In this first video on government intervention we will examine minimum prices.
We’ll first learn what they are, then look at how they impact markets and review factors
influencing their effectiveness.
We will also use this analysis to understand the minimum wage and analyse its impact on
labour markets.
A price minimum, or price floor, is a price control set by the government as the lowest
legal price that can be set for a good or service.
Let’s lay out the market equilibrium before any price floor is enacted.
We can see that the equilibrium price and quantity are set at P* and Q* correspondingly.
Next we impose the price floor (or minimum) Pmin.
At Pmin, set above the market equilibrium price, we have a situation in which quantity
supplied is greater than quantity demanded.
To measure this we look at the quantity demanded at price Pmin and the quantity supplied at
Pmin.
The difference between the two is our excess supply or surplus.
To understand why this happens, think about a product that companies produce.
If the price is forced upwards by the price minimum, it becomes more profitable to sell
this good, resulting in a greater quantity supplied.
However, at this higher price there is less demand, resulting in less quantity demanded.
What we’re left with is the excess supply, or surplus.
A commonly referenced example of price floors is the minimum wage.
As the legal minimum hourly wage that an employer can pay an employee, it has the ability to
impact the labour market.
The government may increase the minimum wage for a variety of reasons.
Some of these include reducing poverty and increasing the living standard of workers
earning the minimum wage.
However, we should also be aware of possible unintended consequences.
With a wage rate set at Wmin, there is Qs supply of workers and Qd demand for workers.
The excess supply of workers at the higher wage rate results in some unemployment.
As labour costs increase, employers are unwilling to employ as many workers at the higher rate
because it decreases their profits.
Now that the reward for working has risen, more workers are willing to supply their labour
at the higher rate.
Commonly in class, we will discuss a country with a high minimum wage.
Many students will kiddingly say they would like to move there.
You can imagine that many more people would be willing to work at higher wage rates resulting
in an increased supply of labour.
If more people decide to offer their labour at the same time as producers are scaling
back employment, the result will be unemployment.
Now, to be effective the minimum wage must be set above the market equilibrium wage rate.
Employers will ignore minimum wages set below the equilibrium rate.
An effective minimum wage is argued to benefit some workers and hurt others, such as unskilled
labourers.
At higher rates of pay, companies are stricter in their employment requirements, showing
a preference for skilled and more productive labour.
In addition, we have examined a simple analysis of the minimum wage.
It is important to consider how elastic the demand for labour is as well as the rate of
change on the minimum wage.
If demand is more inelastic, then the increased wage may not result in as much unemployment.
Additionally, if the change is significant, then the impact on the market will be significant.
Likewise, a smaller change will have a smaller impact.
Next we’ll see what the impact is on producer and consumer surplus.
You’ll recall our earlier discussions of producer and consumer surplus.
If you’re having difficulty following this part of the explanation go back and check
out the videos in Unit 2 on either topic.
I’ll include a link to both videos in the video notes.
As the minimum wage has risen to Wmin, only Qd workers are hired.
They may include workers who were willing to supply their labour at much lower rates.
For those workers, their producer surplus is quite significant, as indicated here by
the red shaded area.
As for the firms, they will employ Qd workers.
For them, the new minimum wage will still allow them to enjoy some benefit from the
consumption of this labour.
Perhaps they can still afford to pay the minimum wage and earn healthy profits, indicating
that this may be a very profitable business already.
In which case, raising wages may be seen as an affordable action to take.
Their surplus is indicated by the green triangle labeled CS.
As some workers and employers have enjoyed benefit from the new wage, there is still
deadweight loss.
Deadweight loss (DWL) is a loss of economic efficiency that can occur when equilibrium
for a good or service is not achieved or achievable.
In this instance we look at the cost to producers and workers as a result of the government
intervention.
If the government did not intervene, the equilibrium would be W* and Q*.
The deadweight loss measures this lost efficiency.
Some consumers and producers of labour are made worse off after the minimum wage.
Firms are unable to employ workers and workers are unable to find work.
Their loss is represented by the shaded area of deadweight loss.
This is a very difficult topic and you may have to go back and review it further to ensure
your understanding.
Once again if you have any questions or comments, please leave me a note below or email me at
enhancetuition@gmail.com or tweet me @enhancetuition.