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    Sociobook Part2

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    Manar Amr

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    © All Rights Reserved
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    of 70
    Chapter Three Government Control of Prices in Mixed Systems Who Are the Winners and Losers? Chapter Outline Learning Objectives Price Ceilings and Floors After completing this chapter, Rent Controls you will be able to: ‘The Housing Market 1. Discuss, in general The Effects of Rent Controls terms, price ceilings and Minimum Wages price floors and why Market Demand for Labor governments sometimes The Demand for Labor by One impose them. Employer 2. Explain the actual market ‘Market Supply of Labor effects of rent controls The Labor Market as an example of a The Effects of the Minimwn price ceiling. Wage 3. Explain the actual market summary effects of the minimum wage as an example of a price floor. (© McGraw-Hill Education /Barry Barker, photographer It was one of many price controls brought in during the grim, panicky period between the attack on Pearl Harbor in 1941 and America’s move to a full wartime economy in 1943, The housing market was seen as another thing that needed to be rationed or, at least, r2gulated—alongside rubber, petrol, coffee, and shoes. By 1947 all these controls were phased vul, except properly-price regulations. Most cities have since scrapped these market distortions; the capi- tal of capitalism has not. 62 Government Control of Prices in Mixed Systems 63 Only one-third of New Yor« City’s 2 million rental apartments are free of some kind of price restraint. A city board sets annual increases and administers an ever more complicated system. In some buildings, people live in similar apartments but pay wildly different levels of rent. In others, lone grandmothers sit in huge apart- ments, aware that moving would mean paying more for a smaller place elsewhere. The oldest controls cover pre-1947 buildings (including any number of lovely houses on the city’s most fashionable streets); these have average rents of $500 a month. A second tier, covered by rent stabilization, rent for $760. Unregu- lated apartments cost an average of $850, but this number is deceptive, since it includes the worst buildings in the outer boroughs. Technically, new constructon is free from these constraints. In fact, a complex system of tax inducements persuades most clever builders “voluntarily” to agree to rent-stabilization restraints. Not surprisingly under these conditions, building is anemic; even with the largest surge in construction since the 1960s, the number of building permits issued in the past year will add less than 1 percent to New York's housing supply. Needless to say, in such a sclerotic system, the poor suffer most. It is hard to find any ecoromist who supports rent restraints. Price controls, even if laboriously tweaked, inevitably produce inefficiencies, reduce supply and cause bad side effects. Black markets and bribery thrive. Building maintenance is often ignored. Landlords and tenants find themselves in poisonous relation- ships, since they are linked by law rather than by voluntarily renewable con- tracts. Unscrupulous property owners go to dangerous lengths to evict tenants in order to get higher-paying replacements; as a result, tenant-protection laws have been enacted that make it almost impossible to evict even a scoundrel. Meanwhile, a vast bureaucracy has grown up to administer the price con- trols, supported by voluntee’s and litigators. The property owner who misses a filing deadline, or has his paperwork mislaid, can be blocked from even permis- sible rent increases. Given all this, most sane New Yorkers would rather eat their money than join the renter class. Oddly enough, for those landlords adept at navigating the system, returns are likely to be unaffected by price caps, as long as properties were acquired after they had been imposed and the potential for income is understood. In- deed, although the press depicts the fight over price restraints as tenants versus landlords, it is more accurate to see it as tenants paying a below-market rent versus tenants who, in effec:, pay the cost of this subsidy, says Peter Salins, the provost of the State University of New York and coauthor of a book on New York's housing market (Scarcity by Design, Harvard University Press, 1992). Who, then, are the lucky terants? According to another study by Mr. Pollakowski, most benefits go to tenants in lower and mid-Manhattan, where the residents are relatively wealthy. The city’s poorer folk, most of whom live in the outer boroughs, receive little or nothing. Perhaps the strongest argument offered by supporters of rent control is that it promotes stability; but, typically long-term 64 Chapter 3 Government Control of Price: in Mixed Systems tenants in unregulated markets receive similar concessions, since it is in a property-owner's interest to retain dependable renters in his buildings. Mr. Salins says the members of the state legislature are well aware of all the basic arguments about the evil effects of price controls on the property market. They believe even more strongly, however, that voters