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Introduction
Principles of Economics, On April 26, 2015, the leadership of labor party mentioned that they will introduce rent control if they are able to form the government. They have taken this decision on the basis of a public poll; who may not have sound knowledge of economics. However, the economists in the country believe that the policy is unsound economically as it can lead to inefficiencies in the market. It is generally well known that the competitive markets run efficiently when they are free from any price ceiling or price floor. The price ceiling creates inefficiencies when it is set below the equilibrium price and price floor creates inefficiencies when it is set above the equilibrium price. The rent control is a type of price ceiling below the equilibrium price because government aims to control the rents within a specified range so it can lead to inefficiencies in case of competitive markets (Jehle and Reny, 2001). The effect of a price ceiling below the market equilibrium is shown in the figure below:
Figure 1 – Impact of Price Ceiling
(Source: Bade and Parkin, 2013)
The figure highlights that the price ceiling results in shortage of the good available in the market as demand increases at lower price and supply eventually decreases. The figure also shows that the markets become inefficient when such price ceilings are introduced in any given market so if the government introduces policies for rent control then the results of such policies will be same (Bade and Parkin, 2013).
Market Structure of Housing Market
The nature and market structure of housing market is identical in almost every country; Principles of Economics the industry is recognized by low barriers to entry and large number of firms operating in the industry. The industry is highly concentrated as a research reveals that top 100 real estate companies had a collective market share of 17% in USA in 2005. The results of this research clearly indicate that the housing market in USA is very competitive and highly concentrated; it must be noted that the housing markets around the world are similar in market structure (National Association of Realtors, 2005). The market structure of housing market is perfectly competitive as indicated by the factors discussed above.
In the view of Beck, Scott and Yelowitz (2012), there are two school of thoughts regarding the competitive nature of the housing market in different countries; one school of thought believes that the market forces determine the prices in housing market based on demand and supply while other group believes that the prices are determined by authorities and companies operating in the industry. As identified earlier, different factors show that the market structure of the housing market is perfectly competitive so the companies / businesses operating within the industry cannot determine prices but the prices must be determined by the competitive forces such as quantity demanded and quantity supplied within the industry.
On the other hand, Paciorek (2013) believes that there is often a shortage of supply in the housing market which leads to higher rents and prices of the houses in the industry. He also believes that the markets are competitive and the prices are determined by the market forces but the supply is inelastic in the short run so it often leads to shortage of supply in the housing market as a whole and prices increase as a result. These findings imply that there is a need for rent controls in the housing industry; however it will lead to inefficiencies as the suppliers will not be willing to rent their homes at the price determined by the government. Overall Principles of Economics, it can be stated that the housing markets are perfectly competitive and the firms operating in the industry are price takers; there is intense competition within the industry.
Allocative / Pareto Inefficiency due to introduction of Rent Controls
In the view of Stilwell (2014), Allocative efficiency refers to the state of economy where the goods produced represent the taste of the consumers; Principles of Economics only those goods are produced which provide utility to the consumer and whose marginal benefit is more than or equal to the marginal cost of the purchasing the product. When these conditions are not met, it can be said that there is allocative inefficiency…
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