Macroeconomics: Principles and Policy - Assignment Example

Rent Control Name School Name Course Instructor Date 1. Why would governments act to establish a binding price ceiling in the market for rental accommodation? Governments would establish binding price ceilings for rental accommodation with the aim of protecting tenants from being overcharged by landlords. The legislations were meant to prevent private residential property owners from increasing rent charges excessively. Legislation would ensure any increase is gradual and that landlords continue to receive fair returns on their investment. This would enhance stability of the economy by slowing down displacement during booming economic cycles. In New York, USA, in the late 1940s, soldiers returned from war and soon thereafter stopped receiving military pay. Their return increased the demand and prices for apartments. This meant they could no longer afford to pay rent and the government intervened to help them by enacting a binding price ceiling on rent. However, this had the effect of increasing demand and lowering the quality of the apartments and soon they were all taken up thereby creating a shortage for late comers (Baumol & Blinder 2011). Another example is Italy where the government enacted a binding price ceiling on rent in order to enhance the growth of the economy. This enabled the people from low socio-economic backgrounds to afford good apartments. On the downside, it made landlords cease performing care and maintenance checks on the apartments because they were no longer able to deal in a perfectly competitive market and this lowered the living conditions within the apartments. 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 and any dead weight loss after the introduction of the price ceiling. The enactment of rent control creates problems. It leads to a persistent excess demand for the rental units available. This leads to inefficiency because the price ceiling is below the equilibrium price. At that price ceiling, the marginal benefit is higher than the marginal cost (Baumol & Blinder 2011, p.83). This inefficiency is equivalent to deadweight welfare loss. 3. Using diagrams where appropriate, explain how a "Black Market" operates in a regulated rental market? Who benefits and who loses from its operation? A black market arises due to rent control. People prefer going for apartments in rent controlled zones. Due to the high demand, few apartments are available. When tenants move out, they sub-let them at higher prices than the rent ceiling thereby giving rise to a black market. The new occupants pay higher than the set ceiling to the registered tenants who in turn reap a profit. Black markets benefit the registered tenants who in turn sub-let them to other tenants. These new tenants also benefit because even though they pay amounts higher than the rent ceiling, in most cases the amount they pay is still below the market equilibrium prices. The main losers are the landlords but that is caused by rent control legislation and not the existent of black markets (Baumol & Blinder 2011, p.72) 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. Immediately after the enactment of rent control legislation, the short term demand and supply of apartments is inelastic. The effects of rent control take time before they manifest themselves. The supply of apartments cannot be adjusted immediately and the number of people seeking these apartments also takes long before it increases. This is because people take time before adjusting their housing arrangements. The price ceiling causes a shortage but since both demand and supply are relatively inelastic, this initial shortage is small ( Mankiw 1998, p.155). This is illustrated below. In the longrun, the effects of price control set in. demand increases at a higher rate than the supply of apartments resulting in an acute shortage. This is because landlords respond to rent control by failing to build new apartments. They also fail to maintain the existing ones. On the demand side, the low attractive rents attract more people who start looking for their own aprtments instead of living with other people such as with roomates or with their parents. This results in elastic supply and demand in the longrun. This eventually leads to the rise of black markets and discrimination ( Mankiw 1998, p.155). This has been the case in New York since it started controlling apartment rent. This has had the effect of reducing tenant mobility and has resulted in a large gap between rent charges for controlled apartments and uncontrolled ones. 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. The best non-price technique that the government can employ is queuing. This method serves in a first-come first-served basis and eliminates the problem of failing to show up such as in the case of reservations where tenants may never show up resulting to wastefulness. These queues can either be physical or by paper whereby the person who has waited the longest gets considered whenever there is a vacancy. This is the fairest method because all people are equally endowed with time and therefore stand equal chances of being considered, even though this comes at a cost of spending much time in the queue (Derr & Small 1977, p.43) Since rent control is mainly aimed at helping the people in the low socio-economic class, queuing is a greet method because the cost of time means only those who are truly in need will be willing to pay it. Additionally, these are likely to be the unemployed people or the old as well as those earning low incomes and their marginal cost of time is low. 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. a) Uniform prices Landlords can set uniform rent prices for their homes and allow tenants to occupy them so long as they are willing to pay the set rent. The uniform price would depend on the amount of supply and demand. The price would be set such that all the available apartments are rented. The amount of rent charged would vary depending on the demand and supply. If more people are looking for accommodation, the prices would rise and whenever new apartments come up thereby increasing supply, the rent charges would decrease. b) Auctions. Landlords can auction their apartments to willing tenants. The price to be charged is not predetermined. The price is determined at the time of bidding. A good example is the English auction where tenants can make bids for the apartments. The last bid is accepted as the rent mount to be charged. This is arrived at the point where nobody is willing to bid more than the value of the current bid. 7. Describe how one of these solutions operates and what advantage it has over the other technique. Uniform pricing exists in perfectly competitive markets where rent charges are relatively the same. When demand for apartments increases, the rents rise and when the demand falls, rent prices go down. On the other hand, an increase in the supply of apartments lowers the rents charges and a decrease raises the rent charges. Uniform pricing is an efficient way of allocating scarce resources such as apartments because all those willing to pay the market price are able to obtain the apartments while only those unwilling to pay may fail to get accommodation. Under such conditions, both landlords and tenants are equally powerful in determining the amount of rent (Penner 2004, p.21) Auctions give tenants the best value. They end up charging the highest possible amount, though sometimes the highest bid may still be lower than the standard market rate. They also get the advantage of setting the rules of the auction. Auctions are best when there is uncertainty and the landlord can maximize his profits even in the face of uncertainty because he ends up charging the maximum amount the market is willing to pay (Fiske 2009). 8. Some economists argue that governments should conduct an auction as a means of allocating the "scarce good" because they consider this solution "economically efficient". What is meant by economic efficiency in this case? Is economically efficiency the same as "equity"? Why? What 2 reasons would you suggest for the use of equity as a means of allocating the scarce good? Economic efficiency in this case means that the potential tenant with the highest use value of the apartment is identified and revenues are maximized in an economically efficient way. Economic efficiency is not the same as equity. Economic efficiency is concerned with optimum production and allocation of economic resources while equity is concerned with how the produced goods and services are distributed throughout the entire society (Hall & Lieberman 2010, p.434) One reason why equity should be used in allocation of scarce goods is to have equal concern for the needs of other people. All scarce goods which are necessities should be distributed fairly to all those who need them. The second reason is for there to be equal life chances for everybody. Individual choices should determine life outcomes instead of the conditions that people live in which are beyond their control. References BAUMOL, W. J., & BLINDER, A. S. (2011). Macroeconomics: principles and policy. Australia, South-Western, Cengage Learning. Derr, D. A., & Small, L. E. (1977). Property rights in transition. New York, MSS Information Corp Fiske, J. R., & Fiske, C. A. (2009). The big book of benefit auctions. Hoboken, N.J., John Wiley & Sons. Hall, R. E., & Lieberman, M. (2010). Microeconomics: principles and applications. Mason, OH, South-Western, Cengage Learning. Mankiw, N. G. (1998). Principles of microeconomics. Fort Worth [u.a.], The Dryden Press. 115, done Penner, S. J. (2004). Introduction to health care economics & financial management: fundamental concepts with practical applications. Philadelphia, Penns, Lippincott Williams & Wilkins. . Read More