MARKET EQUILLIBRIUM IN CONSUMER SURPLUS

QUESTION

MAE 101 ECONOMIC PRINCIPLES

ASSIGNMENT

TOTAL MARKS 20

Governments have on many occasions intervened in the market to establish a binding price ceiling. You are required in answering the following questions to draw upon the experience of at least one government, via an internet and library search, which has instituted a binding price ceiling in the rental accommodation market. Countries that can be researched are India, many states in the USA, Finland, Italy, Malaysia (Penang), United Kingdom and the countries of the Soviet Union (USSR) between 1945 and 1989.

1. Why would governments act to establish a binding price ceiling in the market for rental accommodation?

2 marks

2. Describe, using diagrams where appropriate, the market for rental accommodation before and after the introduction of rent controls. Illustrate the surpluses accumulating to producers and consumers before and after the introduction of the price ceiling.

4 marks

3. How does a “Black Market” operate, using diagrams where appropriate, in a regulated rental market? Who benefits and who loses from its operation?

4 marks

4.What other problems arise with the introduction of rent controls? Discuss, using diagrams where appropriate, two such problems, one on the demand side of the market and one on the supply side of the market.

4 marks

5.Discuss in detail one non-price techniques of allocation that the government could introduce in attempt to achieve equity (fairness) and one for administrative efficiency in the now regulated market. Discuss

2 marks

6.Discuss 2 options that are open to the owners of rental property (landlords) to choose a renter in the absence of a government method of allocation.

2 marks

7.Describe how one of these solutions operates and what advantage it has over the other technique.

Referencing 2 marks

SOLUTION

1)     Ceiling of price is established by the government to maintain equilibrium in the price mechanism in the market. A typical example for price ceiling is during the period of World War II, where the soldiers after the war could not pay the rent as they were not receiving pay from the military base, thus the government put in the price controls so soldiers could afford to pay rent for their families. (Robert,1992)Buyers always complain that the price of the property is more whereas the sellers complain that the prices are low thus to resolve this issue government bought in the solution of binding ceiling price, where it regulates the rental pricing which may be greater or lesser than the market equilibrium price. This rental ceiling has been implemented in 200 US cities.

2)     Market equilibrium is where supply curve intersects with demand curve and for rental accommodation it has different impact based on the applicability of the rental control. If the rental control is applied above the market equilibrium then the market works as if there is no ceiling on the rental value, and the problem of high prices continues. Thus it is essential for market equilibrium with rental accommodation, so let us understand with diagrams the way the market operated before and after the introduction of rental controls.

Market equilibrium before rental control: Before the introduction of the rental control the buyers complained that the prices were high whereas the sellers felt that the prices were low, due to this there was heavy supply but demand was low.

From the above chart we can understand that with no market ceiling the demand is constant whereas the supply which has to intersect demand for maintaining equilibrium is increasing.

After the introduction of the rental ceiling the market equilibrium had a great change with increase in demand and decrease in supply as shown in the below chart.

From the above figure it can be understood that increase in demand due to reduction of price and ceiling of the price led to decrease in supply. This also shows the negative impact in utilization of resources but was helpful for those people could not afford the rising rental prices.(Basu and emerson,2000)

This market equilibrium even has impact on consumer and producer surplus. Consumer surplus is the difference between the amount paid by the consumer and the amount the consumer wills to pay, producer surplus is the difference between amounts received when compared to the actual amount priced. This surplus value is essential to for maintaining market equilibrium and society welfare. If for example there is no imposition of rental ceiling then the rental value increases because of which the demand reduces and the consumer surplus also is effected because he pays more than the actual rent he has estimated to pay and the producer is at advantage of receiving more surplus than he had estimated. Suppose the price is $1,000 as rent for 1000 apartments then the producer without the rent ceiling can demand more than the $1,000 in the view to gain more and the consumer has to incur loss but if there is a rent ceiling fixed for $900 on the apartment value then the producer is at a loss of $100 and the consumer is at the gain of $100 in his surplus.

3)     Black market is a known concept in the current scenario. This market is the place where the goods and services are sold outside the boundary of the rules and regulations of the government which are followed in a regulated market. This market has a drastic impact on the societal development because the goods are sold outside the outline of the policies of the government. Being an illegal market the consumer may be even cheated on the quality of the product. This black market has a drastic effect on the functioning of the regulated market and also on the supply and demand as shown below.

Y

(Price)                                               Supply

Demand

X (Quantity)

From the above graph it can be noted that demand of quantity has decreased due to increase in price and also supply also increased as the products were sold against the norms of the government.(Nath,1984)

Black Market is beneficial for producers who sell the products against the norms of the government and also do not pay the levied taxes and the market drastically affects those consumers who buy product with trust and also pay taxes, because they do not get the quality or quantity of the product they have demanded for.

