Introduction to Microeconomics Class 6 Government Policies in the Supply and Demand Model

Price Controls In economics, we argue: These distortions cause: Best possible outcomes occur with no gov’t interference Yields most efficient allocation of resources When policies to control the price interfere in the market, they create distortions These distortions cause: Shortages Surpluses

What are Price Controls? Setting a price maximum (price ceiling) or price minimum (price floor) in a given market Non-binding price control: the equilibrium is not distorted and the market outcomes are efficient Binding price control: the equilibrium cannot be reached and the market outcomes are inefficient (shortage or surplus)

What are Price Controls? Setting a price maximum (price ceiling) or price minimum (price floor) in a given market Non-binding price control: the equilibrium is not distorted and the market outcomes are efficient Binding price control: the equilibrium cannot be reached and the market outcomes are inefficient (shortage or surplus)

What are Price Controls? Setting a price maximum (price ceiling) or price minimum (price floor) in a given market Non-binding price control: the equilibrium is not distorted and the market outcomes are efficient Binding price control: the equilibrium cannot be reached and the market outcomes are inefficient (shortage or surplus)

Non-Binding Price Ceilings Maximum Legal Price does not affect Equilibrium Max Legal Price Pmax Pe Can charge any price up to Pmax D Q Non-binding Price Ceiling: Gov’t sets max price P max > P equilibrium: set price at Pe No market distortions: can reach equilibrium

Binding Price Ceilings Maximum Legal Price affects Equilibrium Cannot charge any price above Pmax Pe Max Legal Price Pmax Can charge any price up to Pmax Binding Price Ceiling: Gov’t sets max price P max < P equilibrium: cannot set the price at Pe Market distortion: Price = Pmax Supply < Demand @ P max Shortage of goods in the market D Q

Group Discussion https://www.youtube.com/watch?v=oJvTTGOHFkU What are the three main reasons the presenter argues that rent control is bad? What type of distortions does this policy cause? Why have these policies not been abandoned? Can you see any positive aspects to rent control? Either economic or non-economic? http://www.cnbc.com/2015/02/06/what-living-in-venezuela-costs-as-inflation-soars.html

Non-Binding Price Floor Minimum Legal Price does not affect Equilibrium Can charge any price above Pmin Pe Pmin Minimum Legal Price D Q Non-binding Price Floor: Gov’t sets min price P min < P equilibrium: set price at Pe No market distortions: can reach equilibrium

Binding Price Floor Minimum Legal Price affects Equilibrium Can charge any price above Pmin Pmin Minimum Legal Price Pe Cannot charge any price below Pmin Binding Price Floor: Gov’t sets min price P min > P equilibrium: cannot set the price at Pe Market distortion: Price = Pmax Supply > Demand @ P min Surplus of goods in the market D Q

Application Consider two labor markers where a lawyer’s wage rate is approximately $100/hr and a housecleaner’s wage rate is approximately $8/hr. The government decides to impose a minimum wage law of $12/hr. What impact does this have on the market for lawyers? Draw out the supply and demand model. What impact does this have on the market for housecleaners? Draw out the supply and demand model.

Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S Equilibrium $100 Market Equilibrium $8 D D Q Q

Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 $12 Price Floor Min. Wage $12 Price Floor Min. Wage $8 D D Q Q

Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 $12 Price Floor Min. Wage $12 Price Floor Min. Wage $8 D D Qd = Qs Q Qd Qs Q

No effect of the market for lawyers Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 $12 Price Floor Min. Wage $12 Price Floor Min. Wage $8 D D Qd = Qs Q Qd Qs Q Qd = Qs: No effect of the market for lawyers

At $12: Surplus of Housecleaners Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 $12 Price Floor Min. Wage $12 Price Floor Min. Wage $8 D D Qd = Qs Q Qd Qs Q Qd < Qs: At $12: Surplus of Housecleaners

Application Reflection Why does this matter? Binding price floors cause a SURPLUS in the market because supply > demand at the artificially high price When gov’t policies mandate price floors – the market cannot reach equilibrium and is therefore “distorted” meaning Qd does not meet Qs Distortions from these policies only occur when it is binding Price floors: Price floor is above Pe Price ceilings: Price ceiling is below Pe What’s the most important takeaway? When gov’t imposes policies that hinder whether markets can reach equilibrium, these policies create either surpluses or shortages, which are considered market distortions Sometimes the social benefits outweigh the economic costs MUDDIEST POINT?

Key Takeaways Government policies can cause distortions in the market for goods and services by preventing supply and demand to reach equilibrium These distortions create Shortages Surpluses Policies are put in place many times due to the social benefits outweighing the economic costs