CHAPTER 6 Government Actions in Markets

Learning Objectives Explain how price ceilings create shortages and inefficiency (example, rent control) Explain how price floors create surpluses and inefficiency (example, minimum wage)

Price Ceilings

A Regulated Housing Market Price ceilings are regulations that make it illegal to charge a price higher than a specified level. Rent ceilings (sometimes called rent control) are price ceilings applied to housing markets. How does a rent ceiling affect the housing market?

A Regulated Housing Market Rent ceilings set above equilibrium have no effect. Rent ceilings set below equilibrium prevents price from regulating the quantities supplied and demanded.

No Rent Ceiling S 2400 Rent (dollars per unit per month) 2000 1600 D 1200 0 36 72 100 150 Quantity (thousands of units per month)

Rent Ceiling Instead of letting the housing market adjust normally (P*=2000, Q*=72), suppose a rent ceiling of $1600 per month was imposed.

A Rent Ceiling S 2400 Rent (dollars per unit per month) 2000 Rent ceiling 1600 D 1200 0 36 72 100 150 Quantity (thousands of units per month)

A Rent Ceiling S 2400 Rent (dollars per unit per month) 2000 Rent ceiling 1600 Housing shortage D 1200 0 36 72 100 150 Quantity (thousands of units per month)

Effects of a Rent Ceiling Because of the housing shortage, black markets develop. The maximum black market rent would be $2400.

A Rent Ceiling Maximum black market rent S 2400 Rent (dollars per unit per month) 2000 Rent ceiling 1600 Housing shortage D 1200 0 36 72 100 150 Quantity (thousands of units per month)

Effects of a Rent Ceiling For those who abide by the rent ceiling law, there is no incentive to maintain the existing housing stock. As a result, housing quality falls. There is also no incentive to build new housing. Thus, a permanent shortage of housing could exist.

No Rent Ceiling 2800 S 2400 No Regulation - Efficient 2000 1600 D 1200 Rent (dollars per unit per month) 2000 1600 D 1200 0 36 72 100 150 Quantity (thousands of units per month)

No Rent Ceiling 2800 Consumer Surplus = .5(72x800)=28800 S 2400 Rent (dollars per unit per month) 2000 1600 D 1200 0 36 72 100 150 Quantity (thousands of units per month)

No Rent Ceiling 28 Consumer Surplus = .5(72x800)=28800 S 24 Rent (dollars per unit per month) 20 16 Producer Surplus=.5(72x800)=28800 D 12 0 36 72 100 150 Quantity (thousands of units per month)

No Rent Ceiling 28 S 24 No Regulation - Efficient Consumer Surplus Surplus = .5(72x800)=28800 S 24 No Regulation - Efficient Consumer Surplus +Producer Surplus =57600 Rent (dollars per unit per month) 20 16 Producer Surplus=.5(72x800)=28800 D 12 0 36 72 100 150 Quantity (thousands of units per month)

Inefficiency of Rent Ceiling Supply at rent ceiling 2800 S 2400 Rent Ceiling at $1600 Rent (dollars per unit per month) 2000 Rent ceiling 1600 D 1200 0 36 72 100 150 Quantity (thousands of units per month)

Rent Ceilings 100,000 units will be demanded. A shortage of 64,000 units will be created.

Inefficiency of Rent Ceiling Consumer Surplus =.5(36X400)+(36x800)=36000 2800 S 2400 Rent (dollars per unit per month) 2000 Rent ceiling 1600 D 1200 0 36 72 100 150 Quantity (thousands of units per month)

Inefficiency of Rent Ceiling Consumer Surplus =.5(36X400)+(36x800)=36000 2800 S 2400 Rent (dollars per unit per month) 2000 Rent ceiling 1600 D 1200 Producer surplus=.5(36x400)=7200 0 36 72 100 150 Quantity (thousands of units per month)

Inefficiency of Rent Ceiling Consumer Surplus =.5(36X400)+(36x800)=36000 2800 S 2400 Deadweight loss=.5(800x36)=14400 Rent (dollars per unit per month) 2000 Rent ceiling 1600 D 1200 Producer surplus=.5(36x400)=7200 0 36 72 100 150 Quantity (thousands of units per month)

Effects of a Shortage When quantity demanded exceeds quantity supplied, the smaller quantity will be the one actually bought and sold, many suppliers have nothing to sell, and many buyers find there is nothing to buy. 36,000 units are available. Demand for the additional 64,000 units is unsatisfied.

A Housing Market with a Rent Ceiling Are Rent Ceilings Fair? According to the fair rules view, a rent ceiling is unfair because it blocks voluntary exchange. According to the fair results view, a rent ceiling is unfair because it does not generally benefit the poor. A rent ceiling decreases the quantity of housing and the scarce housing is allocated by Lottery First-come, first-served Discrimination

A Housing Market with a Rent Ceiling A lottery gives scarce housing to the lucky. A first-come, first served gives scarce housing to those who have the greatest foresight and get their names on the list first. Discrimination gives scarce housing to friends, family members, or those of the selected race or sex. None of these methods leads to a fair outcome.

Price Floors

Labor Markets and Minimum Wages The interaction of demand and supply in the labor market influences the jobs we get and the wages we earn. Firms make decisions about the quantity of labor to demand. Households make decisions about the quantity of labor to supply.

An Unregulated Labor Market The wage rate balances the quantity demanded and the quantity supplied, determining the level of employment.

A Market for Low-Skilled Labor 6 S Wage Rate (dollars per hour) 5 4 D 3 20 21 22 23 Quantity (millions of workers)

The Minimum Wage A minimum wage law is a regulation that makes hiring labor below a specified wage illegal. In the U.S., the current federal minimum wage is $7.25/hour Most states also have minimum wages. About 40% of the states have minimum wages above the federal minimum. The larger of the federal or state minimum is the one that applies to workers in that state.

Effective and Ineffective Minimum Wage Laws If the minimum wage is set below the equilibrium wage, it has no effect. If the minimum wage is set above the equilibrium wage, the minimum wage law is in conflict with market forces.

Effects of an Effective Minimum Wage Law An effective minimum wage causes the supply of labor to exceed the demand for labor. The excess supply of labor (surplus) is called unemployment. The unemployed workers are searching for jobs. The unemployed are comprised of two groups (layoffs and new entrants). In our example each of these groups has 1 million workers for a total of 2 million unemployed. The minimum wage is inefficient and creates a deadweight loss.

No Minimum Wage S 9 7 5 3 D 20 21 22 23 Quantity (millions of workers) Wage Rate (dollars per hour) 7 5 3 D 20 21 22 23 Quantity (millions of workers)

Minimum Wage and Unemployment 9 S Unemployment Wage Rate (dollars per hour) 7 a b Minimum wage 5 Layoffs New entrants 3 D 20 21 22 23 Quantity (millions of workers)

Minimum Wage and Deadweight Loss 9 S Unemployment Wage Rate (dollars per hour) 7 a b Minimum wage 5 Deadweight loss 3 D 20 21 22 23 Quantity (millions of workers)

The Minimum Wage in Reality Minimum wage laws hit low-skilled workers the hardest, especially the young with few job skills. The unemployment rate for teenagers is consistently more than twice the national average. The actual minimum wage is zero, the wage earned by the unemployed.

Projected Effects of President Obama’s Proposed Increase in the Minimum Wage (CBO Estimates)