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Understanding Government Intervention: Price Ceilings, Price Floors, and Labor Market Effects

This chapter explores government interventions in the market, focusing on price ceilings and price floors. Price ceilings, such as rent control, aim to support low-income families by setting a maximum allowable price, but often lead to shortages and black markets. Conversely, price floors like minimum wage laws seek to enhance low-skilled workers' living conditions. The implications of these policies on supply and demand, as well as their potential to create market distortions, are examined. The effects on housing and labor markets are also discussed in detail.

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Understanding Government Intervention: Price Ceilings, Price Floors, and Labor Market Effects

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  1. Chapter 3: Government Intervention

  2. Market Intervention • Price Ceiling • An imposed maximum allowable price of a good and service; e.g., rent control • Price Floor • An imposed minimum allowable price of a good and service; e.g., minimum wage

  3. Rent Control Policy • Set the rent at a price above the market price to support low income families • Rent control create a shortage and develops conditions for a black market • Rent control also contributes to the deterioration of low income housing as building owners would not want to maintain these units

  4. Effect of Rent Control Policy r=Market rent r2=Controlled rent r1=Black market rent Rent D S r1 Shortage=h1h2 r r2 D S h1 h h2 No. of rental units

  5. Rent Control & Increased Demand • An increase in the demand of housing will result in a higher rent • Higher rent induces the supply of housing as builders find it more profitable to invest • If rent in this market were controlled, the increase in supply would not happen; it would rather cause a larger shortage

  6. Effect of Rent Control D’ Rent D S S’ r1 Shortage=hh3 r2 r D’ D S’ S h h1 h2 h3 Quantity

  7. Minimum Wage Law • Purpose • Improve the wage paid to unskilled labor in order to improve their living conditions • Trend from 1980 to 2000 • Increased from $3.10 to $5.15 • Decreased from 47% of the average earnings to 37% • Reduced from 98% of the poverty level to 79%

  8. Demand for Labor • Labor resources firms are willing and able to employ at various wages • Determinates of labor demand: • Price of the product • Labor productivity • Marginal Revenue Product = • Product Price * Marginal Product of Labor

  9. Market Demand for Labor D Wage A W1 B W2 D=MRP E1 E2 Employment

  10. Supply of Labor • Labor resources workers are willing and able to sell at various wages • Substitution effect: change in hours of work in response to a wage change (positive) • Income effect: change in hours of work in response to an income change (usually negative)

  11. Market Supply of Labor Positive Sub. Effect > Negative Income Effect Wage S B W2 W1 A S E1 E2 Employment

  12. Labor Market Equilibrium Wage D S A W Demand=Supply D S Employment E

  13. Effect of Minimum Wage S Wage D Unemployment=AB=1.25 A B 6.00 5.00 D S 8 9 9.25 Employment

  14. Effect of Minimum Wage Alternative Analysis S D Wage Minimum wage results in no unemployment As long as it remains in the intermediate range 6.00 5.00 D S 8 9 Employment

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