Government Intervention in Market Prices: Price Floors and Price Ceilings
So far in this chapter and in the previous chapter, we have learned that markets tend to move
toward their equilibrium prices and quantities. Surpluses and shortages of goods are short-lived
as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time. So far in this chapter and in the previous chapter, we have learned that markets tend to
move toward their equilibrium prices and quantities. Surpluses and shortages of goods are
short-lived as prices adjust to equate quantity demanded with quantity supplied.
In some markets, however, governments have been called on by groups of citizens to intervene
to keep prices of certain items higher or lower than what would result from the market finding
its own equilibrium price. In this section we will examine agricultural markets and apartment
rental markets—two markets that have often been subject to price controls. Through these
examples, we will identify the effects of controlling prices. In each case, we will look at reasons
why governments have chosen to control prices in these markets and the consequences of these
policies.
Agricultural Price Floors
Governments often seek to assist farmers by setting price floors in agricultural markets. A
minimum allowable price set above the equilibrium price is a price floor. With a price floor,
the government forbids a price below the minimum. (Notice that, if the price floor were for
whatever reason set below the equilibrium price, it would be irrelevant to the determination of
the price in the market since nothing would prohibit the price from rising to equilibrium.) A
price floor that is set above the equilibrium price creates a surplus.
Figure 4.6 "Price Floors in Wheat Markets" shows the market for wheat. Suppose the
government sets the price of wheat at PF. Notice that PF is above the equilibrium price of PE.
At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be
willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price floor of PF. Because PF is above the
equilibrium price, there is a surplus of wheat equal to (W2 − W1) bushels. The surplus persists
because the government does not allow the price to fall.
Figure 4.6 Price Floors in Wheat Markets
A price floor for wheat creates a surplus of wheat equal to (W2 - W1) bushels.
Why have many governments around the world set price floors in agricultural markets?
Farming has changed dramatically over the past two centuries. Technological improvements in
the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to
dramatic increases in crop output per acre. Worldwide production capacity has expanded
markedly. As we have learned, technological improvements cause the supply curve to shift to
the right, reducing the price of food. While such price reductions have been celebrated in
computer markets, farmers have successfully lobbied for government programs aimed at
keeping their prices from falling.
While the supply curve for agricultural goods has shifted to the right, the demand has increased
with rising population and with rising income. But as incomes rise, people spend a smaller and
smaller fraction of their incomes on food. While the demand for food has increased, that
increase has not been nearly as great as the increase in supply. Figure 4.7 "Supply and Demand
Shifts for Agricultural Products" shows that the supply curve has shifted much farther to the
right, from S1 to S2, than the demand curve has, from D1 to D2. As a result, equilibrium quantity
has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2.
On top of this long-term historical trend in agriculture, agricultural prices are subject to wide
swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular
crops, causing sudden increases in prices. Demand for agricultural goods of one country can
suddenly dry up if the government of another country imposes trade restrictions against its
products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of
farmers unstable.
Figure 4.7 Supply and Demand Shifts for Agricultural Products
A relatively large increase in the supply of agricultural products, accompanied by a relatively
small increase in demand, has reduced the price received by farmers and increased the quantity
of agricultural goods.
The Great Depression of the 1930s led to a major federal role in agriculture. The Depression
affected the entire economy, but it hit farmers particularly hard. Prices received by farmers
plunged nearly two-thirds from 1930 to 1933. Many farmers had a tough time keeping up
mortgage payments. By 1932, more than half of all farm loans were in default.
Farm legislation passed during the Great Depression has been modified many times, but the
federal government has continued its direct involvement in agricultural markets. This has
meant a variety of government programs that guarantee a minimum price for some types of
agricultural products. These programs have been accompanied by government purchases of
any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or
production restrictions, and the like.
To see how such policies work, look back at Figure 4.6 "Price Floors in Wheat Markets".
At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is
market pressure on the price of wheat to fall. To prevent price from falling, the government
buys the surplus of (W2 - W1) bushels of wheat, so that only W1 bushels are actually available
to private consumers for purchase on the market. The government can store the surpluses or
find special uses for them. For example, surpluses generated in the United States have been
shipped to developing countries as grants-in-aid or distributed to local school lunch programs.
As a variation on this program, the government can require farmers who want to participate in
the price support program to reduce acreage in order to limit the size of the surpluses.
After 1973, the government stopped buying the surpluses (with some exceptions) and simply
guaranteed farmers a “target price.” If the average market price for a crop fell below the crop’s
target price, the government paid the difference. If, for example, a crop had a market price of
$3 per unit and a target price of $4 per unit, the government would give farmers a payment of
$1 for each unit sold. Farmers would thus receive the market price of $3 plus a government
payment of $1 per unit. For farmers to receive these payments, they had to agree to remove
acres from production and to comply with certain conservation provisions. These restrictions
sought to reduce the size of the surplus generated by the target price, which acted as a kind of
price floor.
What are the effects of such farm support programs? The intention is to boost and stabilize
farm incomes. But, with price floors, consumers pay more for food than they would otherwise,
and governments spend heavily to finance the programs. With the target price approach,
consumers pay less, but government financing of the program continues. U.S. federal spending
for agriculture averaged well over $22 billion per year between 2003 and 2007, roughly $70
per person.
Help to farmers has sometimes been justified on the grounds that it boosts incomes of “small”
farmers. However, since farm aid has generally been allotted on the basis of how much farms
produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.
If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement
the incomes of small or poor farmers rather than to undermine the functioning of agricultural
markets.
