Question

Although adjustment to the equilibrium may take a long time in a stock-flow housing model, adjustment is fast under some circumstances, which makes for an easy analysis. This problem considers such a case and illustrates the effect of rent control. Suppose that the initial demand curve for housing is given by p = 3 – H, where p is the rental price per square foot of housing and H is the size of the stock in square feet. Note that this equation gives the height up to the demand curve at any H. The flow supply curve for housing is given by p = ΔH + 2, where ΔH is the change in the stock. Again, this equation gives the height up to the flow supply curve at any value of ΔH. Note that the slopes of the two curves are –1 and 1, respectively, a fact that allows simple answers to be derived below.

A) Compute the price that prevails in the market after this increase in the housing stock. Is further adjustment of the stock required to reach equilibrium? How many periods does it take for the market to reach the new equilibrium? Instead of following the sequence you have just analyzed, now suppose that rent control is imposed immediately after the demand shock, with the controlled price set at pc = 3.

Answer 1

Rent control can be a response to rapidly rising rents caused by market changes, but it may result in a shortage of available units as the demand exceeds the artificially capped supply.

Step-by-step explanation:

Rent control is enacted as a measure to ensure housing affordability when the market experiences a rapid increase in rents, which could be caused by changes in tastes, business expansions, or higher incomes in the area. This shift in demand can push rental prices up due to increased competition for housing.

For instance, if the original equilibrium price and quantity of rental housing are at $500 and 15,000 units respectively, and due to changes in the market the demand curve shifts right, the new equilibrium might see prices rise to $600 with an increase in equilibrium quantity to 17,000 units.

However, if rent control sets in to limit the rent to the original $500, it can lead to a shortage in the market. Considering the market forces are still at play, the quantity demanded at this controlled price would exceed the quantity supplied, leading to a disparity where 19,000 units are demanded but only 15,000 units are supplied, creating a shortage of 4,000 units.

This ironic situation demonstrates that while rent control is intended to help renters, it actually reduces the overall availability of rental units compared to what the market would have supplied at the higher equilibrium rent of $600.