Government Policies That Alter the
Private Market Outcome
Price controls
Price ceiling: a legal maximum on the price
of a good or service Example: rent control
Price floor: a legal minimum on the price of
a good or service Example: minimum wage
Taxes
The govt can make buyers or sellers pay a
specific amount on each unit.
We will use the supply/demand model to see
how each policy affects the market outcome
(the price buyers pay, the price sellers receive,
and eq’m quantity).
EXAMPLE 1: The Market for Apartments
Rental P S
price of
apts
$800
Eq’m w/o
price
controls
D
Q
300
Quantity
of apts
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How Price Ceilings Affect Market Outcomes
A price ceiling P
above the S
Price
eq’m price is $1000
ceiling
not binding—
has no effect $800
on the market
outcome.
D
Q
300
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How Price Ceilings Affect Market Outcomes
The eq’m price P S
($800) is above
the ceiling and
therefore illegal.
$800
The ceiling
is a binding Price
$500
constraint ceiling
on the price, shortage
D
causes a Q
250 400
shortage.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How Price Ceilings Affect Market Outcomes
In the long run, P S
supply and
demand
are more $800
price-elastic.
Price
So, the $500
ceiling
shortage shortage
is larger. D
Q
150 450
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Shortages and Rationing
With a shortage, sellers must ration the goods
among buyers.
Some rationing mechanisms: (1) Long lines
(2) Discrimination according to sellers’ biases
These mechanisms are often unfair, and
inefficient: the goods do not necessarily go to the
buyers who value them most highly.
In contrast, when prices are not controlled,
the rationing mechanism is efficient (the goods
go to the buyers that value them most highly)
and impersonal (and thus fair).
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EXAMPLE 2: The Market for Unskilled Labor
Wage W S
paid to
unskilled
workers
$6.00
Eq’m w/o
price
controls
D
L
500
Quantity of
unskilled workers
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How Price Floors Affect Market Outcomes
A price floor W
below the S
eq’m price is
not binding –
has no effect $6.00
on the market
Price
outcome. $5.00
floor
D
L
500
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How Price Floors Affect Market Outcomes
labor
The eq’m wage ($6) W surplus S
is below the floor Price
and therefore $7.25
floor
illegal.
$6.00
The floor
is a binding
constraint
on the wage,
D
causes a L
surplus (i.e., 400 550
unemployment).
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Minimum Wage
Min wage laws unemp-
do not affect W loyment S
highly skilled Min.
$7.25
workers. wage
They do affect $6.00
teen workers.
Studies:
A 10% increase
in the min wage
D
raises teen L
unemployment 400 550
by 1–3%.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING 1
Price controls
The market for
P
140 hotel rooms
S
130
Determine
120
effects of:
110
A. $90 price 100
ceiling 90
B. $90 price 80 D
floor 70
C. $120 price 60
floor 50
40
0 Q
50 60 70 80 90 100 110 120 130
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING 1
A. $90 price ceiling
The market for
P
140 hotel rooms
The price S
falls to $90. 130
120
Buyers 110
demand 100
120 rooms, Price ceiling
90
sellers supply 80 D
90, leaving a shortage = 30
70
shortage. 60
50
40
0 Q
50 60 70 80 90 100 110 120 130
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING 1
B. $90 price floor
The market for
P
140 hotel rooms
Eq’m price is S
130
above the floor,
120
so floor is not
110
binding.
100
P = $100, 90
Q = 100 rooms. Price floor
80 D
70
60
50
40
0 Q
50 60 70 80 90 100 110 120 130
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING 1
C. $120 price floor
The market for
The price P
140 hotel rooms
surplus = 60 S
rises to $120. 130
120
Buyers Price floor
110
demand
100
60 rooms,
90
sellers supply
80 D
120, causing a
70
surplus.
60
50
40
0 Q
50 60 70 80 90 100 110 120 130
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
