Unit 2: Microeconomics:
Understanding the
Canadian Market Economy
Chapter 4: Demand and Supply
Chapter 5: Applications of Demand and Supply
Chapter 6: Business Organization and Finance
Chapter 7: Production, Firms, and the Market
Chapter 8: Resource Economics: The Case of Labour Economics
Chapter 5: Applications of
Demand and Supply
• Overview
• Elasticity of demand
• The total revenue approach to elasticity
• Factors affecting demand elasticity
• Elasticity of supply
• Factors affecting supply elasticity
• Utility Theory
• Government intervention in markets
Introduction
• This chapter deals with the practical application of
the demand and supply concepts discussed in
Chapter 4
• The ways businesses and governments can use these
concepts as a guide in making sound economic
judgments
Elasticity of Demand
• Elasticity is the responsiveness of quantities demanded
and supplied to changes in price
• In Chapter 4, we learned that consumers buy more of a
product when its price falls and less of it when its prices
rises
• What we did not learn is how much more they will buy
or how much less
• Economists have developed a formula to measure the
actual change in quantity demanded for a product whose
price has changed
Elasticity of Demand
• The effect of the change is in the numerator (people
buying more or less) while the cause is in the
denominator (the change in price that affects
people’s buying decisions)
Elasticity of Demand: Gas
Station Example
• Suppose a large gas station sells 10 million liters of
gasoline a month at a price of $0.50 per liter
• If the station’s owners raise their price to $0.54 per
liter, the quantity demanded by the station’s
customers falls to 9.5 million liters
Elasticity of Demand: Gas
Station Example
• First, let’s calculate the percent change in price
• Between the original price of $0.50 and the new
price of $0.54, the change is $0.04
• Which of these percentages should we use in our
calculations? We should compromise by using the
average price, which is $0.52
• This figure of 7.69 percent will serve as the
denominator of our equation
Elasticity of Demand: Gas
Station Example
• To determine the percent change in quantity
demanded, we use the average between the original
of liters sold and the quantity after the price change
• Since the quantity demanded fell from 10 to 9.5 million
liters, the average quantity demanded is 9.75 million
liters.
• The change in quantity is -0.5 million liters.
Therefore, the percent change in quantity demanded
is:
Elasticity of Demand: Gas
Station Example
• This figure of 5.13 percent will serve as the
numerator of our equation
• The value of ∆Qd is negative because the quantity
demanded falls
• We ignore the negative sign because we are interested
in the amount of change, not the direction
• We can now use the general formula to determine
the coefficient of demand
Elasticity of Demand: Gas
Station Example
• Any coefficient between 0 and 1 is called an
inelastic coefficient
• This is because a given percent change in price
causes a smaller percent change in quantity
demanded
• A 7.69 percent change in price causes a 5.13 percent
change in quantity demanded
Elasticity of Demand: Gas
Station Example
• Staying with our gasoline example, we find there is a
different coefficient for a different set of prices and
quantities demanded
• This is the case even if the change in price ($0.04)
and the change in quantity demanded (0.5 million
liters) are the same
• Copy Figure 5.1 into your notes
Table 5.1: The changing market for gasoline
Price per Litre of
Gasoline
Quantity Demanded
(million litres)
$0.50
10.0
Coefficient of
Demand
0.67
$0.54
9.5
$0.58
9.0
$0.62
8.5
$0.66
8.0
1.1
$0.70
7.5
$0.74
7.0
$0.78
6.5
$0.82
6.0
Elasticity of Demand: Gas
Station Example
• Between $0.66 and $0.70, we find the percent
change in price is 5.88 per cent
• We calculate the percent change in quantity
demanded as 6.45 percent
• The coefficient therefore is 1.1
Elasticity of Demand: Gas
Station Example
• Note here that any coefficient greater than 1 is called
an elastic coefficient
• A given percent change in price causes a greater
percent change in quantity demanded
• A 5.88 percent change in price causes a 6.45 percent
change in quantity demanded
• A coefficient that is equal to 1 is called a unitary
coefficient because a given percent change in price
causes an equal change in quantity demanded
The Total Revenue Approach
to Elasticity
• It’s extremely useful for economics and business people
to know whether total revenues will rise or fall when
prices rise or fall
• Will a rise in price mean increased revenues of our gas
station owner in spite of the fall in quantity demanded?
