Hill – Mankiw 9th Edn Chapter 6: Supply, Demand, and Government Policies
Mankiw, N. G. (2021) Principles of microeconomics (9th ed.)
Principles of economics (9th ed.)
Mason, OH: South-Western Cengage Learning.
University of New Brunswick, Saint John campus
Saint John, New Brunswick, Canada
Chapter 6 – Supply, Demand, and Government Policies
Here are some things to consider when reading this chapter.
- Knowledge and value judgements
Supply and demand are used to examine the effects of various government policies. Mankiw writes: “Policies often have effects that their architects did not intend or anticipate” (p. 109).
If the supply and demand model is appropriate to analyse a policy, do government policy makers really not have knowledge of or access to such an analysis? Or is the positive economic analysis using this model missing something? Could Mankiw’s remark give the student an idea that just a few chapters into the book they understand economics better than the government policy makers?
Yet, even if the model’s predictions are accurate, a value judgement is required to determine what policy is appropriate. In every case, some people are made better off after the policy is enacted, while others are worse off. If economists are said to oppose particular policies, what value judgements are they making? If policy makers implement those policies, what different value judgements are they making?
- “The rhetoric of economics texts”
This is the title of an article by American economist David George, who pointed out the importance of understanding how textbook authors attempt to persuade. Words can be chosen to convey an attitude that the reader is invited to share. For example, in this chapter (and in Chapters 8 and 9) Mankiw describes how governments “impose” policies from price controls to taxes and tariffs.
A standard definition of “to impose” is “to force (something unwelcome or unfamiliar) to be accepted or put in place” (from Oxford Languages via Google). As David George remarks, the “authoritarian flavor of the word suggests that its application to taxation antedates popular government. It is also noteworthy that businesses are never described as imposing prices upon their customers” (1990, p. 866). More neutral language is available. Governments enact regulations and set tax rates, for example.
Similarly, the word “burden” is used about 95 times in the book in referring to “the tax burden” and who bears it. A burden is defined as “a load, typically a heavy one” (Oxford Languages). George writes that the term “has come to symbolize the onerousness of taxes.… Once again we find the private sector receiving different treatment. One never encounters reference to the ‘burden of costs’ when studying the theory of the firm for the household” (1990, p. 867).
Again, neutral language is available. For example, instead of asking “who actually bears the burden of the tax” (p. 119), Mankiw could write “who actually pays the tax?”
- Price ceilings and dealing with shortages
The text explains that when a market is an equilibrium “anyone who wants to pay the market price” can get the product. “Free markets ration goods with prices” (p. 111). One could also say that “anyone who is willing and able to pay the market price” gets to buy the good. This emphasizes that demand depends not just on tastes but also on the ability to pay. If the distribution of income after taxes and cash transfers leaves some people unable to afford certain necessities, price ceilings are one way to try to deal with the problem.
The text describes describe various unappealing rationing mechanisms (time wasting lineups, unfair discrimination by sellers). It fails to note one of the most notable examples in US history: the price ceilings set on many goods during World War II and the system of rationing established to try to share the shortages equitably across all households. (See the brief description here.)
- An alternative view of rent controls
(i) The rent control illustrated in this chapter is a caricature of actual rules and regulations on rents.
Actual rent controls are typically more sophisticated to avoid the kind of problems that could arise with the crude rent control Mankiw examines in which rents are held at a fixed price indefinitely. For example, rent controls in the state of Oregon introduced in 2019 include the following features: (a) no rent increases during the first year of a tenancy; (b) after the first year of tenancy, eviction is permitted only with cause; (c) rent increases are limited to a maximum of 7 percent + the annual inflation rate; (d) if a renter voluntarily vacates, there are no restrictions on the new rent that can be charged; (e) controls on rent increases do not apply to new construction for the first 15 years. (Details are available here. A summary of rent control laws by US state is available here.) In short, the effects of regulations in the rental market depend on the specific details of the policy.
(ii) Why are many economists and textbooks, including Mankiw’s, so negative about rent controls?
Urban economist Richard Arnott suggests two reasons. “The first is ideological. The debate over rent control has been a battleground between those who believe in the free market and those who do not. The echoes of the debate carry over to other policy arenas where its resolution has far more quantitative import” (Arnott 1995, p. 112), who might be referring to minimum wages, examined in the next section.
The second reason is methodological differences about whether the perfectly competitive model can be used to analyse rental markets. An important feature of perfectly competitive markets is that buyers face no cost of switching between sellers should a seller attempt to raise its price above the market price. In contrast, rental markets have no unique market price because apartments vary in size, quality, and location. Searching for new accommodation is costly, as is moving. Economists call these features ‘frictions’, in contrast with the frictionless perfectly competitive market. Even if there are many buyers and sellers, these frictions give landlords the power to raise prices above what would otherwise be competitive levels.
