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Topic 3 Lecture Notes

Topic 3 Lecture Notes - Econ 1 PRINCIPLES OF MICROECONOMICS...

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Econ 1 – PRINCIPLES OF MICROECONOMICS LECTURE NOTES Foster, UCSD 15-Oct-09 TOPIC 3 – APPLICATIONS A. Price Controls 1. Price Ceilings: a) Defn and effects. [Fig. 1] 1) A price ceiling is a law establishing a maximum legal price that may be charged for some good. 2) If P max < P*, result is a shortage. 3) If P max P*, there is no effect. b) Motives for price ceilings. 1) Keep price low to help poor people afford it – rent control 2) Punish suppliers -- usury laws (interest rate ceilings). 2) Reduce price of basic inputs to curb inflation. 3) Redirect resources out of price-controlled industry. c) Rationing the shortage: Queuing – first-come, first-served. Coupon rationing -- gasoline coupons during WW II. You needed to pay the price of gasoline, PLUS one coupon. Government decided who got the coupons. Seller preference – seller provides the limited quantity to his favored customers, which can be discriminatory. Black markets – seller or criminals acquire the good at lower P max , then resell illegally to desperate buyers at P’. 2. Case Study -- Rent Control in New York: [Fig. 2] a) The market for rental housing. 1) H = sq. ft. of rental housing space in a city. 2) SR supply curve is very steep ( i.e. , price inelastic), since the stock of H only changes slowly over time. 3) LR supply is more price elastic since H can increase thru new construction or renting of rooms in private homes, and decrease thru condo conversion and depreciation. 4) The law of demand holds. If rents rise, people move away, rent smaller digs, buy homes, or stay with parents. b) Consequences of rent control. 1) Market starts in equilibrium at [R* H*]. Then a rent ceiling of R max is imposed. Supply can't change in the SR, but more is demanded, so shortage H d − H* develops. shortage X s X d D S P’ P* P max Fig. 1 H’ H* H d R* R max D S’ S LRS Fig. 2
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Ec 1 APPLICATIONS p. 2 2) The principal SR beneficiaries are people already renting in the city whose rent has gone down. Newcomers looking for cheap rent will not find apartments available. 3) Landlords are hurt immediately, since the market value of their apartment buildings has decreased by the present value of all the lost future rents. 4) Vitiating rent control Have to pay for furniture Large non-refundable cleaning or security deposits Have to pay extra for the key to the apartment 5) Seller preferences for families with no pets or children and with high incomes will be used to ration shortage. Poor people may end up worse than before. 6) Since renting apartments is no longer so profitable, the LR supply will fall as apart- ments are converted to condos and as landlords pay less for maintenance and upkeep of the existing stock. Supply drops and shortage worsens.
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