• If the elasticity coefficient is inelastic, then the answer is yes
• Let’s refer consider whether total revenues rise when owners
hike the price per liter of gas from $0.50 to $0.54
The Total Revenue Approach
to Elasticity
• At the original price of $0.50 per liter, the owners sell 10
million liters of gas
• Total revenue is 10 million liters X $0.50 = $5 million
• At $0.54, revenues are 9.5 million liters X $0.54 = $5.13
million
• As always happens with an inelastic demand coefficient,
when the price of gasoline rises, the quantity demanded
falls at a lower rate (5.13 percent) than the rate at which
price rises (7.69 percent)
• Although people buy less gasoline at the higher price, this
potential loss of revenue is compensated for by the greater
percent increase in price
The Total Revenue Approach
to Elasticity
• If the price falls again to $0.50, revenues will fall
• Though people buy more gas at the lower price, this
potential revenue increase is offset by the greater
percent decrease in price
• This changes when the coefficient is elastic
• When prices rise from $0.66 to $0.70 per liter, revenues
fall from $5.28 million to $5.25 million
• The percent rise in price (5.88 percent), with its
potential to raise revenues, is undercut by an even
greater percent fall in quantity demanded (6.45 percent)
The Total Revenue Approach
to Elasticity
• When price falls with an elastic coefficient, total
revenues will rise
• The percent decrease in price is less than the percent
increase in quantity of gasoline purchased
• When the coefficient is unitary, total revenues are
not affected by an increase or decrease in price
• The percent increases or decreases in price and quantity
demanded are the same
In Summary
• Goods with inelastic demand coefficients:
• When price rises, total revenues rise
• When price falls, total revenues fall
• Goods with elastic demand coefficients:
• When price rises, total revenues fall
• When price falls, total revenues rise
• Goods with unitary demand coefficients:
• When price rises or falls, total revenues stay the same
Factors Affecting Demand
Elasticity
• Availability of substitutes
• Goods that have substitutes tend to be more elastic than
goods that do not
Factors Affecting Demand
Elasticity
• Nature of the item
• Goods that are necessities tend to be more inelastic
than goods that are considered luxuries
• A necessity such as bread is inelastic. Price changes do
not significantly change the quantities consumers
purchase
• A luxury such as a vacation cruise will be quite elastic
because if prices rise, people can do without this kind
of vacation
Factors Affecting Demand
Elasticity
• Fraction of income spent on the item
• Goods that are expensive and take up a large part of
the household budget will be elastic
• If prices rise for big ticket items like houses, cars, or
furniture, people either do without the item entirely,
postpone the purchase, or search for substitutes
• An item that takes up a smaller percentage of the
budget (ex: shoelaces) is inelastic and may rise in price
without registering a significant decline in the amount
purchased
Factors Affecting Demand
Elasticity
• Amount of time available
• Over time, some goods may become more elastic
because consumers eventually find substitutes for them
• In the short term, however, demand for these goods can
be quite inelastic because consumers may not know
what substitutes are available immediately after the
price rises
Elasticity of Supply
• As market prices rise, suppliers want to supply more
so their profits will increase
• Can a supplier increase output as easily as
consumers decrease demand, or is it more difficult to
increase quantity supplied to take advantage of
higher prices?
• Elasticity of supply measures how responsive the
quantity supplied by a seller is to a rise or fall in
price
Elasticity of Supply
• The formula to determine the coefficient of supply
is:
Elasticity of Supply: Steel
Manufacturer Example
• Suppose the market price of steel rises from $120 per
tonne to $140
• Wishing to take advantage of the higher price, the
manufacturer expands production immediately from
1 million tones a day to 1.2 million tones
• What will the coefficient of supply be?
