MARKET PRICING IN ECONOMICS

QUESTION

MIBT

MAE 101 ECONOMIC PRINCIPLES

ASSIGNMENT

TRIMESTER ONE 2012

DUE    FRIDAY WEEK NINE

5 P.M.

HARD COPY ARE REQUIRED TO BE PLACED IN

LECTURER’S PIEGON HOLE

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

1.  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

1. 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

1. 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

1. 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

1. 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

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

Referencing                                                                       2 marks

 SOLUTION

1)     Competitive markets are the current era slogan and it is well known that competition has imbibed itself well into the market. Price mechanism has been impacted a lot due to this competitive markets and the markets effected more is the rental accommodations, it has become impossible for an economical person to pay the rising rental prices thus the government introduced the technique of ceiling of price such that there is a limitation to the price demanded by the sellers or the suppliers of the property. In the current market buyer complain that the prices are very high, whereas the sellers complain that the prices are very low and start demanding more as rentals because of which supply increased and demand decreased, thus to avoid this disturbance the government introduced the binding price ceiling method where the rental values should be in a way such that common people can afford it. Example, after the World War II many soldiers could not afford to rent a house due to the increase in the rental values thus, as relief to their worry government introduced the price ceiling method where the rental prices are bound to limitation and an economic man can afford it. This price ceiling method has been implemented in 200 US cities. From the above explanation it can be noted that overcoming the disadvantages the government introduces the price ceiling method to achieve socio-economic objectives and price stability (Roosevelt, 1941).

2)     In the present competitive market the rental accommodation market is at a greater advantage with the demand for rental houses and the suppliers increasing the price as per the increase in demand. But, due to the disadvantage that a common man is having issue with renting a property rental control has been introduced in the market where there controls issued over the rental property. These rental controls should be introduced in a way that they affect the market equilibrium. If the rental controls are above the market equilibrium then the market will function as if there has been no rental obligations thus, there essentiality for maintaining rental control in a way that the market operated properly. As the government is introducing rental control it is essential to understand the rental accommodation market before and after the rental control and also it is essential to note its impact on consumer and producer surplus.(Moffat,n.d)

Markets before introduction of the rent control were impacted with the increase in the supply and decrease in the demand as the price increased, this is well illustrated in the below chart which shows how the demand and supply are effected in the market without rent control. We see the supply curve moving towards the right indicating that it is increasing slowly, whereas the demand curve is decreasing and constant.

Next we observe the effect of the rental market with the introduction of the rent control. If the concept of rent control is introduced in the market then the demand starts increasing that is to say that the demand curve moves to the right whereas the supply remains constant or decreases. The same is illustrated in the below graph.

As we have understood the rent control effect on the market we need to understand its effect over the consumer surplus and the producer surplus. Consumer surplus is the difference between the amount paid by the consumer and the amount the consumer was willing to pay, whereas the producer surplus is the difference between the amount actually claimed by the supplier and he actually received. Without rent control the consumer surplus is negatively affected and with rent control the producer surplus is affected. For example, if there is a rent control of $1000 each for 1500 apartments and the consumer plans to pay $1800 then he is at a gain of $300 and the producer who was planning to sell at a rate 0f $2000 is at a loss of $500 and in the absence of the rent control the affect is reversed. Thus, implementation of rent control on the market does have affect over the demand and supply of the accommodations and also the consumer and producer surplus.

3)     A secondary market that arises when the government imposes control over the price in the market is known as the Black Market. This market is booming the current era even with the precautionary steps of the government. It is understood that the supplier is never at ease to the norms of rent control where he is tend to incur loses or be neutral thus he plans a way to attain gains that is to sell the property outside the boundaries of government control i.e. thorough a different media  – Black Market. These Black Markets are virtual markets and here the prices of the goods or commodities or rentals are sold at prices little lesser or more than the market equilibrium, mostly at a higher price. They market the demand of the consumer who is in urgency of a rental accommodation, i.e. the urgent need of the consumer is targeted in the Black Market. These Black markets operate affecting the regulated markets and also the supply and demand in the markets as shown below.

In the above chart we can understand that with the increase in the price from $60 to $200 the supply remains constant and the demand is shifting from Qs to Qd i.e. as per the rental accommodation the supply remains constant and the demand decreases.

4)     Problems with the introduction of the rent control include the following:

1. Shortage in rental housing
2. Deterioration of the rental stock
3. Boom of Black Markets/Shadow Markets
4. People already under renting gain a privileged position
5. Nepotism becomes major reason for allocation
6. The landlords in the long run may cut down the maintenance charges and let the property despair
7. Increase in demand for the low rental houses which may decrease the supply of low rent houses.(Sloman,2004)
8. It would be arbitrary to note who gets the low rental house and who does not get it.
9. Rent Control or Ceiling on rent reduces the quantity and quality of the houses available

From the supply point of view the rent control would have drastic effect in scarcity of low rental houses because of which in long run many become house less. The effect on demand is increasing the demand for a low rental house during the situation of scarcity. These effects are illustrated in the diagram below.

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 it can be concluded that rent control is one of the better way to destroy a city, apart from bombing (Lindbeck Assar, 1972).

5)     Government intervenes in the functioning of the market to maintain equilibrium in the market in such a way that both the consumer and the producer are at the advantage. An equilibrium market is where the requirements of both the consumer and producer are met but due to growing competition and increase in price the consumers are affected. It mainly aims at maintaining fairness in the market functioning. There are many techniques the government has taken to maintain condition such that there is no market failure due to product and allocation inefficiency. It introduced policies such as the competition theory, binding price ceiling and floors, subsidized goods, sales tax, prohibition policy, Indirect Taxes etc. Prohibition policy and subsidized goods may some of the non-price techniques of the government such that the market is protected from failure. The prohibition policy is a kind of ruling where prohibition is imposed on certain commodities such that the consumer is not enslaved to them, this technique maintains control over the prohibited goods such as cigarette and alcohol where the prohibition is mentioned on the labeling of the commodity such that people are aware of the consequences.(Basu,2000) The reason for implementation of these techniques would be to maintain efficiency in the market and develop interaction between the government and business.

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.(Brown,n.d)

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.(Nath,1984) 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;
• Roosevelt D. Franklin, Price Controls and the Cost of Living, Vol. VII, No. 21, Vital Speeches of the Day, 1941.
• Government and the Market, Lecture.

LA71

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