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Chapter 6

Economics 1021A/B Chapter Notes - Chapter 6: Price Ceiling, Deadweight Loss, Economic Equilibrium


Department
Economics
Course Code
ECON 1021A/B
Professor
Michael Parkin
Chapter
6

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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
A HOUSING 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
A BLACK 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 OF A RENT CEILING
marginal social benefit from housing exceeds its marginal social cost and a deadweight loss
shrinks the producer surplus and consumer surplus

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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 OF A MINIMUM WAGE
in the labour market, the supply curve measures the marginal social cost of labour to workers
this cost is leisure forgone

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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
A TAX 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
A TAX 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
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