Slide #1.

Government Control of Prices in Mixed Systems
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Slide #2.

Supply, Demand, and Government Policies In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. Prices in mixed systems are not necessarily a response to market demand and supply Sometimes the government sets a minimum or a maximum price for certain goods.
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Slide #3.

CONTROLS ON PRICES Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Examples: price ceilings and floors.
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Slide #4.

Are Price controls Effective? Can government control of prices improve the market outcome? In principle, there are two lessons to be learn: The market reacts to the government’s policies which in many cases weakens the effect of the policy Unexpected and negative consequences result from government intervention
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Slide #5.

CONTROLS ON PRICES Price Ceiling A legal maximum on the price at which a good can be sold. Set by the government to limit inflation or to Keep prices of selective goods affordable for low income individuals Used in many cities to keep housing costs down In 1970 more than 200 US cities enacted some form of rent control
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Slide #6.

CONTROLS ON PRICES Price Floor A legal minimum on the price at which a good can be sold. Typically used to benefit the sellers of a certain good The 1938 Fair Labor Standards Act established the first federal minimum wage laws Minimum wage laws were widely supported as a means to maintaining the minimum standards of living
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Slide #7.

Rent Control Rent controls are ceilings placed on the rents that landlords may charge their tenants. The goal of rent control policy is to help the poor by making housing more affordable. One economist called rent control “the best
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Slide #8.

Demand for Housing The demand curve shows the Rent total number of housing units demanded at each price Demand is downward sloping As the rental price increases, households substitute away from housing by Sharing housing units with others Consuming smaller housing units Housing demand is inelastic in the short run Demand 0 Quantity
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Slide #9.

Supply for Housing The supply curve shows the total number of housing units supplied at each price Supply is upward sloping As the rental price increases, more housing units will be available through Construction of new units (long run) Conversion from other uses (short run) Housing supply is inelastic in the short run Rent Suppl y 0 Quantity
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Slide #10.

Equilibrium An increase in demand Rent results in a higher rental price and an increase in quantity supplied of rental apartments In the long run, new housing units are constructed as investment in housing becomes more profitable and the supply shifts right S1 S2 D2 D1 0 Quantity
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Slide #11.

Rent Control Rent control was enacted before WWII, as policy makers were worried about inflation. After WWII, several American cities kept rent control regulations in place to keep housing affordable for low income groups
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Slide #12.

Effect of Rent Control Ren t A shortage results, which grows with increasing demand People are forced to delay the decision to move out of rent controlled units or to add to their living space. Supply $500 400 Shortage Rent Control Demand 0 9 Quantity supplied Quanti Quantity ty demanded 11
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Slide #13.

Effect of Rent Control Ren t Rent is not low for everyone Since a rent higher than $400 is illegal, the $500 market cannot work to allocate the housing units among people. Illegal payments to 400 landlords Rent is higher in non rent controlled areas 0 Supply Shortage Rent Control Demand 9 Quantity supplied Quanti Quantity ty demanded 11
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Slide #14.

Long Run Effects No incentives to construct new housing units as it becomes less profitable Housing supply shrinks in the long run as some home builders exit the market Fewer rent controlled housing units which
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Slide #15.

Long Run Effects Housing quality deteriorates as landlords have less incentives to maintain them Resource misallocation occurs as goods of value are underprovided since the price is not allowed to reflect housing value.
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Slide #16.

Minimum Wage Setting a minimum hourly wage is seen as a way to preserve a certain level of income for those at the end of the income scale Questions: Do all workers benefit from the minimum wage? What are the consequences on the labor market? How does the minimum wage affect poverty?
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Slide #17.

Demand for labor is downward sloping Demand for labor is a derived demand Wage Labor Demand Labor demand Quantity of
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Slide #18.

Deriving Labor Demand When an additional worker is hired, production increases and thus the total revenue of the firm increases This increase in revenue is called the marginal revenue product, Labo r Total Product 0 0 1 5 2 25 3 50 4 70 5 80 6 85 7 86 Margina l Product MRP
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Slide #19.

