Principles of Microeconomics: Supply, Demand, and Government Policies

ECON 1051: Principles of Microeconomics

Instructor Information

  • Name: Andres Cuadros-Meñaca, PhD

  • Institution: University of Northern Iowa

  • College: Wilson College of Business

Roadmap of the Lecture

  • Objectives

  • Price Ceilings

  • Price Floors

Objectives

Upon completion of this section, students will be able to:

  • Explain how a price ceiling works:

    • Discuss the implications of a rent ceiling, including its role in creating a housing shortage and inefficiency.

  • Explain how a price floor works:

    • Analyze how a minimum wage impacts unemployment and overall economic efficiency.

Price Ceilings

  • Definition:

    • A price ceiling, or price cap, is a regulatory framework set by the government that establishes an upper limit on the price at which a specific good, service, or factor of production may be traded. Common applications include:

    • Housing rents

    • Prescription drugs

    • Taxi fares

    • Legal Implication: Trading above the imposed price ceiling is illegal.

Rent Ceilings

  • Definition:

    • A rent ceiling is a specific regulation that prohibits charging rent above a designated threshold.

  • Impact of Rent Ceilings:

    • The impact of a rent ceiling is contingent upon its level relative to the market equilibrium rent.

Case Analysis of Rent Ceilings

  1. Rent Ceiling Above Equilibrium:

    • Scenario: Rent ceiling set above $550, where equilibrium rent = $550

    • Equilibrium Quantity: 4,000 units of housing.

    • Outcome: No market distortion; equilibrium remains intact.

  2. Rent Ceiling Below Equilibrium:

    • Scenario: Rent ceiling set below the equilibrium (e.g., $400)

    • Effects:

      • Quantity of housing supplied decreases to 3,000 units.

      • Quantity of housing demanded increases to 6,000 units.

      • Housing Shortage: 3,000 units shortage arises.

Consequences of a Housing Shortage

  • When a rent ceiling generates a housing shortage, two outcomes typically occur:

    1. Black Market Emergence:

    • An illegal market where housing can be traded above the price ceiling.

    1. Increased Search Activity:

    • The time spent by individuals looking for housing increases significantly.

      • Black Market Dynamics:

      • Quantity of housing available decreases to 3,000 units.

      • 3,000th unit of housing sells for $625.

      • Increased search costs and time dedicated to finding housing alternatives.

Efficiency Considerations

  • Outcome of Rent Ceiling:

    • The presence of a rent ceiling typically leads to inefficiency in the housing market:

    • Marginal Benefit (MB) exceeds Marginal Cost (MC).

    • Total surplus, the sum of consumer surplus and producer surplus, diminishes.

    • A deadweight loss is created.

    • Graphical Representation: See detailed quantitative analysis in accompanying figures explaining the shifts in consumer and producer surplus under efficient versus inefficient scenarios.

Rationale Behind Rent Ceilings

  • Why Have Rent Ceilings?

    • Although rent ceilings produce adverse outcomes, various factors contribute to their implementation:

    • Current renters benefit and may lobby for such regulations.

    • Renters usually outnumber landlords, impacting political dynamics and electoral outcomes.

Price Floors

  • Definition:

    • A price floor is another type of government regulation, establishing a lower limit on the price at which a certain good, service, or labor may be traded.

    • Example: Minimum wage regulations.

Minimum Wage Dynamics

  1. Market Equilibrium for Labor:

    • Variables:

      • Demand and supply dynamics for fast-food servers determine the equilibrium.

    • Equilibrium Wage Rate: $7 per hour

    • Equilibrium Quantity of Workers: 6,000 servers

  2. Impacts of Setting Minimum Wage Above Equilibrium:

    • Scenario: Minimum wage set at $10 per hour.

    • Effects:

      • Quantity of labor demanded decreases to 3,000 workers.

      • Quantity of labor supplied increases to 8,000 individuals.

      • Resulting Unemployment: 5,000 individuals, consisting of:

      • 3,000 who were fired

      • 2,000 seeking jobs at $10/hour

  3. Job Market Dynamics:

    • The allocation of available jobs must occur among the excess number of job seekers.

      • Increased search activity and potential for illegal hiring practices arise.

  4. Minimum Wage Rate Dynamics:

    • At a higher wage (e.g., $10), someone may accept a position for less (as low as $5/hour), creating avenues for illegal wage manipulation.

Efficiency of Minimum Wage

  • Assessing Efficiency:

    • Graphical presentations illustrate differing firm and workers' surplus, signaling inefficiencies created by minimum wage regulations, especially in terms of lost resources due to job search activities and resulting deadweight losses.

Rationale Behind Minimum Wage

  • Why Maintain Minimum Wage?

    • Studies suggest the employment effects of minimum wage can be modest.

    • Labor unions often advocate for minimum wage, motivating wage regulations based on collective bargaining strategies and economic equity.

References

  • Gregory Mankiw, Principles of Microeconomics, Tenth Edition, Cengage, 2024

  • Robin Bade and Michael Parkin, Foundations of Microeconomics, Ninth Edition, Pearson Education Inc., 2021