4)  Problems with the introduction of rent control are detailed as below:

–        Decrease in the supply of low rent houses

–        Increase in demand of low rent houses which may result in many people becoming homeless

–        It would be arbitrary to note who gets the low rent house and who does not get it

–        The land lord in the long run a cut down maintenance charges on the property and let it to disrepair

–        Price controls and commodity shortages

–        Shadow markets

As noted above we understand that rent control has affected demand as well as supply of low rent apartments in countries like New York and other states of US.  This rent control has impact on supply and demand of houses as showed in the below graph:

In the above graph it can be understood that with the decrease of rental value form R0 to R1 the Quantity of the apartment has reduced from Q2 to Q1 to Q3, it can be explained that in a particular city if the rent value is reduced as per the rent control then the supply would have a slight effect S in the short run, moving forward the Quantity will reduce from Q2 to Q1, where only a few amount of people will not be able to rent an accommodation, if we move further into the long run the quantity will decrease as shown in the graph from Q2 to Q3 resulting in many people homeless. Thus, this rent control even though is helpful for people to afford houses for regulated price reduces the supply of these houses from S to S¹ as demand D raises as shown in the graph. Thus, we can conclude that rent control does have some negative impact in the market.(Moffat,2004)

5)     Governments have been intervening in the market conditions to maintain fairness in its functioning. There are many techniques government have taken for maintaining the market condition such that there is no market failure due to product inefficiency and allocated inefficiency. The government can introduce some of the policies such as competition policy, prohibition policy, Indirect taxes, subsidies, etc. The reason for government to intervene in to the market is to protect the consumer from lack of information. Prohibition policy can be one of the non-price technique policies in a way that government can make it a rule for prohibiting the use of certain products or commodities in the market which may affect the interest of the consumers. By introducing this technique it can maintain control over the use of prohibited commodities such as Cigarettes by children below age of 18, they can maintain this prohibition in a way by mentioning the harm of cigarettes on the label of the pack with compulsory warning to reduce smoking. This way of techniques taken by the government will certainly help in achieving equity fairness. One of the steps for administrative efficiency to be taken by the government in the now regulated market would be checking the performance standards in order to create simpler, better and faster interaction between the government and business there is efficient production of goods and serviced to the consumers.

6)     The owner of a rental property has to abide by the government method of allocation. In the absence of such method he is at his will to decide his tenant. Before, taking in a person as a tenant the owner should be very careful to avoid any future issues. He has the right to choose the tenant and the rent he needs to fix on them provided that his tenant selection is not discriminatory. In this situation he is not governed under the protection of the government. The owner has options such as leasing his property, or entering in to the contract of tenancy at will. He has the freedom to decide which agreement is more advantageous in meeting his requirements. These options are useful for the owner to choose his renter in the absence of government method of allocation. Lease agreement has advantage of tenant staying put and there is guarantee of payment till the lease period is over. Tenancy at will is an agreement where the owner has the right to ask the tenant to leave the premises if he is in need of the premises.(Riley,2006)

7)     As stated in the above answer it is understood that the two options property lease and tenancy at will are available to the owner in the absence of government method of allocation of these two tenancy at will is more acceptable because the tenants will not be completely willing to choose the option of leasing and also owners consider this option so that they can ask the tenant to leave the property by giving an appropriate notice. Some landlords prefer lease agreements because the tenant is bound to stay put and make the rent payment till the lease period expires but this agreement is not completely advantageous if the tenant runs into bankruptcy or he is not in a position to pay the rent. Thus tenancy at will is more preferable option and the tenant can convert his will into lease agreement if they are comfortable with the premises. Therefore it can be concluded that in the available options tenancy at will is the advantageous agreement option to the owner.

REFERENCE:

• Lee G. Robert, Rent Control—The Economic Impact of Social Legislation,  Oxford Journal of legal studies, Vol. 12, No. 4 (Winter, 1992), pp. 543-557, Oxford University Press; http://www.jstor.org/stable/764611
• Kaushik Basu and Patrick M. Emerson, The Economics of Tenancy Rent Control, The Economic Journal, Vol. 110, No. 466 (Oct., 2000), pp. 939-962, Blackwell Publishing for the Royal Economic Society; http://www.jstor.org/stable/2667859
• Shyam Nath, Impact of Rent Control on Property Tax Base in India: An Empirical Analysis, Economic and Political Weekly , Vol. 19, No. 19 (May 12, 1984), pp. 805-810, Economic and Political Weekly; http://www.jstor.org/stable/4373250
• Rent Control in the Empire State, Columbia Law Review, Vol. 50, No. 7 (Nov., 1950), pp. 978-988, Columbia Law Review Association, Inc.; http://www.jstor.org/stable/1119104
• M. Bronfenbrenner, Regressus in Black Market Demand: A Reply, The American Economic Review, Vol. 37, No. 5 (Dec., 1947), pp. 934-936, American Economic Association; http://www.jstor.org/stable/1812870
• Mike Moffatt, The Effects of a Black Market Using Supply and Demand; http://economics.about.com/od/demand/ss/black_market.htm
• Sloman, John and Mark Sutcliffe (2004), Economics for Business, 3rd ed., Prentice Hall  “Rent control: A lease on stupidity,” The Voice of the People, the New York Daily News, June 17, 1985.
• William Tucker, Policy Analysis on How Rent Control Drives Out Affordable Housing, Cato Policy Analysis No. 274, 1997; http://www.cato.org/pubs/pas/pa-274.html
• Geoff Riley, Market Failure – Introduction, Eton College, 2006; http://tutor2u.net/economics/revision-notes/a2-micro-market-failure-introduction.html
• Tenancy at Will, Article by Tricia Ellis-Christensen, Conjecture Corporation, 2012; http://www.wisegeek.com/what-is-tenancy-at-will.htm
• David Brown, Ralph Warner & Janet Portman (Nolo), The California Landlord’s Law Book;

KI32

Please  Click on the  below links to Chat Now  or fill the Order Form !