microeconomics book solution 5

Microeconomics book - S71-S86_Krugman2e_PS_Ch05.qxp 9:25 PM Page S-71 chapter The Market Strikes Back 1 Suppose it is decided that rent control in

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Solution S-71 5 chapter: The Market Strikes Back 1. Suppose it is decided that rent control in New York City will be abolished and that market rents will now prevail. Assume that all rental units are identical and so are offered at the same rent. To address the plight of residents who may be unable to pay the market rent, an income supplement will be paid to all low-income households equal to the difference between the old controlled rent and the new market rent. a. Use a diagram to show the effect on the rental market of the elimination of rent control. What will happen to the quality and quantity of rental housing supplied? b. Use a second diagram to show the additional effect of the income-supplement policy on the market. What effect does it have on the market rent and quantity of rental housing supplied in comparison to your answers to part a? c. Are tenants better or worse off as a result of these policies? Are landlords better or worse off? Is society as a whole better or worse off? d. From a political standpoint, why do you think cities have been more likely to resort to rent control rather than a policy of income supplements to help low- income people pay for housing? 1. a. With a price ceiling at P C , the quantity bought and sold is Q C , indicated by point A. The ceiling at P C is eliminated and the rent returns to the market equilibrium E 1 , with an equilibrium rent of P 1 . The quantity supplied increases from Q C to the equilibrium quantity Q 1 . At the same time, you should expect the quality of rental housing to improve. As you learned in this chapter, one of the inefficiencies caused by price ceilings is inefficiently low quality. As the rent returns to the equi- librium rent, landlords again have the incentive to invest in the quality of their apartments in order to attract renters. Q 1 P 1 P C D 1 S A Q C Quantity of apartments E 1 Monthly rent Price ceiling S71-S86_Krugman2e_PS_Ch05.qxp 9/16/08 9:25 PM Page S-71
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b. The income-supplement policy causes a rightward shift of the demand curve from D 1 to D 2 . This results in an increase in the equilibrium rent, from P 1 to P 2 , and an increase in the equilibrium quantity, from Q 1 to Q 2 , as the equilibrium changes from E 1 to E 2 . c. Landlords are clearly better off as a result of these two policies: more landlords rent out apartments, and at a higher monthly rent. It is not clear whether tenants are better or worse off. Some tenants who previously could not get apartments can now do so, but at a higher rent. In particular, those tenants who do not receive the income supplement and who used to rent cheap apartments under the price ceiling are now worse off. Society as a whole is better off because the deadweight loss caused by a price ceiling has been eliminated: there are now no missed gains from trade.
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This note was uploaded on 01/19/2011 for the course ECON 11853 taught by Professor Brianallenhunt during the Spring '10 term at Georgia State University, Atlanta.

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Microeconomics book - S71-S86_Krugman2e_PS_Ch05.qxp 9:25 PM Page S-71 chapter The Market Strikes Back 1 Suppose it is decided that rent control in

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