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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” 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. With a price ceiling, there are two possibilities: price The price ceiling could be at or above p*. p* is a legal price and we would have equilibrium. (“Non-binding” price ceiling.) S pc1 p* pc2 excess D demand QS QD The price ceiling could be below p*. p* is illegal. (“Binding” price ceiling.) Price is pc2 and we have excess demand (“shortage”). quantity 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. Even if price ceiling can be strictly enforced, a “nonprice 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. Rent control: A binding price ceiling on the rental housing market. ($/ft.2/ month) SSR SLR p* D1 Q* Probably best to think of “quantity” as total square footage -- rather than number of apartments. (ft2/month) Short-run supply perfectly inelastic? In the (sufficiently) short run, number of aprtmts is fixed. Rent control is often imposed in response to a big influx of population - increasing demand for rental housing. Effects of such a demand shift - WITHOUT rent control: ($/ft.2/ month) SSR SLR p** p*** p* D2 D1 Q* Q*** In short-run: Rent jumps to p**. No quantity effect. In long-run: Rent comes down (part-way) to p***. Quantity increases to Q***. (ft2/month) Now consider the effects of the demand shift WITH rent control imposed at level of original equilibrium, p*: ($/ft.2/ month) SSR excess demand SLR p* In the short-run: No increase in rent, but excess demand . . . D2 D1 Q* . . . that persists throughout long-run. (ft2/month) Rent control “cancels” the price signal that otherwise would have increased quantity of rental housing. 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/ . . .) Now price floors. As with price ceilings, there are two possibilities: price The price floor could be above p*. p* is illegal. (“Binding” price floor.) Price is pf2 and we have excess supply (“surplus”). S pf2 p* pf1 excess supply QD D QS The price floor could be at or below p*. p* is a legal price and we would have equilibrium. (“Non-binding” price floor.) quantity 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! 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) 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 = $22,050/yr. (http://aspe.hhs.gov/poverty/10poverty.shtml) Market for (“low-skill”) labor: wage ($/hr.) S wmin w* surplus LD Note: In labor markets, firms are “demanders,” households are “suppliers.” D LS quantity of labor (hrs.) In this case, surplus = “unemployment” -- people who want to work at wmin but cannot. 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 wmin.) 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 . . .) How big is the “displaced worker” effect? One recent study . . . (http://www.theworkbuzz.com . . .) . . . says it’s “small.” Economists are still somewhat divided on the minimum wage.