Economics Chapter 6: Government Action in Markets
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.
-Labour market and housing are 2 most important markets
-Price is determined by supply and demand; sometimes governments don’t like that price,
they want a different price and will impose laws that make it illegal to charge a higher price
Example: The equilibrium rent is $1,000 a month; A rent ceiling is set at $800 a month.
-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 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 market.
-Because the legal price cannot eliminate the shortage, other mechanisms
Illegal: Black markets
-With a housing shortage, people are willing to pay up to $1,200 a month; higher willingness
-Rent Ceiling below equilibrium creates: black markets, increased search activity, and a
shortage of housing
-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; a lot more
searching required to find what one is looking for
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.
higher than the equilibrium
-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.
Made so they are not technically breaking the law: ‘key fee’, ‘furnished apartment’
Inefficiency of Rent Ceilings
-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.
-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; smaller than would have been in free market
-There is a potential loss from increased search activity.
-Burn up resources
Are Rent Ceilings Fair?
-poor people don’t have to pay high prices
-According to the fair rules view, a rent ceiling is unfair because it blocks voluntary
-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 allocated by
Lottery- whoever is lucky
First-come, first-served: gives scarce housing to those who have the greatest foresight
and get their names on the list first.
Discrimination- personal preferences: gives scarce housing to friends, family members, or
those of the selected sex, or those without a dog.
None of these methods are fair
A Labour Market with a Minimum Wage
-Floor price: is a regulation that makes it illegal to trade at a price lower than a specified
-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.
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; workers supply labour
The quantity of labour hired at the minimum wage is less than the quantity that would be
hired in an unregulated labour market; wage will be lower but quantity will be higher
-Because the legal wage rate cannot eliminate the surplus, the
minimum wage creates unemployment.
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.
-The supply of labour measures the marginal social cost of labour to workers (leisure
Cost of work is forgone leisure time -The demand for labour measures the marginal social benefit from
labour (value of goods produced).
-A minimum wage set above the equilibrium wage decreases the
quantity of labour 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 areas.
Is the Minimum Wage Fair?
-A minimum wage rate in Canada is set by the provincial governments.
-In 2009, the minimum wage rate ranged from a low of $7.50 an hour in New Brunswick to a
high of $10.00 an hour in Nunavut.
-Most economists believe that minimum wage laws increase the unemployment rate of low-
skilled younger workers; discrimination
-Everything you earn and most things you buy are taxed.
-Who really pays these taxes?
Income tax and the social insurance taxes are deducted from your pay, and provincial
sales tax and GST are added to the price of the most 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 social
-Tax incidence is the division of the burden of a tax between buyers and sellers.
-When an item is taxed, its price might rise by the full amount of the tax, by a lesser amount,
or not at all.
-If the price rises by the full amount of the tax, buyers pay the tax. Buyer pays a higher price
-If the price rise by a lesser amount than the tax, buyers and sellers share the burden of the
tax, they both pay
-If the price doesn’t rise at all, sellers pay the tax.
-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.
Example: To see why, we look at the tax on cigarettes in Ontario.
-On February 1, 2006, Ontario raised the ta