What this lesson teaches
I can describe taxes, subsidies, price controls and quotas as ways a government intervenes in a market.
Syllabus 9570, 2.1.3(a). Government Intervention in Markets: Governments may intervene in markets in the form of taxes, subsidies, price controls (maximum and minimum prices) and quantity controls (quotas)
Make a guess
A good harvest is about to push the coffee price below the floor that a buffer stock agency defends. What does the agency do?
- Lowers the floor for this year, because a large harvest has to sell somehow.
- Buys coffee and stores it, so the price stays at the floor.
- Sells coffee from its store, so that farmers earn more from the higher supply.
Show the answer
Buys coffee and stores it, so the price stays at the floor.
Buying adds to demand and takes coffee off the market, so the price is held up at the floor.
A minimum wage is a price floor for labour. A buffer stock buys and sells a crop to keep its price within a band.
A minimum wage is a minimum price in the labour market. If it is set above the equilibrium wage, employers demand less labour (Ld), while more people want to work (Ls). The gap is unemployment caused by the floor.
How many jobs are lost depends on the wage elasticity of demand for labour. If firms can easily replace workers with machines, or wages are a large share of costs, many jobs go. If demand is inelastic, most workers keep their jobs and earn more.
Singapore has no general minimum wage. Its Progressive Wage Model sets wage ladders for particular jobs, such as cleaning and security, tied to training and higher productivity.
A buffer stock scheme aims to keep the price of a crop, such as rice or coffee, within a band. When a good harvest would push the price below the floor, an agency buys the crop and stores it. When a poor harvest would push the price above the ceiling, it sells from its store.
Buffer stocks smooth prices and farm incomes. But storage is costly, some crops spoil, and if the floor is set too high the agency keeps buying, so the stock and the cost grow every year. The International Tin Council's buffer stock ran out of money in 1985 after years of buying to hold the tin price up.
- Minimum wage above equilibrium
- Ls exceeds Ld, so there is unemployment; how much depends on the wage elasticity of demand for labour.
- Buffer stock
- Buy and store when the price would fall below the floor; sell when it would rise above the ceiling.
Worked example: A buffer stock for rice
An agency keeps the rice price between $5 and $7 a kilogram. A bumper harvest would push the price down to $4; a drought would push it up to $9.
- Bumper harvest: the agency buys rice until the price rises back to $5, and stores it.
- Drought: the agency sells from its store, adding to supply, until the price falls back to $7.
- If good harvests outnumber bad ones, the store keeps growing, and so do storage and spoilage costs.
Watch out for this
A minimum wage always helps low-paid workers.
Workers who keep their jobs earn more. But if the wage is set above equilibrium, some lose their jobs or are never hired. How many depends on the wage elasticity of demand for labour.
Check your understanding
A minimum wage is set above the equilibrium wage, and machines can easily replace these workers. What is the likely result?
- Employment is unchanged, because firms still need the same number of workers.
- Employment rises, because the higher pay draws more people into work.
- Employment falls a lot, because demand for these workers is wage elastic.
Show the answer
Employment falls a lot, because demand for these workers is wage elastic.
Right. When machines are a close substitute, a higher wage makes firms switch, so many jobs are lost.