Answer to Question #186756 in Microeconomics for Yassar Mehdi

Question

Illustrate when a government intervenes in a competitive labor market to change the unfair

outcome of the market determined wages by taking the policy of price Floor under binding

constraint. Also evaluate the adverse effects for labor market of this policy.

Answer 1

When a price floor is imposed by some government, it is for the overall wellbeing by setting a higher wage below which a producer cannot go. 

When a price floor is imposed by the government, it is mostly with an intention to correct the situation of the market. This can be because the wages are too low for the well-being of the workforce and this policy of price floor works to put a higher wage bar. 

Under this policy, a wage bar is set over the one that is currently existing. This bar will raise the wages of the workers. This raised wage will now create a situation where suddenly more people start looking for jobs thus, the supply of employees will be higher than before. However, employers cannot afford to employ so many new people and this will create a situation of a "surplus" of workers. Eventually, this will reduce the surplus that consumers used to enjoy because of the prices being higher. These higher prices will show their adverse effects by reducing the consumer's capacity to purchase.They reduce or completely stop their demand for the commodity. This will adversely impact the surplus of the sellers too and create a deadweight loss. 

To show on a graph, 

In this graph, the original condition was at E with Q workers at a wage of W. But with the price floor, the wages have gone up. 

Now, Q1 is the labor demanded by the producers and Q2 is the supply of labor. The area between Q1 and Q2 is the excess of supply. 

The result is the deadweight loss of area AEB.