Price Ceilings: Rent Controls

Course Outline

Price Ceilings: Rent Controls

Rent controls are a type of price ceiling. We’ll use our diagram to show how rent controls create shortages by reducing the supply of apartments available on the market. Rent controls also result in reduced product quality, since they reduce the returns to landlords from renting apartments. Landlords respond by cutting costs or performing less maintenance, leading to lower quality. There are search costs associated with rent controls, and they also lead to a misallocation of resources since apartments are not allocated to renters who value them the most.

Teacher Resources


Today, we'll be looking at rent controls, an application of what we've done already, because rent controls are simply a type of price ceiling. Let's get going.


Here's the list of the effect of price ceilings, which you've now seen many times. I'm going to talk about each one of these in the context of rent controls, except for a loss in gains from trade that doesn't really introduce any new issues, so I won't talk about that. Let's talk about the other items, however.


Okay. Rent controls create shortages. Let's do our usual diagram, except this time on the horizontal axis we have the quantity of rental apartments. On the vertical axis, we have price. Here's our demand and here's our supply. The main thing we want to add here is that the supply of apartments in the short-run is going to be very inelastic. Why? Well, in the short-run, the apartments are simply there. They're already built, there's not much you can do to change the supply of apartments. Now, this is not quite true. You can take an apartment which is about to come on to the market and turn it instead into a condo. You might switch some uses. You might tear down an apartment early, things like that. But, basically, the supply is going to be fairly inelastic in the short-run.


So, we have a controlled rent. This means that they'll be a shortage in the short-run and it's given by this amount on the diagram. Note that most of the shortage comes from an increase in the quantity demanded when you push the rent below the market equilibrium right, when you lower the rent. Only a little bit of the shortage comes from a decrease in the quantity supplied.


In the long-run, however, the long-run supply is going to be much more elastic than the short-run supply. So, in the long-run, the shortage will get much worse. In the long-run, what will happen is that fewer apartments will be built, more apartments will be allowed to run down to become dilapidated, to slowly go off the market. Apartments will be turned into condominiums. Instead of building apartments, people will build car garages, people will build other types of housing, and so forth. So in the long-run, the shortage from a rent-control gets much worse than in the short-run.


Here's an interesting graph from Ontario, Canada, showing how rent controls can reduce the number of new units being built. So, prior to rent control even being debated, there are about 30 to 40 thousand new units being built every year in Ontario, Canada. After rent control was put into place in 1975, there were fewer than 10,000 new units being built every year. Also note, that the number of new apartments being built, which might be rent-controlled, declined even before rent control was put into place, and that makes perfect sense. An apartment has got to pay for itself over 30 or 40 years. They are very durable, long-lived assets.


So if you hear today that in the next year or two, rents may be controlled, you're going to say, "Well, I don't want to build this apartment unit. It's not going to be profitable anymore. I was expecting so many rents for the next 30 or 40 years - that's now being cut. This unit is not going to be profitable, I don't want to build it anymore." And that's exactly what we saw. A discussion in rent controls reduced the number of apartments being constructed. We've also put, by the way, the number in red, the number of non-rental- controlled housing that was being built at the time. And you can see, it didn't change very much. So this illustrates that it was the rent control itself and not other factors in the market, such as the state of the economy, which reduced the number of rent-controlled apartments being built every year. So this illustrates how rent controls can create a shortage by reducing the supply.


As with other types of price controls, rent controls create reductions in product quality. So the rent controls reduce the return to landlords from renting apartments, and owners are going to respond to that price control by trying to cut costs. So, they're going to reduce maintenance. They're going to slow down the repairs to elevators, they're not going to mow the lawns as often. After all, you can still sell just as many units as they did before. They can keep all of their units rented at the rent-controlled price. even when they cut maintenance and repair costs and amenities, and they don't put in the new pool or they don't put in the playground and so forth. They're no longer in a competitive market. They have lots and lots of people who want to rent their apartments at the below-market price, so they don't need to spend so much on maintenance and repairs, and other benefits. And, since their profits are falling, they want to try and cut costs as much as possible.


Indeed, when rent controls are very strong, serviceable apartment buildings quickly turn into slums, and slums turn into abandoned and hollowed-out buildings. This happened in New York City, this happened in Paris, this happened in many cities around the world, which instituted strong rent controls. Rent controls create wasteful lines and other search costs. So, finding an apartment in New York City often takes a long time and you have to spend a lot of money to get a rent-controlled apartment. In one famous example, episode of Seinfeld, George looks for apartments by consulting the obituaries and rushing to the landlord anytime he sees someone who died who had a nice apartment. And that's in fact one of the techniques, which New Yorkers use to try and get a rent-controlled apartment.


Another effect of rent controls is to increase discrimination because rent controls reduce the price of discrimination. In a free market, landlords might discriminate. But then, they pay a price because it's going to take them longer to rent out the apartment. But, precisely because the rent control makes the quantity demanded exceed the quantity supplied, there are more people lining up to get apartments than there are apartments. So, landlords can more easily, or at lower cost, pick and choose whom they rent to. Therefore, for minorities or for people with children, or for people whom landlords are perhaps slightly don't want in their apartment, the cost to them of obtaining apartment is going to be even higher than for the average person.


Another effect of rent controls, which is very common is paying bribes to get a rent-controlled apartment. Bribes, of course, are illegal. This is illegal, but there are ways of disguising the bribe. One way, for example, would be to charge extra for a furnished apartment. What does a furnished apartment look like in New York City for rent-controlled apartment? It looks like this. That's a furnished apartment. You get the idea - it's a way of paying a bribe under the table.


As with other types of price ceilings, rent controls create a misallocation of resources. That is the apartments are not allocated to the renters who value them the most. If you ever get control of a rent-controlled apartment in New York City, for example, you never, ever, ever give it up. So, I've known some people who keep an apartment in New York City just as a vacation home, just for the summer, they go there occasionally. It doesn't have a lot of value to them, but the price is so low that it makes sense to keep the apartment. If they had to pay the market price, then the high-value bidders, the ones who really valued the apartment, would bid the price up and the goods would be allocated to them. Instead, what we have is people who only use the apartment occasionally, keeping the apartment, while other people with large families are scrunched into apartments which are much too small for them.


Another classic example: the older couple who stay in their large rent-controlled apartment even when their kids have moved out. It doesn't make sense for them to move out because they're not paying the full price, they're not paying the actual value. So you get apartments who are allocated to older couples who actually have a low value for the apartment, even when there are people who have a much higher value for that same apartment and they cannot find an apartment. One study of this found, for example, that 21% of renters in New York City live in an apartment that has more or fewer rooms than they would choose if they lived in a city without rent controls. So the apartments become misallocated.


Okay. That's it for price ceilings. Next time, we're going to be looking at price floors - a price below which it is illegal to go.



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