In 1996, the U.S. Congress passed the Federal Agriculture Improvement and Reform Act of
1996, or FAIR. The thrust of the new legislation was to do away with the various programs of
price support for most crops and hence provide incentives for farmers to respond to market
price signals. To protect farmers through a transition period, the act provided for continued
payments that were scheduled to decline over a seven-year period. However, with prices for
many crops falling in 1998, the U.S. Congress passed an emergency aid package that increased
payments to farmers. In 2008, as farm prices reached record highs, Congress passed a farm bill
that increased subsidy payments to $40 billion. It did, however, for the first time limit payments
to the wealthiest farmers. Individual farmers whose farm incomes exceed $750,000 (or $1.5
million for couples) would be ineligible for some subsidy programs.
Rental Price Ceilings
The purpose of rent control is to make rental units cheaper for tenants than they would
otherwise be. Unlike agricultural price controls, rent control in the United States has been
largely a local phenomenon, although there were national rent controls in effect during World
War II. Currently, about 200 cities and counties have some type of rent control provisions, and
about 10% of rental units in the United States are now subject to price controls. New York
City’s rent control program, which began in 1943, is among the oldest in the country. Many
other cities in the United States adopted some form of rent control in the 1970s. Rent controls
have been pervasive in Europe since World War I, and many large cities in poorer countries
have also adopted rent controls.
Rent controls in different cities differ in terms of their flexibility. Some cities allow rent
increases for specified reasons, such as to make improvements in apartments or to allow rents
to keep pace with price increases elsewhere in the economy. Often, rental housing constructed
after the imposition of the rent control ordinances is exempted. Apartments that are vacated
may also be decontrolled. For simplicity, the model presented here assumes that apartment
rents are controlled at a price that does not change.
Figure 4.8 Effect of a Price Ceiling on the Market for Apartments
A price ceiling on apartment rents that is set below the equilibrium rent creates a shortage of
apartments equal to (A2 − A1) apartments.
Figure 4.8 "Effect of a Price Ceiling on the Market for Apartments" shows the market for rental
apartments. Notice that the demand and supply curves are drawn to look like all the other
demand and supply curves you have encountered so far in this text: the demand curve is
downward-sloping and the supply curve is upward-sloping.
The demand curve shows that a higher price (rent) reduces the quantity of apartments
demanded. For example, with higher rents, more young people will choose to live at home with
their parents. With lower rents, more will choose to live in apartments. Higher rents may
encourage more apartment sharing; lower rents would induce more people to live alone.
The supply curve is drawn to show that as rent increases, property owners will be encouraged
to offer more apartments to rent. Even though an aerial photograph of a city would show
apartments to be fixed at a point in time, owners of those properties will decide how many to
rent depending on the amount of rent they anticipate. Higher rents may also induce some
homeowners to rent out apartment space. In addition, renting out apartments implies a certain
level of service to renters, so that low rents may lead some property owners to keep some
apartments vacant.
Rent control is an example of a price ceiling, a maximum allowable price. With a price ceiling,
the government forbids a price above the maximum. A price ceiling that is set below the
equilibrium price creates a shortage that will persist.
Suppose the government sets the price of an apartment at PC in Figure 4.8 "Effect of a Price
Ceiling on the Market for Apartments". Notice that PC is below the equilibrium price of PE.
At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.
Reading over to the demand curve, we find that consumers would like to rent A2 apartments at
the price ceiling of PC. Because PC is below the equilibrium price, there is a shortage of
apartments equal to (A2 - A1). (Notice that if the price ceiling were set above the equilibrium
price it would have no effect on the market since the law would not prohibit the price from
settling at an equilibrium price that is lower than the price ceiling.)
Figure 4.9 The Unintended Consequences of Rent Control
Controlling apartment rents at PC creates a shortage of (A2 − A1) apartments.
For A1 apartments, consumers are willing and able to pay PB, which leads to various
“backdoor” payments to apartment owners.
If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for
rent control and why do governments often give in to the demands? The reason generally given
for rent control is to keep apartments affordable for low- and middle-income tenants.
But the reduced quantity of apartments supplied must be rationed in some way, since, at the
price ceiling, the quantity demanded would exceed the quantity supplied. Current occupants
may be reluctant to leave their dwellings because finding other apartments will be difficult. As
apartments do become available, there will be a line of potential renters waiting to fill them,
any of whom is willing to pay the controlled price of PC or more. In fact, reading up to the
demand curve in Figure 4.9 "The Unintended Consequences of Rent
Control" from A1 apartments, the quantity available at PC, you can see that for A1 apartments,
there are potential renters willing and able to pay PB. This often leads to various “backdoor”
payments to apartment owners, such as large security deposits, payments for things renters may
not want (such as furniture), so-called “key” payments (“The monthly rent is $500 and the key
price is $3,000”), or simple bribes.
In the end, rent controls and other price ceilings often end up hurting some of the people they
are intended to help. Many people will have trouble finding apartments to rent. Ironically, some
of those who do find apartments may actually end up paying more than they would have paid
in the absence of rent control. And many of the people that the rent controls do help (primarily
current occupants, regardless of their income, and those lucky enough to find apartments) are
not those they are intended to help (the poor). There are also costs in government administration
and enforcement.
Because New York City has the longest history of rent controls of any city in the United States,
its program has been widely studied. There is general agreement that the rent control program
has reduced tenant mobility, led to a substantial gap between rents on controlled and
uncontrolled units, and favored long-term residents at the expense of newcomers to the
city.Richard Arnott, “Time for Revisionism on Rent Control,” Journal of Economic
Perspectives 9(1) (Winter, 1995): 99–120. These distortions have grown over time, another
frequent consequence of price controls.
A more direct means of helping poor tenants, one that would avoid interfering with the
functioning of the market, would be to subsidize their incomes. As with price floors, interfering
with the market mechanism may solve one problem, but it creates many others at the same
time.
