Objectives © Pearson Education, 2005 Markets in Action Chapter 6

© Pearson Education, 2005

Objectives

Markets in Action

Chapter 6


Objectives

After studying this session , you will able to:

Explain how housing markets work and how price ceilings create housing shortages and inefficiency

Explain how labour markets work and how minimum wage laws create unemployment and inefficiency


Housing Markets and Rent Ceilings

The 1995 flood in the Gelderland province of the Netherlands wrecked hundreds of homes and caused €450 million worth of damage.

How did the region cope with such a vast reduction in housing?



The Market Before and After the Flood

The quantity of housing was 10,000 units and the rent was €1,000 a month at the intersection of D and SS.



The flood decreased the supply of housing and the supply curve shifted leftward.

The rent increased to €1,100 a month and the quantity decreased to 7,400 units.

(We won’t concentrate on the LS – the long run supply.)



A building program follows which increases supply and the supply curve starts to shift rightward.

The quantity of housing increases and the rent falls to the pre-flood levels (other things remaining the same).



A Regulated Housing Market

A price ceiling is a regulation that makes it illegal to charge a price higher than a specified level.

When a price ceiling is applied to a housing market it is called a rent ceiling.

A rent ceiling set above the equilibrium rent has no effect - it works as if there were no ceiling.

But if the rent ceiling is set below the equilibrium rent, it if the rent ceiling is set below the equilibrium rent, it has powerful effectshas powerful effects.



Figure 6.2 shows the effects of a rent ceiling set below the equilibrium rent.

What happens if rent ceiling is above €1,100 a month???

The equilibrium rent is €1,100 a month.

A rent ceiling is set at £1,000 A rent ceiling is set at £1,000 a month.a month.

So the equilibrium rent is in the illegal region.



At the rent ceiling, the quantity of housing demanded exceeds the quantity supplied and there is a housing shortage.



With a housing shortage, people are willing to pay more than €1,000 a month.

Because the legal price cannot eliminate the shortage, two developments occur:

Search activity

Black markets



Search ActivityThe time spent looking for someone with whom to do business is called search activity.

When a shortage exists, search activity increases.

Search activity is costly, so the opportunity cost is equal to it’s price + value of the time spent searching for the good --- opportunity cost of housing equals the rent paid (regulated) plusplus the opportunity cost of the search activity.



Black Markets

A black market is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been imposed.

A shortage of housing creates a black market in housing.



Illegal arrangements are Illegal arrangements are made between renters and made between renters and landlords at rents above the landlords at rents above the rent ceilingrent ceiling - and generally above what the rent would have been in an unregulated market.

The maximum black market rent is €1,200 a month – check what the quantity demanded is and what people

are willing to pay for this.



Inefficiency of Rent Ceilings

A rent ceiling leads to an inefficient use of resources.

The quantity of rental housing is less than the efficient quantity and there is a deadweight loss.

Figure 6.3 illustrates this loss.



A rent ceiling decreases the quantity of rental housing (to less than the efficient quantity to 4.4. rather than 7.4),and shrinks the producer and consumer surplus to create a deadweight loss.


The Labour Market and Minimum Wage

New, labour-saving technologies become available every year, which mainly replace low-skilled labour.

Does the persistent decrease in the demand for low-skilled labour depress the wage rates of these workers?

The immediate effect of these new technologies is - a decrease in the demand for low-skilled labour, - a fall in the wage rate and - a decrease in the quantity of labour supplied.



A Minimum Wage

A price floor is a regulation that makes it illegal to trade at a price lower than a specified level.

When a price floor is applied to labour markets, it is called a minimum wage.



A minimum wage set below the equilibrium wage rate has no effect on how the market works.

A minimum wage set above the equilibrium wage rate has A minimum wage set above the equilibrium wage rate has powerful effects.powerful effects.



Figure 6.5 illustrates.

The equilibrium wage rate is €5 an hour.

The minimum wage rate is set at £6 an hour.

So the equilibrium wage rate is in the grey-shaded illegal region.



If the minimum wage is set above the equilibrium wage rate:

• The quantity of labour supplied by workers exceeds the quantity demanded by employers.

• There is a surplus of labour.

Employers cannot be forced to hire more labour than they wish at the legal wage rate.

Because the legal wage rate cannot eliminate the surplus, the minimum wage creates unemploymentminimum wage creates unemployment.



The quantity of labour The quantity of labour employed is the quantity employed is the quantity demanded at the minimum demanded at the minimum wage rate.wage rate.

The quantity of labour supplied exceeds the quantity demanded.

UnemploymentUnemployment is the gap between the quantity demanded and the quantity supplied.



Inefficiency of a Minimum WageThe quantity of labour employed is less than the efficient quantity and there is a deadweight loss.

Efficient quantity: where D=S , at 21million hours of work per year.

With minimum wage, quantity of hours drops to 20million hours of work per year.



Figure 6.6 illustrates.

A minimum wage decreases the quantity of labour employed, shrinks the workers’ surplus and the firms’ surplus by using resources in job search activity,and creates a deadweight loss.


Objectives

After studying this session , you will able to:

Explain how housing markets work and how price ceilings create housing shortages and inefficiency

Explain how labour markets work and how minimum wage laws create unemployment and inefficiency

Review Quiz


A forest fire destroys a large housing area. If the housing market is unregulated, then immediately after the fire, the price of housing _______. But after some time, the ______________ housing starts to increase and the price starts to ______________. a. rises; supply of; fallb. falls; supply of; risec. falls; demand for; rised. rises; demand for; rise further

Review Quiz


A forest fire destroys a large housing area. If the housing market is unregulated, then immediately after the fire, the price of housing _______. But after some time, the ______________ housing starts to increase and the price starts to ______________. a. rises; supply of; fallb. falls; supply of; risec. falls; demand for; rised. rises; demand for; rise further

Review Quiz


A forest fire destroys a large housing area. If a rent ceiling keeps the rent constant, then after the fire, a housing _________ creates a __________ and the black market price ____________.

a. surplus; consumer surplus; falls

b. shortage; producer surplus; rises

c. shortage; deadweight loss; rises

d. surplus; producer surplus; more than doubles

Review Quiz


A forest fire destroys a large housing area. If a rent ceiling keeps the rent constant, then after the fire, a housing _________ creates a __________ and the black market price ____________.

a. surplus; consumer surplus; falls

b. shortage; producer surplus; rises

c. shortage; deadweight loss; rises

d. surplus; producer surplus; more than doubles

Review Quiz


With an effective minimum wage, the number of hours of labour employed is determined by the ___________ and the __________.

a. demand for labour; supply of labour

b. supply of and demand for labour; the minimum wage

c. demand for labour; minimum wage

d. supply of labour; minimum wage

Review Quiz


With an effective minimum wage, the number of hours of labour employed is determined by the ___________ and the __________.

a. demand for labour; supply of labour

b. supply of and demand for labour; the minimum wage

c. demand for labour; minimum wage

d. supply of labour; minimum wage

Review Quiz


The End

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Objectives © Pearson Education, 2005 Markets in Action Chapter 6