Elasticity of Supply: Steel
Manufacturer Example
• First, we calculate the percent change in price
• Just with demand elasticities, we have to find the
average of the two prices, which in the case of the steel
manufacturer is $130 per tonne
• The change in price is $20, thus the percent change is:
Elasticity of Supply: Steel
Manufacturer Example
• We must also find the average of the two figures for
quantity supplied, which is 1.1 million tonnes
• The change in quantity supplied is 0.2, thus the
percent change is:
• Using the supply elasticity formula, we can now
calculate the coefficient of supply:
Elasticity of Supply: Steel
Manufacturer Example
• The same rules apply to supply coefficients as to
demand coefficients
• Any supply coefficient less than one is classified as
inelastic, equal to one is unitary, and more than one
is elastic
Elasticity of Supply: Steel
Manufacturer Example
• The steel manufacturer’s ability to increase production
supply is elastic within this price range
• This means that when price increases by a certain percentage
(15.38 percent in this case), the manufacturer is able to
increase quantity supplied at an even greater rate (18.18
percent)
• A seller with an elastic supply is better positioned to take
advantage of an increase in demand for the product
• Quantity supplied can easily and quickly be increased to
meet demand, resulting in an increase in revenues
Elasticity of Supply: Steel
Manufacturer Example
• A price range that has inelastic supply has a supply
coefficient of less than one
• The seller can’t increase the quantity supplied by a
greater percentage than the percent increase in price
• A price range that has a unitary supply elasticity has
a coefficient equal to one
• The seller is just able to match a price increase by the
same percentage increase in quantity supplied
Factors Affecting Supply
Elasticity
• Time
• The longer the time period a seller has to increase
production, the more elastic the supply will be
• In the short term supply is inelastic, and in the long
term it is elastic
Factors Affecting Supply
Elasticity
• Ease of storage
• When the price of a product drops, sellers have 2
choices:
• They can sell the product at the new lower price
• They can put some of their inventory into storage and sell
it after the price rises again
Factors Affecting Supply
Elasticity
• Cost factors
• Increasing supply may be costly depending on the
industry
• Manufacturers may be able to increase production in
the short term by requiring workers to put in more
overtime
• A permanent increase in production, however, may
entail building new factories, which is a far more costly
move on the part of the manufacturer
• Supply is more elastic in industries that have lower
input expenses
Making Consumption
Choices: Utility Theory
• In Chapter 4, we saw how a market demand curve is the
sum of the many individual demand curves of the
consumers who buy a particular product
• But what factors determine the demand for the products
that each of us buys?
• Is there a rational way of explaining the decisions we
make about buying and consuming?
• Alfred Marshall “the father of supply and demand”put
forth the theory known as the marginal utility theory of
consumer choice, or utility theory for short
Making Consumption
Choices: Utility Theory
• Lisa has the choice of buying either a veggie burger or
frozen yoghurt
• What factors might influence Lisa in making her choice?
• First she would probably consider how many veggie
burgers she’s had lately
• If she has had several, she would gain little extra satisfaction
from consuming another
• The economic term for “satisfaction” or “usefulness” is
utility
• The economic term for extra is marginal
• So the marginal utility Lisa would receive from yet another
veggie burger is low
Making Consumption
Choices: Utility Theory
• However if she has bought little frozen yoghurt in
the past week, the extra satisfaction she would gain
from buying more yoghurt would be higher
• Since the marginal utility of buying more yoghurt is
greater for Lisa than the marginal utility of eating
another veggie burger, Lisa would most likely buy
the yoghurt
Making Consumption
Choices: Utility Theory
• Suppose, however, that Lisa wanted both veggie
burgers and frozen yoghurt
• We assume that, like most consumers, she wants to
maximize her satisfaction, or utility, for the income
she has available to spend on these items
• Suppose she has $10 to spend this week on these two
items
• The burgers cost $2 and the frozen yoghurt costs $1
• How should she determine how much of each she
should buy?
Table 5.10: Lisa’s monthly consumption of veggie burgers and frozen yoghurt
Veggie
Burgers
Total
Utility
Marginal
Utility
Frozen
Yoghurt
Total
Utility
Marginal
Utility
1
10
10
1
11
11
2
18
8
2
18
7
3
24
6
3
22
4
4
28
4
4
25
3
5
30
2
5
26
1
Making Consumption
Choices: Utility Theory
• It arbitrarily assigns numerical values called utils, or
units of satisfaction to the burgers and yoghurt
• We see that the utility Lisa receives from consuming
one veggie burger or one frozen yoghurt is high
• Total utility is 10 utils for one burger and 11 utils for
one frozen yoghurt
Making Consumption
Choices: Utility Theory
•
For the first unit of the item in question, the marginal utility is always
the same as total utility
• Lisa is gaining 10 utils of extra satisfaction by consuming one veggie burger
instead of none and similarly, 11 utils of extra satisfaction by consuming one
frozen yoghurt instead of none
•
If Lisa buys a second veggie burger or a second frozen yoghurt, the
extra satisfaction she experiences drops slightly to 8 utils for the
second burger and 7 for the second frozen yoghurt
• Her total satisfaction is now 18 utils for two veggie burgers and also 18 utils for
the two frozen yoghurts – a total of 36 utils
•
We see the same pattern for the third and fourth veggie burger or
frozen yoghurt: marginal utility steadily falls as Lisa consumes one
more of either product
• Total utility continues to rise as more is consumed, but not as quickly
Making Consumption
Choices: Utility Theory
• If Lisa’s budget were unlimited, she could maximize
her utility by consuming 5 veggie burgers and 5
frozen yoghurts
• This would cost her (5 X $2) + (5 X $1) = $15
• This combination produces 30 + 26 = 56 utils, which is
the highest total utility achievable (as shown in Table
5.10)
Making Consumption
Choices: Utility Theory
• Since she has limited herself to $10, Lisa must find
another combination that will yield her the highest
satisfaction, or total utility possible
• Which combination of veggie burgers and frozen yoghurt
will give her the most satisfaction?
