Lecture Nine: Government Actions in Markets
October 27, 2011
A Housing Market with a Rent Ceiling
A price ceiling or price cap is a regulation that make it illegal to charge a price
higher than the 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 is set below the equilibrium, there are powerful effects
- More people would want houses or apartments at the new, lower price
- The quantity demanded would be more than the quantity available
- This creates a shortage of resources available.
Because the legal price cannot eliminate shortages of resources, other
mechanisms operate to compensate for this
- Search activity
- Black markets
The more time it would take to find an apartment due to shortage is a cost. Some
people may be willing to pay more illegally to eliminate the waiting or searching
The time spent looking for someone with whom to do business is called search
When a price is regulated and there is a shortage, search activity increases.
Search activity is costly and the opportunity cost of housing equals is rent
(regulated) plus the opportunity cost of the search activity (unregulated).
A black market is an illegal market that operated alongside a legal market in
which a price ceiling or other restriction has been imposed. Illegal arrangements are made between renters and landlords above the rent
ceiling and generally above what the price would be in an unregulated market.
Inefficiency of Rent Ceilings
A rent ceiling decreases the quantity of housing supplied to less than the
A deadweight loss arises, producer surplus shrinks, consumer surplus shrinks.
- There is also a potential loss from increased search activity.
Are Rent Ceilings Fair?
According to the fair rule view, a rent ceiling is unfair because it blocks
According to the fair results view, a rent ceiling is unfair because it does not
generally benefit the poor.
A rent ceiling decreases the quantity of housing and the scarce housing is
- Lottery: gives housing to the lucky
- First come, first served: gives housing to those who have the best foresight and
get their names on the waiting list first
- Discrimination: friends, family members, people with certain characteristics
None of these methods are fair.
A Labor Market with a Minimum Wage
A price floor is a regulation that makes it illegal to trade at a level than a
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 was no minimum wage.
If the minimum wage is set above the equilibrium price, there are many effects.
- There would be more people wanting to work for a higher wage
- Producers would decrease the amount of jobs available because they cannot
afford the same amount of workers at the higher price
- This creates a surplus of labour and a shortage of available jobs Minimum Wage Brings Unemployment
The quantity of labour supplied exceeds the quantity demanded and
unemployment is created
- People are willing to work for less, but by law the firms must pay more
Inefficiency of a Minimum Wage
A minimum wage leads to an 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
The demand for labour measures the marginal social benefit f