Define Price Ceiling and Price Floor with at least one example of each. You may receive 2 bonus points for each graphical explanation.
Both price ceilings and price floors cause inefficiency in the market. Explain with examples.
Chapter 19
What are the three main causes of shift of factor demand curve? Explain with examples.
Define Labor Unions and Monopsony. How do these factor markets for labor exert market power in different ways? Explain with examples.
Full Answer Section
(Inefficiency):
Price ceilings can lead to shortages because the quantity supplied (Qs) is less than the quantity demanded (Qd) at the artificially low price ceiling (Pc). This creates excess demand (Qd - Qs) as buyers are willing to purchase more than what's available at the capped price. This can lead to:
- Black markets: Sellers may resort to selling goods illegally at a higher price to meet the unmet demand.
- Lower quality goods: To maintain profits at the lower price, producers may skimp on quality.
- Producer shortages: Discouraged by the low price, producers may shift production to other goods or exit the market altogether, further reducing supply.
Price Floor: A government-imposed minimum price that a seller must receive for a good or service.
- Example: The government might establish a price floor for agricultural products to ensure a minimum income for farmers.
(Inefficiency): Price floors can lead to surpluses because the quantity supplied (Qs) is greater than the quantity demanded (Qd) at the artificially high price floor (Pf). This creates excess supply (Qs - Qd) as sellers are offering more than what buyers are willing to purchase at the mandated price. This can lead to:
- Surplus goods: The government or producers may be stuck with unsold inventory.
- Reduced quality: To compete at the higher price, producers might prioritize quantity over quality.
- Resource misallocation: Resources like storage and manpower are diverted to managing the surplus, reducing overall economic efficiency.
Shifts in Factor Demand Curve (3 Main Causes)
1. Change in Output Price:
- Example: A surge in demand for smartphones increases the price of smartphones. This, in turn, increases the demand for factory workers needed to produce them, shifting the demand curve for labor (Df) to the right (Df1).
2. Change in Input Prices:
- Example: Technological advancements reduce the cost of robots used in car manufacturing. This makes using robots more attractive compared to human labor, causing the demand curve for factory workers (Df) to shift left (Df2).
3. Change in Complementary/Substitute Factors:
- Example: As the use of computers becomes more widespread in offices (complementary factor), the demand for administrative assistants (Df) also increases (Df1). Conversely, if self-driving cars become widely available (substitute factor), the demand for taxi drivers (Df) would decrease (Df2).
Labor Unions and Monopsony: Market Power in Factor Markets
Labor Unions: Organizations formed by workers to represent their collective interests in wage negotiations, working conditions, and benefits.
Monopsony: A market structure where there is only one buyer (employer) for a particular type of labor.
Market Power Exertion:
- Labor Unions: Through collective bargaining, unions can negotiate higher wages and better working conditions for their members than individual workers could achieve on their own. This can lead to higher wages (W) than the equilibrium level (We) in a competitive market.
Labor Union Market Power Graph
- Monopsony: In a monopsony market, the single employer has significant control over wage setting. They can pay wages (W) below the equilibrium level (We) in a competitive market, as workers have limited options.
Monopsony Market Power Graph
Examples:
- Labor Unions: The American Federation of Teachers (AFT) negotiates contracts for teachers, advocating for higher salaries and smaller class sizes.
- Monopsony: A town with only one major hospital has significant monopsony power in the local market for nurses. This could allow the hospital to set wages lower than what nurses could earn elsewhere.
