1. Review: In competitive markets, price adjusts to “balance” supply and demand. Markets are in equilibrium most of the time. (We might regard this as a remarkable outcome if we didn’t understand the supply and demand model -- remember, no one’s in charge!) Some government policies are designed to interfere with the market process of price determination. “Price controls”

2. Price ceiling: A legal maximum on the price at which a good can be sold. Price floor: A legal minimum on the price at which a good can be sold. Economists almost always oppose price controls: They’re well-intentioned, but...... they rarely help all who are supposed to benefit,... and they often have unintended bad effects.

3. With a price ceiling, there are two possibilities: D S price quantity p c1 The price ceiling could be at or above p*. p* is a legal price and we would have equilibrium. (“Non-binding” price ceiling.) excess demand p c2 The price ceiling could be below p*. p* is illegal. (“Binding” price ceiling.) Price is p c2 and we have excess demand (“shortage”). Q S Q D p*

4. Price ceilings are intended to help buyers. With a (binding) price ceiling, only some who want to buy at the ceiling price are able to buy. Shortage creates problems: Disappointed demanders have incentive to offer an illegally high price...... so price ceilings are inherently hard to enforce.

5. Even if price ceiling can be strictly enforced, a “non- price rationing mechanism” is needed. Usually, price “rations” the available supply. Those willing to pay p* (or more) get to buy, others do not. With a binding price ceiling, the usual price rationing mechanism is not allowed to work. Non-price rationing mechanisms? -- those willing to wait in line the longest get to buy. -- only “friends” of suppliers get to buy.

6. Rent control: A binding price ceiling on the rental housing market. D1D1 S LR S SR Probably best to think of “quantity” as total square footage -- rather than number of apartments. Short-run supply perfectly inelastic? In the (sufficiently) short run, number of aprtmts is fixed. ($/ft. 2 / month) (ft 2 /month) Q* p*

7. Rent control is often imposed in response to a big influx of population - increasing demand for rental housing. Effects of such a demand shift - WITHOUT rent control: D2D2 ($/ft. 2 / month) Q* (ft 2 /month) D1D1 S LR S SR p* In short-run: Rent jumps to p**. No quantity effect. p** In long-run: Rent comes down (part-way) to p***. Quantity increases to Q***. p*** Q***

8. Now consider the effects of the demand shift WITH rent control imposed at level of original equilibrium, p*: ($/ft. 2 / month) Q* (ft 2 /month) D1D1 S LR S SR p* D2D2 In the short-run: No increase in rent, but excess demand... excess demand... that persists throughout long-run. Rent control “cancels” the price signal that otherwise would have increased quantity of rental housing.

9. Rent control does deprive landlords of the short-run “windfall” they otherwise get from increased demand. Does it benefit tenants? Some benefit -- those with rent-controlled apartments who are happy where they are. Some lose -- those who make up “excess demand.” Again: Excess demand isn’t relieved in long-run because rent control “cancels” the price signal. (More on rent control: http://www.econlib.org/...)http://www.econlib.org/...

10. Now price floors. As with price ceilings, there are two possibilities: D Sprice quantity p f1 The price floor could be at or below p*. p* is a legal price and we would have equilibrium. (“Non-binding” price floor.) excess supply p f2 The price floor could be above p*. p* is illegal. (“Binding” price floor.) Price is p f2 and we have excess supply (“surplus”). Q D Q S p*

11. The point of price floors is to benefit suppliers. To accomplish this, government has to purchase surplus. Agricultural commodity price support programs...... for corn, for example. What can the government do with the surplus? Sell it? Give it away? Build more government corn bins!

12. Minimum wage: A price floor on the labor market. Current federal minimum wage = $7.25/hr. (as of 07/24/09) Current Iowa minimum wage = $7.25/hr. Current Illinois minimum wage = $8.25/hr. Currently the highest state minimum wage = $8.67/hr. (Washington) (In San Francisco, minimum wage = $9.92/hr.) (source: http://www.dol.gov/esa/minwage/america.htm#content)http://www.dol.gov/esa/minwage/america.htm#content

13. Consider Iowa minimum wage of $7.25/hr. In terms of annual income (assuming a work year of 50 weeks x 40 hrs./wk. = 2000 hrs.): $7.25/hr x 2000 hrs./yr. = $14,500/yr. U.S. Health and Human Services 2010 Poverty Guideline: Family of 4 = $22,050/yr. (http://aspe.hhs.gov/poverty/10poverty.shtml)http://aspe.hhs.gov/poverty/10poverty.shtml

14. Market for (“low-skill”) labor: D S wage ($/hr.) quantity of labor (hrs.) Note: In labor markets, firms are “demanders,” households are “suppliers.” surplus In this case, surplus = “unemployment” -- people who want to work at w min but cannot. w min L D L S w*

15. It’s supposed to benefit low-skill workers. Does it? Some benefit -- those who keep their jobs when minimum wage goes into effect. Some lose -- those who are displaced. (Employment falls (!) when law raises wage from w* to w min.) Are the benefits well-targeted? (Does it help mainly “bread-winners” in low income households -- or mainly middle-class teenagers?) (More on minimum wage: http://en.wikipedia.org...)http://en.wikipedia.org...

16. How big is the “displaced worker” effect? One recent study... (http://www.theworkbuzz.com...)http://www.theworkbuzz.com...... says it’s “small.” Economists are still somewhat divided on the minimum wage.