LS 7 - CHAPTER 6 Markets in Action Housing Markets and Rent...

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1 Markets in Action CHAPTER 6 Housing Markets and Rent Ceilings The 1906 earthquake in San Francisco left 200,000 people—more than half the city—homeless. By the time the San Francisco Chronicle started publishing again, a month after the earthquake, there was not a single mention of a housing shortage. The classified advertisements listed many more houses and flats for rent than the advertisements for houses and flats wanted. How did the market achieve this outcome? Housing Markets and Rent Ceilings The Market Response to a Decrease in Supply Figure 6.1 shows the San Francisco housing market before the earthquake. The quantity of housing was 100,000 units and the rent was $16 a month at the intersection of the curves D and SS .
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2 Housing Markets and Rent Ceilings The earthquake decreased the supply of housing and the supply curve shifted leftward to SS A . The rent increased to $20 a month and the quantity decreased to 72,000 units. Housing Markets and Rent Ceilings The long-run supply of housing is perfectly elastic at $16 a month. With the rent above $16 a month, new houses and apartments are built. Long-Run Adjustment Housing Markets and Rent Ceilings The building program increases supply and the supply curve shifts rightward. The quantity of housing increases and the rent falls to the pre-earthquake levels (other things remaining the same).
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3 Housing Markets and Rent Ceilings A price ceiling is a regulation that makes it illegal to charge a price higher than a specified level. When a price ceiling is applied to a housing market it is called a rent ceiling . If the rent ceiling is set above the equilibrium rent, it has no effect. The market works as if there were no ceiling. But if the rent ceiling is set below the equilibrium rent, it has powerful effects. A Regulated Housing Market Housing Markets and Rent Ceilings Figure 6.2 shows the effects of a rent ceiling that is set below the equilibrium rent. The equilibrium rent is $20 a month. A rent ceiling is set at $16 a month. So the equilibrium rent is in the illegal region. Housing Markets and Rent Ceilings At the rent ceiling, the quantity of housing demanded exceeds the quantity supplied and there is a housing shortage.
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4 Housing Markets and Rent Ceilings With a housing shortage, people are willing to pay $24 a month. Because the legal price cannot eliminate the shortage, other mechanisms operate: ± Search activity ± Black markets Housing Markets and Rent Ceilings Search Activity The time spent looking for someone with whom to do business is called search activity . When a price is regulated and there is a shortage, search activity increases. Search activity is costly and the opportunity cost of housing equals its rent (regulated) plus the opportunity cost of the search activity (unregulated). Because the quantity of housing is less than the quantity
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LS 7 - CHAPTER 6 Markets in Action Housing Markets and Rent...

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