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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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 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
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.