Why would governments act to establish a binding price ceiling in the market for rental accommodation?
A binding price ceiling occurs when the state or the government sets the price of a product below the equilibrium price in a free market (Bergin 2005, p. 46). Binding price ceilings are used by governments to encourage the consumption of essential goods and services. Thus, the government of the UK uses binding price ceilings in the rental accommodation market to enable the citizens, especially, the poor to afford accommodation.
Describe using diagrams where appropriate, the market for rental accommodation before and after the introduction of rent controls. Illustrate the surpluses accumulating to producers and consumers before and after the introduction of the price ceiling
Before the introduction of the binding price ceiling, the equilibrium price (rent) and the number of houses will be determined by the forces of demand and supply. This can be illustrated in figure 1. The market equilibrium occurs at point A. Thus, Q0 and P0 are the equilibrium quantity of houses and rent respectively. Consumer surplus occurs when the actual price of a product is less than the highest price that consumers are willing to pay (Nicholin & Snyder 2011, p. 56).
Thus, before the introduction of the price ceiling, the consumer’s surplus will be point B in figure 1. Producer’s surplus occurs when the actual price of a product is more than the least price that producers are willing to sell their products. Thus, point C is the producer’s surplus. Figure 2 illustrates the change in the market after the introduction of binding price ceilings. The rent will reduce from P0 to P1. Similarly, the number of available houses will reduce from Q0 to Q1. Point E and F are the consumer and producer surpluses respectively.
How does a ‘black market’ operate, using diagrams where appropriate, in a regulated rental market? Who benefits and who loses from its operations?
A black market for rental accommodation operates outside the legal or the formal one (Mandel 2007, p. 89). In figure 3, the binding price ceiling causes a reduction in the number of houses available for renting from Q0 to Q1. The quantity of houses demand, on the other hand, increases to Q3. Since the prices are fixed by the government, the supply of houses can not easily adjust to the quantity demanded.
However, in the black market, the rent can be increased illegally by owners of apartments. Thus, if the rent is increased from the binding price ceiling, P1 to P2, the number of houses supplied will increase from Q1 to Q2. Additionally, the number of houses demanded will decrease from Q3 to Q4. In a nutshell, black market operations lead to an increase in prices and quantity supplied, as well as, a decrease in quantity demanded. Thus, consumers lose by paying high rent. The government also loses since black-market activities are not taxed. The owners of apartments will benefit by charging higher rent.
What other problems arise with the introduction of rent controls? Discus, using diagrams where appropriate, two such problems, one on the demand side of the market and one on the supply side of the market
On the supply side, a binding price ceiling will cause a shortage of houses in the market (Mankiw 2011, p. 78). This is because the binding price ceiling reduces the profits of apartment owners. Thus, property developers respond by either stopping to construct new apartments or reducing the number of apartments they construct in a year. On the demand side, there will be a problem with rationing due to the shortage of houses.
The demerits of rationing include long waiting lists and discrimination of renters. Additionally, renters might be forced to bribe property agents to find houses. The supply and demand-side problems are illustrated in figure 4. In the short run (figure 4a), the demand and supply for apartments are relatively inelastic. Thus, the shortage of housing is small. However, in the long-run (figure 4b), the demand and supply for apartments tend to be more elastic. Consequently, the shortage is very large.
Discuss in detail one non-price technique of allocation that the government could introduce in an attempt to achieve equity and one for administrative efficiency in the now regulated market
The shortage caused by the binding price ceiling can cause inequality in accessing rental apartments. Additionally, the binding price ceiling makes apartment owners worse off by reducing their income. Thus, the government can enhance equity by giving subsidies to owners of apartments (Cowell 2006, p. 66). The subsidies will compensate the owners of the apartments for the income lost due to the binding price ceiling. This will encourage the construction of more apartments in response to the high demand. Thus, inequality in accessing rental apartments will reduce.
In a controlled market, administrative efficiency can be achieved through a first come first served allocation technique. In this case, a waiting list will be used to allocate the available houses to the renters.
Discuss 2 options that are open to the owners of rental property (landlords) to choose a renter in the absence of a government method of allocation
First, the landlords can use the price mechanism to choose a renter. For instance, a landlord who is targeting the high-income earners can charge high rent. The high rent will discourage low-income earners from renting the property. Thus, the property will be available only to high-income earners. Second, the landlords can use product differentiation to choose a renter. For instance, the landlord can furnish his apartment to serve renters who are interested in furnished apartments.
Describe how one of these solutions operates and what advantage it has over the other technique
The price mechanism operates by performing their functions. First, it performs the signaling role (Tewari 2003, p. 83). In this case, the increase and decrease in prices is a reflection of scarcity and surpluses in the market. Second, prices enable consumers to express their preferences. Finally, prices are used by producers to ration products that are in short supply. Thus, landlords can use prices to ration the availability of houses. The advantage of the price mechanism over product differentiation is that it is easy and cheap to implement. Product differentiation is difficult to implement since it might not be easy to modify the houses after construction.
Bergin, J 2005, Microeconomics Theory, Cengage Learning, New York.
Cowell, F 2006, Microeconomics, McGraw-Hill, New York.
Mandel, R 2007, Microeconomics Theory, John Wiley and Sons, New York.
Mankiw, G 2011, Principles of Microeconomics, McGraw-Hill, New York.
Nicholin, W & Snyder, Microeconomics Theory, Sage, London.
Tewari, D 2003, Principles of Microeconomics, Routledge, New York.