After you have worked through this section of the learning unit, you should be able to:
- explain the consequences of a price ceiling on a market
An efficient allocation between possible renters is one in which those who want an apartment badly enough and are willing to pay a higher price will acquire the apartment (those who are willing to pay R3 000), while those who do not need it that badly and are not willing to pay R3 000 will not acquire it. This, however, does not happen in this market because there is a price ceiling which causes an excess demand for apartments – 40 000 people are willing to rent an apartment at R2 000, but only 20 000 apartments are available.
Apartments
A price ceiling causes an excess demand, which means that a mechanism needs to be put in place to solve the rationing problem in the market. In the market for apartments, there are 40 000 people looking for apartments, but there are only 20 000 apartments. A decision needs to be made about who acquires these apartments.
How do you think this rationing should be resolved?
Select all the possibilities you think apply.
All of the above are possible, but leads to inefficiencies.
A consequence of rent control is that people acquire an apartment in this market through luck, bribery or personal connections. It also creates an incentive for people to keep an apartment that no longer suits their needs.
Take the case of Frederick, who has retired and bought a house in a seaside village, but still keeps his lease on the rent-controlled apartment in the city which he uses when he visits the city. At R2 000, it is affordable for him to keep the apartment. If the rent he has to pay is R3 000, he would probably consider giving up the apartment and staying over with friends or family when he visits the city. However, a family that desperately needs an apartment and is willing to pay R3 000 cannot acquire an apartment. When there is a shortage of apartments, the cost of finding an apartment increases, and in the process resources are wasted.
Since there is little incentive for suppliers to increase the quantity of apartments and to improve the quality of the apartments, the shortage will persist and the quality of the apartments will deteriorate. Instead of building new apartments, it might be more profitable to build offices and shopping centres. Some apartment suppliers might also decide to convert their apartment buildings into office buildings.
This situation also leads to the creation of illegal markets (black markets) such as subletting. If you can access a rent-controlled apartment at R2 000, you might be able to sublet it for, say, R4 000, and be able to pocket R2 000. The owner of the apartment does not share in this R2 000.
We have discussed the effect of price ceilings on the specific case of rent controls for apartments. In general, whether for soccer tickets, university fees or any good or service, a price ceiling has the following impacts:
- A persistent shortage (excess demand) develops.
- There is an increase in the rationing costs. These are the costs associated with things such a queuing and/or developing administration system to decide how the good or service is to be distributed.
- An illegal or "black market" develops because of the persistent shortage, which makes illegal trade profitable. Since there are people willing to pay more for the product but cannot acquire it, an incentive is created for black marketeers to acquire the product at the lower price and sell it at a higher price. The price that the black marketeers charge is usually higher than the equilibrium price in an unregulated or free market.
- Opportunities for corruption and bribery are created.
- Price ceilings also create winners and losers. Those people who are able to acquire the good or service benefit, while those who cannot lose out. There are fewer consumers paying a lower price. Producers lose out because they are willing to supply a higher quantity at a higher price, but because of the low price, they supply a lower quantity.
Activity
The following demand and supply curves for an economics course illustrate the impact of a price ceiling of R2 500 on the course fee.
Which of the following statements are correct with regard to the above?
- Owing to the excess demand that is created, a rationing mechanism needs to be put in place to determine which students will be allowed to take the course.
- In the absence of the price ceiling, the price will be the rationing method, and only those students who are willing and able to pay R3 500 will be allowed to take the course.
- Owing to the price ceiling, more students will be enrolled for the course.
a and b.
A consequence of a price ceiling is that it interferes with the rationing function of the price mechanism and the result is an excess demand. In the absence of the price ceiling, the equilibrium price will be reached and there will be no excess demand, and the 15 000 students who are able and willing to pay R3 500 will be enrolled for the course.
When a price ceiling of R2 500 is imposed, 18 000 students will be able and willing to take the course but there will only be place for 12 000 students. This then requires an additional rationing mechanism to determine who these 12 000 students will be.
A price ceiling requires an additional rationing mechanism because an excess demand is created in the market. Which of the following are possible ways to deal with this excess demand?
- The excess demand should be dealt with on a first-come-first-served basis.
- A production quota system should be implemented whereby government would limit the production of the product.
- The supplier should decide who should be able to obtain the product.
- Government should purchase the surplus production.
- Government should decide who should be able to obtain the product.
a, c and e.
The following are all possible measures to deal with the excess demand:
- The excess demand should be dealt with on a first-come-first-served basis.
- The supplier should decide who should be able to obtain the product.
- Government should decide who should be able to obtain the product.
The others are ways to deal with a surplus. - A production quota system should be implemented whereby government would limit the production of product.
- Government should purchase the surplus production.
The market price for a loaf of bread is R15. Government imposes a price ceiling of R12 per loaf of bread. A consequence of this action is that a black market for bread could develop since people who can obtain the bread at R12 can sell it to others who are willing to pay R15 for a loaf of bread and pocket the difference.
- The argument is correct.
- The argument is incorrect because it applies to a price floor.
- The argument is incorrect because nobody is willing to pay R15 for a loaf of bread.
a. The argument is correct.
It is indeed a consequence of a price ceiling that a black market might develop. In this scenario, there is an excess demand for bread at R12. This means some people who are willing and able to pay for bread cannot acquire it. Owing to the demand for bread, there are people willing and able to pay R15 and more for a loaf of bread, and if the black marketeer can obtain it for R12, he or she can sell it for R15 or the price people are prepared to pay for.