Krugman and Wells Chapter 5OverviewRent control: Santa Monica 1998Price controlsPrice ceiling example: rent controlPrice ceiling example: rent controlPrice ceiling example: rent controlPrice ceiling example: rent control Price ceiling example: rent controlPrice ceiling example: rent controlPrice ceiling example: rent controlSo why price ceilings/rent controls?Rent control: Santa Monica 1998Price floor example: butterPrice floor example: butterPrice floor example: butterAnd just to be clearPrice floor example: butterSo why price floors?And to explain it one last way…Quantity ControlsSlide Number 22Quantity ControlsQuantity control: taxi medallionsQuantity control: taxi medallionsQuantity control: taxi medallionsSo why quantity controls?Applying this to liquor licensesSummaryKrugman and Wells Chapter 5 Steven J. Haider EC201 Spring 2015p2 Overview  Chap. 3: how competitive markets work  Chap. 4: measuring the benefits from markets  This chapter: we examine two types of market interventions  Price controls (floors and ceilings)  Quantity controls  Both will lead to reductions in surplus/inefficient outcomes Caution: we’re now using chapters 3 and 4 material. Please keep up with the homework problems or the lectures will not make sense!p3  Rent controls  Location, location, location  $700/month, but worth $1400/month  Other facts  $2000 showing fee  Changes in 1/99, and 2 available in 6/98  3 interviews  Neighbors  Keep apartment when moving?  Long-term elderly occupants Rent control: Santa Monica 1998p4 Price controls  Price ceiling: a restriction on the maximum price allowed  Example: rent control Example: wage controls during WW II (gave rise to firm-provided health insurance)  Price floor: a restriction on the minimum price allowed  Example: minimum wage (the price of labor in the labor market) Example: some agricultural programs (guaranteed price on a commodity) Both of these actions are market interventions, perhaps with certain intended consequences. With our models, we can predict consequences more generally…p5 Price ceiling example: rent control  If the market were competitive, we would expect the equilibrium price/quantity: $1000/month and 2.0m unitsp6 Price ceiling example: rent control  Suppose price ceiling of $800/month  At $800/month, quantity supplied is 1.8m and the quantity demanded is 2.2m  Although there is excess demand at this price, the price cannot increase because of the price ceiling  Predicted outcome: $800/month and 1.8m units transacted  There is housing shortage of 400,000 (not 200,000)  Outcome is determined by the supply curvep7 Price ceiling example: rent control  Suppose a price ceiling of $1200/month  Predicted outcome: $1000/month and 2.0m units  Why? Price wants to be where S=D, and the ceiling doesn’t keep us from there  This price ceiling is not bindingp8 Price ceiling example: rent control  Other effects: inefficiently low quantity  Competitive equilibrium is efficient—so price ceiling causes too few apartments to be transacted Deadweight loss: the loss of total surplus due to a market intervention  Deadweight loss is the yellow trianglep9 Price ceiling example: rent control  Other effects: inefficient allocation to consumers  There may be someone holding on to an $800 apartment who values the apartment at $850, with someone not in an apartment (the shortage) who would value it at $1100p10 Price ceiling example: rent control  Other effects: other distributional issues  Winner: individuals who pay $800 rather than $1000  Losers: (a) sellers who receive $800 rather than $1000; (b) seller who receive zero/don’t produce rather than $1000; (c) buyers who don’t rent rather than rent at $1000p11 Price ceiling example: rent control  Other effects: wasted resources  There are 400,000 extra people chasing the apartments: how are they allocated? Standing in line?  Other effects: inefficiently low quality  With such excess demand, little incentive to upkeep the apartment  (Incentive is there, but a little outside our model)  Other effects: black markets  Side payments / “finders fees”  Other effects: reduced costs to discrimination  In equilibrium, it can be costly to withhold apartment from “the wrong type”  With a waiting line of 400,000, one can be choosy….p12 So why price ceilings/rent controls?  We’ve discussed a lot of potential negative effects  Persistent shortage  Inefficiencies  Black market/illegal activities/wasted activities  Possible explanations  People do not understand economics (“unintended” vs. “unexpected” consequences)  Perhaps there are strong beliefs that the market is not competitive  Example: maybe there are few landlords who control market  “Insiders”, who benefit from the low rents, have political power  People who already live in the area pay low rents and vote  The lower rent for “insiders” is seen as fair  Imagine someone who has lived someplace for 30 years—cannot afford to stay with rents sky-rocketing  The policy might promote a more diverse community  A community might want to retain lower-income individuals (diversity in race, diversity in occupation) Constructing “appropriate” policy requires the consideration of all these factorsp13  Rent controls  Location, location, location  $700/month, but worth $1400/month  Other facts  $2000 showing fee  Changes January 1999  2 apartments available in June 1998  3 interviews  Neighbors  Keep apartment?  Long-term elderly occupants Rent control: Santa Monica 1998 Below market price Discrimination? Shortage Waste/illegal Illegally sublet? Waste/illegal Fairnessp14 Price floor example: butter  If the market were competitive, we would expect the equilibrium price/quantity: $1.00/lb and 10.0m lbsp15 Price floor example: butter  Suppose price floor of $1.20/lb  Predicted outcome: $1.20/lb and 9m lbs  Supply is 12m lbs, implying a butter surplus of 3m lbs  Would a price floor of $0.80 lead to a surplus? No…  The price floor would not be binding  What happens to surpluses?  Could it sit on shelves?  Gov’t may get it: stores it, throws it away, school lunches…p16 Price floor example: butter  Other effects: inefficiently low quantity 