Illustrating the market process and the

distortionary effects of price controls -Continuation- part3.

By legally manipulating the market price, price controls distort

this process by preventing mutually beneficial exchanges which

would have otherwise occurred in the absence of the legal restriction.

Figures 2 and 3 illustrate the direct distortions resulting

from the implementation of price controls.

A price floor is a legally mandated

price that is set above

the equilibrium price. The

government mandated price is

illustrated by the solid line (PF)

in Figure 2. As discussed above,

a price above the equilibrium

price (PE) will result in a surplus,

where suppliers produce

more than consumers demand

(QS > QD). In the unhampered

market, the price would fall

to erode the surplus. However,

suppliers are unable to lower

their price, by law, below the

mandated price floor. The result is that the surplus persists.

To provide an illustration of this logic, suppose that the market

for labour is coordinated through genuine market prices. In

this case supply and demand will tend to be brought into balance.

Now suppose the government imposes a price floor in the

form of a minimum wage, above the equilibrium price, with the

goal of improving standards of living of low-skilled workers. At

the artificially high price, the quantity of labour supplied will

exceed the quantity of labour demanded, resulting in a surplus

of labour. In other words, some workers who want to work at

the artificially high price will be unable to find employment and

people who want work doing will be unable to find people to do

the work even though, without the legal price floor, there would

be willing workers.