1 In this chapter, look for the answers to these questions: What are price ceilings and price floors? What are some examples of each?How do price ceilings and price floors affect market outcomes?How do taxes affect market outcomes? How does the outcome depend on whether the tax is imposed on buyers or sellers?What is the incidence of a tax? What determines the incidence?
2 Market Disruptions How do we ration goods and services? PricesQueuesLotteriesPrices ration available resources most efficiently
3 Market DisruptionsWhen a drought occurs in the United States, what is the best means of rationing water?California vs. Puerto Rico
4 Market DisruptionsWhen a drought occurs in the United States, what is the best means of rationing water?California vs Puerto Rico
5 Government Policies That Alter the Private Market Outcome Price controlsPrice ceiling: a legal maximum on the price of a good or service. Example: rent control.Price floor: a legal minimum on the price of a good or service. Example: minimum wage.We will use the supply/demand model to see how each policy affects the market outcome (the price buyers pay, the price sellers receive, and eq’m quantity).
8 Black Markets Market for illegal g/s Market in which g/s trade at prices above their legal maximum pricesTickets to sporting eventsRent in some citiesStacia BekemeyerBlack Markets
9 What do you think the housing market might look like in Amsterdam?
10 Questions 1. Why do we call a price that is lower than the equilibrium a price ceiling?2. What would be the long-run effects of aprice ceiling policy?3. Isn’t it true that lower prices are a goodthing for consumers?
11 Rent Control placement of price ceilings on rents in particular cities Over 200 American cities operate under some kind of rent controlExample:New York City, Santa Monica, CA, Berkeley, CA
12 Two Functions of Rental Prices 1) promote efficient maintenance of existing housing / stimulate construction of new housingRent controls discourage the construction of new rental units. Why?Rent -- most important long-term determinant of profitability / rent controls artificially depress themExamples:Dallas, Texas (16% vacancy) no rent control built 11,000 new rental units.San Francisco (1.6 % vacancy) with rent control built 2000 new rental units
13 Two Functions of Rental Prices 2) allocate existing scarce housing among competing claimantsWhat happens to the current supply of housing?When rental rates are held below the market equilibrium levels, property owners cannot recover the cost of maintenance, repairs, and capital improvements through higher rents.In extreme situations, fixed costs exceed the rental returns. The result is abandoned buildingsExample: New York City and its numerous abandoned buildings.
14 Rent Control Who loses in rent control? Who gains in rent control? landlordslow income individuals looking for first apartmentWho gains in rent control?Upper-income professionalsImportant: Effective rent controls discourage new rental unit construction, decrease spending on existing rental units and leads to a “Housing gridlock”
15 EXAMPLE 1: The Market for Apartments QRental price of aptsSD$800300Eq’m w/o price controlsQuantity of apartments
16 How Price Ceilings Affect Market Outcomes A price ceiling above the eq’m price is not binding – it has no effect on the market outcome.PQSPrice ceiling$1000D$800300
17 How Price Ceilings Affect Market Outcomes The eq’m price ($800) is above the ceiling and therefore illegal.The ceiling is a binding constraint on the price, and causes a shortage.PQSD$800Price ceiling$500250400shortage
18 How Price Ceilings Affect Market Outcomes QSDIn the long run, supply and demand are more price-elastic.So, the shortage is larger.$800Price ceiling$500shortage150450
19 Alternative Market Outcomes Section 8 GrantsPQSD$800Price ceiling$500shortage150450
20 Shortages and Rationing With a shortage, sellers must ration the goods among buyers.Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biasesThese mechanisms are often unfair, and inefficient: the goods don’t necessarily go to the buyers who value them most highly.In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair???).
21 Price Floors in the Labor Market Minimum Wagewage floor, legislated by the government, setting the lowest hourly wage rate that firms may legally pay workersProponents:ensure low-income workers a “decent” standard of livingOpponents:causes increased unemploymentNote:Economists estimate that a 10% increase in the real minimum wage decreases total employment of those affected by 1 to 2%.
22 EXAMPLE 2: The Market for Unskilled Labor WLWage paid to unskilled workersSD$4500Eq’m w/o price controlsQuantity of unskilled workers
23 How Price Floors Affect Market Outcomes A price floor below the eq’m price is not binding – it has no effect on the market outcome.WLSD$4500Price floor$3
24 How Price Floors Affect Market Outcomes labor surplusThe eq’m wage ($4) is below the floor and therefore illegal.The floor is a binding constraint on the wage, and causes a surplus (i.e.,unemployment).WLSPrice floor$5D400550$4
25 The Minimum Wage Min wage laws do not affect highly skilled workers. They do affect teen workers.unemp-loymentWLSMin. wage$5D400550$4
26 Earned Income Tax Credit refundable tax credit primarily for individuals and couples with qualifying childrenTheory -- Minimum wage laws are a undue burden on small business
27 Price Floors in Agriculture Historical note: 1933 Federal government placed price floors on agricultureHow it works:1. Government sets a support price for ag product / acts to ensure that price never falls below support price2. excess quantity supplied or surplus is purchased by government3. program run on a per bushel basis / larger farms better offNote: 1996 these supports were supposed to be eliminated except for tobacco and peanuts
28 Ag Price FloorAg. Price supports create surplus Ag product in the market.surplusPQSAg. Surplus$5D400550$4
29 A C T I V E L E A R N I N G 1: Price floors & ceilings QPSThe market for hotel roomsDDetermine effects of:A. $90 price ceilingB. $90 price floorC. $120 price floor29
30 A C T I V E L E A R N I N G 1: A. $90 price ceiling QPSThe market for hotel roomsDThe price falls to $90.Buyers demand 120 rooms, sellers supply 90, leaving a shortage.Price ceilingshortage = 3030
31 A C T I V E L E A R N I N G 1: B. $90 price floor QPSThe market for hotel roomsDEq’m price is above the floor, so floor is not binding.P = $100, Q = 100 rooms.Price floor31
32 A C T I V E L E A R N I N G 1: C. $120 price floor QPSThe market for hotel roomsDsurplus = 60Price floorThe price rises to $120.Buyers demand 60 rooms, sellers supply 120, causing a surplus.32
33 Evaluating Price Controls Markets are usually a good way to organize economic activity.Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices.Price controls are often intended to help the poor, but they often hurt more than help them:The min. wage can cause job losses.Rent control can reduce the quantity and quality of affordable housing.
34 CHAPTER SUMMARYA price ceiling is a legal maximum on the price of a good. An example is rent control. If the price ceiling is below the eq’m price, it is binding and causes a shortage.A price floor is a legal minimum on the price of a good. An example is the minimum wage. If the price floor is above the eq’m price, it is binding and causes a surplus. The labor surplus caused by the minimum wage is unemployment.