6. GOVERNMENT POLICIES Gasoline Prices 9/11 • Within 24 hours of 9/11 some gasoline stations in the Cleveland area dramatically increased prices. • Assess this action. Supply Ceteris Paribus Input prices Technology Expectations Number of sellers Gasoline Prices $ S p D qr Quantity Gasoline Prices $ S1 S p1 p D q1 q Quantity Importance of price and market forces Market forces and price perform essential allocation role. Allocating goods and services and scarce resources to their highest and best use. This allocation function is automatic involving myriad decisions by producers and consumers. If markets are not permitted to work, how is this allocative function performed? PRICE CEILINGS RENT CONTROLS January 13, 2004 In what has become an annual ritual, tenants of many of New York City's 60,000 rent-controlled apartments berated the state officials responsible for computing their rent increases at a hearing last Tuesday. Tenants were understandably upset — they face 7.5 percent rent increases in each of the next two years. But their landlords, whose operating costs increased more than 17 percent this year, did not have much to celebrate either. The hearing provided yet another vivid illustration of how dysfunctional the city's rent regulation system is, and how it worsens the very problems it was created to solve. Rent regulations, which were established in the post-World War II era, are intended to preserve neighborhood diversity and stability, and to ensure that rents do not jump to levels that only the wealthy can afford, forcing lower- income residents to cheaper areas. But in practice, such laws do not really serve diversity well; they simply freeze the status quo, so neighborhoods remain only as diverse as they are now, which isn't very diverse at all. An apartment can only be rent-controlled if it is in a building constructed before 1947 and if its current tenant (or his family) has occupied it since 1971. Such an apartment becomes "decontrolled" only when those tenants leave and no relative assumes the lease. Likewise, rent increases for rent-stabilized apartments are limited until the tenant moves out, when the "legal rent" (a fiction that has nothing to do with market value) can be raised about 17 percent to 20 percent. Tenants in these apartments have a strong interest in staying put, since they can't take their rent subsidy with them. PRICE CEILINGS •Rent controls are an example of price ceilings. •Price ceilings set a price below the equilibrium rate that cannot be exceeded, i.e. no property owner can charge a rental rate greater than the ceiling price. •Price ceilings are legislated by governments and represent government intervention in the marketplace. •Price ceilings are usually established when the outcomes of the market are considered to be unacceptable—equity values prevail over market values. •What are the consequences? RENT CONTROLS $ S of rental housing equilibrium in absence of price ceiling. r D for rental housing qr Quantity $ RENT CONTROLS S of rental housing r Controlled Rent rc D for rental housing qr Quantity $ RENT CONTROLS S of rental housing Quantity demanded exceeds quantity supplied r Controlled Rent rc D for rental housing qs qr qd Quantity Quantity supplied Quantity demanded $ RENT CONTROLS S of rental housing Who benefits? r Who loses? Controlled Rent rc D for rental housing qs qr qd Quantity Quantity supplied Quantity demanded $ RENT CONTROLS S of rental housing r Savings to renters rc D for rental housing qs qr qd Quantity Quantity supplied Quantity demanded Excess demand $ RENT CONTROLS S of rental housing Loss to previous r renters. Savings to renters rc D for rental housing qs qr qd Quantity Quantity supplied Quantity demanded Excess demand $ RENT CONTROLS S of rental housing Loss to previous r renters. Savings to renters Unmet demand rc D for rental housing qs qr qd Quantity Quantity supplied Quantity demanded Excess demand The rent regulation scheme is no more precise in distributing its costs than it is in bestowing its benefits. While tenants are protected, landlords have to pay market rates for all of their expenses, including real estate taxes, insurance, water and fuel oil, all of which have risen steeply in recent years. Real estate taxes rose 18.5 percent this year, and insurance costs for many owners have jumped 50 percent since 9/11. Yet rents on stabilized apartments went up this year just 4.5 percent for a one-year lease or 7.5 percent for a two-year lease. Why should landlords, unlike purveyors of virtually every other commodity in New York, be prohibited from setting their own prices? Moreover, by distorting the relationship between property income and expenses, rent regulation depresses the returns on property, which in turn causes landlords to under invest. Are rent controls good economic policy? Alternatives to Rent Controls Is there a better way to achieve the same goal? Housing Vouchers A better way to create more affordable housing and to diversify neighborhoods would be to replace the current system of rent regulation with a subsidy system similar to the federal Section 8 housing program. Vouchers would be distributed to those who qualified based on