Chapter 6/8 – Price Controls and Taxes
- Enacted when policy makers 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
- A legal maximum on the price at which a good can be sold.
- It is only effective if set below equilibrium price, where it will lead to a shortage. Above
equilibrium price, it will have no effect (not binding).
Example: Rent Control
The government’s goal is to help the poor by making housing more affordable. It sets a maximum rent
for housing that is below equilibrium price.
In the short run, the number of apartments is fixed, so Supply of housing is inelastic. Demand for
housing in the short run is relatively inelastic.
In the 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 inelastic. Low rents encourage people to look
for housing, so Demand is elastic.
In the long run, the housing
shortage is large. Where rent
controls exist, landlord must
- Waiting lists
- Converting apartments to
condominiums. Numerical Example:
The equations for demand and supply for 1-bedroom apartments in Glanbrook are:
Qd = 1700 – 2P
Qs = 2P – 900
Therefore P = 650 at equilibrium.
Qd = 1700 – 2(650) = 400 = Qs =
What if the province imposes a rent
If P = 500,
Qd = 1700 – 2(500) = 700
Qs= 2(500) – 900 = 100
Shortage = Qd – Qs = 600
Price Ceilings Lead To
- Shortages that worsen over time
- Inefficient allocation to consumers
o People who want the good badly may not get it while those who care less do
- Wasted resources
o A lot of time can be spent trying to find an apartment
- Inefficiently low quality
o No incentive for landlords to keep up apartments if they have to rent cheaply.
Example: “I’ll rent you an apartment if you slip me an extra $500 a month under the table.”