do not like getting socked with rent increases. For New York's politicians, it is a time of small thoughts. Source: "The Great Manhattan Rip-Off," The Economist Newspaper, June 5, 2003. © The Economist Newspaper Limited, .ondon. All rights reserved. Used with permission ‘The distinguishing feature between the pure market economy anda mixed market economy is that government is often actively involved in the individual markets of the latter. One common way in which government involves itself in mixed sys- tems concerns the way in which prices are determined. As was detailed in Chapter 2, prices in market-oriented economies tend to be set by the forces of demand and supply. Should the supply of an item increase relative to its demand, its price will fall. Alternatively, when demand rises relative to supply, price can be expected to rise. And it is this free movement of prices, in response to demand-and-supply conditions, that serves to allocate resources in the way in which the public wishes. Suppose, for example, that two new alternative formats for watching televi- sion become availeble—high-definition and progressive scan—which are initially roughly equal in price and quality. Before long and for whatever reason, the public strongly prefers high definition. What would be the expected market reaction? That is, would the public’s desire for more high-definition machines and, of course, fewer progressive-scan devices be satisfied? As presented in Chapter 2, the answer is clearly yes! The process is simple: The demand for the high-definition devices would increase, driving the price of the items up. This in- creasing price for the devices initially induces existing producers to increase their own outputs. And, in the longer run, new investment into this industry can be ex- pected as other, previous producers of perhaps related products are attracted into high-definition production by the lure of the relatively high prices and resulting profits. In each case you should see this analysis as a simple applicction of the laws of supply and demand. And, more importantly, you should see that the consum- ers, in fact, win—they get the additional high-definition devices that they wanted. But what about the progressive-scan market? Just the opposite is happening, of course. The price for these devices will be falling in response to the falling demand. The falling prices induce existing producers to either cut their outputs or perhaps even discontinue producing the progressive-scan devices completely. Again, the consumers win—they wanted ‘ewer progressive-scan devices, and the market, operating, through freely moving prices, brought about the reallocation of resources that the public wanted. Prices in mixed systems are not, however, always a simple response to demand- and-supply conditions. In fact, throughout history, and in nearly every market- oriented economy today, prices for certain goods and services have been and are Price Ceilings and Floors 65 under the legal con‘rol of government. Sometimes they set minimum prices that must be paid for a particular good or service, effectively making it illegal to sell the item below this price. The classic example of this is the minimum wage. Another common example is that of minimum allowable prices for agricultural products that are in severe sarplus like wheat or diary products. In other circumstances, legally binding maximum prices are set by government. In this chapter we focus on rent controls as an example of a maximum allowable price being set. It is also common following a natural disaster such as a hurricane or wide-spread flooding, for maximum prices to be put in place for items deemed essential like ice, water, and gasoline. In many circumstances, the intention of government is to benefit some specific group of either producers or consumers who otherwise might be negatively affected were the market allowed to determine prices in accordance with demand-and-supply conditions. And in most of these cases, it is probably fair to conclude that government's intentions are laudable. For example, when world agricultural markets are such that an extreme surplus of dairy products ex leading to market prices which might force a large segment of the domestic dairy industry out of business, governments attempt to protect dairy farmers through a minimum permissible price for milk. And such a policy would likely have public support, at least from a humanitarian if not economic perspective. Similarly, when apartment rents appear to be outpacing the incomes of the working poor, govern- ment implementation of rental rate freezes or maximum rents certainly does not seem indicative of a government that cares little about the lives of its people. What we must address is whether these types of policies—well intentioned or not—are effective. That is, can government control of prices improve upon the functioning of the market? You should be on the lookout here for two important lessons that have a2plications in nearly every area of government economic ac- tion: (1) When government takes action in a market, the market reacts. And this reaction, in many cases, serves to simply negate much of what the government action was designed to accomplish. (2) As with all human