explicit criteria defined by state and city lawmakers. The costs would be borne in the same manner as other government programs — through a progressive tax system. If preserving affordable housing is a virtue, then society as a whole should bear its costs. $ RENT SUBSIDIES S of rental housing As an alternative to a price ceiling, what will be the effect of providing renters with a rent subsidy [r-rs]? r rent subsidy rs D for rental housing qr Quantity RENT SUBSIDIES $ S of rental housing The rent subsidy is an increase in income causing demand to increase. Quantity demanded increases of qs. Government subsidies = rent subsidy r Vertical distance= rs subsidy Ds D qr qs Quantity Subsidies to Suppliers Subsidies to Apartment Builders/Owners [Cost to government] $ S of rental housing equilibrium in absence of subsidy. Ssubsidized r rs D for rental housing qr qs Quantity Subsidies to Apartment Builders/Owners [Cost to government] $ S of rental housing equilibrium in absence of subsidy. Ssubsidized public subsidy r rs D for rental housing qr qs Quantity PRICE FLOORS MINIMUM WAGE PRICE FLOORS •The minimum wage is an example of price floor. •Price floors set a price above the equilibrium rate that cannot decreased, i.e. no employer can pay a wage rate less than the ceiling floor. •Price floors are legislated by governments and represent government intervention in the marketplace. •Price floors are usually established when the outcomes of the market are considered to be unacceptable—equity values prevail over market values. •What are the consequences? $ S of workers w D for workers q Quantity At the minimum wage, quantity supplied is greater than $ quantity demanded. s Minimum wage we d o qd qs Quantity $ Increase in wages of o-qd workers. s Minimum wage we d o qd qs Quantity $ Increase in wages of o-qd workers. s Minimum wage we Wages lost by qd –x workers now unemployed. d o qd x qs Quantity unemployment Behind the rhetoric, the debate over the minimum wage revolves around the issue of the slope of the demand curve for labor and the responsiveness of quantity demanded to price [wage increases] W W SL SL WM WM W W d Q d Q displacement effects If the demand for labor is If the demand for labor is relatively elastic [gradually relatively inelastic [steeply sloped], the displacement sloped], the displacement effect will be relatively large. effect will be relatively small. Is there a better way to achieve the same objective of higher minimum wages? PRICE FLOORS AGRICULTURAL PRICE SUPPORTS Market for Wheat Without Government Intervention $ S of wheat pw D for wheat qw Quantity Government sets price floor of Ps by guarantying to to purchase all wheat not sold on the private market for that price. $ S of wheat ps Price Support pw D for wheat qw Quantity Take a minute and assess probable outcomes of agricultural price supports for wheat. What will be quantity demanded? What are the outcomes for consumers? $ S of wheat higher price to consumers ps pw D for wheat qd qw Quantity lost private consumption What will be quantity supplied? What are the outcomes for wheat farmers? $ S of wheat higher price to consumers ps total revenue of wheat farmers pw D for wheat qd qw qs Quantity excess supply $ S of wheat higher price to consumers ps pw private consumption D for wheat qd qw qs Quantity excess supply Government expenditures= $ S of wheat higher price to consumers ps government purchases pw private consumption D for wheat qd qw qs Quantity excess supply Government expenditures= =tax expenditures $ Issue: What happens to government owned surpluses? S of wheat higher price to consumers ps government purchases=tax pw dollars private consumption D for wheat qd qw qs Quantity excess supply Contrast this to a policy of paying farmers not to plant acreage. SOIL BANK PROGRAM Market for Wheat Without Government Intervention $ S of wheat pw D for wheat qw Quantity Paying farmers not to plant decreases supply. $ S of wheat S of wheat p1 What is cost to taxpayer? pw D for wheat q1 qw Quantity What is cost to taxpayer? $ S of wheat S of wheat p1 pw D for wheat q1 qw Quantity What subsidy level will be required to bribe farmers not to plant? $ S of wheat S of wheat p1 Potential cost to taxpayer. pw D for wheat q1 qw Quantity California Energy Deregulation Before deregulation price is regulated at Pr. $ S of energy pr D for energy qr Quantity Deregulation • To make energy deregulation politically palatable to California residents, the price of electricity was pegged at the pre- existing regulated price. • Subsequently, the nation and California experienced an energy shortage. • What were the consequences to California? The supply of energy decreased. $ S1 S of energy What happened to price? pr D for energy qr Quantity Price is regulated by pre-existing agreement. $ S1 S of energy Price cannot play its Cost to taxpayer allocative role. pr How can existing supply o-q1 be allocated? D for energy 0 q1 qr Quantity energy shortage If price can’t ration, what does? • Rolling blackouts to allocate existing supplies. • Use of moral suasion to encourage voluntary conservation of energy? • What are consumer’s incentives for voluntary conservation? • Water rationing.