Chapter 6 – Government Actions in Markets
A Housing Market with a Rent Ceiling
We spend most of our income on housing than on any other good or service, so it isn’t
surprising that rents can be a political issue.
Price ceiling or price cap – a government regulation that makes it illegal to charge a price
higher than a specified level
The effect of a price ceiling on a market depends on whether it is above or below the equilibrium
A price ceiling set above the equilibrium price has no effect. The price does not constrain
the market forces. The force of law and the market forces are not in conflict.
A price ceiling set below the equilibrium price has a powerful effect on a market. The
price ceiling attempts to prevent the price from regulating the quantities demanded and
supplied. The force of law and the market forces are in conflict.
o Supply and demand intersect above the price ceiling which means there is more
demand and less supply
Rent ceiling – when a price ceiling is applied to a housing market
A rent ceiling set below the equilibrium rent creates
o A housing shortage
o Increased search activity
o A black market
A housing shortage
At the equilibrium price, the quantity demanded equals the quantity supplied.
In a housing market when the rent is at the equilibrium level, the quantity of housing
supplied equals the quantity of housing demanded and there is neither a shortage nor a
surplus of housing
A rent set below the equilibrium rent, the quantity of housing demanded exceeds the
quantity of housing supplied – there is shortage
The quantity available is the quantity supplied and must be allocated among the
Increased Search Activity Search Activity – the time spent looking for someone with whom to do business with
When price regulated and there is a shortage, search activity increases.
The opportunity cost of a good is equal not only to the price but also the value of the search
time spent finding the good.
The opportunity cost of housing is equal to the rent (a regulated price) plus the time and
other resources spent searching for the restricted quantity available.
A rent ceiling controls only the rent portion of the cost of housing the cost of increased
search activity might end up making the full cost of housing higher than it would be
without the a rent ceiling
A Black Market
Black market – is where illegal trading occurs; an illegal market where the equilibrium price
exceeds the price ceiling.
“key money” – is money that tenants pay for worthless fittings and charges to make the place a
With a lose enforcement, the black market rent is close to the unregulated rent
With a strict enforcement, the black market rent is close to the highest price a renter is
willing to pay
Inefficiency of a Rent Ceiling A rent ceiling set below the equilibrium price results in an inefficient underproduction of housing
The marginal social benefit exceeds the marginal cost, and deadweight loss shrinks the
producer surplus and consumer surplus
Consumer surplus shrinks (green); producer surplus shrinks (blue)
Pink rectangle loss faced by consumer; deadweight loss arise
Are Rent Ceilings Fair?
According to the first one, it does not block voluntarily exchange so no. According to the 2 , it
would allocate its resources to the poorest first.
Blocking rent adjustments doesn’t eliminate scarcity but since the rent ceiling decreases the
quantity of housing available it creates an even bigger challenge for the housing market
When rent cannot permit allocation other methods are placed
A lottery – to those who are lucky , not poor
First-come, first-served – to those who have the greatest foresight and who get their
names on first
Discrimination – based on the views and self-interest of the owner of the housing; self-
interest of the bureaucracy that administers the allocation that counts o Based on friendship, family ties, and criteria such as race, ethnicity, or sex
When rent adjustments are blocked, other methods of allocating scarce housing resources
operate that do not produce a fair outcome
A Labour Market with a Minimum Wage
A labour market influences the jobs we get and the wages we earn.
Firms decide how much labour to demand and the lower the minimum wage the higher the
Households decide how much labour to supply and the higher the minimum wage the greater
the quantity labour supplied
Price floor – the government-imposed regulation that makes it illegal to change a price lower
than a specified level is called a price floor
The price floor set below the equilibrium price has no effect. The price floor does not
constrain the market forces.
o Since firms are willing to pay more for the supply of labour
The price floor set above the equilibrium price has powerful effects on the market. The
price floor attempts to prevent the price from regulating the quantities demanded and
o Firms have to pay more for labour then they want to
Minimum wage – the price floor is applied to a labour market.
A minimum wage above the equilibrium creates unemployment
When the wage rate is at the equilibrium level, the quantity of labour supplied equals the
quantity of labour demanded, neither shortage nor surplus of labour.
When the wage rate is above the equilibrium wage, the quantity supplied exceeds the quantity
of labour demanded – there is a surplus of labour.
The demand of labour determines the number of people employed, the surplus is unemployed
A wage rate below the equilibrium is illegal
Inefficiency of a Minimum Wage
In the labour market, the supply curve measures the marginal social cost of labour to workers,
leisure forgone. The demand curve measures the marginal social benefit from labour. The value
of goods and services produced. In a unregulated labour market, the labour supplied allocates the economy’s scarce labour
resources to the jobs they are valued most highly. The market is efficient.
The minimum wage frustrates results in unemployment and increased job search.
The marginal social benefit exceeds the marginal social cost (demand > supply)
o creates a deadweight loss that shrinks the firms’ surplus and the workers’ surplus
Minimum wage is unfair in both views of fairness; it delivers unfair results and imposes unfair
Only those people who have jobs and keep them benefit from the minimum wage.
The unemployed end up worse off than they would without minimum wage
When the wage rate doesn’t allocate labour, other mechanisms determine who finds jobs
Minimum wage blocks voluntary exchanges , firms want to hire more and people want to
work more but by the minimum wage law they are not permitted to do so
*Always compare charts to equilibrium price
Tax incidence – the division of the burden of a tax between buyers and sellers
If the price paid by buyers rises by the full amount of the tax , then the burden of the tax
falls entirely on buyers
If the price paid by buyers rises by a lesser amount than the tax, then the burden falls
partly on buyers and partly on sellers
If the price paid by buyers doesn’t change at all then the burden of the tax falls entirely
on the seller
A Tax on Sellers
Increased cost of production which decreases supply
Supply curve shirts to supply + tax
Less supply and higher cost , buyers pay $2 of the $3 tax and sellers pay $1
A Tax on Buyers
Lowers the amount they are willing to pay sellers, so decreases demand
Shifts the demand curve to the left , demand curve – tax = new position Pa