Government Intervention and Inequality: Question 7

Worked solution

Part (a): The free-market equilibrium

Scanning the table for the row where quantity demanded equals quantity supplied:

Only at $300 per week do the two columns match, both at 700 thousand apartments. This is the free-market equilibrium.

Part (b): The shortage at the maximum rent, and why it occurs

At the maximum rent of $250 per week, reading directly from the table: quantity demanded is 800 thousand apartments per week, while quantity supplied is only 600 thousand apartments per week. The shortage is the difference: $800 - 600 = 200 \text{ thousand apartments}$

A maximum (ceiling) price is set below the free-market equilibrium price of $300. Because the demand curve is downward sloping, the lower price of $250 encourages more tenants to want an apartment (quantity demanded rises to 800). Because the supply curve is upward sloping, the same lower price discourages some landlords from offering their property for rent, so quantity supplied falls (to 600). With quantity demanded now exceeding quantity supplied at this price, the result is an excess demand, a shortage, of 200 thousand apartments per week. (This is the opposite of a minimum, or floor, price, which is set above equilibrium and causes an excess of supply over demand. A surplus.)

Part (c): A non-price method of allocating the apartments

Since the price can no longer rise to ration the limited 600,000 apartments among the 800,000 tenants who want one, some other, non-price method is needed. One example is a waiting list: tenants register their interest with a housing authority or landlord, and apartments are allocated in the order applications were received (first-come, first-served) as vacancies arise, rather than being awarded to whichever tenant is willing and able to pay the most.

Part (d): Is a black market likely, and what would it do to the policy?

With 200,000 tenants per week unable to obtain an apartment legally at $250, some of them are likely to be willing to pay more than the legal maximum to secure one, for example, an “under the table” payment to a landlord, or an illegal payment to an existing tenant willing to give up their lease. This creates a black market. Because it is illegal, sellers in a black market can typically charge whatever desperate buyers are willing to pay, which is likely to push the black-market price above even the original $300 free-market rent. This directly undermines the government’s aim: the tenants who do end up securing an apartment through the black market pay more than they would have paid before the maximum rent was introduced, while the government has no ability to monitor or tax these illegal transactions.

Final answers

• (a) Free-market equilibrium: rent $=$ $300 per week, quantity $=$ 700 thousand apartments.
• (b) Shortage $=$ 200 thousand apartments per week, because the maximum rent is set below equilibrium, raising quantity demanded and lowering quantity supplied.
• (c) A waiting list (first-come, first-served) system rather than allocation by willingness to pay.
• (d) A black market is likely, and it would push some tenants’ effective payments above the original $300 rent, undermining the aim of cheaper housing.