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Econ 1B03 Chapter 6&8 Part 1.docx

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McMaster University
Hannah Holmes

Richard Damra Monday, February 11, 2013 Econ 1B03 – Chapter 6&8 – Supply, Demand & Government Policies Chapter 6  Recall: In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.  While equilibrium conditions may be efficient, it may be the case that not everyone in society is satisfied and the government may want to get involved.  Now we’ll look at government policies and how they affect supply and demand. Price Controls  Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.  The government will freeze prices at a predetermined level that they feel will make members of society better off Price Ceilings  Price Ceiling: A legal maximum on the price at which a good can be sold.  The price ceiling is not binding (not effective) if it is set above equilibrium price.  The ceiling is binding (effective) if set below equilibrium price, leading to shortage  Example: Rent control o The government’s goal: to help the poor by making housing more affordable. o It sets a maximum price (rent) for housing that is below equilibrium price.  In the SR (Short run), the number of apartments is fixed, so Supply of housing is inelastic.  Potential renters may not be highly responsive to rents because they take time to adjust their housing arrangements (eg. Give notice to current landlord), so Demand for housing in the SR is really inelastic.  Rent Control in SR: o o Rent ceiling has to be set below equilibrium price Richard Damra Monday, February 11, 2013 o Supply is fixed, Quantity demanded increased because of price drop, but with a limited amount of houses, there is a shortage.  In the LR (Long Run), low rents can mean that landlords may convert to condos, get out of the rental business and/or won’t maintain existing apartments, so Supply is Elastic.  Low rents encourage people to look for housing (move out from your parents if the price is right), so Demand is elastic.  Rent Control in LR: o o Rent control is below equilibrium price, therefore binding. Supply has decreased in the long run because everyone can respond more to the change in price thus resulting in a bigger shortage than in the SR. The DWL = combination of consumer and producer surplus could’ve enjoyed if we were at equilibrium but we’re not because of government. o Can’t get surplus if you can’t buy or sell something  In the LR, the housing shortage is large.  Where rent control exists, landlords must resort to non price rationing of housing. o Landlords can keep long waiting lists. o Can discriminate(no kids, no pets..etc) o Some take bribes (key money). o Some may convert existing apartments to condos. Numerical Example  The equations for demand and supply for 1-bedroom apartments in Glanbrook are: o Qd = 1700 – 2P o Qs = 2P – 900  What is equilibrium rental price and apartments rented? o In equilibrium Qd = Qs o 1700 – 2P = 2P – 900 o P = $650, Qd = 400 = Qe (equilibrium quantity)  What if the province imposes a rent ceiling of $500? – There is going to be a shortage o If P = 500, Qd = 1700 – 2(500) = 700 o Qs = 2(500) – 900 = 100 Richard Damra Monday, February 11, 2013 o Shortage = Qd – Qs = 700 – 100 = 600 apartments  Price Ceilings Can Lead To  Shortages that can worsen over time.  Inefficient allocation to consumers o Those want the good badl
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