Markets and efficiency

Today: Why controlling the market is often bad for

efficiency

Rent control in Isla Vista

Who thinks it is a good idea? Why? Who thinks it is a bad idea? Why?

Current Isla Vista rental market About $1400-$1500 per bedroom About $700-$750 per person per month

(assuming 2 people per bedroom)

Rent control in Isla Vista

Suppose that rent control was implemented in Isla Vista, at $1500 per month for a 2-bedroom apartment

Who currently lives in I.V.? Who would want to live in I.V. if

rent control was passed?

Outcome

More people want to live in I.V. than apartments are available

This, by itself, will lead to a shortage of apartments in I.V.

Some of you will be very unhappy that you cannot live in the home of first choice

What will managers do? Apartment managers

will know that a flood of applications will come in for leases starting in June and September

They will be able to pick and choose who lives in their apartments

What will managers do?

Other methods can be used to choose tenants Increased credit requirements Increased deposits Increased application fees Reduced amenities (low quality carpet,

infrequent painting and maintenance) (Illegally) accept bribes

What will happen over time? Nobody will want to build new

apartments for rent, lowering the long-run supply

Some apartments may convert to vacation condos if short-term rentals are not included in rent-control law

More grad students, post-docs, faculty, and staff will likely live in I.V.

But wait!

Don’t I have a right to live in I.V.? No

Unless the government steps in once again, rent control will lead to a sizable excess demand

Long-run consequences of rent control Suppose that the

long-run equilibrium of 2-bedroom apartments in I.V. is $3,000 per month rent, and 2,000 units rented

With rent control of $1,500/month, we see excess demand

($100s)

(100s units)

15

30excess demand

Long-run consequences of rent control Notice that

supplied apartments for rent are cut in half in the long run with rent control

Only 1/3 of the people that want apartments will get them

($100s)

100s units

15

30excess demand

Let’s survey the class again

Rent control in Isla Vista Who thinks it is a good idea? Why? Who thinks it is a bad idea? Why?

Rent control summary

Who wins? People renting in I.V. w/rent control

(maybe) Who loses?

People who want to live in I.V. w/o rent control but are unable to find an apartment

Apartment owners and managers Some people currently renting in I.V.

Elasticity and price control How does

elasticity play a role in price controls?

We need to look at elasticity on both the supply and demand sides

($100s)

100s units

15

30excess demand

Elasticity and price control Demand

Q, 20 30 (↑50%) P, 30 15 (↓50%) ε = %ΔQ / %ΔP = 1

Supply Q, 20 10 (↓50%) P, 30 15 (↓50%) ε = %ΔQ / %ΔP = 1

($100s)

100s units

15

30excess demand

Elasticity and price control When both price

elasticity of supply and demand are 1, a price control 50% below the equilibrium price leads to an excess demand equal to the initial equilibrium quantity

($100s)

100s units

15

30excess demand

Elasticity and price control What if each elasticity is smaller

than in my example? What if excess demand in I.V.

apartments is only 200 units instead of 2,000 units?

None of the arguments change, although the severity may decrease some

Price control and surplus

With lower consumption, total economic surplus goes down

One side of the market may make gains, however

Price control and surplus Equilibrium without

price controls Price: B Quantity: Q1 Consumer surplus:

ΔABC Producer surplus:

ΔBCD Total surplus: ΔACD

Price ceiling at G Quantity supplied:

Q2 Excess demand:

Q3 – Q2 Consumer

surplus: Trapezoid AEFG (at most)

Producer surplus: ΔDFG

Price ceiling at G Total surplus is

trapezoid ADFE (at most)

ΔCEF is potential surplus that is never gained

Price ceiling at G Are consumers

better off with price controls?

Gain Rectangle BGFH

Losses ΔCEH Queuing costs

Price ceiling at G Suppliers are

worse off Producer surplus

falls to ΔDFG

Summary/Other ideas A price ceiling, such as rent control,

is an ineffective means of providing low-cost rent to those that want it

Maybe there is another way of achieving a goal of low rent

Two possible ways of doing this Subsidies to students that rent First-come, first-served policy

For Wednesday

Think about whether or not subsidies or a first-come, first-served policy could be more efficient than rent control

Read pages 197-199