Download Price Floors

Assignment for Next Lecture
• Do Homework 4 on ‘Homework Assignment’
by next Monday Noon
• Read Chapter 5
• Topics Next Time
– Concept of Elasticity (degree of price responsiveness)
Market Strikes Back
Lecture 6
In This Lecture
• Market Interventions
–
–
–
–
Price Floors
Price Ceilings
Taxes or Subsidies
Quotas
• Examples
– Minimum Wages and Wage Subsidies
– Rent Control
– Trade Policy (Quota and Tariffs)
Market Interventions
Even in a society where individuals are free to make
voluntary exchanges, a society may decide to intervene
in the market through its government. We will discuss
the reasons in a later lecture, but for the time being let
us assume that the government wants to favor one side
of the trades over the other.
– Suppliers want high prices.
– Buyers of a good want low prices.
Consider two examples that highlight how governments
may intervene.
Market Interventions, cont.
• To favor the suppliers of a good, the government could adopt
– price floors (the minimum price that can be paid to a supplier for a
good or service)
• Example: a minimum wage
– or subsidies -- supplements to the market price paid to the supplier
• Example: a wage subsidy such as the Earned Income Tax Credit
(EITC)
• To favor the demanders of a good, the government could adopt:
– price ceilings (a maximum price that can be charged)
• Example: rent control
– subsidies --a supplement to demanders’ incomes
•
Example: rent subsidies
A Word of Caution
In a later lectures we will argue that a perfectly competitive market will
create the greatest amount of combined surplus for consumers and firms.
However, we will also suggest that markets can under certain situations fail
and consequently the market outcomes can be improved through
government intervention (recall Lecture 2). Also the government could
justify intervention to pursue non efficiency related goals -- equity or
fairness -- often at the expense of efficiency.
Sometimes the sacrifice of efficiency is not justified by the gains in another
goal. Justifying this loss in efficiency is not the focus of today’s lecture,
however; rather our focus is the potential impacts of government
intervention on prices and quantities -- positive analysis.
Opinion Survey
Do you favor raising the federal
minimum wage from its current level of
$5.15 to $7.15 per hour?
a.
b.
Yes
No
Basic facts (beliefs?) about the
minimum wage
• A minimum wage increase would raise the wages
of millions of workers.
• Minimum wage increases benefit working
families.
• Minimum wage increases benefit disadvantaged
workers.
• Source:
http://www.epinet.org/content.cfm/issueguides_minw
age_minwagefacts
Why many economists oppose the
minimum wage
• The displacement effects of increasing the minimum
wage outweigh the increased incomes to the workers
who retain their jobs.
• Most minimum wage earners are not poor.
– Average family income of a minimum wage employee is
$44,331.
– Only one in five minimum wage workers lives in a poor
family.
– Most people don’t get stuck at the minimum wage.
– Only 15% of minimum wage earners are single parents or
single earners in a family with kids.
• The minimum wage is a blunt instrument for trying to
raise the incomes of the poor.
Price Floors:
The Minimum Wage
and the Low Skill Labor Market
•
In the absence of any intervention, low
skill workers earn Wo and L0 are
employed.
•
Government institutes a Minimum Wage
equal to MW (to be effective it must be
above the equilibrium wage)
•
Workers earn MW but only L1 are
employed and LS want to work at this
wage
•
Unemployment is U = LS - L1
•
Individuals who do find work are better off
but Lo-L1 loss their jobs and can’t find
work and LS-L0 are enticed into labor
market and can’t find jobs
Wage
S
MW
Wo
U
L1
Lo
D
LS
Labor
Wage Subsidies and the Low Skill
Labor Market
•
Assume the worker is paid a per hourly
subsidy of WS. Workers should be willing to
supply the same amount of labor if employers
paid them Wo- WS (they would take home the
same amount of money per hour).
•
The Labor Supply Curve relevant to the
employers shifts downward by WS. (The
analysis is the reverse of that for taxes. Note
that the supply price for labor at Lo falls.
•
Market wage paid by employers falls to WE
•
Employers hire more workers -- total
employment rises to L1
•
Workers take home per hour MW=WS+WE
•
Total amount of subsidy paid by taxpayers
Wage
S
S’
MW
Wo
WE
WS
D
Lo
L1
Labor
Clinton Persuaded
New York Times, April 27, 1993
President Clinton has vowed to eliminate poverty
among families with a full-time worker. To back that
pledge, he proposed a $27 billion increase over five
years in the earned income tax credit -- which lowers
taxes for low-paid workers or pays them cash if they
are too poor to pay taxes. The credit insulates the
poor from Social Security payroll taxes and, looking
ahead, higher energy taxes. It thus acts to untax the
poor who work.