actions, unexpected and often negative consequences result from government intervention in markets. This is not to say that such intervention has no beneficial effects but rather that one should not necessarily feel that government price-setting activities can be a panacea for marketoutcomes that we dislike. To consider these issues, we look at two of the most common examples of gov- ernment determina:ion of prices, rent controls, and the minimum wage. Before we launch into this, we need to refine the definitions of government action that we have been using, PRICE CEILINGS AND FLOORS price ceiling Maximum allowable Price for a good or service, usually set by government. . Price ceilings, or maximum prices, have been put into effect from time to time by government for two primary purposes. First, they have been established across- the-board in an attempt to hold inflation in check. Also, they have been used on a selective basis to keep the purchase of certain items within the reach of those 66 Chapter 3 Government Control of Prices in Mixed Systems price floor imum allowable price for a good or service, typically set by a governmental unit or by a group of sellers. at the lower end of the income scale. This latter purpose may also have an anti- inflationary intent. We will concern ourselves in this chapter with selective price ceilings, using rent controls as an illustration. Rent controls have been used extensively in metropolitan areas of many coun- tries as a device to hold housing costs in check for low-income groups. During the 1970s alone, more than 200 U.S. ci enacted some type of rent control. The most well-known example of such controls in the United States is undoubtedly that of New York City, which has had rent controls in effect since World War II. Taking the cake internationally, however, is Paris, France, where rent controls have existed, to some extent, since the late 1700s. On a much snaller scale, it common for a university to set rental rates on university apartments at relatively low levels to help alleviate problems encountered by low-income students. When price floors, or minimum prices, are set for particular items, the intent of the government usually is to increase the incomes of those who sell the item. A classic example is that of minimum-wage legislation. The Fair Labor Standards Act of 1938 established the first federal minimum wage of 25 cents per hour for workers. in designated industries. By 1981, the minimum had increased to $3.35 per hour. For the remainder of the decade, however, the minimum remained unchanged. Given a rising general level of prices since that time, those earning the minimum found that while their wage remained constant, their purchasing power was eroding. This situation eventually led to an increase in the minimum to $5.15 per hour in 1997. It would be another decade before Congress and the president agreed to another in- crease, In the spring of 2007, agreement was reached on a three-step increase in the federal minimum wage. The first step increased the minimum to $5.85 in the sum- mer of 2007. The minimum then rose to $6.55 in the summer of 2008 and then finally to its current level of $7.25 in the summer of 2009. While the federal government has been reluctant to increase the minimum, states are proving far less so. As of 2015, 29 states had minimums set above the federal level. Further, this trend is growing as 9 of the 29 increased their minimums between 2014 and 2015. The current “high- water” mark is that of Washington state, with its hourly minimum of $9.47. Minimum-wage laws have had wide support from the general public. They apply, of course, to workers at the lower end of the income scale and were enacted to combat what Congress identified as “labor conditions detrimental to the main- tenance of the minimum standard of living necessary for health, efficiency, and general well-being of the workers.” RENT CONTROLS Almost everyone looks with disfavor on slums. In certain areas of most cities, one sees housing conditions that are distressing to say the least. Several families may be using the same bath and toilet facilities. Some families live in units that are not well-lighted or well-ventilated. Two or more families may be living in the same apartment. The buildings and apartments may be in various slates of disrepair. Why do people live in them? Usually these are as much as lower-income families Rent Controls 67 can afford. Or, if you have tried to find an apartment in Manhattan recently, you know that they may be all that is available. Why do these problems occur? Do the rent con- trols that have been operative in places such as New York City serve the best interests of lower-income groups? An examination of the housing market without, and then with, rent controls in effect will help us evaluate the housing problems of the poor. The Rental Market There is nothing particularly unique about the market for rental housing, so it is reasonable to assume that, without government intervention, the market for rental housing will behave as any other well-functioning market in a mixed economy. That is, we cain expect that the interaction between all potential renters and all rental property owners will lead to an equilibrium price and