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Lecture

Chapter 6 Lecture Notes.doc

17 Pages
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Department
Economics
Course Code
ECON 101
Professor
Corey Van De Waal

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CHAPTER 6: GOVERNMENT ACTIONS IN MARKETS  Even though house prices are falling, some rents rose by 10 percent in 2007.  Can governments cap rents to help renters?  Can governments make housing more affordable by raising incomes with minimum wage laws?  The government taxes almost everything we buy.  But who actually pays and who benefits when a tax is cut: buyers or sellers?  The government subsidizes some farmers and limit the quantities that other farmers may produce.  Do subsidies and production limits help to make markets efficient? 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 specified level.  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 as if there were no ceiling.  But if the rent ceiling is set below the equilibrium rent, it has powerful effects. - a 40000 unit shortage is present • If the rent ceiling is above the equilibrium then it serves as nothing significant because if the rent is above the equilibrium market will use equilibrium price rather than the ceiling price Housing Shortage Figure 6.1 shows the effects of a rent ceiling that is set below the equilibrium rent. • The equilibrium rent is $1,000 a month. • A rent ceiling is set at $800 a month. • So the equilibrium rent is in the illegal region. • At the rent ceiling, the quantity of housing demanded exceeds the quantity supplied. • There is a shortage of housing. Because the legal price cannot eliminate the shortage, other mechanisms operate:  Search activity  Black markets With a housing shortage, people are willing to pay up to $1,200 a month. Search Activity  The time spent looking for someone with whom to do business 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 Black Markets  A black market is an illegal market that operates alongside a legal market in which a 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 rents above the rent ceiling—and generally above what the rent would have been in an unregulated market. Inefficiency of Rent Ceilings *** if marginal benefit is greater than marginal cost it is inefficient because there is room for increasing the quantity  A rent ceiling set below the equilibrium rent leads to an inefficient underproduction of housing services.  The marginal social benefit from housing services exceeds its marginal social cost and a deadweight loss arises. Figure 6.2 illustrates this inefficiency  A rent ceiling decreases the quantity of housing supplied to less than the efficient quantity.  A deadweight loss arises.  Producer surplus shrinks.  Consumer surplus shrinks.  There is a potential loss from increased search activity. A Labour Market with a 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 labour 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 were no minimum wage.  It is illegal to set a price under the price floor  If the minimum wage is set above the equilibrium wage rate, it has powerful effects.  If the minimum wage is set above the equilibrium wage rate, the quantity of labour supplied by workers exceeds the quantity demanded by employers.  There is a surplus of labour.  The quantity of labour hired at the minimum wage is less than the quantity that would be hired in an unregulated labour market.  Because the legal wage rate cannot eliminate the surplus, the minimum wage creates unemployment. Figure 6.3 on the next slide illustrates these effects. • The equilibrium wage rate is $6 an hour. • The minimum wage rate is set at $7 an hour. • So the equilibrium wage rate is in the illegal region. • Anything under the price floor is illegal • The quantity of labour employed is the quantity demanded. • For the price floor to be effective it must be above the equilibrium point Minimum Wage Brings Unemployment  The quantity of labour 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 a Minimum Wage  A minimum wage leads to an inefficient outcome.  The quantity of labour employed is less than the efficient quantity.
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