Download Chapter 5 - McGraw Hill Higher Education

Chapter 5
Policy Analysis
With Supply and Demand
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Learning Objectives
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What is a price floor?
What is the effect of minimum wage on the market?
What is a price ceiling?
What is rent control?
What is economics of a draft vs. voluntary enlistment?
What is economics of market for human organs?
What is economics of healthcare?
What is economics of parking meters?
What is economics of agricultural subsidies?
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5-2
Price Floor
• Price floor
= minimum legal price
set by government.
• It affects only when
set above the
equilibrium price.
• Effective price floor
creates surplus.
Price
Quantity demanded after
the price floor is imposed.
Quantity supplied after the
price floor is imposed.
$12
Supply
Price Floor
$8
Demand
40
60
78
Quantity
Surplus
3
5-3
Minimum Wage and Market for
Unskilled Labor
• Minimum wage
= price floor in labor market.
• Minimum wage law
increases wages of
unskilled workers with
jobs.
• However it also creates
surplus labor, which
equals unemployment.
• It may cause firms to
raise product prices.
Wages
per hour
Unemployment
Supply
$6
Minimum
wage
$4
Demand
8,000
13,000
20,000
Number of unskilled workers
4
5-4
Elasticity of Demand and Minimum
Wage
Number of workers
employed with
Number
of and
workers
minimum
wage
employed
with
inelastic demand
minimum
curve wage and
an elastic demand
curve.
Supply of
unskilled labor
Minimum Wage
An elastic demand
for unskilled labor
Number of workers
employed with no
minimum wage
An inelastic demand
for unskilled labor
9,800
10,000
Wage
Rate
2,000
• Inelastic demand
= demand for labor is
not price sensitive.
• Elastic demand
= demand for labor is
very price sensitive.
• The more elastic
demand for labor, the
more jobs eliminated
by minimum wage
law.
Number of Workers
5
5-5
Minimum Wage
• Minimum wages increase wages of workers with
jobs.
• Surplus of labor created by minimum wage can
result in worse working conditions.
• Minimum wages impose the greatest cost on
those with the least skills.
• Minimum wages increases demand for skilled
workers and hence their wages.
• Minimum wage law creates incentives for black
market and illegal workers.
6
5-6
Price Ceiling
• Price ceiling
= maximum legal price
set by government.
• It affects only when
set below the
equilibrium price.
• Effective price ceiling
creates shortage.
Price
Quantity demanded
after the price ceiling
is imposed.
Quantity supplied
after the price ceiling
is imposed.
Supply
$8
Price ceiling
$6
Demand
50
60
71
Quantity
Shortage
7
5-7
Rent Control
• Rent control
= price ceiling in market for
apartments.
• Rent control creates
shortage of apartments,
specially in the long run.
• The greater the price
elasticity of demand, the
greater the shortage.
Monthly
Rent
Demand for
apartments
Supply of
apartments
$900
Rent control
$600
7,100
13,000 Quantity
Shortage
8
5-8
Rent Control
• Landlords and potential tenants who can’t find
apartments lose.
• Existing apartment holders can gain.
• It creates incentives for individuals to take up
more housing space than they otherwise would.
• It reduces individuals’ mobility.
• It reduces quality of apartment buildings.
• It creates incentives for black market and illegal
activities.
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5-9
Draft vs. Voluntary Enlistment
• With voluntary enlistment, the government
has to pay market wages to get its desired
number of soldiers.
• With a draft, the government can pay
whatever wages it wants. Soldiers lose
with lower wages.
• A draft forces transfer of wealth from
soldiers to civilians not subject to the draft.
10
5-10
Market for Human Organs
• In the U.S., market for
human organs is illegal.
• So, legal price of human
organs = $0.
• It creates shortage.
• Free markets correct
shortages by raising
prices.
• The ban promotes barter
exchange, other illegal
activities and black
market in organ transfers.
$ Price of
kidneys
Demand for
Kidneys
Supply of
Kidneys
15,000
Quantity of
kidneys
Size of shortage if price is zero.
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5-11
Should Government Pay
for Health Care?
• Free health care benefits
create shortages for
services with very priceelastic demand.
• Governments offering
free healthcare limit costs
by rationing services.
• Price controls over
necessities create
incentives for producers
to develop luxury goods
instead of necessities.
The point on the
supply curve where
quantity = 110,000
Price
An elastic
demand for
MRIs
Supply of MRIs
$2,000
$1,000
If price = $0
consumers will be here
on their demand curve
50,000
110,000
Number of scans
12
5-12
Parking Meters
• Parking meter =
government set parking
price.
• Below equilibrium price
creates shortage and
deadweight loss of
waiting on weekdays.
• Higher price eliminates
shortage by reducing
quantity demanded.
• Above equilibrium price
creates surplus on
weekends.
Price
Supply of
parking spaces
Demand for
spaces on a
weekend
Government set
parking price
Demand for
spaces on a
weekday
800
1,000
1,900
Quantity
13
5-13
Agricultural Subsidies
• Government supported
price for agricultural
produce is higher than
equilibrium price.
• The greater the price
elasticities of demand
and supply, the higher
cost of agricultural
support price.
• Artificial agricultural
prices lead to wastage of
resources.
• Government can reduce
supply by paying farmers
not to grow crops.
Price
per bushel
Surplus
Demand for
wheat
Supply of
wheat
$4
$3
14
20
30
Number of bushels in millions
14
5-14
Do You Know?
• When does a price floor have no effect on a
market?
Price floor will not be effective if it is set below
the market equilibrium price.
• Why can the minimum wage law and rent control
create black markets?
The minimum wage law and rent control prevent
markets from reaching equilibrium. Since it can
not legally reach equilibrium, markets develop
unofficial ways to do so.
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5-15
Do You Know?
• How does the elasticity of demand for health
care affect the cost to a government that provide
free health care to all of its citizens?
When a government offers it free, the price of
health care is zero for its citizens. If the demand
for health care is elastic, quantity demanded
increases by manifolds. Hence, the government
has to bear the higher costs.
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5-16
Summary
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Price floor = minimum legal price.
Price floor creates surplus.
Price ceiling = maximum legal price.
Price ceiling creates shortage.
Government distorts efficient functioning of
market by artificially controlling prices such as
minimum wage law, rent control, military draft,
ban on market for human organs, parking
meters and agricultural subsidies.
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5-17
Coming Up
How is wealth created and
destroyed?
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