ECON101 Chapter Notes - Chapter 6: Marginal Utility, Deadweight Loss, Social Cost
26 Jun 2018
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Econ Chapter 6 notes
A Housing Market with a Rent Ceiling
Price Ceiling/Price Cap: a government regulation that makes it illegal to charge a price higher
than a specified level
oIf price ceiling set above the equilibrium price = no effect, because does not constrain
market force
oIf price ceiling set below the equilibrium price = powerful effect, because price ceiling
ties to prevent from regulating quantities demanded and supplied. Thus, force of law
and market forces are conflicting
Rent ceiling: when price ceiling is applied to housing market. This creates:
oHousing shortage
oIncreased search activity
oBlack market
A Housing Shortage
If rent is below equilibrium rent, quantity of housing demanded exceeds quantity of housing
supplied, so there is a shortage of housing. Shortage must be allocated among frustrated
demanders. This allocation occurs through increased search activity and black markets.
Increased Search Activity
Search activity: time spent looking for someone with whom to do business
When price is regulated and there is a shortage, search activity increases.
The opportunity cost of a good is equal not only to its price but also to the value of search time
spent on finding the good.
oE.G. Opportunity cost of housing = rent (regulated price) + time and other resources
spent searching for restricted quantity available (phone calls, automobiles, gas)
A Black Market
Black market: illegal market in which equilibrium price exceeds rent ceiling
When there is a rent ceiling, renters and landlords try to find ways to increase rent
oE.G. make tenant pay high cost for worthless objects ($2,000 for drapes)
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Level of black market depends how tightly rent ceiling is enforced
oLess enforcement: black market is close to unregulated rent
oStrict enforcement: black market rent = max price renter is willing to pay
Inefficiency of a Rent Ceiling
Rent ceiling set below equilibrium rent results in inefficient underproduction of housing services
The marginal social benefit of housing exceeds its marginal social cost and deadweight loss
shrinks the producer and consumer surplus. There is also a potential loss from housing search.
Are Rent Ceilings Fair?
According to fair rules view, anything that blocks voluntary exchange is unfair so rent ceilings
are unfair
According to the fair results view, a fair outcome is one that benefits the less well-off, so the
fairest outcome is the one that allocates scarce housing to the poorest
Blocking rent adjustments does not eliminate scarcity, but creates bigger challenge for housing
market. They must ration smaller quantity of housing and allocate that housing among people
who demand it.
Possible mechanisms to allocate scarce housing are:
oLottery
Allocates to those who are lucky, not poor
ofirst come first served
allocates to those who have best foresight, not poorest
odiscrimination
allocates based on views and self-interest of owner of housing, not poorest
It is hard to make a case of rent ceilings on basis of fairness. When rent adjustments are
blocked, other methods of allocating do not produce a fair result
A Labour Market with a Minimum Wage
Labour Market: market that influence the jobs we get and wages we earn.
oFirms decided how much labour to demand, Households decide how much labour to
supply
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oThe higher the wage, the greater quantity of labour supplied, and vice versa
Price Floor: a government regulation that makes it illegal to charge a price lower than a specified
level
Effects of price floor on market depend whether floor is on level above/below equilibrium price
oPrice floor set below the equilibrium price = no effect, because it does not constrain the
market forces
oPrice floor set above the equilibrium price = powerful effect on market, because this
price tries to prevent the price from regulating the quantities demanded and supplied,
and the force of law and market forces are in conflict
Minimum Wage: when price floor is applied to a labour market. When imposed at a level that is
above the equilibrium wage, it creates unemployment
Minimum Wage Brings Unemployment
At wage rate above equilibrium wage, quantity of labour supplied exceeds quantity of labour
demanded, so there is a surplus of labour. The demand for labour determines the level of
employment, and the surplus of labour is unemployed.
Inefficiency of a Minimum Wage
In labour market, the supply curve measures marginal social cost of labour to workers. This cost
is leisure forgone.
Demand curve measure marginal social benefit from labour, and this benefit is the value of
goods and services produced.
Minimum wage frustrates market mechanism, results in unemployment and increased job
search. At the quantity of labour employed, the marginal social benefit of labour exceeds its
marginal social cost and a deadweight loss shrinks the firm’s and workers’ surplus
The full loss from the minimum wage is the sum of the deadweight loss and the increased cost
of job search
Is the Minimum Wage Fair?
Unfair in both views of fairness, as it deliver an unfair result and imposes an unfair rule
Result is unfair because only people who have jobs benefit, the unemployed end p worse off
than they would be with no minimum wage. They might incus a large cost of job search.
Imposes an unfair rule because it locks voluntary exchange (even though firms want to hire
more and people are willing to work more, but not permitted by minimum wage to do so)
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Document Summary
Thus, force of law and market forces are conflicting. Rent ceiling: when price ceiling is applied to housing market. This creates: housing shortage, increased search activity, black market. If rent is below equilibrium rent, quantity of housing demanded exceeds quantity of housing supplied, so there is a shortage of housing. This allocation occurs through increased search activity and black markets. Search activity: time spent looking for someone with whom to do business. When price is regulated and there is a shortage, search activity increases. The opportunity cost of a good is equal not only to its price but also to the value of search time spent on finding the good: e. g. Opportunity cost of housing = rent (regulated price) + time and other resources spent searching for restricted quantity available (phone calls, automobiles, gas) Black market: illegal market in which equilibrium price exceeds rent ceiling.
