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Chapter 4

Economics 1021A Chapter 4


Department
Economics
Course Code
ECON 1021A/B
Professor
Terry Biggs
Chapter
4

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Economics 1021A Chapter 6 2013-10-19
A price ceiling or price cap is a regulation that makes it illegal to charge a price higher than a
specified level.
When a price ceiling is applied to a housing market it is called a rent ceiling.
If the rent ceiling is set above the equilibrium rent, it has no effect. The market works as if there were no
ceiling.
But if the rent ceiling is set below the equilibrium rent, it has powerful effects.
At the rent ceiling, the quantity of housing demanded exceeds the quantity supplied. There is a shortage of
housing.
Because the legal price cannot eliminate the shortage, other mechanisms operate:
Increased search activity
The time spent looking for someone with whom to do business is called search activity.
When a price is regulated and there is a shortage, search activity increases.
Search activity is costly and the opportunity cost of housing equals its rent (a regulated price) plus the
opportunity cost of the search activity.
A black market
A black market is an illegal market that operates alongside a legal market in which a price ceiling or
other restriction has been imposed.
A shortage of housing creates a black market in housing.
Illegal arrangements are made between renters and landlords at rents above the rent ceiling—and
generally above what the rent would have been in an unregulated market.
A rent ceiling set below the equilibrium rent leads to an inefficient underproduction of housing services.
The marginal social benefit from housing services exceeds its marginal social cost and a deadweight loss
arises.
A rent ceiling decreases the quantity of housing supplied to less than the efficient quantity. A deadweight
loss arises, producer surplus shrinks, consumer surplus shrinks.
There is a potential loss from increased search activity.
Fairness
According to the fair rules view, a rent ceiling is unfair because it does not allow for equality of opportunity
(equal access).
According to the fair results view, a rent ceiling is unfair because it does not generally benefit the poor.
A rent ceiling decreases the quantity of housing and the scarce housing is allocated by:
Lottery
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