• The formula that yields the answer is the utility
maximization formula:
• MU = marginal utility
• MU/price signifies the amount of satisfaction received per
dollar
Table 5.12: Lisa’s marginal utility/price of veggie burgers and frozen yoghurt
Veggie
Burgers
Marginal
Utility
MU
Price
Frozen
Yoghurt
Marginal
Utility
MU
Price
1
10
5
1
11
11
2
8
4
2
18
7
3
6
3
3
22
4
4
4
2
4
25
3
5
2
1
5
26
1
Making Consumption
Choices: Utility Theory
•
We can now determine Lisa’s best combination for maximizing her
satisfaction
• She can do so by purchasing 3 veggie burgers and 4 frozen yoghurts because, at
these positions, the MU/price is equal for both items
•
Since Lisa is receiving the same amount of satisfaction per dollar for
each item, she has no reason to buy more of one and less of the other
• An economist would say she is in a condition of consumer equilibrium
•
She has spent 3 X $2 = $6 on veggie burgers and 4 X $1 on frozen
yoghurt for a total of $10
• More importantly, she has maximized her total utility by amassing 49 utils
• No other combination will give her more total utils within her $10 budget
Applications of Utility Theory
• The Demand Curve
• Recall from Chapter 4 that the demand curve slopes
downward from top left to bottom right
• Consumers will buy more only if price falls
• The theory of marginal utility supports this
• People consume more, the extra satisfaction they receive
declines
• If people receive less satisfaction as they consume more
of a product, they will want to pay less for that product
the more they buy it
Application of Utility Theory
• Adam Smith’s paradox
• Smith wrestled with an economic problem he was
never able to solve, one he called the paradox of value
• Why, he wondered, are diamonds more costly than
water, when water is essential to human life and
diamonds are not?
• Smith could not understand why the demand for a
necessity should not be high enough to assure the price
is as high as the price for luxury items
• This paradox remained unsolved until the development
of utility theory
Application of Utility Theory
• The key to unlocking the paradox lies in the
difference between the total and marginal utility for
water and diamonds
• Water has greater total utility than diamonds
• Diamonds are scarce compare to water
• Satisfaction received from a diamond is extremely high
• The marginal utility buyers receive from purchasing a
diamond means they are willing to pay a high price for
something that has little total utility
• In comparison, the very abundance of water means that
most people can consume so much of it that its marginal
utility is pushed very low
Application of Utility Theory
• Consumer Surplus
• If we examine the concept of marginal utility closely
enough, we come to a surprising conclusion: we get a
bargain on everything we buy!
• Economists call this result a consumer surplus
• Let’s suppose we asked Lisa how many cases of bottled
water she would buy at different prices
Table 5.13: Lisa’s consumer surplus for bottled water
Price
Number of Cases of
Water
Consumer Surplus
$9
1
$9 - $6 = $3
$8
2
$8 - $6 = $2
$7
3
$7 - $6 = $1
$6
4
$6 - $6 = $0
Application of Utility Theory
• Lisa would buy only 1 case if the price per case was $9
• However, if after consuming this 1 case the price dropped
to $8, she would buy another
• A total of 2 cases in one month and a total cost of $17
• Lisa would continue to buy 1 more case of water each
time the price fell further until, when the price reached
$6, she would have bought 4 cases
• This is a perfect illustration of marginal utility because it
demonstrates that Lisa would buy more cases of water
only if the price fell
Application of Utility Theory
• The sellers of bottled water do not drop their prices
throughout the month to encourage Lisa to buy
more of their product
• They charge a constant price, say $6 a case
• Lisa actually receives a surplus for the first 3 cases of
bottled water she buys
• This surplus is calculated by subtracting the amount
she would have paid for each case of water from the
amount she actually paid
Government Intervention in
Markets
• The market engines of demand and supply automatically
produce the vast range of goods and services that
consumers want and then distribute these goods and
services with a minimum of waste or shortages
• All this is done without the benefit of any individual or
group providing direction for the economy
• Governments do intervene extensively in the market
• Why do they do this?