According to Arnott, most housing economists believe that these features are too important to be ignored in practice. Since the mid-1980s most of them have begun to use non-competitive models that emphasize search costs and the importance of contracts. Because of this different perspective, they are much less critical of rent control. Arnott conjectures: “Perhaps a majority, at least among the younger generation, would agree with the statement that a well-designed rent control program can be beneficial” (Arnott 1995, p. 112).
- An alternative view of minimum wages
(i) Is perfect competition the best model of the labour market when analysing minimum wages?
Minimum wages are used as an example of a price floor that results in a surplus in the market. It’s analysed using a supply and demand diagram that “shows the labor market, which, like all markets, is subject to the forces of supply and demand” (p. 115, my emphasis). The wording invites the student to think that the supply and demand model is not just a possible model of the labour market, but that it actually describes the labour market. Further, it is asserted that all markets can be treated in this way.
In 2001, American labour economist Allan Krueger wrote: “The use of the minimum wage is indicative of a more general tendency in introductory economics classes to teach economics as a settled science, as a set of established and universally accepted principles that govern how the economy works. Yet this is not the way most economic research is done in practice, and it does not characterize the way economists approach their field” (2001, p. 244).
Instead, he thought that economists should “explain the limitations of their models, teach the research methods and findings that have been used to establish (and reject) their core principles, and seek to provide students with an understanding of which models work best in which circumstances and why”, as other scientific disciplines do (2001, p. 243).
The labour market, like the rental market, is characterized by frictions. In the same way that landlords have the power to set rents, so too do employers set wages. With imperfect information, workers face costs in searching for a new job and experience a variety of costs if they quit their existing job (e.g., loss of the value of skills specific to that workplace, loss of social contacts, possibly greater commuting costs). The critical question is whether these frictions are of major or minor importance. That can determine which model is most appropriate – the competitive model or a monopsony model that incorporates employer’s ability to set wages. (Chapter 18 examines labour markets in more detail and acknowledges the existence of monopsonistic power but claims that it is rare. The Commentary for that chapter examines that claim.)
(ii) Predictions of the effects of minimum wages: evidence
The supply and demand model predicts that a minimum wage above the market equilibrium wage leads to a labour surplus described as “unemployment.” Recall that the labour supply curve shows how many hours of work workers would like to supply at each possible equilibrium market wage. If fewer hours are employed, this is not necessarily reflected in an increase in measured unemployment (i.e., people without work actively seeking it). Some workers could remain employed but with fewer hours than they would wish (termed ‘underemployment’), or they might choose a different activity, such as pursuing further education or training.
Mankiw writes that teenagers are more affected than most because of their relative lack of skill and experience. “Many economists have studied how minimum-wage laws affect the teenage labor market. These researchers compare the changes in the minimum wage over time with the changes in teenage employment. Although there is some debate about the effects of minimum wages, the typical study finds that a 10 percent increase in the minimum wage depresses teenage employment by 1 to 3 percent” (p. 116). No source is given.
Krueger, writing in 2001, quotes a paragraph from Mankiw’s 1997 edition that is almost identical to the one given above. The 1997 version said there was debate about how much the minimum wage decreased employment; the current version, if read carefully, is consistent with some researchers finding no effect or even a positive effect. However, the supply and demand model used would likely rule out such possibilities in the reader’s mind. Krueger remarks that Mankiw and other textbook authors miss the opportunity to give students an example of how economists investigate this question and how theory and empirical work are interconnected.
The source of the “1 to 3 percent”? Krueger traces it back to a 1982 survey of studies, which concluded that about 1 percent was the better estimate. Since that time, the estimates of the effects of minimum wages have become ever smaller (Krueger 2001, p. 247). In his 1995 book with David Card, Myth and Measurement: The New Economics of the Minimum Wage, they present a wide variety of evidence using ‘natural experiments’, a method Mankiw does not mention. These are situations where, for example, the minimum wage changes in one jurisdiction but not in neighbouring jurisdictions, permitting comparisons where many other factors that could affect employment are similar. These showed that increases in minimum wages were not associated with noticeable declines in employment. Such results are not consistent with the textbook assumption of perfectly competitive labour markets but are consistent with models of monopsonistic power on the part of employers.
The persistence of such evidence is probably the reason behind the response of the experts that Mankiw gives (p. 117). When asked in 2015 whether they agreed with the statement, “If the federal minimum wage is raised gradually to $15-per-hour by 2020, the employment rate for low-wage U.S. workers will be substantially lower than it would be under the status quo”, only 34 percent agreed, while 29 percent disagreed and 37 percent were uncertain. This division of opinion hardly supports the strong prediction of the supply and demand model, but Mankiw makes no comment about it.
Arnott, Richard (1995) “Time for revisionism on rent control?”, Journal of Economic Perspectives, 9: 99–120.
Card, David, and Alan Krueger (1995) Myth and Measurement: The New Economics of the Minimum Wage, Princeton University Press.
George, David (1990) “The rhetoric of economics texts”, Journal of Economic Issues, 24(3): 861-78.
Krueger, Alan (2001) “Teaching the minimum wage in Econ 101 in light of the new economics of the minimum wage”, Journal of Economic Education, 32: 243–58.