Business 115 Module 5.3: Price Controls, Minimum Wage, and Elasticity

Module 5 Overview: Price Elasticity and Its Applications

Weekly Topics Covered:
- Price Elasticity:
  - Elasticity of Demand.
  - Cross-price Elasticity.
  - Elasticity of Supply.
- Tax Incidence:
  - Impact of Taxes.
  - The relationship between Elasticity and Tax Incidence.
  - The link between Elasticity and Deadweight Loss.
- Price Controls:
  - Price Floors and Price Ceilings.
  - The Minimum Wage, the Elasticity of Labour Demand, and Unemployment.

Introduction to Price Controls

Definition: Price controls are government-mandated legal minimums or maximums set for particular goods or services. They are designed to hold market prices above or below the competitive equilibrium price.
Price Ceiling:
- Definition: A legal maximum price that producers are permitted to charge for a good or service.
- General Purpose: Typically implemented to assist consumers by making essential goods or services more affordable.
- Examples: Rent controls (limiting how much a landlord can charge) or maximum increases in university tuition fees.
Price Floor:
- Definition: A legal minimum price that consumers (or buyers) must pay for a good or service.
- General Purpose: Typically implemented to assist producers (or suppliers) by ensuring they receive a minimum level of income.
- Examples: Minimum prices for agricultural goods or the minimum wage for labor.

Price Ceilings: Binding and Non-Binding Scenarios

Non-Binding Price Ceiling:
- If the price ceiling is set above the competitive equilibrium price, it is considered non-binding.
- Example: If the equilibrium price for petrol is $\$3$ and the government sets a price ceiling at $\$4$ , the market remains at the equilibrium price of $\$3$ and equilibrium quantity of $100$ . The ceiling has no effect on market outcomes.
Binding Price Ceiling:
- A price ceiling is binding if it is set below the competitive equilibrium price.
- Example Model:
  - Equilibrium Price: $\$3$ .
  - Price Ceiling: $\$2$ .
  - Quantity Supplied: $75$ units.
  - Quantity Demanded: $125$ units.
  - Resulting Shortage: The difference between quantity demanded and quantity supplied ( $125 - 75 = 50$ units).
Economic Responses to Shortages:
- Queues: Long waiting lines for consumers attempting to purchase the limited supply.
- Rationing: Government intervention to distribute limited resources. A historical example includes the "Your Ration Book" issued by the New Zealand Food Office during "The Great Ice Cream Shortage" in the summer of $1943$ (Serial Number: $BL 796254$ , RB.2 [Child]).
- Black Markets: Illegal markets where goods are sold at prices higher than the legal price ceiling.

Price Floors: Binding and Non-Binding Scenarios

Non-Binding Price Floor:
- A price floor is non-binding if it is set below the competitive equilibrium price.
- Example: Equilibrium price is $\$3$ and the floor is set at $\$2$ . The market continues to operate at the $\$3$ equilibrium with $100$ units exchanged.
Binding Price Floor:
- A price floor is binding if it is set above the competitive equilibrium price.
- Example Model:
  - Equilibrium Price: $\$3$ .
  - Price Floor: $\$4$ .
  - Quantity Demanded: $80$ units.
  - Quantity Supplied: $120$ units.
  - Resulting Surplus: The excess supply where quantity supplied exceeds quantity demanded ( $120 - 80 = 40$ units).
Economic Responses to Surpluses:
- Dumping: Excess supply may be literally discarded or "dumped" in other countries at very low prices.
- Black Markets: Unauthorized sales where goods are sold at prices lower than the legal price floor.

The Minimum Wage as a Price Floor

Definition: The minimum wage is the lowest hourly, daily, or monthly remuneration that an employer may legally pay to a worker. It effectively serves as a price floor in the labor market.
New Zealand Context:
- New Zealand was the first country in the world to introduce legislation determining a minimum wage through the Industrial Conciliation and Arbitration Act 1894.
- The current legal framework is the Minimum Wage Act 1983.
- The legislation mandates that the government must review the minimum wage annually.
- Historical Growth: In $1984$ , the NZ minimum wage was $\$2.50$ . By $2021$ , it increased to $\$20$ .
International Comparisons:
- France: The government determines the minimum each year. It considers the increase in average wages but must, by law, increase the minimum wage by at least the rate of inflation.
- USA: Minimum wage changes are not automatic or annual; they require the passage of new legislation by Congress.
- Purchasing Power Parity (PPP) Comparisons: Adjusted for $2019$ US dollars, minimum wages in France and New Zealand have historically been higher and followed a more consistent upward trend compared to the USA from $1985$ to $2015$ .

Labour Market Dynamics and Unemployment

The Competitive Labour Market:
- Before a minimum wage is applied, the market reaches an equilibrium wage and an equilibrium level of employment where the Quantity of Labour demanded equals the Quantity of Labour supplied.
Impact of a Minimum Wage (Binding Price Floor):
- When the minimum wage is set above the equilibrium wage, a labor surplus occurs.
- Quantity Demanded: The number of workers firms are willing to hire decreases.
- Quantity Supplied: The number of individuals willing to work at the higher wage increases.
- Result: The gap between the quantity supplied and quantity demanded represents unemployment.
Role of Elasticity:
- The magnitude of unemployment created by a minimum wage depends on the elasticity of labour demand.
- If labour demand is relatively inelastic (steep curve), the increase in unemployment will be smaller.
- If labour demand is relatively elastic (flat curve), the increase in unemployment will be larger for the same wage hike.

Empirical Evidence and Nuances

Disagreement in Research: Empirical studies do not reach a consensus on the effect of minimum wages on unemployment. While many show a small increase or no effect, some studies even suggest a decrease in unemployment.
Factors Influencing Real-World Outcomes:
- Varying elasticities of labour demand across different industries and regions.
- Non-Competitive Markets: In some markets, employers have "market power" (monopsony) and set wages below the competitive equilibrium. In these cases, a minimum wage increase might not lead to job losses.
- Statistical Challenges: Difficulty in identifying a clear "causal effect" separate from other economic variables.
Historical Data Analysis (USA $1979 - 2016$ ):
- Data comparing the percentage change in the real minimum wage against percentage changes in unemployment shows that spikes in unemployment are often more closely correlated with economic recessions than with increases in the real minimum wage.

Extensions: Labour Economics and Climate Policy

Further Study in Labour Economics (Econ 302): Topics include:
- Education and training.
- Health and safety in the workplace.
- Immigration impacts.
- Discrimination in the labour market.
Climate Change Application (New Zealand ETS):
- New Zealand uses an Emission Trading Scheme (ETS) to put a price on carbon to reduce greenhouse gas emissions.
- The government has implemented both a price ceiling and a price floor for carbon within this market.
- The objective is to reduce price volatility, thereby providing a more stable environment to encourage long-term investment in carbon reduction technologies.

Summary of Price Controls

Price Ceilings: Benefit some consumers through lower prices but risk creating shortages (where Demand > Supply).
Price Floors: Benefit some producers through higher prices but risk creating surpluses (where Supply > Demand, such as unemployment in the labor market).
Elasticity's Role: The specific size of any resulting shortage or surplus is determined by the price elasticity of both demand and supply in that specific market.