Government Intervention and Inequality: Question 6

Worked solution

Step 1: Recall what a maximum price does

A maximum (or ceiling) price is a legal upper limit on how high a price is allowed to go. For the policy to have any effect at all, it must be set below the free-market equilibrium price. A maximum set above equilibrium would simply be ignored, since the market would already settle below it.

Because the legal rent is now lower than the price that would normally balance the market:

• Quantity demanded rises, since more tenants can afford (or want) a home at the lower rent.
• Quantity supplied falls, since landlords are willing to offer fewer properties for rent at the lower legal price.

Step 2: Check option B

With quantity demanded rising and quantity supplied falling relative to equilibrium, quantity demanded now exceeds quantity supplied at the maximum rent. This gap is a shortage. Option B describes this correctly.

Step 3: Rule out A, C and D

• Option A describes a surplus, which is the result of a minimum (floor) price set above equilibrium, not a maximum price set below it, it reverses the correct mechanism.
• Option C wrongly assumes price controls leave quantity unaffected. In reality, the fall in the price paid by tenants changes landlords’ incentives, so quantity supplied genuinely falls.
• Option D is incorrect because the whole point of a legally binding maximum price is that landlords are not permitted to charge above it; any illegal activity that emerges (a black market) is a consequence of the shortage, not landlords legally raising the advertised rent.

Final answer

Option B. A maximum rent set below the free-market equilibrium causes quantity demanded to exceed quantity supplied, creating a shortage of rental housing.