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

2. 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

3. 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)

4. 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)

5. 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)

6. 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

7. 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 < P max
Shortage of goods in the market D Q

8. 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?

9. 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

10. 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 > P min
Surplus of goods in the market D Q

11. 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.

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

13. 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

14. 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

15. 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

16. 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

17. 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?

18. 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