Government Markets in Action
A Housing Market with a Rent ceiling
- A price ceiling or price cap is a regulation that makes it illegal to charge a price higher than a
- When a price ceiling is applied to a housing market, it is called a rent ceiling.
- If the rent ceiling is set above the equilibrium rent, it has no effect. The market works if there
were no ceiling
- But if the rent ceiling is set below the equilibrium rent, it has
- The figure shows the effects of a rent celling that is set below
the equilibrium rent.
o The equilibrium rent is $1,000/mo
o A rent ceiling is set at $800/mo
o So the equilibrium rent tis in the illegal region.
o A the rent ceiling, the quantity of housing demanded
exceed the quantity supplied
There is a shortage of housing
Because landlords can’t be forced to supply a
greater quantity than they wish, the quantity of housing supplied at the rent
ceiling is less than the quantity that would be supplied in an unregulated
o Because the legal price cannot eliminate the shortage, other mechanisms operate
Increased search activity
A black market
o With the shortage, someone is willing to pay up to $1,200/mo.
Increased search activity
- The time spent looking for someone with whom to do business it is called search activity
- When a price is regulated and there is a shortage, search activity increases
- Search activity is costly and the opportunity cost of housing equals its rent (regulated) plus the
opportunity cost of the search activity (unregulated)
- Because the quantity of housing is less than the quantity in an unregulated market, the
opportunity cost of housing exceeds the unregulated rent. A black market
- A black market is an illegal market that operates alongside a legal market in which price ceiling
or other restriction has been imposed
- A shortage of housing creates a black market in housing
- Illegal arrangements are made between renters and landlords at rent above the rent ceiling- and
generally above what the rent would have been in an unregulated market
Inefficiency of a rent ceiling
- A rent ceiling set below the equilibrium rent leads to an inefficient underproduction of housing
- The marginal social benefit from housing services exceeds its marginal social cost and a
deadweight loss arises.
A Housing market with a rent ceiling
- A rent ceiling decreases the quantity of housing supplied to less than
the efficient quantity
o A deadweight loss arises
o Producer surplus shrinks
o Consumer surplus shrinks
o There is potential loss from increased search activity.
Are rent ceilings fair?
- According to the fair rules view, a rent ceiling is unfair because it blocks voluntary exchange.
- According to the fair results view, a rent ceiling is unfair because it does not generally benefit
- A rent ceiling decreases the quantity of housing and the scarce housing is allocated by
o First-come, first-served
- A lottery gives scarce housing to the lucky
- A first-come, first-served gives scarce housing to those who have the greatest foresight and get
their names on the list first
- Discrimination gives scarce housing to friends, family members or those selected by race or sex.
- None of these methods lead to a fair outcome
A labor market with minimum wage
- A price floor is a regulation that makes it illegal to trade at a price lower than a specified level
- When a price floor is applied to labor markets, it is called a minimum wage.
- If the minimum wage is set below the equilibrium wage rate, it has no effect. The market works
as if there was no minimum wage - If the minimum wage is set above the equilibrium wage rate, it has powerful effects.
Minimum wage Brings unemployment
- If the minimum wage is set above the equilibrium wage rate, the quantity of labor supplied by
workers exceeds the quantity demanded by employers
o There is a surplus of labor
- The quantity of labor hired at the minimum wage is less than the quantity that would be hired in
an unregulated labor market.
- Because the legal wage cannot eliminate the surplus, the minimum wage created
- The figure shows:
o The equilibrium wage rate is $9/hr.
o The minimum wage rate is set at $10/hr.
o So the equilibrium wage is in the illegal region
o The quantity of labor employed is the quantity demanded
- The quantity of labor supplied exceeds the quantity demanded and
unemployment is created
- With only 20 million hours demanded, some workers are willing to
supply the last hour demanded for $8
Inefficiency of minimum wage
- A minimum wage leads to inefficient outcome
- The quantity of labor employed is less than the efficient quantity
- The supply of labor measures the marginal social cost of labor to workers (leisure forgone)
- The demand for labor measures the marginal social benefit from labor (value of goods
A labor market with a minimum wage
- A minimum wage set above the equilibrium wage decreases the
quantity of labor employed
- A deadweight loss arises
- The potential loss from increased job search decreases both workers’
surplus and firms’ surplus
- The full loss is the sum of the red and grey shaded areas.
Is minimum wage fair?
- Minimum wage rate in Canada is set by the provincial governments
- In 2011, the minimum wage rate from a low of $8.75/hr. in BC to a high of $11.00/ hr. in
Nunavut - Most economists believe that minimum wage laws increase the unemployment rate of low-
skilled younger workers
- Everything you earn and most thing you buy are taxed
- Who really plays these taxes?
- Income taxes and the social security taxes
- Are deducted from your pay, and HST (or GST) is added to the price of the things you buy, so
isn’t it obvious that you pay these taxes?
- Isn’t it equally obvious that your employer pays the employer’s contribution to the socials
- You are going to discover that it isn’t always obvious who pays a tax and that lawmakers don’t
decide who will pay!
- Tax incidence doesn’t depend on tax law.
- The law might impose a tax on buyers or sellers, but the outcome
will be the same
- To see why, we look at the tax on cigarettes in ON.
- Tax on sellers:
o On Feb 1, 2006 ON raised to tax of sales of cigarettes to
$3.09 a pack of 25
o The figure shows the effects of this $2 a pack tax
o With no tax, the equilibrium price is $6/pack
o A tax on sellers of $3 a pack is introduced
o Supply decreases and the curve S+tax on sellers shows the
new supply curve
o The market price paid by buyers rises to $8 per pack and the quantity bought decreases
o The price received by the sellers fall back to $5 per pack
o So with the tax of $3 a pack, buyers pay $2 pack more and
sellers receive $1 pack less.
- Tax on buyers:
o Again, with no tax, the equilibrium price is $6 a pack
o A tax on buyers of $3 per pack is introduced
o Demand decreases and the curve D- tax on buyers the
new demand curve
o The price received by sellers falls to $5 per pack and the
o The price paid by buyers rises to $8 per pack
o So with the tax of $3 a pack, buyers pay $2 more, and sellers receive $1 less
o Tax incidence is the same regardless of whether the law says sellers pay or buyers pay Tax incidence and Eleasticity of Demand
- The division of taxes between buyers and sellers depends on the eleasticities of demand and
- To see how, wer look at two extreme cases
o Perfectly inelecastic demand: Buyers pay entire tax
o Perfectly eleastic demand: Sellers pay the entire tax
- The more ineleastic the demand, the largers the buyers’ share of the tax
Perfectly Ineleastic demand
- Demand for this food is perfectly ineleastic-the demand curve is vertical
- Whena tax is imposed