Question

Governments artificially keep minimum wage above equilibrium, and in some cases, keep rent payments below the market equilibrium. What are the ramifications of a too high minimum wage and a too low rent payment? Provide examples of the pros and cons of each scenario.  

Answer 1

When government sets minimum wage above equilibrium wage, there is less labor demanded at higher wage and more labor is supplied at higher wage. This causes a surplus to exist in market. This surplus denotes the unemployment caused a higher minimum wage.

The pros of this policy is that -

• It provides higher wages to the most lower section of the society who were previously earning the equilibrium wage and even lower. Hence increasing income of low income households.

The cons of a higher unemployment wage are -

• People who were previously employed at the wage of Wm, some of them will be unemployed because raising minimum wage to Wm has increased competition at that wage which drive some people to unemployment.
• Another con is that, higher minimum wages can attract teenagers (particularly the ones belonging to low income households) to drop out of school and take up jobs. This causes loss of more productive human capital.
• Another con and counter affect of the minimum wage is that this policy is targetted to reduce poverty. However unemployment increases due to minimum wages can drive out the lowest of unskilled workers out of the market with no scope for experience or skill development. This can drive them to extreme poverty.

When government imposes a maximum wage below equilibrium, at a lower rent more is demanded while less is supplied. This causes shortage in the market.

The pros of this policy are -

• A lower rent makes hosuing affordable for many. The short run pro is a decrease in rent.

The cons of the policy are -

• In the short run, number of rentable houses are fixed and supply in perfectly inelastic, while demand is more elastic. In the short run, there is some shortage of housing as demand is increasing which can lead to people sharing rooms.
• The main con of a binding price ceiling on rent is that in the long run, supply of housing no longer remains inelastic. Lower rents make landlords reluctant about maintaining good rentable rooms and increasing quantity of apartments in the future. While lower rents make demand more elastic and more people (like students, migrants living together) look for new housing. This creates a large shortage of housing in the long run.