Deck 3: Government Control of Prices in Mixed Systems: What Are the Actual Outcomes

Question 1

Explain the concepts known as income and substitution effects. How do these relate to the supply of labor?

Answer 1

Regarding the market supply of labor, there is a general assumption that increasing the hourly wages will result in workers willingly increasing their hours. This should not be taken as gospel; as separate entities, workers may have outlying reasons not to increase their workable hours (school, a second job, children or family obligations), regardless of a wage increase. Changing wages is by no means a predictable guarantee that labor demand needs will be met.
There are two effects that can occur as a result of a wage change. The substitution effect is the change in working hours resulting from a wage change. It holds the assumption that all other factors are equal. According to the substitution effect, the wages paid are also the price of participating in non-working activities. If the wage increases, so does the price of indulging in these activities. Theoretically, this leads to a decrease in non-work activity by the workers and an increase in the amount of time they are willing to work at their firm.
The income effect measures the change in hours that may take place if there is a change in the worker's income. Again, this holds that all other factors are equal. A substantial income increase leads to an increased demand to indulge in non-work activities. The amount of hours workers are willing to work theoretically decreases as a result.
In truth, increasing wages at a general level will result in a slight increase the number of hours worked.

Question 2

When governments impose prices in an attempt to help some particular group of producers or consumers, there are often unintended consequences. Use the case of rent controls to show this.

Answer 2

Rent controls are a form of price ceiling implemented to keep housing or rental prices from being unaffordable for low income customers or tenants. They are contingent based upon housing demand, supply, and prices. As such they are subject to the same laws of supply and demand that other goods and services are subject to.
The actual effects of rent controls include generating housing shortages, inability to keep down housing costs for all customers, eliminations of profit-inducing factors that would prevent housing shortages, deteriorating quality of the property, and rental levels that below the potential value of the housing units. All of these factors combine to ultimately lead to groups of tenants who are locked into deteriorating living conditions, potential renters who are unable to find suitable living arrangements, and tenants who are forced to make clandestine and even unethical payment arrangements with their landlords.

Question 3

In what sense might minimum wages actually hurt those who are intended to be helped?

Answer 3

Like rent controls, minimum wages are a regulatory measure meant to help low income workers and those new to the workforce. Also like rent control, it has exhibited effects that were unintended and even detrimental to those it was intended to help.
Because of the relationship between the demand for labor and the marginal revenue product of labor, employers will only hire workers whose marginal output exceeds the wage price. By increasing the minimum wage, as has been done and proposed recently, employers have incentive to decrease the quantity of work provided. This will likely lead to fewer available working hours for employees. Additionally, raising the minimum wage to a price higher than the market equilibrium, unemployment rates are likely to go up due to a surplus of laborers.

Question 4

What effect would you expect minimum wages to have on the attainment of job experience and training of the young?

Question 5

Within the context of the alternative approach to minimum wages, there is little or no unemployment effect due to the minimum. Explain this.

Question 6

Why might a rational firm, in response to an increase in the minimum wage, not choose to reduce employment?

Question 7

What effect would you expect rent controls to have on: (1) the availability of housing in the short run, (2) the availability of housing in the long run, and (3) the quality of housing available?

Question 8

If minimum wages and rent controls create significant inefficiency in the market, why do they remain so popular publicly?

Question 9

Minimum wages and rent controls are implemented in an attempt to help those of modest means. Suggest better alternatives.

Question 10

Suppose that Congress enacts a large personal income-tax cut that effectively increases the wages of workers nationally. Relying on income and substitution effects, would you expect workers to offer more hours of their labor to their employers in response to the tax cut?

Question 11

Define and give an example of the law of diminishing returns.

Question 12

In a competitive labor market without discrimination, a worker is paid his or her marginal revenue product. Define marginal revenue product and explain why it determines the worker's wage.

Question 13

How effective is the minimum wage as an antipoverty tool?

Question 14

Define and give examples of price floors and price ceilings.

Question 15

Define the term marginal revenue product of labor. What are the two components of this, and why is it said to reflect the firm's demand for labor?

Question 16

Explain why the demand for labor is said to be a derived demand.