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c10competitive markets applications.qxd 7/15/10 4:58 PM Page 409

10.2 PRICE CEILINGS AND FLOORS 409
• Consumer surplus will be lower than with no price floor.
• Some (but not all) of the lost consumer surplus will be transferred to producers.
• Because there is excess supply with a price floor, the size of the producer surplus
will depend on which of the producers actually supply the good. Producer surplus
may either increase or decrease with a price floor.
• There will be a deadweight loss.
Let’s begin by studying the effects of a minimum wage law. There are many types
of labor in an economy. Some workers are unskilled, while others are highly skilled.
For most types of skilled labor, the minimum wage set by the government will be well
below the equilibrium wage rate in a free market. A minimum wage law will have no
effect in such a market. We therefore focus on the market for unskilled labor, where
the minimum wage requirement may be above the wage level in a free market. (In the
labor market, the producers are the workers who supply the labor, while the con-
sumers are the employers who purchase the labor—i.e., hire the workers.)
Figure 10.10 illustrates the supply and demand curves in the market for unskilled
labor. The vertical axis shows the price of labor, that is, the hourly wage rate, w. The
horizontal axis measures the number of hours of labor, L. The supply curve S shows
how many hours workers will supply at any wage rate. The demand curve D indicates
how many hours of labor employers will hire.
With no minimum wage law, equilibrium occurs at the point where the demand
curve and the supply curve intersect (point V ). At this point, the equilibrium wage rate
is $5 per hour, and the market-clearing quantity of labor is 100 million hours per year.
Every worker willing to supply labor at the equilibrium wage rate (workers between
points Z and V on the supply curve) will find work, and every employer willing to pay
that rate (employers between points Y and V on the demand curve) will be able to hire
all the workers he wants.
Suppose the government enacts a minimum wage law requiring employers to pay
at least $6 per hour. At that wage rate, the labor market will not clear. Employers will
demand 80 million hours of labor (point R), but workers will want to supply 115 mil-
lion hours (point T ). Thus, the minimum wage law has decreased the demand for
labor by 20 million hours (100 million 80 million) and has caused an excess labor
supply (unemployment) of 35 million hours (115 million 80 million, or the hori-
zontal distance between points T and R). Unemployment measures more than just the
decrease in the demand for labor (20 million hours); rather, it measures the excess sup-
ply of labor (35 million hours).
Now we can use Figure 10.10 to calculate the consumer surplus, producer sur-
plus, net economic benefits, and deadweight loss, with and without the minimum
wage law. (Note that Figure 10.10 is divided into two cases, as explained below.)
With no minimum wage, consumer surplus is the area below the demand curve
and above the equilibrium wage rate of $5 per hour. In Figure 10.10, this is areas A
B C E F. Producer surplus is the area above the supply curve and below the
equilibrium wage rate. In Figure 10.10, this is areas H I J. The net economic
benefit is the sum of consumer surplus and producer surplus. In Figure 10.10, this is
areas A B C E F H I J.
With the minimum wage, as you can see from Figure 10.10, we will consider two
cases, differing by which producers (i.e., workers) actually find jobs: Case 1 maximizes
producer surplus, while Case 2 minimizes producer surplus. In both cases, employers
are willing to hire labor up to point R on the demand curve, and the consumer surplus
they receive is the area below that portion of the demand curve and above the rate