Price Floors and Ceiligns Flashcards
Price Floor
Price Floors are minimum prices set by the government for certain commodities and services that it believes are being sold in an unfair market with too low of a price and thus their producers deserve some assistance. Price floors are only an issue when they are set above equilibrium price, since they have not effect if they are set below market clearing price.
When they are set above the market price, then there is a possibility that there will be an excess supply or surplus. If this happens, producers who can’t foresee trouble ahead will produce the larger quantity where new price intersects their supply curve. Unknown to them, consumers will not buy that many goods at a higher price and so those goods will go unsold.
Price Floor II
There will be economic harm done even if suppliers can look ahead and see there isn’t sufficient demand and cut back on production in response. There is still deadweight loss associated with this reduction in quantity, reflected in the loss of consumer and producer surplus at lower levels of production. Producers can gain as a result of this policy, but only if their supply curve is relatively elastic. Consumers will definitely lose with this kind of regulation, as some people are priced out of the market and others have to pay a higher price than before.
Problems of low wages
Low pay can result from a number of labour market failures, including:
- lack of access to the labour market, as a result of barriers to entry including discrimination
- lack of bargaining power by individuals in uncompetitive labour markets, such as where there is one employyer, a monopsonist.
- lack of skills leading to very elastic demand for labour, so that a higher wage would reduce demand, hence workers have to accept this wage, or remain unemployed.
- inward migration from low-pay countries, where workers are prepared to accept extremely low wages, for often short periods of a time, which this drives down the wages for indigenous employees.
National Minimum Wage is a price floor
If NMW is higher than the market clearing wage for a particular job, then demand will contract and supply extends. The contraction of demand is the result of a combined income and substitution effect in response to the higher wage rate. At a higher wage rate, the firm’s income, it’s profits, will, ceteris paribus, fall and the firm will reduce demand, hence the income effect.
The substitution effect implies that at a high wage rate firms will look to substitute workers when they can, for other workers or with capital. One reason the minimum wage is fixed for all workers is to reduce substitution effect, and make demand for labour more inelastic. On the supply side, the higher wage will encourage existing employees to supply more labour, or it will encourage workers out of voluntary unemployment.
Price Ceilings
Price Ceilings are maximum prices set by the government for particular goods and services that they believe are being sold at too high of a price and thus consumers need some help purchasing them. Price ceilings only become a problem when they are set below the market equilibrium price.
Price Ceiling II
When the ceiling is set below the market price, therewill be excess demand or a supply shortage. Producers won’t produce as much at a low price, while consumers will demand more because it is cheaper. Demand will outstrip supply, so there will be a lot of people who want to buy at this lower price but can’t. Still, if demand curve is relatively elastic, then the net effect to consumer surplus will be positive.
Producers are truly harmed, as their surplurs is doubly hit with a reduction in the number of firms willing to take that lower price, and those who remain in the market have to take a lower price.