• Are they threatening the “magic of the market” by
intervening?
Government Intervention in
Markets
• Three examples of controversial government
actions:
• If the government believes the people are paying too
much for an item, it will introduce a ceiling price
• If the government believes sellers are receiving too little
for a product, it will introduce a floor price
• If the government believes it must intervene in a market
for social or environmental reasons, it will introduce a
subsidy or a quota as a solution
Ceiling Prices
• A ceiling price is a restriction placed by a
government in order to prevent the price of a
product from rising above a certain level
• If the ceiling price is set below the equilibrium price, a
shortage will result
Ceiling Prices
• Suppose an international crisis has interfered with oil supplies
and prices start to climb
• The government, concerned by the hardship these price
increases have caused for motorists, places a price ceiling (PC)
on gasoline
• The equilibrium price was $0.65 per litre, with 100 million
litres per month demanded and supplied
• The price ceiling prohibits prices from rising above $0.60 per
litre
• At this price, 110 million litres (QD1) are demanded, and 90 million
litres (QS1) are supplied
• This creates a shortage of QD1 – QS1 = 20 million litres
Ceiling Prices
•
There are three possible outcomes of price ceilings:
•
First, the shortages can cause long lineups for the product
•
Second, price ceilings may create a black market for certain goods
• A shortage of a product encourages some people to buy up as much of
it as they can at the ceiling price, stockpile it, and then sell it at a higher
price to people who can’t get enough for their own use
•
Third, price ceilings may cause the quality of a product to suffer if
sellers try to reduce their costs in order to make more money
• This is less likely to occur with natural resource products, but it occurs
more frequently for products like rental accommodations
Floor Prices
• A floor price is a restriction that prevents a price
from falling below a certain level
• If the floor price is set above equilibrium price, it will
cause a surplus
Floor Prices
• Suppose the government believes that milk producers are
making too little profit on milk, priced at $0.50 a litre
• The government may set a floor price of $0.60 per litre,
below which prices are not allowed to fall
• The line PF is the floor price of $0.60 per litre
• At that price, 10 million litres will be supplied
• The higher floor price cuts the quantity demanded to 8
million litres
• The result, QS1 – QD1, is a surplus of 2 million litres of milk
Floor Prices
• Maintaining the floor price causes two problems:
• First, there is the problem of what to do with the surplus
• In order to keep the floor price at $0.60 per litre, the
government must buy the surplus of milk (using taxpayers’
money)
• Little chance that the surplus will generate a return
• Cannot be sold within the country at prices below the floor
price without undercutting the floor price
• Surpluses can be sold on the world market or donated to less
developed countries
• Since milk is perishable, it is turned into products that can be
stored, such as powdered milk, butter, and cheese
Floor Prices
• Second, consumers pay a higher price for the
product and receive less
• Consumers in an unregulated market would probably
have paid the equilibrium price of $0.50 per litre and
would have received 9 million litres of milk
• With the floor price set by the government, they pay
$0.60 per litre ($0.10 more) and receive 8 million litres
(1 million litres less)
Subsidies and Quotas
Subsidies
• Both price ceilings and price floors share a common
problem:
• Less of the product is actually transacted between
sellers and buyers when these policies force the price
away from its equilibrium price
• In order to avoid this problem, governments
sometime enact subsidies
• A subsidy is a grant of money to a particular industry
by the government
Subsidies
• Figure 5.18 shows how the milk market will be
affected by a subsidy of $ 0.10 per litre
• The supply line increases by the amount of the subsidy
since producers turn out more milk because they are
receiving an extra $0.10 per litre
• The new equilibrium price of $0.45 is lower than the
old equilibrium price of $0.50, and the quantity sold is
increased by 3 million litres (from Q1 to Q2)
Subsidies
• A subsidy has the advantage of benefiting buyers
with lower prices and sellers with extra revenue
• More of the product is exchanged between buyers and
sellers with extra revenue
• A subsidy has a couple of drawbacks:
• The taxpayer pays for the program
• Some critics charge that subsidies keep inefficient
producers in business
• In the global economy, subsidies are often seen as a
barrier to fair trade
Subsidies and Quotas
Quotas
• A quota is a restriction placed on the amount of a
product that individual producers are allowed to
produce
• Administered by organizations called marketing
boards composed of representatives from the
government and from the producers
Quotas
• Figure 5.19 illustrates what happens when a
