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Review: In competitive markets, price adjusts to
“balance” supply and demand.
Markets are in equilibrium most of the time.
(We might regard this as a remarkable outcome if we
didn’t understand the supply and demand model -remember, no one’s in charge!)
Some government policies are designed to interfere
with the market process of price determination.
“Price controls”
Price ceiling: A legal maximum on the price at which a
good can be sold.
Price floor: A legal minimum on the price at which a
good can be sold.
Economists almost always oppose price controls:
They’re well-intentioned, but . . .
. . . they rarely help all who are supposed to benefit,
. . . and they often have unintended bad effects.
With a price ceiling, there are two possibilities:
price
The price ceiling could be
at or above p*. p* is a legal
price and we would have
equilibrium. (“Non-binding”
price ceiling.)
S
pc1
p*
pc2
excess
D
demand
QS
QD
The price ceiling could be
below p*. p* is illegal.
(“Binding” price ceiling.)
Price is pc2 and we have
excess demand (“shortage”).
quantity
Price ceilings are intended to help buyers.
With a (binding) price ceiling, only some who want to
buy at the ceiling price are able to buy.
Shortage creates problems:
Disappointed demanders have incentive to offer an
illegally high price . . .
. . . so price ceilings are inherently hard to
enforce.
Even if price ceiling can be strictly enforced, a “nonprice rationing mechanism” is needed.
Usually, price “rations” the available supply. Those
willing to pay p* (or more) get to buy, others do not.
With a binding price ceiling, the usual price rationing
mechanism is not allowed to work.
Non-price rationing mechanisms?
-- those willing to wait in line the longest get to buy.
-- only “friends” of suppliers get to buy.
Rent control: A binding price ceiling on the rental
housing market.
($/ft.2/
month)
SSR
SLR
p*
D1
Q*
Probably best to
think of “quantity”
as total square
footage -- rather
than number of
apartments.
(ft2/month)
Short-run supply perfectly inelastic?
In the (sufficiently) short run, number of aprtmts is fixed.
Rent control is often imposed in response to a big influx
of population - increasing demand for rental housing.
Effects of such a demand shift - WITHOUT rent control:
($/ft.2/
month)
SSR
SLR
p**
p***
p*
D2
D1
Q*
Q***
In short-run:
Rent jumps to p**.
No quantity effect.
In long-run:
Rent comes down
(part-way) to p***.
Quantity increases
to Q***.
(ft2/month)
Now consider the effects of the demand shift WITH rent
control imposed at level of original equilibrium, p*:
($/ft.2/
month)
SSR
excess
demand
SLR
p*
In the short-run:
No increase in rent,
but excess
demand . . .
D2
D1
Q*
. . . that persists
throughout
long-run.
(ft2/month)
Rent control “cancels” the price signal that otherwise
would have increased quantity of rental housing.
Rent control does deprive landlords of the short-run
“windfall” they otherwise get from increased demand.
Does it benefit tenants?
Some benefit -- those with rent-controlled
apartments who are happy where they are.
Some lose -- those who make up “excess demand.”
Again: Excess demand isn’t relieved in long-run because
rent control “cancels” the price signal.
(More on rent control: http://www.econlib.org/ . . .)
Now price floors. As with price ceilings, there are
two possibilities:
price
The price floor could be
above p*. p* is illegal.
(“Binding” price floor.)
Price is pf2 and we have
excess supply (“surplus”).
S
pf2
p*
pf1
excess
supply
QD
D
QS
The price floor could be at
or below p*. p* is a legal
price and we would have
equilibrium. (“Non-binding”
price floor.)
quantity
The point of price floors is to benefit suppliers.
To accomplish this, government has to purchase
surplus.
Agricultural commodity price support programs . . .
. . . for corn, for example.
What can the government do with the surplus?
Sell it?
Give it away?
Build more government corn bins!
Minimum wage: A price floor on the labor market.
Current federal minimum wage = $7.25/hr.
(as of 07/24/09)
Current Iowa minimum wage = $7.25/hr.
Current Illinois minimum wage = $8.25/hr.
Currently the highest state minimum wage = $8.67/hr.
(Washington)
(In San Francisco, minimum wage = $9.92/hr.)
(source: http://www.dol.gov/esa/minwage/america.htm#content)
Consider Iowa minimum wage of $7.25/hr.
In terms of annual income (assuming a work year of 50
weeks x 40 hrs./wk. = 2000 hrs.):
$7.25/hr x 2000 hrs./yr. = $14,500/yr.
U.S. Health and Human Services 2010 Poverty
Guideline:
Family of 4 = $22,050/yr.
(http://aspe.hhs.gov/poverty/10poverty.shtml)
Market for (“low-skill”) labor:
wage
($/hr.)
S
wmin
w*
surplus
LD
Note: In labor
markets, firms are
“demanders,”
households are
“suppliers.”
D
LS
quantity of labor
(hrs.)
In this case, surplus = “unemployment” -- people
who want to work at wmin but cannot.
It’s supposed to benefit low-skill workers. Does it?
Some benefit -- those who keep their jobs when
minimum wage goes into effect.
Some lose -- those who are displaced. (Employment
falls (!) when law raises wage from w* to wmin.)
Are the benefits well-targeted? (Does it help mainly
“bread-winners” in low income households -- or
mainly middle-class teenagers?)
(More on minimum wage: http://en.wikipedia.org . . .)
How big is the “displaced worker” effect?
One recent study . . .
(http://www.theworkbuzz.com . . .)
. . . says it’s “small.”
Economists are still somewhat divided on the minimum
wage.