Answer to Question #244878 in Microeconomics for Biba

Question

6. A conservative critic of government programs has written, “Governments know how to do one thing well. They
know how to create shortages and surpluses.” Explain this quotation using examples like the minimum wage or interest-rate ceilings. Show graphically that if the demand for unskilled workers is price- elastic, a minimum wage will decrease the total earnings (wage times
quantity demanded of labor) of unskilled workers.

Answer 1

Yes. Government can create shortage and surplus using ceiling and floors on prices. Price ceiling will create shortage and price floors create surpluses.

Consider the case of interest rate market, in the below diagram as an example for price ceiling. Observe that the ceiling has created an increase in demand and decrease in supply, in a way creating a shortage.

Shortage would imply shortage of money for borrowing.

An example of a minimum floor would be a minimum wage demonstrated in the below graph. Here, the min is set at Wmin where the supply of labor is higher than that of demand. Hence, there is surplus of resources.

Consider the above graph where the total earnings are given by the rectangles drawn from the origin to M and E. the rectangle drawn to E (in light blue) has a smaller area than that of the rectangle drawn to M (in light pink). This shows that total earnings at the minimum wage in this price-elastic case are lower than that at the market wage.