Question

Show the effect of a rent ceiling on outcomes (price, quantity, economic rents) in a local housing market where demand for housing has increased. (8 marks) Suggest a possible long-run solution to any problems that are caused

Answer 1

Rent ceiling is a form of price control used by government to keep house rent below a certain price. In the US it was brought in New York to account for house shortages during world-war II. However it is still being used by the government to keep house rents under check.

However, the effects of a rent ceiling on real estate sector has been criticised by economists as it leads to under investement in real-estate market and it is overall considered negative for the housing market.

Rental Market with Price Ceiling S 1200 1100 1000 900 800 700 Price ($) 600 500 400 300 Price Ceiling 200 D 100 100 500 600 200 300 400 Quantity (Homes)

Let us suppose the government fixes rental ceiling at $400.

The natural equilibrium level is found when demand and supply curve intersect with each other. As we can see when the rent was $600, the demand for housing units was 300.

After the price ceiling, supply of housing units has decreased to 200 units from 300 units earlier. Thus, we can see that rent ceiling unnecessarily creates shortage of supply of housing units.

The long run solution is to allow the free market mechanism to work so that demand can be met with supply at a fair price.