Markets II: Market Mechanics
Readings: OpenStax: Chapter 4 & Chapter 5
Outline: ▪ Surpluses and Shortages ▪ Price Ceilings o Binding/Not Binding o Example: Rent Ceilings ▪ Price Floors o Example: Minimum Wage ▪ The Labor Market and Immigration Surplus A surplus (or, excess supply) occurs when the quantity supplied is greater than the quantity demanded.
Suppose the current price of jerseys is fifty dollars: P = $50
▪ Then quantity demanded, QD =
▪ And quantity supplied, QS =
Which results in a surplus of ______.
P Jerseys $60 S
$50
$40
$30 $20
$10 D $0 Q 0 5 10 15 20 25 30 35
Facing a surplus, sellers try to increase sales by cutting the price.
This causes QD to rise and QS to fall, which reduces surplus. Prices continue to fall until the market reaches equilibrium.
1 Shortage A shortage (or, excess demand) occurs when the quantity demanded is greater than the quantity supplied.
Suppose the current price of headphones is two dollars: P = $20
▪ Then quantity demanded, QD =
▪ And quantity supplied, QS =
Which results in a shortage of ______.
P Headphones
$60 S
$50
$40
$30
$20
$10 D
$0 Q 0 5 10 15 20 25 30 35
Facing a shortage, sellers increase the price. This causes QD to fall and QS to rise, which reduces the shortage. Prices continue to rise until the market reaches equilibrium.
2 Non-Binding Price Ceiling
P Apartments Market A price ceiling is a legal maximum on the $1,200 S price of a good or service $1,000
▪ Example: $800
A price ceiling above the equilibrium price is $600 not binding; therefore it has no effect on the $400 market outcome. $200 D
$0 Q 0 100 200 300 400 500
Binding Price Ceiling Now consider an equilibrium price that is above the price ceiling, and is therefore illegal. ▪ The ceiling is a binding constraint on the price, and causes:
Apartments Market P $1,200 S $1,000
$800
$600
$400
$200 D
$0 Q 0 100 200 300 400 500
3 The Labor Market We can apply the principles of supply and demand Labor Market to the labor market. S $12 Workers supply labor; $10 Firms demand labor. ▪ Price: $8 $6 ▪ Quantity: $4
$2 D $0 0 500 1000 1500 2000
Price Floor A price floor is legal minimum on the price of a good or service.
▪ Example:
A price floor below the equilibrium price is not binding; therefore it has no effect on the market outcome.
Labor Market $12 S0
$10 Price (wage) Price $8
$6
$4
$2 D0 $0 0 500 1000 1500 2000 2500
Quantity (of workers)
4 Price Floor Now consider an equilibrium wage (the price of labor) that is below the floor, and therefore illegal.
The floor is a binding constraint on the wage, causes a surplus (i.e., unemployment).
Labor Market
S0 $12
Min $10 Price (wage) Price Wage
$8
$6
$4
$2
D0 $0 0 500 1000 1500 2000 2500
Quantity (of workers)
Minimum Wage Changes in unemployment (binding min. wage)
▪ Increase in the demand for labor:
What happens to the number of unemployed workers:
▪ Before:
▪ After:
Unemployment ______.
5 Minimum Wage Changes in unemployment (binding min. wage)
▪ Increase in the supply of labor:
What happens to the number of unemployed workers:
▪ Before:
▪ After:
Unemployment ______.
Labor Market
S $12 0
Min $10 Price (wage) Price Wage
$8
$6
$4
$2
D0 $0 0 500 1000 1500 2000 2500 Quantity (of workers)
6 Immigration and the Labor Market Immigration: ▪ Primary effect:
▪ Secondary effect:
Labor Market
S0 $12
$10
$8
$6
$4
$2 D0 $0 0 500 1000 1500 2000 2500 Labor Market S $12 0
$10
$8
$6
$4
$2
D0 $0 0 500 1000 1500 2000 2500
What happens to the equilibrium wage? What happens to unemployment?
7 Evaluating Price Controls Recall one of our principles from the first chapter is that markets are usually a good way to organize economic activity.
▪ Prices are the signals that guide the allocation of society’s resources. This allocation is altered when
policymakers restrict prices.
▪ Price controls often intended to help the poor, but can hurt more than help (e.g., rent ceilings and
minimum wage).
Immigration has an ambiguous effect on equilibrium wages and unemployment because in addition to a supply-side effect, immigrants also have a demand-side effect on the labor market.
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