Effects of Government Regulation on Demand and Supply

A government can impose various restrictions that will lead to an imbalance in the quantity and price equilibrium resulting in a deadweight loss.

These interventions include:

A price ceiling is the highest price at which it is legal to trade a particular good or service.

Assume that the demand and supply of housing determines the equilibrium rent of $550 a month and the equilibrium quantity of 4,000 units of housing.

The following graph shows the efficient housing market with maximum consumer and producer surplus.

Suppose the government imposes a rent ceiling of $400 per month which is below the equilibrium price. As a result the following changes happen.

Rent ceiling restricts quantity supplied. Supplied quantity is 3000 and quantity demanded is 6000. Shortage of 3000 units.
Rent ceiling creates a black market. Some people will be willing to pay $625 per month for a house.
Resources get used in costly search activity including both time and cost.
A dead weight loss arises.

A price floor makes it illegal to pay a price lower than a specified level. An example of price floor is minimum wage.

Let’s say the equilibrium wage rate per hour is $5 at the equilibrium quantity of 5000 workers.

Minimum wage is imposed at $7 per hour. The graph will change as follows:

The minimum wage restricts the quantity demanded by the firms. At $7 per hour, only 3000 jobs are available.
People will find it hard to find jobs, and some people will be willing to take a job at lower rate. Someone will be ready to take a job at $3 per hour also. Illegal wage rates will range from $3 to below $7.