Chapter 3: Government Intervention Chapter 3: Government Intervention

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

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

Effect of Rent Control Policy

Rent

No. of rental units

S

S

r

h

D

D

h1 h2

r1

r2

Shortage=h1h2

r=Market rentr2=Controlled rentr1=Black market rent

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

Effect of Rent Control

Rent

Quantity

S

S

r

h

D

D

h1

r2Shortage=hh3

D’S’

S’D’

r1

h2 h3

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%

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

Market Demand for LaborMarket Demand for Labor

Wage

Employment

D

D=MRP

W1

E1 E2

BW2

A

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)

Market Supply of Labor

Wage

Employment

W1

W2

E1 E2

B

S

S

A

Positive Sub. Effect > Negative Income Effect

Labor Market Equilibrium

Wage

Employment

D

D

W

E

A

S

S

Demand=Supply

Effect of Minimum Wage

Wage

Employment

D

D

5.00

9

S

S

8 9.25

6.00

Unemployment=AB=1.25A B

Effect of Minimum Wage Alternative Analysis

Wage

Employment

D

D

5.00

9

S

S

8

6.00

Minimum wage results in no unemploymentAs long as it remains in the intermediate range