The invention of a vaccine that provides complete immunity to a contagious disease effectively eliminates that disease as a public bad for the entire population.

A rent ceiling is the legally mandated maximum price that a landlord is allowed to charge for a rental property.

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This diagram models a city's housing rental market, where 'rent' refers to the payment from a tenant to a landlord for accommodation. The market begins in equilibrium with 8,000 tenancies at a rent of €500. Following an increase in demand, a new, higher equilibrium rent of €830 would be established in an unregulated market. This price increase is significant because the housing supply is inelastic in the short run. The diagram also shows a rent ceiling imposed at the original €500 level, which creates excess demand. In this situation, the quantity of tenancies is determined by the suppliers, who are on the short side of the market. A long-run supply curve is included to show how the market might adjust over time, reaching an equilibrium of (12,000, 500).

Analysis of a Rent Ceiling with Shifts in Demand and Long-Run Supply (Figure 8.25)

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

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CORE Econ - The Economy 2.0: Microeconomics

In the housing market example illustrated by Figure 8.25, the local government implements a rent ceiling at €500. This policy action is a direct response to concerns that a rent increase, driven by higher demand, would make housing unaffordable for many families.

Rent Ceiling Imposed Due to Affordability Concerns

The initial equilibrium in the housing rental market is the point where the market clears, established at the intersection of the supply and demand curves. In this specific model, this occurs at the coordinates (8,000, 500), indicating an equilibrium quantity of 8,000 tenancies at a rent of €500.

Initial Equilibrium in the Housing Rental Market at (8,000, €500)

In a supply and demand diagram for the housing market, the number of tenancies is on the horizontal axis and the rent in euros is on the vertical axis. The initial market is defined by a downward-sloping, straight-line demand curve and an upward-sloping, straight-line supply curve. An increase in demand is represented by a new downward-sloping demand curve that is parallel to and positioned above the original one.

Graphical Representation of an Increase in Demand in the Housing Market

Following a positive shift in demand in the housing market, a state of disequilibrium occurs at the original price. This is characterized by excess demand, graphically represented as the horizontal distance between the new demand curve and the original equilibrium point of (8,000, €500).

Excess Demand in the Housing Market at the Original Equilibrium Price

In a housing market with a rent ceiling, for instance at €500, an increase in demand can cause excess demand. This market disequilibrium creates opportunities for rent-seeking because a significant economic rent emerges. This rent is the difference between the higher price some tenants are willing to pay (e.g., €1,100) and the controlled price. Graphically, this is shown as the vertical distance between the new demand curve and the rent ceiling at the quantity of available tenancies (8,000).

Economic Rent and Rent-Seeking Opportunities in a Rent-Controlled Market

When a rent ceiling is set at €500, the 8,000 available tenancies are not necessarily allocated to the individuals with the highest willingness to pay. Instead, any tenant willing to pay at least the controlled rent might obtain housing. This means that someone whose valuation is just over €500 could get a tenancy while someone willing to pay much more might not, leading to an inefficient allocation of resources.

Inefficient Allocation of Tenancies Under a Rent Ceiling

When an increase in housing demand appears to be permanent, a long-term policy solution is to encourage the construction of new houses. This action effectively shifts the housing supply curve to the right, increasing the quantity of available tenancies. As illustrated in the market diagram (Figure 8.25), this shift can lead to a new long-run equilibrium, such as at the point (12,000, 500), where more housing is available at an affordable rent, assuming supply can expand sufficiently.

Long-Run Supply Adjustment Through Housebuilding Policies

This activity examines a rental housing market scenario based on Figure 8.25. The market begins at an equilibrium point with 8,000 tenancies available at a rent of €500. After a surge in demand, municipal authorities intervene by establishing a rent ceiling at the initial €500 price and also legally forbidding the practice of subletting. The objective is to evaluate the outcomes of these governmental policies using the given data.

Activity: Analyzing the Housing Market Under a Rent Ceiling (Figure 8.25)

In the short run, the supply of rental housing is inelastic because constructing new homes is a time-consuming process. Therefore, an immediate increase in the quantity of available tenancies can only occur if existing owner-occupiers choose to become landlords and rent out their properties.

Short-Run Inelasticity of Housing Supply

The housing market is modeled on a graph where the horizontal axis represents the number of tenancies and the vertical axis shows the rent in euros. Market dynamics are illustrated by a downward-sloping, straight-line demand curve and an upward-sloping, straight-line supply curve. Points on the graph are represented by coordinates in the format of (tenancies, rent).

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