It is a cardinal truth that, often in an economy, the outcomes of the unregulated market act against the public interests. In such a situation, people often seek the help of law and, resultantly, the government authorities intervenes in the process and control or fix the prices in the market. By imposing a price ceiling on certain products or services the government fixes the maximum price that can be charged for that product or services.
A ceiling is effective only when it is set below the price which would otherwise emerge as the equilibrium price in the market. A recent example of such ceiling is the fixation of the price of gasoline by the United States Government. The effect of price ceiling can be analyzed through a demand-supply diagram as above. DD and DD are the initial demand and supply curves respectively. The equilibrium price of gasoline (say) is P and the corresponding quantity is OQ. Let us assume that the demand increases and the demand curve DD shifts to the right to D`D`.
In case of a free market scenario, price will automatically increase to P` to maintain the equilibrium of demand and supply. However, if the government intervenes in the process and exercises some kind of ceiling, the price will not be permitted to rise above P. Clearly there will be an excess demand and the supply will fall short by the amount QQ`. Rent Control and its Effects In case of a price fixation, where the price for a commodity is fixed below the equilibrium level, market forces of demand and supply are not permitted to operate freely.
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Rent control is a unique example of such price fixation policy of government authorities in an economy. The best-known example of such price fixation is the ceiling imposed on the rents of houses in New York City by the United States government. This type of ceiling is used by the government authorities (especially in command economies) for rented houses. Rent control can prevent housing markets from reaching equilibrium in case when the rents are already set below the market equilibrium price.
Rent control limits the increase in monthly rental rates or establishes laws which are used to determine the ‘fair’ rents for housing. It keeps the rents lower than that would otherwise prevail in competitive market equilibrium. Such deliberate policy of controlling rents undoubtedly helps the lower-income groups of people who would otherwise have to spent a greater proportion of their income for renting houses. Figure 2: Room Rented in Thousands But it should be borne in mind that the policy of fixing the rents can often cause shortages in the supply of houses.
Suppose the market equilibrium rent per room in a certain city is $100, and at this rent, 4500 rooms are available. Now, let us assume that the local rent control ordinance impose a ceiling of $50 per room. Since the controlled rent is much below the market equilibrium rent, it would definitely create a shortage in the rooms available. As the price of rooms is now less, people would demand more rooms and, on the other hand, due to less profit, the land lords would be unwilling to provide much room.
From the above figure, it is clear that at $50 per room, the number of rooms demanded is 7000, while the number of rooms supplied is only 2000. Clearly the shortage arises from an increase in the number of rooms demanded from the quantity that would prevail at the equilibrium rent, and from a decrease in the quantity of houses supplied to a level below the quantity that would exist at the equilibrium level. Rent control makes the houses less expensive for the tenants.
To counter this policy, landlords decrease the quantity and often the quality of the rooms available which ultimately results in the shortage of rental houses. The only solution of such a crisis lies in some kind of non price allocation or rationing. Since the prices can not increase to ration a shortage during a ceiling period, some other means must be established to distribute available resources to those consumers who are willing and able to pay. Non-price rationing policy distributes the available resources on a basis other than willingness to pay.
There is a huge debate among the economists regarding this issue. Many people argue that non-price rationing gives the lower income group the opportunity to consume more of a product they would, otherwise, not been able to afford. While this is true in some cases, it should also be borne in mind that the lower income class is not always fortunate to obtain available supplies during a shortage period. A simple example of such rationing is a ‘first-come first-serve’ rule.
Available resources are distributed to those who are waiting in the queue. But people often choose not to buy the product or service if the gain they expect from it, is less than the price they have to pay plus the value of their time wasted and also the annoyance of waiting. Conclusion It is crystal clear from the above ideas that, in case of a price ceiling or rent control, there are always dissatisfied buyers, willing to pay more than the legal price to get the products or services they need.
In the long run, the market often transforms in to a zone of black marketing and illegal trading. It is beyond any iota of doubt that, the longer the period, the more destructive is the effects of ceiling; we have worst of both the worlds – higher price and smaller quantity.
- Block, W. Rent Control, The Concise Encyclopedia of Economics, The Library of Economics and Liberty,
- http://www. econlib. org/library/Enc/RentControl. html
- Hazlitt, H. What Rent Control Does, Economics in One Lesson
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