Principles of Economics
One of the major reasons for the government intervention in the market is to improve the general welfare where the free market operations fail to allocate resources effectively. Rental control is a program set by some governments in order to make decisions regarding how much rent is to be charged by landlords on tenants. Most landlords with apartments have over the years taken advantage of the tenants by raising rent charges and making it hard for the people in the lower class in the society to find affordable houses. It is for this reason that various governments have tried to come up with rules and policies that are set to counter this misallocation of resources. Ways have been devised on how to abolish these but it has however not been an easy task as introduction of the rental control policy has faced opposition from different quarters.
In the current house market structure, we have the free market and price control rental system. Most people with rental houses tend to prefer the free market system since property can be valued at very high prices depending on the owner’s preference as well as the market demand. This is unlike in the price controlled system. In cities where the government decides to introduce the price control system, there tends to be a relative low supply in the housing units compared to the demand that follows after introduction of this rule. This is attributed by the fact that the introduction of price ceiling on rent, will attract many people as they would easily prefer living in houses in which they can afford paying rent and living comfortably (Glaeser and Luttmer 2013:1027).
Moreover, individuals can determine their yearly rent payment as it does increase by large rates hence budgeting once financial obligation becomes an easy task. Random allocation of housing units is a major occurrence that comes with price controls to the individuals willing to acquire this house. This factor in turn enables people who had never imagined owning apartment units, own one since rent is affordable. Since the prices of a price controlled house differ from that of a free market houses, it discourages those who would have wished to own rental apartments as rental charges are seemingly low. At this state, the diminishing returns tends to be low as the gap between those who demand and are willing to pay for the houses is high than the supplied levels (Glaeser and Luttmer 2013:1029).
Property owners greatly prefer owning houses in uncontrolled markets. Misallocation highly occurs with the price control rule. At some instances, misallocation tends to produce varying effects on both the consumer and producer. Some consumers may actually have rented houses for some high value compared to the time they spend in them or the services they derive from the given houses. In other instances allocation may not occur appropriately as some consumers may get houses with fewer rooms than they expected. This act tends to derive both producer surplus and consumer surplus effect (Glaeser and Luttmer 2013:1029). Therefore, from the above we can say that price control results in some distortions. Business won’t be usual for the property owners as prices will set to be reduced below the market equilibrium. Second, there will be misallocation of renters as observed above. In most cases the net benefit derived from a house is not arrived at by consumers.
Thirdly, the houses receiving price controls might end up offering poor services and others might be of very poor quality. The consumers are normally many and the houses in high demand. Since prices are lower than what the landlord would want, he/she ends up cutting off some services. Fourth, there is a decrease in tenant mobility. This is caused by the fact that the tenants are comfortable with the houses since they fit their budget. Moving out would turn costly as there are no other affordable houses and yet the previous houses are in high demand.
Impact of the Policy on Pareto- Efficiency
Pareto efficiency is a distribution strategy where the situation of one individual can’t be improved without affecting the situation of another person and in most cases the latter’s situation is worsened(Glaeser and Luttmer 2003:1027). In other cases Pareto efficiency is achieved when a good or service is allocated to the consumer who is willing to pay more for service/good in question. In the housing market Pareto efficiency occurs when price control measures are introduced. Price control method tends to worsen the situation of a house owner while improving the situation of the tenant. In other words, before introduction of the price controls, landlords used to change prices however they wished depending on the market prices. However, with pareto efficiency, an optimum price by which rent charges shouldn’t exceed is introduced. This in turn favors the consumer (Glaeser and Luttmer). Some consumers are moved from poor housing conditions into these new apartments where prices are affordable. Therefore, this situation hardly happens in free and uncontrolled markets.
Pareto efficiency is also evident in the free markets although affecting only consumers. In the free markets, it tends to differentiate the rich from the poor (Besanko and Braeutigan, 2013). This kind of market has unlimited prices which are not favorable to the poor family. Landlords keep coming up with better serviced houses of high quality which in turn come with high rental charges. Therefore, the rich end up asking for and living in the said apartments while the poor are far driven into slums or other forms of undesirable settlements. In cases where price controls are introduced and the said rich occupants move on to better suburbs that fit their status creating room for the middle class tenants, then there would be no Pareto efficiency since both groups are benefitting.
Factors Determining Size of Allocative Efficiency
Inflation is one of the major factors causing introduction of the rental control policy (Krugman and Wells 2012:133). Over the years, inflation has caused an increase in price of consumer goods. This increase has resulted in the increasing rate of operation cost of many apartments. This in turn has led to the increase in rental charges which has not been good news to the tenants. The rent increase has caused immense pressure on the government to introduce rent control policies to ease pressure on tenants. This policy is beneficial to both the poor and rich. Controlling production is the other reason that might result in this policy. At most times landlords tend to make a lot of profits from tenants in the free market. This might be as a result of new services or abrupt increase in rental prices as the standards of living increase. Landlords in turn use the extra surplus to develop more apartments. The government can thus introduce this policy to counter the exploitation of tenants. Another factor that may attract the government’s intervention is the laying of poorly defined property rights (Krugman and Wells 2012:165). This includes factors like exclusivity rule which most landlords love to go against. The rule of exclusivity states that all benefits and costs that accrue as a result of owning and using the property should fall on the landlord. However, most landlords opt to charge the tenants or increase the overall price of rent as a result of the costs that might accrue in the process.
Another factor that might result in introduction of this policy is instances where certain housing companies merge and develop some form of cartels that lead to creation of monopolies. This results in increased rental prices that are most of the time unaffordable for ordinary citizens. Tenants have to dig deep since most houses are under these monopolies. The governments intervention is hence required inform of creation of price ceilings for the rental charges.
It is thus important for the government to come up with measures that seek to benefit both the tenants and landlords. In most cases, landlords have been crying foul of this policy as it does not favor them in most instances. Thus convincing reasons for introducing the policy should be made after several consultations with the parties involved in order to avoid opposition that derails implementation of the policy. There should also be better economic signals put in place that help people make better decision economically. For the housing market to function well there should also be creation of proper property rights that regard ownership of property.
Besanko, D. and Braeutigan, R. (2013) Microeconomics, Chapter 10. New York, NY: John Wiley & Sons.
Glaeser, E. and Luttner, E. (2003). The Misallocation of Housing under Rental Control. American Economic Review, Vol 93(4), Pp 1027-1030.
Krugman, P. and Wells, R. (2012). Microeconomics, Chapter 4 and 5. New York, NY: Worth Publishers.