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Price Controls

Price controls are usually justified as a way to help consumers, but those who advocate them often ignore their incentive effects. Consider, for example, rent controls, a popular form of a price ceiling. If the demand curve and the short-run supply curves are inelastic, then a sizable drop in rents may result in a very small shortage. The benefits to consumers (lower prices) will, in the judgment of most, clearly outweigh the costs to consumers (less housing). Further, the short-run supply of housing should be quite inelastic because apartment buildings take time to build and even longer to wear out.

However, incentives matter a great deal in the long run. Effective rent controls discourage the construction of new buildings and encourage the retirement of old buildings. Apartment buildings wear out faster when they are not properly maintained, and if an owner cannot pass on the cost of improvements, his incentive to maintain the building is lessened. With time, sellers will approach a long-run supply curve that is much flatter than the short-run curve, and the small initial shortage may become quite large. Rationing will be on a first-come, first-served basis, and under-the-table payments will be encouraged. Even if the long-run costs to consumers outweigh the benefits, the program may remain politically popular because those who benefit by living in rent-controlled apartments can vote, whereas those harmed cannot vote since the shortage of housing forces them to live in other political jurisdictions.

New York City has had a system of rent controls since World War II. It is a complex program, without all rental property controlled, yet it has had consequences that a supply and demand model leads one to expect. Obtaining an apartment in a rent-controlled building is very difficult, and the city has had a major problem with property abandonment. Those planning to abandon (which is illegal) try to maximize their cash flow by cutting or eliminating maintenance and by not paying taxes.

The most visible price floor in the United States is the minimum wage. The U.S. Congress passed a minimum wage law in 1938 and has raised its level and extended its coverage several times since then. The stated goal of the minimum wage is to help the poor. It will not directly affect most workers because they have wages that are above the minimum. Only those workers who are earning less than the minimum will be directly affected.

A graph of a price floor indicates that the minimum wage will help some people. Some people, whose wages are below the minimum, will see their wages rise. But others will be harmed. Some people will not be able to find work at the new, higher wage. They will not be hired if the value of the work they can do is less than the minimum wage. These people will become the surplus that a price floor generates. They, however, may not realize the cause of their difficulties, and so may not realize that the minimum wage harms them.

Many advocates of minimum wages do not argue in terms of the model of supply and demand (though some do). Rather, they use a power model that sees the issue as a conflict between employer and employee. If employers have power, then they may pay less than the value that is or can be contributed by the worker. In a sense, the employer "exploits" the worker. In this model, the minimum wage helps workers at the expense of employers' profits. In contrast, the model of supply and demand suggests that the minimum wage helps some workers at the expense of others. Obviously it is more difficult to argue in favor of a minimum wage using the model of supply and demand.

The question of which model is the better model is an empirical question settled by a statistical analysis of the available facts. Economists have done numerous studies to try to discover the effects of the minimum wage. Most studies suggest that the minimum wage does have some adverse employment results. They find that the minimum wage results in unemployment for some, especially those whose skills and abilities are very low, and higher wages for others. This is what the model of supply and demand predicts will happen.

Next we see how rationing determines the distribution of income.

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