KW_Macro_Ch_04_Sec_02_Price_Floors

KW_Macro_Ch_04_Sec_02_Price_Floors - chapter 4 > The...

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>> The Market Strikes Back Section 2: Price Floors chapter 4 Sometimes governments intervene to push market prices up instead of down. Price floors have been widely legislated for agricultural products, such as wheat and milk, as a way to support the incomes of farmers. Historically, there were also price floors on such services as trucking and air travel, although these were phased out by the United States in the 1970s. If you have ever worked in a fast-food restaurant, you are likely to have encountered a price floor: the United States and many other countries maintain a lower limit on the hourly wage rate of a worker’s labor—that is, a floor on the price of labor, called the minimum wage . Just like price ceilings, price floors are intended to help some people but generate predictable and undesirable side effects. Figure 4-3 shows hypothetical supply and demand curves for butter. Left to itself, the market would move to equilibrium at point E, with 10 million pounds of butter bought and sold at a price of $1 per pound. But now suppose that the government, in order to help dairy farmers, imposes a price floor on butter of $1.20 per pound. Its effects are shown in Figure 4-4, where the line at $1.20 represents the price floor. At a price of $1.20 per pound, producers would want to supply 12 million pounds (point B on the supply curve) but con- sumers would want to buy only 9 million pounds (point A on the demand curve). The minimum wage is a legal floor on the wage rate, which is the market price of labor.
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2 CHAPTER 4 SECTION 2: PRICE FLOORS Figure 4-3 $1.40 $ 1.30 $ 1.20 $ 1.10 $ 1.00 $ 0.90 $ 0.80 $ 0.70 $ 0.60 14.0 13.0 12.0 11.0 10.0 9.0 8.0 7.0 6.0 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 6.0 7.0 0 8.0 9.0 10.0 11.0 13.0 12.0 14.0 $1.40 1.30 1.20 1.10 1.00 0.90 0.80 0.70 0.60 Quantity of butter (millions of pounds) Price of butter (per pound) D S E Quantity supplied Quantity demanded Quantity of butter (millions of pounds) Price of butter (per pound) The Market for Butter in the Absence of Government Controls Without government intervention, the market for butter reaches equilibrium at a price of $1 per pound and with 10 million pounds of butter bought and sold.
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There would therefore be a persistent surplus of 3 million pounds of butter. Does a price floor always lead to an unwanted surplus? No. Just as in the case of a price ceiling, the floor may not be binding—that is, it may be irrelevant. If the equi- librium price of butter is $1 per pound but the floor is set at only $0.80, the floor has no effect. 3
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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KW_Macro_Ch_04_Sec_02_Price_Floors - chapter 4 > The...

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