Clinton, the Politician
• Clinton also pushed legislation through
Congress that raised the minimum
wage from $4.25 in 1992 to $5.15 in
1997.
Value of Minimum Wage, 1954-2004
[in 2001 dollars]
Price Ceilings:
High Price Rental Markets
Rents
•
Initially there are Ho housing units that
rent for Ro
•
Government sets a price ceiling--the
highest price that supplies can require of
demanders--MR < Ro
Ro
•
The number of housing units offered for
rent falls to H1
MR
•
The amount of housing demanded rises
to to HD
•
Leaving a shortage in the rental market of
HS = HD - H1
•
Would a subsidy paid to renters be
preferable to rent control?
S
HS
H1
Ho
D
HD
Rental
Housing
Housing Subsidy Paid to Renters
Rents
D’
•
For Landlords to be willing to supply HD
rental properties, the rent (supply price)
would have to rise to RS.
•
Renters are only will to pay MR for HD
housing, but if they are given a subsidy
equal to A dollars per unit of housing,
their demand for housing would increase.
•
A new equilibrium would be established
with the equilibrium quantity at HD and
the equilibrium price of RS. The cost to
renters is RS - A = MR.
•
Unfortunately the cost to taxpayers is A
dollars times the number of units HD.
•
What problems created by rent controls
are solved by subsidies?
S
RS
A
Ro
MR
D
Ho
HD
Rental
Housing
Real Gasoline Prices
American Car
Japanese Car
Japanese Car Market
•
As the price of gas rose, demand for
Japanese cars rose and demand for
American cars fell
•
American Car makers lost market share
and approach Reagan Administration for
relief -- they wanted the government to
increase the price of Japanese cars to
make their cars more attractive to
American car buyers.
•
Options
Price
S
P*
P1
Po
D’
D
Qo
Q1
Japanese Cars
–
–
–
Price Floor on Japanese Cars
Tariffs (tax) on Japanese Cars
Quota on Japanese Imports
Tariff Option
Price
•
Tariff -- a tax on an import that the
importer (Japanese Car marker) has
to pay. Levied on each car. Tariffs
increase the cost of doing business.
•
A tariff of amount T per car would
raise the cost of a Japanese car by
$T -- the supply curve would shift
upward by $T.
•
The tariff of amount T would rise the
price to the consumer to P*. At this
price, consumers would demand the
number of Japanese cars they did
before the rise in the gas prices.
S’
S
P*
T
D’
D
Qo
Japanese Cars
Quota Option
S’
Price
S
P*
• A quota limits the quantity of a
good that can be sold. In our
situation, the government
would limit the number of
Japanese cars to Qo.
P1
• The Supply of Japanese cars
would now be equal to S’.
P0
D’
D
Qo
Japanese Cars
• The price of Japanese cars
would rise to P*.
Which Option -- Tariff or Quota?
•
Both options reduce Japanese cars sales to their original levels and the price of
a Japanese car rises to P* -- American car buyers are equally worse off (pay
more for less).
•
In both options, the number of Japanese cars fall by the same amount, the
impact on American car makers should be the same. What is the that impact?
Are they happy?
•
The tariff raises tax revenues (T x Qo) that could be used to compensate US
citizens, BUT Japanese car makers are selling the same quantity of cars they
did prior to rise in gas prices for less? Aren’t they going to be mad?
•
With the quota, Japanese car makers are selling the same amount of cars they
did before the rise in gas prices for more money? Aren’t they happy?
Question 6 (Problem 9):
The U.S. government would like to help the American auto industry
compete against foreign automakers that sell trucks in the United
States. It can do this either by imposing a quota on the number of
foreign trucks imported or by imposing an excise tax on each foreign
truck sold in the United States. The hypothetical demand and supply
schedules for imported trucks are given in the following table:
Question 5 (Problem 7)
• Question:For the last 70
years the U.S. government
has used price supports to
provide income assistance to
American farmers. At times
the government has used
price floors, which it
maintains by buying up the
surplus farm products. At
other times, it has used target
prices, a policy by which the
government gives the farmer
an amount of money equal to
the difference between the
market price and the target
price for each unit sold.
Consider the market for corn
depicted in the accompanying
figure.
Question 7 (Problem 11)
a.
Consumers
Producers
Pretax
$50
$50
Postax
$55
$30
CHANGE
$5
$20
TAX = $5 + $20 = $25
$20 > $5  incidence on producers