Eco 6351 Economics for Managers Chapter 3d. Supply and Demand Prof. Vera Adamchik

Government Intervention Price ceilings (housing markets) Price floors (agricultural markets and labor markets)

Price Ceilings A price ceiling is a regulation that makes it illegal to charge a price higher than a specified level. When a price ceiling is applied to housing markets, it is called a rent ceiling.

The effect of a price ceiling A price ceiling set above the equilibrium price has no effect because the price ceiling does not constrain the market forces. A price ceiling set below the equilibrium price has powerful effects on a market. A price ceiling attempts to prevent the price from regulating the quantities demanded and supplied.

Housing Markets and Rent Ceilings $24=maximum black market rent Equilibrium rent is $20 a unit Rent ceiling is $16 a unit Shortage = 56,000 units of housing

Consequences of rent ceilings Wasteful search activity: frustrated would-be renters scan the newspapers, not only for housing ads but also for death notices! A black market: frustrated renters and landlords constantly seek ways to increase rents (for example, an exorbitant price for new locks and keys – called “key money”).

Rent Ceiling Pros A rent ceiling prevents the rent from increasing Cons The quantity supplied remains constant There is a housing shortage Wasteful search Black markets

Price Floors A price floor is a regulation that makes it illegal to charge a price below a specified level. If the price floor is set below the equilibrium price, the price floor has no effect. If the price floor is set above the equilibrium price, the price floor is in conflict with the market forces and does have effects on the market.

Agricultural Markets Farm output fluctuates a great deal because of fluctuations in the weather. The demand for most agricultural products is inelastic, therefore, a bumper harvest (an increase in supply) decreases the price and decreases farm revenue, and a poor harvest (a decrease in supply) increases the price and increases farm revenue.

Farm Price Stabilization Policy Government agencies act to stabilize farm prices and revenues. The most extensive interventions occur in the European Union. But they also occur in the US, where they are designed to stabilize the prices of many agricultural products, such as grains, milk, eggs, tobacco, rice, peanuts, and cotton.

Farm Price Stabilization Policy Governments intervene in agricultural markets. They: set price floors, set production limits (quotas), subsidize, hold inventories.

Price Floor With no intervention, the total farm revenue is $3*16=$48 mln

Price Floor With a price floor of $4 a ton, the total revenue is $4*14=$56 mln But a surplus is 18-14=4 mln tons

Price Floor Someone must buy this surplus production If farmers (illegally) offer it for sale, the price will fall to $2!

The government’s price stabilization agency must buy the persistent surpluses. If the price is persistently greater than the equilibrium price, the government agency buys more than it sells and ends up with large inventory. The cost of buying and storing the inventory falls on taxpayers.

Price floors in agri markets Pros limit price fluctuations in agricultural markets limit farm revenue fluctuations Cons usually create surpluses of food products end up with large inventory the cost of buying and storing the inventory falls on taxpayers

Labor markets New labor-saving technologies become available every year. As a result, the demand for some types of labor,usually the least skilled types, decreases; the wage rate falls; the quantity of labor employed decreases (some people go to school to train and to obtain more skills, but some people leave the labor force for good).

Minimum wages A labor market may be regulated with a minimum wage, that is, the lowest legal wage that can be paid. The minimum wage in the US is set by the federal government’s Fair Labor Standards Act. Some state governments have passed minimum wage laws that exceed the federal minimum.

Labor markets and minimum wages Minimum wage is above the eqm wage Unemploy-ment arises No mechanism for ending unemploy-ment

The minimum wage Cons Pros increases the quantity of labor supplied. Some young people even quit school before completing high school creates unemployment increases the amount of time people spent searching for a job Pros helps maintain employment and income for low-skilled labor