How Price Ceilings Affects Market Outcomes - Essay Example

Adam Smith strongly adheres to a laissez-faire market where the "invisible hand" operates to maximize the utility of all economic actors. In this free, unregulated market, equilibrium prices and exchange quantities are solely determined by market forces. However, this situation becomes problematic as equilibrium conditions can prove to be inefficient and unsatisfactory to other economic participants. Thus, it is deemed appropriate to create policies patterned from economic theories to attain market efficiency.

Policymakers intervene in the market by establishing market controls. When the government thinks that the prevailing market price is unfair to buyers and sellers, they enact price controls that involve setting a price ceiling or a price floor. 

It should be noted that setting a price ceiling can bring two different outcomes in the economy. The price ceiling becomes not binding if it is set above the equilibrium price. The price ceiling is only binding if it is lower than the equilibrium price. However, this situation brings about shortages because the quantity demanded is greater than quantity supplied. It should be noted that a binding price ceiling also leads to non-price rationing in the form of long lines, black markets, and seller discrimination.

The Case of Rent Control in the Short Run and Long Run The primary goal of rent control policy is to make housing more affordable to the less fortunate. Thus, the government enacts rent control which establishes the price ceiling that tenants can charge their landlords. However, as will be illustrated below, one economist says that rent control is "the best way to destroy a city other than bombing" (Mankiw 84). In the short run, both the demand and supply for housing are inelastic. Since supply cannot adjust in the short run, supply cannot adjust therefore, the supply curve is drawn as a vertical line.

The demand curve is downward sloping and intersects with the supply curve at the equilibrium price. As the price ceiling is only binding when it is below the equilibrium price, policymakers set the price ceiling below the equilibrium price. This results in a shortage in housing as the quantity demanded is higher than the quantity supplied. In the long run, the demand and supply for housing are inelastic. The supply curve is upward-sloping intersecting with the downward-sloping demand at equilibrium quantity and price.

If a price ceiling is imposed; it will yield the same results as the short-run situation. However, the shortage is more pronounced in the long run due to the slope of the supply curve. The result of rent control in both the long run and the short run is the same-housing shortage. At a price lower than equilibrium consumers' demand is higher than what is willingly provided by the providers. This situation gives the landlords an incentive to discriminate among the tenants. Logically, they will provide housing to those who are willing and able to pay a price higher than the price ceiling.