Price Floors and Ceilings

1. Government Intervention in the Marketplace: 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...

2. Think about apartments in Manhattan... S Price So, let’s say a studio apt. in Manhattan costs roughly $4000 a month (true!). $4000 At this price, let’s pretend that 25,000 apartments are rented each month. D Why? Because it’s New York, that’s why. Quantity 25,000 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.” So how can we resolve this issue? 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... Orale, I know, huh? I need a house, ay.

3. 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. Why did we create it? 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. 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.

4. 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 Price We need to look at how much producers will supply at this price and how much consumers will demand at this price. $4000 $2000 Because producers are making less money, they will not provide as many apartments. D Quantity 25,000 Because consumers are getting cheaper apartments, they want more of them. { 15,000 35,000 When your demand is higher than your supply (which always occurs with a price ceiling), you have a shortage of goods. In this scenario a shortage of 20,000 apartments occurs.

5. 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

6. 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?

7. My logic is sound, but it doesn’t make me “right.” We know from our little situation that the equilibrium price of labor should actually be around $1 S Price $5 For obvious reasons, this would be a terrible scenario $1 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. D Quantity 50,000 Now, when we look at where the price meets supply and where it meets demand, we see a different issue. { 30,000 75,000 More people want to work (supply) when they get paid more, but fewer companies are hiring (demand). In this scenario a surplus of 45,000 workers occurs. When your supply is higher than your demand (which always occurs with a price floor), you have a surplus of goods.

8. 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.

9. So, what do I need to remember? Price FLOORs Price CEILINGs S S Price Price $5 $1 $4000 $2000 D D Quantity Quantity 50,000 25,000 30,000 75,000 15,000 35,000 Prevents prices from getting too low (like hitting a floor). Prevents prices from getting too high (like hitting a ceiling). Always leads to a surplus. Always leads to a shortage.