Price Floors and Ceilings

We already know that markets tend to move

towards equilibrium naturally, but sometimes this can create problems in the real-world...

Government Intervention in the Marketplace:

So, let’s say a studio apt. in Manhattan costs roughly $4000 a month (true!).

At this price, let’s pretend that 25,000 apartments are rented each month.

Why? Because it’s New York, that’s why.

Looking at the graph to the right, we get a clear sense of supply, demand and equilibrium based on our scenario. We also see that the market is “happy.”

The problem is that $4000 is way more than a lot of people can pay and we need people to live there and work there...

S

DQuantity

Pri

ce

$4000

25,000

So how can we resolve this

issue?Orale, I know, huh? I need a

house, ay.

Think about apartments in Manhattan...

Let’s try “rent control” in NYC:

First off, what is rent control?

A government-imposed mandate on the maximum price that may be charged for rent in certain cities.

It was introduced in the 1940s to combat inflation but today is used to help lower income households live in areas that they otherwise could not.

Why did we create it?

It’s estimated that an additional 1.2 million people commute to

Manhattan everyday to work, but they don’t live there.

It’s also estimated that each additional square foot of an

apartment in Manhattan adds appx. $48.33 to your

monthly rent.

In economics, we call rent control a “price ceiling”A price ceiling is a maximum price legally charged for a good or service.

Let’s pretend the government comes in and says that $4000 is too high, so they “set” the price of rent at $2000 a month.

S

DQuantity

Pri

ce

$4000

25,000

$2000

We need to look at how much producers will supply at this price and how much consumers will demand at this price.

15,000 35,000

Because producers are making less money, they will not provide as many apartments.

Because consumers are getting cheaper apartments, they want more of them.

When your demand is higher than your supply (which always occurs with a price ceiling), you have a shortage of goods.

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In this scenario a shortage of 20,000 apartments occurs.

Are price ceilings good ideas?

If 35,000 people want apartments, but there are only 15,000 available, thats’ going to create issue with who gets one... so how do people decide?

Waiting lists? Bribery? Discrimination? Luck?

Rent-controlled apartments tend to be run-down because landlords are trying to make up for the lost profits taken by the rent-control. Residents also have to wait long periods of time for even routine maintenance to occur.

What about attracting people? Landlords don’t have to do this because people are always lining up for a rent-controlled apartment; there’s no incentive to work hard making things attractive.

Even still, you are getting an apartment in Manhattan for half price

So, what other government interventions are there?

Let me ask you: Do you think that minimum wage is a fair amount of money to get paid for working an hourly job?I think minimum wage is too high (yeah, I said it).

Why? It’s simple, let’s pretend that minimum wage didn’t exist. Let’s also pretend that you are looking for a job and when you find one at McDowell’s (see right), there are also two other people that want that same job.

I would bet your boss would put you in a bidding war with the others based on how much you are willing to work for, hourly. Ultimately, the wage would get so low (less than $1) that two of the three people applying would leave. So do you think I’m right?

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DQuantity

Pri

ce

$1

50,000

$5

My logic is sound, but it doesn’t make me “right.”

30,000 75,000

We know from our little situation that the equilibrium price of labor should actually be around $1

For obvious reasons, this would be a terrible scenario

Thus, the government imposes a “price floor” that forces wages higher.

A price floor is a minimum price that must be paid for a good or service. Now, when we look at where the price meets supply and where it meets demand, we see a different issue.

More people want to work (supply) when they get paid more, but fewer companies are hiring (demand).

When your supply is higher than your demand (which always occurs with a price floor), you have a surplus of goods.

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In this scenario a surplus of 45,000 workers occurs.

Are price floors good ideas?

If a lot of people are looking for jobs, but there are not very many available, there is going to be a larger amount of unemployment.

Employers also have a ton of choice in whom they pick to work which makes it harder for unskilled workers.

Remember, minimum wage is not calculated on poverty guidelines and is often so low that people who work 40 hours a week at this rate, do not make enough to support themselves.

But then again, you are getting paid more for each hour you work if you earn minimum wage.

So, what do I need to remember?

Price FLOORs

Price CEILINGs

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DQuantity

Pri

ce

$4000

25,000

$2000

15,000 35,000

S

DQuantity

Pri

ce

$1

50,000

$5

30,000 75,000

Prevents prices from getting too high (like hitting a ceiling).

Prevents prices from getting too low (like hitting a floor).

Always leads to a shortage. Always leads to a surplus.