quantity exchanged determined by the point where the supply of rental units (for simplicity, assume all rental units are the same in size, quality, and the like) just equals the demand for units. Suppose that at such an equilibrium the market price is $500 per month and 10,000 units are exchanged. This initial situation is shown as point A in Figure 3.1, at the intersection of supply SS and demand DD (ignore the other supply and FIGURE 3.1 Effects of an Increase in Demand for Housing with and without Rent Controls Ifthe demand for housing units is DD and the supply is $5, the equilibrium level of rent is $500 and the equilib- rium quantity occupied is 10,000 units, as at point A. An increase in the demand to D,D, increases the rent to $600 and the quantity occupied to 11,000, as at point C. The increased profitability of producing housing causes supply to increase over time to 5,S;, increasing the units occupied to 12,500 as at the long term equilibrium at point D. If, however, rent controls are enacted when the rental rate is $500, the long-run increase in housing supply would not take place, resulting in a shortage of 3,000 units over time (from 10,000 to 13,000, or simply the gap between point A and point B). Rent per unit ($) 800 600 525 500 0 10 11:12.5 13 Quantity (thousands of units per month) 68 Chapter 3 Government Control of Prices in Mixed Systems demand curves in the figure for the moment). Most importantly, note that at this equilibrium there is neither a shortage nor a surplus of rental urits or, as put in Chapter 2, the intentions of those demanding, rental units match exactly those of the suppliers of units at the initial equilibrium. The Effects of Rent Controls Starting again at point A in Figure 3.1, suppose that for whatever reason, general household incomes begin rising significantly. This will cause the demand for all normal goods to rise and certainly housing must be a normal good. This rise in de- mand is seen as the movement from DD to D,D which initially causes a shortage of housing units of 3,000 per month (the distance from point A to point B). As with any other shortage in a well-functioning market, the shortage cf housing units causes Lents lu rise as polential renters compete for available units. As the price rises, of course, suppliers are induced to offer more units for sale each month. In the short term, most of the new housing will come from existing suppliers as the construction of actual new units is somewhat time consuming. This increase in the number of units made available is seen as the movement up the initial supply curve, SS, from point A to the new short term equilibrium at point C where the quantity exchanged is 11,000 units per month at a price of $600 each. What can we say about this new equilibrium? The simplest statement is that the market works. That is, consumers as a group desired more housing units as their incomes rose and the market brought this about as the increased equilibrium price induced rental property suppliers to add 1,000 new units per month to the market. And this is just the short term market adjustment. In the longer term, long enough for new construction to take place, we can expect new suppliers to enter the market since using available land for housing purposes rather than another use like retail space has become relatively more profitable. This is seen in the shift to the new supply 5,, and leads to the final equilibrium at point D at which 12,500 units are rented each month for $525 each. In short, rising incomes led to a demand for more rental units for housing and the market, left to its own devices, brought this about. To see how all of this changes when a ceiling on the rent of housing, units is imposed, return to the initial equilibrium at point A in Figure 3.1. Once again sup- pose that household incomes are in general rising, leading to the increase in de- mand from DD to D,D, and an immediate shortage of 3,000 rental units per month (again, the distance from point A to point B). This time, however, suppose that the government senses the rising pressure on rents and imposes a ren: control or price ceiling at the initial equilibrium price of $500. No doubt one coald assume that most of those making a decision to impose the rent control have good intentions, primarily to keep housing affordable to those of relatively modest means. While it is true that the price ceiling can keep the price of rental units at $500, if it does so there becomes no incentive for existing suppliers to increase their offerings in the short term (the increase in quantity supplied from point A to point C) or for new investors to begin offering, rental units in the longer term (the increase in supply from $5 to $,5,). In short, the primary effect of the rent control is :o create a short- age of housing units that the market, operating on its own, has nc incentive to fill. Rent Controls 69 Not all households looking for apartments are able to find them. Some individ- uals and even families are forced to share living, quarters. Numerous households take in boarders. Many young adults are forced either to delay leaving the family home for their own places or to return to the family home. Not

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