Question

In the market in which David and Ellen have rent-controlled apartments, Ellen gets an apartment and Charlie does not. In the market with no price controls, thesituation is reversed. Charlie gets an apartment and Ellen does not. How would you compare the efficiency of these two outcomes?

Answer 1

When the market is free the quantity demanded is equal to the quantity supplied. And this is called equilibrium where the price is P_eqand quantity demanded is Q_eq.

When there is rent control: Rent control is a legal maximum price that can be charged. This is also called as price ceiling. Whenthe ceiling price is below the market equilibrium price, than there will be excess demand of Q_d, but the supply at this price will beQ_s, creating a shortage in the market.

At this rent controlled system, there is huge demand but the supply is limited. This limited supply is distributed among the people based on somecriteria or quota or first come first basis.

In the rent controlled environment if Ellen gets an apartment it might be due to a quota orbased on first cum first serve basis.

Without rent controls:

When there are no rent controls the market adjusts to market equilibrium price and quantity. And a resource is allocated to a person who values itthe most. Thus in the free market Charlie gets an apartment as he can afford the price. And Ellen could not as the price he is willing to pay islower than the market equilibrium price.

Efficiency: When there are rent control there is an efficiency loss given by the area in the graph c+e.

A free market will allocate the resourceoptimally based on its value, but if there are controls than the optimal allocation is lostcreating a deadweight loss or efficiency loss.

When there are no rent controls the market allocates resourcesbased on supply and demand. Thusa rent control creates inefficiencyin the markets.