MECO 6303 – Business Economics

1. MECO 6303 – Business Economics Lesson Six Economic Policies Part A Consumer and Producer Surplus; Price Fixing, minimum wages and rent cotnrols.

2. Consumer Surplus P Consumer surplus and the difference between price and value – the diamond-water paradox. P1 P2 P3 P* D Q O Q3 Q1 Q2 Q* Lesson Six

3. Producer Surplus P S P* P1 P2 P3 Q O Q3 Q1 Q2 Q* Lesson Six

4. Consumer and Producer Surplus S Consumer surplus P* Producer surplus D Q* Lesson Six

5. Observations on Consumer and Producer Surplus • At the equilibrium price consumer and producer surplus are maximized • Anything that moves us away from that point will reduce consumer and producer surplus • These concepts are partial equilibrium concepts and serve best for isolated markets Lesson Six

6. Price Fixing • Fixing prices = non-price rationing • A floor – minimum wages • A ceiling – rent controls • Price fixing always has unintended consequences that are the opposite of what is intended. • Floors cause surpluses • Ceilings cause shortages. Lesson Six

7. A floor Transfer from consumers to producers Surplus = Qs - QD S Pmin Loss of Consumer Surplus P* Loss of Producer Surplus D O QD Q* QS Lesson Six

8. A ceiling Transfer from producers to consumers S Loss of Consumer Surplus P* Loss of Producer Surplus Pmax D Shortage = QD - QS O QS Q* QD Lesson Six

9. A price floor – minimum wages Supply of labor Wage rate Transfer from employers to workers. Wmin LS – LD is a surplus of labor = Unemployment. C • Loss of C & P Surplus • Can it be enforced? • Whom does it benefit? A W* E B Demand for labor Quantity of unskilled labor LD LS L* Lesson Six

10. The effects of minimum wages • The apparent aim of a minimum wage law is to benefit the poor – those at the bottom of the wage scale. • Some effects are obvious some are not • An increase in current unemployment (compared to what it would otherwise be) • The increase affects primarily the least productive, those economically worst off. • The disemployed may be affected for extended time. • Note the effects on consumer and producer surplus • So why do minimum wage laws exist? Whom do they benefit? Primarily organized labor (trade unions). Lesson Six

11. A Price Ceiling – rent control Transfer from renters to owners Rental rate Supply of housing HD – HS is a shortage of housing rbribe C A E r* B rmax Demand for housing HD HS H* Quantity of housing Lesson Six

12. The effects of rent control • The apparent aim of a rent control law is to benefit the poor – those least able to afford decent housing. • Some effects are obvious some are not • An decrease in affordable housing • The decrease affects those economically worst off. • The displaced may be affected for extended time. Rental housing construction and maintenance depends on the rate of return. • So why do rent control laws exist? Whom do they benefit? I don’t know. • Salary caps, and similar controls, work in the same way. Lesson Six

13. Conclusions • Supply and Demand concepts are part of an “engine of analysis” • We always start with it – there may be complications, but there is no better starting point • The examples of price fixing show how powerful it can be. Lesson Six