Deriving Labor Demand As additional workers are hired output increases at a decreasing rate The additional output, i.e., Marginal Product, declines This is referred to as the law of Diminishing Marginal Product Assume price= $0.5 Labo r Total Product MRP 0 Margina l Product - 0 1 30 30 15 2 50 20 10 3 65 15 7.5 4 79 14 7 5 84 5 2.5 6 86 2 1 -
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Slide #20.

Deriving Labor Demand Hiring an extra worker raises the cost for the firm The cost of hiring an extra worker is the wage, W The extra worker will be hired if the marginal benefit exceeds (or equals) the marginal cost of hiring him.  The extra worker will be hired if: the MRP >=W
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Slide #21.

Labor Demand If W=2.5, How many MRP workers will be hired? If W=5, How many workers will be hired? The labor demand curve is the downward sloping part of the MRP curve 5 Labor Demand 2.5 1 5 6 Quantity of
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Slide #22.

Labor Supply What will happen to the number of hours worked as the wage rate increases? Time allocate between work and leisure Substitution effect: work more consume less leisure Income effect: higher income leads to consuming more leisure and working less eneral Conclusion: Labor supply is upward slop
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Slide #23.

How the Minimum Wage Affects the Labor Market Wage Labor surplus (unemployment) Labor Supply Minimum wage Equilibrium wage Labor demand 0 Quantity demanded Quantity supplied Quantity of Labor
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Slide #24.

How the Minimum Wage Affects the Labor Market The minimum wage results in an increase in the quantity supplied of workers and a decline in the quantity demanded. Unemployment results as workers who are willing to work at the min wage are more than the jobs offered
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Slide #25.

Who gets to work at the minimum wage? The answer will determine the distributional impact of the policy Several researches suggests that employers when faced with a larger labor pool under the minimum wage law, can discriminate between workers. Teenagers tend to be discriminated against due to their limited training and education relative to others in the pool Similarly for women and minorities.
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Slide #26.

TAXES Governments levy taxes to : raise revenue for public projects Change market price to reduce trade in a particular good
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Slide #27.

How Taxes Affect Market Outcomes Tax incidence Tax incidence is the manner in which the burden of a tax is shared among participants in a market. Tax incidence is the study of who bears the burden of a tax. Taxes result in a change in market equilibrium.
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Slide #28.

How Taxes Affect Market Outcomes  When a tax is imposed there are two prices of interest: The price that the buyers pay, . The price that sellers receive, . The difference between the two is the tax, t. Let’s first consider a tax on sellers.
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Slide #29.

A Tax on Sellers Price Price buyers pay S1 3.00 Price Sellers get Demand,D1 0 100 Quantity of Ice-Cream Cones
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Slide #30.

A Tax on Sellers Price S2 S1 $2.50 A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). Tax ($0.50) 2.00 Demand,D1 0 50 Quantity of Ice-Cream Cones
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Slide #31.

A Tax on Sellers Price of Ice-Cream Cone S2   $3.30 3.00 Price Before tax 2.80 S1 Tax ($0.50)   Demand,D1 0 90 100 Quantity of Ice-Cream Cones
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Slide #32.

A tax on the buyer vs. a tax on the seller? A $t tax imposed on the buyer has the same effect as a $t tax imposed on the sellers The price received by the seller is the same. The price paid by the buyer is the same. The tax creates a wedge between the supply and demand curves. The burden of the tax is shared between buyers and sellers.
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Slide #33.

Effects of a tax  Losers: both buyers and sellers, regardless of who the tax is imposed on Price S Price buyers pay ($3.3) Price without tax Tax wedge ($0.5) Winners: government revenue Price sellers Receive ($2.8) D 0 Qt The tax results in a reduction in quantity Quantity
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Slide #34.

How the Minimum Wage Affects the Labor Market Wage Labor demand Labor Supply 7 5 0 50 70 Quantity of Labor
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