage rate balances the quantity
demanded and the quantity supplied,
determining the level of employment.
Wage Rate (dollars per hour)
A Market for Low-Skilled Labor
S
6
5
4
D
3
20
21
22
23
Quantity (millions of workers)
The Minimum Wage
 A minimum wage law is a regulation that
makes hiring labor below a specified wage
illegal.
 In the U.S., the current federal minimum
wage is $7.25/hour
 Most states also have minimum wages.
 About 40% of the states have minimum
wages above the federal minimum.
 The larger of the federal or state minimum
is the one that applies to workers in that
state.
Effective and Ineffective
Minimum Wage Laws
 If the minimum wage is set below the
equilibrium wage, it has no effect.
 If the minimum wage is set above the
equilibrium wage, the minimum wage
law is in conflict with market forces.
Effects of an Effective
Minimum Wage Law
 An effective minimum wage causes the supply of
labor to exceed the demand for labor.
 The excess supply of labor (surplus) is called
unemployment.
 The unemployed workers are searching for jobs.
 The unemployed are comprised of two groups
(layoffs and new entrants).
 In our example each of these groups has 1 million
workers for a total of 2 million unemployed.
 The minimum wage is inefficient and creates a
deadweight loss.
Wage Rate (dollars per hour)
No Minimum Wage
S
9
7
5
3
D
20
21
22
23
Quantity (millions of workers)
Wage Rate (dollars per hour)
Minimum Wage and
Unemployment
9
7
S
Unemployment
a
b
Minimum
wage
5
Layoffs
New entrants
3
D
20
21
22
23
Quantity (millions of workers)
Wage Rate (dollars per hour)
Minimum Wage
and Deadweight Loss
Deadweight
loss
9
7
S
Unemployment
a
b
Minimum
wage
5
3
D
20
21
22
23
Quantity (millions of workers)
The Minimum Wage
in Reality
 Minimum wage laws hit low-skilled
workers the hardest, especially the
young with few job skills.
 The unemployment rate for
teenagers is consistently more than
twice the national average.
 The actual minimum wage is zero,
the wage earned by the unemployed.
Projected Effects of President
Obama’s Proposed Increase in the
Minimum Wage (CBO Estimates)