Price Ceilings: Rent Controls

Rent controls are a type of price ceiling. We’ll use our diagram to show how rent controls create shortages by reducing the supply of apartments available on the market. Rent controls also result in reduced product quality, since they reduce the returns to landlords from renting apartments. Landlords respond by cutting costs or performing less maintenance, leading to lower quality. There are search costs associated with rent controls, and they also lead to a misallocation of resources since apartments are not allocated to renters who value them the most.

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[Alex] Today, we'll be looking
at rent controls,

an application
of what we've done already,

because rent controls
are simply a type of price ceiling.

Let's get going.

Here's the list of the effect
of price ceilings,

which you've now seen many times.

I'm going to talk about each one of these
in the context of rent controls,

except for a loss in gains from trade

that doesn't really introduce
any new issues,

so I won't talk about that.

Let's talk about the other items, however.

Okay. Rent controls create shortages.

Let's do our usual diagram,
except this time on the horizontal axis

we have the quantity
of rental apartments.

On the vertical axis, we have price.

Here's our demand
and here's our supply.

The main thing we want to add here

is that the supply of apartments
in the short-run

is going to be very inelastic.

Why? Well, in the short-run,
the apartments are simply there.

They're already built, there's not
much you can do

to change the supply of apartments.

Now, this is not quite true.

You can take an apartment
which is about to come on to the market

and turn it instead into a condo.

You might switch some uses.

You might tear down an apartment early,
things like that.

But, basically, the supply
is going to be fairly inelastic

in the short-run.

So, we have a controlled rent.

This means that they'll be a shortage
in the short-run

and it's given by this amount
on the diagram.

Note that most of the shortage
comes from an increase

in the quantity demanded
when you push the rent below

the market equilibrium right,
when you lower the rent.

Only a little bit of the shortage
comes from a decrease

in the quantity supplied.

In the long-run, however,

the long-run supply is going to be
much more elastic

than the short-run supply.

So, in the long-run, the shortage
will get much worse.

In the long-run, what will happen
is that fewer apartments will be built,

more apartments
will be allowed to run down

to become dilapidated,
to slowly go off the market.

Apartments will be turned
into condominiums.

Instead of building apartments,
people will build car garages,

people will build other types of housing,
and so forth.

So in the long-run, the shortage
from a rent-control gets much worse

than in the short-run.

Here's an interesting graph
from Ontario, Canada,

showing how rent controls can reduce
the number of new units being built.

So, prior to rent control
even being debated,

there are about 30 to 40 thousand
new units being built every year

in Ontario, Canada.

After rent control was put into place
in 1975,

there were fewer than 10,000 new units
being built every year.

Also note, that the number
of new apartments being built,

which might be rent-controlled,

declined even before rent control
was put into place,

and that makes perfect sense.

An apartment has got to pay
for itself over 30 or 40 years.

They are very durable, long-lived assets.

So if you hear today that in the next year
or two, rents may be controlled,

you're going to say,

"Well, I don't want to build
this apartment unit.

It's not going to be profitable
anymore. I was expecting so many rents

for the next 30 or 40 years -

that's now being cut.

This unit is not going to be profitable,
I don't want to build it anymore."

And that's exactly what we saw.

A discussion in rent controls
reduced the number of apartments

being constructed.

We've also put, by the way,
the number in red,

the number of non-rental-
controlled housing

that was being built at the time.

And you can see,
it didn't change very much.

So this illustrates
that it was the rent control itself

and not other factors in the market,
such as the state of the economy,

which reduced the number
of rent-controlled apartments

being built every year.

So this illustrates
how rent controls can create a shortage

by reducing the supply.

As with other types of price controls,

rent controls create reductions
in product quality.

So the rent controls reduce the return
to landlords from renting apartments,

and owners are going to respond
to that price control

by trying to cut costs.

So, they're going to reduce maintenance.

They're going to slow down
the repairs to elevators,

After all, you can still sell
just as many units

they're not going to mow the lawns
as often as they did before.

They can keep all of their units rented
at the rent-controlled price.

even when they cut maintenance
and repair costs and amenities,

and they don't put in the new pool

or they don't put in the playground
and so forth.

They're no longer in a competitive market.

They have lots and lots of people
who want to rent their apartments

at the below-market price,
so they don't need to spend so much

on maintenance and repairs,
and other benefits.

And, since their profits are falling,

they want to try and cut costs as
much as possible.

Indeed, when rent controls
are very strong,

serviceable apartment buildings
quickly turn into slums,

and slums turn into abandoned
and hollowed-out buildings.

This happened in New York City,
this happened in Paris,

this happened in many cities
around the world,

which instituted strong rent controls.

Rent controls create wasteful lines
and other search costs.

So, finding an apartment in New York City
often takes a long time

and you have to spend a lot of money
to get a rent-controlled apartment.

In one famous example, episode of
Seinfeld, George looks for apartments by

consulting the obituaries and rushing to
the landlord anytime he sees someone who

died who had a nice apartment. And that's
in fact one of the techniques which New

Yorkers use to try and get a
rent-controlled apartment. Another effect

of rent controls is to increase
discrimination because rent controls

reduce the price of discrimination. In a
free market, landlords might discriminate.

But then, they pay a price because it's
going to take them longer to rent out the

apartment. But, precisely because the rent
control makes the quantity demanded exceed

the quantity supplied. There are more
people lining up to get apartments than

there are apartments. So, landlords can
more easily, or at lower cost, pick and

choose whom they rent to. Therefore, for
minorities or for people with children, or

for people whom landlords are perhaps
slightly don't want in their apartment,

the cost to them of obtaining apartment is
going to be even higher than for the

average person. Another effect of rent
controls, which is very common, is paying

bribes to get a rent-controlled apartment.
Bribes, of course, are illegal. This is

illegal, but there are ways of disguising
the bribe. One way, for example, would be

to charge extra for a furnished apartment.
What does a furnished apartment look like in

New York City for rent-controlled
apartment? It looks like this. That's a

furnished apartment. You get the idea -
it's a way of paying a bribe under the

table. As with other types of price
ceilings, rent controls create a

misallocation of resources. That is the
apartments are not allocated to the

renters who value them the most. If you
ever get control of a rent-controlled

apartment in New York City, for example,
you never, ever, ever give it up. So, I've

known some people who keep an apartment in
New York City just as a vacation home,

just for the summer, they go there
occasionally. It doesn't have a lot of

value to them, but the price is so low
that it makes sense to keep the apartment.

If they had to pay the market price, then
the high-value bidders, the ones who

really valued the apartment, would bid the
price up and the goods would be allocated

to them. Instead, what we have is people
who only use the apartment occasionally,

keeping the apartment, while other people
with large families are scrunched into

apartments which are much too small for
them. Another classic example: the older

couple who stay in their large
rent-controlled apartment even when their

kids have moved out. It doesn't make sense
for them to move out because they're not

paying the full price, they're not paying
the actual value. So you get apartments

who are allocated to older couples who
actually have a low value for the

apartment, even when there are people who
have a much higher value for that same

apartment and they cannot find an apartment.
One study of this found, for example, that

21% of renters in New York City live in an
apartment that has more or fewer rooms

than they would choose if they lived in a
city without rent controls. So the

apartments become misallocated. Okay.
That's it for price ceilings. Next time,

we're going to be looking at price floors,
a price below which it is illegal to go.

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