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Chapter 6

Chapter 6- Government Actions in Markets

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Department
Economics
Course
Economics 1021A/B
Professor
Michael Parkin
Semester
Fall

Description
Chapter 6- A Housing Market with a Rent Ceiling • a government regulation that makes it illegal to charge a price higher than a specified level is called a price ceiling or a price cap effects depend crucially on whether the ceiling is imposed at a level that is above or below the • equilibrium • a price ceiling set above the equilibrium price has no effect • a price ceiling below the equilibrium price has powerful effects • the price ceiling attempts to prevent the price from regulating the quantities demanded and supplied • a price ceiling is applied to a housing market is a rent ceiling • creates a housing shortage, increased search activity and a black market AHOUSING SHORTAGE • at a rent set below the equilibrium rent, the quantity of housing demanded exceeds the quantity of housing supplied • the quantity available is the quantity supplied • this quantity must be allocated among the frustrated demanders, through increased search activity INCREASED SEARCH ACTIVITY • search activity- time spent looking for someone with whom to do business • when a price is regulated and there is a shortage, search activity increases • rent-controlled housing market, frustrated would-be renters scan the newspapers opportunity cost of a good is equal not only to its price but also to the value of the search time • spent finding the good • opportunity cost of housing is equal to the rent plus the time spent searching for the restricted quantity available • search activity is costly uses resources that could have been used in other productive ways • • cost of increased search activity might end up making the full cost of housing higher than it would be without a rent ceiling ABLACK MARKET • rent ceiling encourages illegal trading in a black market black market- an illegal market in which the equilibrium price exceeds the price ceiling • • when a rent ceiling is in force, frustrated renters and landlords constantly seek ways of increasing rents • i.e. pay an exorbitant price for new locks and keys, called “key money” • level of a black market rent depends on how tightly the rent ceiling is enforced • might pay amount by incurring search costs the bring the total cost up • end up incurring a cost that exceeds what the equilibrium rent would be in a unregulated market INEFFICIENCY OFARENT CEILING • marginal social benefit from housing exceeds its marginal social cost and a deadweight loss shrinks the producer surplus and consumer surplus • because the quantity of housing supplied is less than the efficient quantity, a deadweight loss arises • loss is borne by consumers • full loss from the rent ceiling is the sum of the dead-weight loss and the increased cost of search activity ARE RENT CEILINGS FAIR? • according to the fair rules view, anything that blocks voluntary exchange is unfair, so rent ceilings are unfair according to the fair result view, a fair outcome is one that benefits the less well off • • fairest outcome is the one that allocates scarce housing to the poorest people • blocking rent adjustments doesn’t eliminate scarcity • market allocates the small quantity of housing among the people who are willing to rent housing at the rent ceiling • discrimination based on friendship, family ties and criteria such as race is more likely to enter the equation, cannot prevent it • 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 • the labour market is the market that influences the jobs we get and the wages we earn • the lower the wage rate, the greater is the quantity of labour demanded • the higher the wage rate, the greater is the quantity of labour supplied wage rate adjusts to make the quantity equal • • when wage rates are low, labour unions might turn to governments and lobby for a higher wage rate • a government imposed regulation that makes it illegal to charge a price lower than a specified level is called a price floor a price floor set below the equilibrium price has no effect, force of the law and the market • forces are not in conflict • a price floor set above the equilibrium price has powerful effects • the price floor attempts to prevent the price fro regulating the quantities demanded and supplied when a price floor is applied to a labour market, it is called a minimum wage • • a minimum wage imposed at a level above the equilibrium wage creates unemployment MINIMUM WAGE BRINGS UNEMPLOYMENT • when the wage rate is at the equilibrium level, the quantity of labour supplied equals the quantity of labour demanded • at a wage rate above the equilibrium wage, the quantity of labour supplied exceeds the quantity of labour demanded- there is a surplus of labour • demand for labour determines the level of employment INEFFICIENCY OFAMINIMUM WAGE in the labour market, the supply curve measures the marginal social cost of labour to workers • • this cost is leisure forgone • demand curve measures the marginal social benefit from labour • benefit is the value of the goods and services produced minimum wage frustrates the market mechanism and results in unemployment and increased • job search • marginal social benefit of labour exceeds its marginal social cost • deadweight loss shrinks the firms’surplus and workers’surplus • 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? • minimum wage is unfair on both views of fairness: delivers an unfair result and imposes an unfair rule • result is unfair because only those people who have jobs and keep them benefit from the minimum wage • unemployed end up worse off • when the wage rate doesn’t allocate labour, other mechanisms determine who finds a job i.e. discrimination • minimum wage imposes an unfair rule because it blocks voluntary exchange Taxes TAX INCIDENCE • 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 of the tax 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 sellers tax incidence does not depend on the tax law • ATAX ON SELLERS • a tax on sellers is like an increase in cost, so it decreases supply • new supply curve- add the tax to the minimum price that sellers are willing to accept for each quantity sold • supply curve shifts to the red curve labelled S + tax on sellers • equilibrium occurs where the new supply curve intersects the demand curve ATAX ON BUYERS a tax on buyers lowers the amount they are willing to pay sellers, so it decreases demand • • we subtract the tax from the maximum price that buyers are willing to pay for each quantity bought • demand curve shifts downward to become the red curve labelled D- tax on buyers • equilibrium occurs where the new demand curve intersects the supply curve at a quantity of 325 million packs a year EQUIVALENCE OF TAX ON BUYERS AND SELLERS • tax on buyers has the same effects as the tax on sellers Can We Share the Burden Equally? • when a transaction is taxed, there are two prices: the price paid by buyers, which includes the tax; and the price received by sellers, which excludes the tax • buyers respond to the price that includes the tax and sellers respond to the price that excludes the tax a tax is like a wedge between the price buyers pay and the price sellers receive • • the size of the wedge determines the effects of the tax The Employment Insurance Tax • imposes on both buyers of labour and sellers of labour the market for labour, not the federal government, decides how the burden of the Employment • Insurance tax is divided between firms and workers • the division of the burden of a tax between buyers and sellers depends on the elasticities of demand and supply Tax Incidence and Elasticity of Demand • perfectly inelastic demand- buyers pay • perfectly elastic demand- sellers pay PERFECTLY INELASTIC DEMAND • i.e. insulin • add the tax to the minimum price at which companies are willing to sell • new supply curve is S + tax • price rises, but the quantity does not change PERFECTLY ELASTIC DEMAND • with no tax, the price of a pink pen is $1 and the quantity is 4000 pens a week • government imposes a tax of $0.10 • new supply curve is S + tax • price remains at $1 a pen, and the quantity decreases to 1000 pink pens a week • $0.10 tax leaves the price paid by buyers unchanged but lowers the amount received by sellers by the fully amount of the tax • sellers pays the entire tax • division depends on the elasticity of dem
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