This note is a part of my Zettelkasten. What is below might not be complete or accurate. It is also likely to change often.
19th September, 2020

Market Regulations prevent self-regulation and reduce efficiency

These are notes from MITxMicromasters program in Data, Economics and development policy.

The Invisible hand of the market determines the price and quantity for Competitive Equilibrium. External regulations and interventions prevents the market mechanisms from acting at full force.

Some popular market interventions are:

Price Floors

Price floors (like minimum wage) are designed to set a minimum selling price of a commodity. This regulation forces the constrained party to engage with the market at the minimum price instead of the equilibrium one.

In case of a price floor, the constrainted party is the the buyers, the buyers will buy the quantity determined by the intersection of the demand curve and the price floor line. Even though the available supply will be much higher (at the intersection of the supply curve and the price floor line) which will lead to a excess of demand in the market. *In case of an effective minimum wage, the buyers are the workers and the suppliers are the employers. The gap between the demand and the supply is unemployment (in a perfect market).

Price Ceilngs

Price ceilings (like maximum gas pricing) are designed to set a maximum selling price of a commodity.

In case of a price ceiling the constrained party is the suppliers; the suppliers will be forced to suppy a lower quantity determined by the intersection of the supply curve and the price ceiling line. Whereas the demand will be much higher (at the intersection of the demand curve and the price ceiling line) which will lead to a shortage of supply in the market.

Problems with Market Regulations

  • Reduced Trade Efficiency
    • An efficient outcome of a market is one where all trades which make both parties happy, get made.
    • If a trade which can happen which is prevented, it is an inefficient outcome. In case of a minimum wage, there are people who will be willing to work at an equilibrium minimum wage who are not getting jobs because of the government minimum wage.
  • Allocation problem
    • When there is an excess demand, who gets the limited supply which is available?
    • In the 1970s, the allocation was decided by lines - who waited in lines got the gas. This created more problems - waiting in line wasted gas and wasted peoples time (which can be used to increase productivity)

Advantages of Regulating the Market

NOTE: A binding regulation or intervention is one which actually forces a change in the market. If a price ceiling is above the equilibrium, it does nothing and is not binding.