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Markets and efficiency

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

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Markets and efficiency

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  1. Markets and efficiency Today: Why controlling the market is often bad for efficiency

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

  3. Current Isla Vista rental market • About $1400-$1500 per bedroom • About $700-$750 per person per month (assuming 2 people per bedroom)

  4. 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?

  5. 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

  6. 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

  7. 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

  8. 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.

  9. 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

  10. Long-run consequences of rent control ($100s) • 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 excess demand 30 15 (100s units)

  11. Long-run consequences of rent control ($100s) • 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 excess demand 30 15 100s units

  12. 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?

  13. 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.

  14. Elasticity and price control ($100s) • How does elasticity play a role in price controls? • We need to look at elasticity on both the supply and demand sides excess demand 30 15 100s units

  15. Elasticity and price control ($100s) • 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 excess demand 30 15 100s units

  16. Elasticity and price control ($100s) • 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 excess demand 30 15 100s units

  17. 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

  18. Price control and surplus • With lower consumption, total economic surplus goes down • One side of the market may make gains, however

  19. Price control and surplus • Equilibrium without price controls • Price: B • Quantity: Q1 • Consumer surplus: ΔABC • Producer surplus: ΔBCD • Total surplus: ΔACD

  20. Price ceiling at G • Quantity supplied: Q2 • Excess demand: Q3 – Q2 • Consumer surplus: Trapezoid AEFG (at most) • Producer surplus: ΔDFG

  21. Price ceiling at G • Total surplus is trapezoid ADFE (at most) • ΔCEF is potential surplus that is never gained

  22. Price ceiling at G • Are consumers better off with price controls? • Gain • Rectangle BGFH • Losses • ΔCEH • Queuing costs

  23. Price ceiling at G • Suppliers are worse off • Producer surplus falls to ΔDFG

  24. 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

  25. 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

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