provincial marketing board enforces a reduced quota
on all milk producers in the province
• S2 shows the shift in supply to the left
• P2 is the new, higher price, and Q2 is the new, smaller
amount of milk that is actually sold
Quotas
• Quotas set by marketing boards raise farmers’ incomes
mainly because food is an inelastic commodity
• When prices rise on an inelastic product, sales revenue also
rises because quantity demanded does not fall by much
• Farmers were given the authority to establish marketing
boards years ago because governments believed that their
incomes were, on average, very low
• Farmers are producing an essential commodity, and if
too many of them go out of business, Canadians will
wind up paying more for their food
Quotas
• Critics claim that marketing boards raise prices
above equilibrium, with the result that less of the
product is actually produced and exchanged
• The fact remains that most of the Canadian meat,
vegetables, and dairy products we buy in
supermarkets are sold to the stores by marketing
boards
Rent Controls
• A rent-control program is a good example of a price
ceiling
• Most Canadian provinces and many American states
have enacted such programs, and the controversy that
surrounds them never seems to end
• Rent is the price people pay for accommodation
• Like any other market price, it is determined by
demand and supply
Rent Controls
• Figure 5.20a shows the rent the market sets for the
quantity of apartments demanded and supplied in a
particular building
• At $500 for a one-bedroom apartment, the owner will
supply 50 apartments
• The supply line is vertical because the owner can’t
increase supply immediately
• That would involve building more units
• The supply of apartments is fixed, or perfectly inelastic, in the
short term
Rent Controls
• Suppose an increase in renters occurs, shifting demand
upwards
• This encourages the owner to raise rents to $600 a month
• This increase has 2 effects:
• Those who can afford the higher rent will stay and pay
• Those who can’t will have to find less expensive
accommodation elsewhere
• Higher rents mean more profits for the owner, who is
therefore encouraged to build more units
Rent Controls
• Figure 5.20b illustrates the effect of this long-term
decision to construct another apartment building
• The supply curve shifts to the right
• This long-run supply curve, with greater elasticity,
also has beneficial effects for renters
• The supply of apartments is increased, and the rental
price, at least in theory, falls to $550
• This is how a free rental market works, and both renters
and apartment owners appear to win in the long run
Rent Controls
• Suppose that in response to the increase in demand
that caused rents to rise to $600 in the short term,
the government comes under pressure to alleviate
the economic hardship renters are experiencing
• The government introduces a rent-control program:
a law that freezes, reduces, or controls the amount of
rent that owners can charge
• We’ll assume that a freeze on rent for one-bedroom
apartments will be fixed at $500
Rent Controls
• Figure 5.21 shows that if demand continues to rise to D2,
there will be a shortage of supply of 10 units
• If this kind of shortage is occurs in buildings everywhere,
people will have difficulty finding essential accommodation
• People looking for an apartment will be tempted to offer
building owners more money “under the table” in hopes of
beating others to a vacancy
• Owners, with no incentive to keep buildings in good repair to
attract new tenants, may stop making essential repairs and
renovations
• With rental prices fixed, they will also be disinclined to build
more units
Rent Controls
• While many people wonder whether rent controls
are worth these costs
• However, without rent control owners are able to
raise rent prices to whatever they can get and hold
bidding wars between interested tenants
Minimum Wages
• Governments also intervene
to establish floor prices when
they believe the price sellers
are receiving is too low
• A wage is the price a worker
receives for supplying labour
to a business with a demand
for it
• Figure 5.22a shows that
100,000 workers are
receiving wages of $5 an
hour
Minimum Wages
• Suppose the government responds to public pressure to raise
the low wages of these workers by setting a minimum wage
• A wage that is higher than the one set by the forces of demand
and supply
• Figure 5.22b shows the results of the government’s efforts
• The minimum wage is set at $6 an hour
• Businesses adjust to this by employing only 70,000 workers
• The higher wage rate attracts an additional 30,000 workers into
the labour market
• This is a total of 130,000 workers who are willing to work
• This means the minimum wage has created an unemployment
problem 60,000 workers who can’t find jobs
Minimum Wages
• Floor prices tend to create surpluses
• Minimum wages create surpluses of potential workers
who cannot find jobs
• The minimum wage also increases the wages of
thousands of people at the low end of the wage scale
• These people receive a more substantial paycheque
than they would have if wages had been set solely by
supply and demand