Introduction

The government often intervenes on the market for many reasons. Such as solving market
inequalities, promoting economic justice, breaking up monopolies and controlling negative
externalities for the people. A number of techniques are used by the government to regulate the
market. In this case we can see three strategies. Assuming that the housing market is too hostile
for ordinary citizens, the government has used the following strategies to regulate these:-

a) Price ceiling or Rent control: A price ceiling is the maximum price for a good or
service that producers have to set by the order of government. ‘Rent control’ is a good
example for this technique. Government sets rent below the market equilibrium in rent
control.
b) Rental Subsidy: A subsidy is a form of cash benefit to the citizens from their
government. There are two types of subsidies: producer subsidy and consumer subsidy.
Rental subsidy is a good example as a consumer subsidy. In the second method,
government can use rental subsidy to increase affordability of houses to consumers.
c) Low Public Housing: As a third strategy, government applied low-cost housing policy
that aims to create houses with lower rents that are affordable for citizens with an
average household income.

During the study of the case from three perspectives above, we encountered some related
concepts. Such as: Consumer and producer surplus, deadweight loss, black market etc.

Literature review

The main objective of the government to control rent is to make homes more reasonable for
low-income tenants. However, this rental control only deals with the effects of the cause,
instead of remedying the cause. To analyze our case we have considered certain matters to keep
in knowledge to our discussion.

Government Intervention

It is the regulatory actions taken by a government in order to affect or interfere with decisions
made by individuals, groups, or organizations regarding social and economic matters.

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Why Governments Intervene In Markets?

Governments intervene in markets when they inefficiently allocate resources. Governments

intervene in markets to address inefficiency. In an optimally efficient market, resources are
perfectly allocated to those that need them in the amounts they need. In inefficient markets that
is not the case; some may have too much of a resource while others do not have enough. The
government tries to combat these inequities through regulation, taxation, and subsidies.

Maximizing Social Welfare

In an unregulated inefficient market, organizations can wield monopolistic power, raising entry
costs and limiting the development of infrastructure. Without regulation, businesses can
produce negative externalities without consequence. This all leads to diminished resources,
stifled innovation, and minimized trade and its corresponding benefits. Government
intervention through regulation can directly address these issues.

Macro-Economic Factors

Governments also intervene to minimize the damage caused by naturally occurring economic
events. Recessions and inflation are part of the natural business cycle but can have a devastating
effect on citizens. In these cases, governments intervene through subsidies and manipulation
of the money supply to minimize the harsh impact of economic forces on its constituents.

Socio-Economic Factors

Governments may also intervene in markets to promote general economic fairness.

Government often try, through taxation and welfare programs, to reallocate financial resources
from the wealthy to those that are most in need. Other examples of market intervention for
socio-economic reasons include employment laws to protect certain segments of the population
and the regulation of the manufacture of certain products to ensure the health and well-being
of consumers.

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 Situation of Housing Market after “Rent Control”

To analyze the scenario after the government has imposed rent control, we must assume that
the housing market is in a state of equilibrium (see Appendix A).

In above chart, Demand (DD) & supply (SS) curves have intersected at equilibrium point E.
At E,

Equilibrium Rent = 300$/month

Equilibrium Quantity = 300,000 Houses/month

Now government think this rent is too high and want to regulate it by imposing rent control at
$ 200 per month. When the government set rent to $200 from $300 the supply curve will shift
to right. However, there will be no shift in demand curve as tenant’s income level hasn’t
change. After rent control-

New Supply Curve = SS’

New Equilibrium = E’

Equilibrium Quantity = 350,000 Houses/month

Interpretation:

This intervention by government will result short run and long run impacts. It definitely
benefits the tenants in short run.
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Now we can answer, who bears the heaviest cost in the short run when rentals are kept
down by rent controls. That is, the landlords are worse off as rent control keeps price at
lower price. If they abide by the government, they have to rent houses at $200 rent per month.
Whereas, they used to charge 300$ before rent control. So, they will lose the black shaded area
($300-2004 = $100).

The maximum number of houses will be 300 as housing companies or landlords will never
make more houses for low profit. Tenants will benefit cost wise because they pay less, but there
is less housing to go around. So, there will be less apartment in the market. Red shaded area
(350-300 = 50,000) is over production. However, in the long run this intervention will cause a
reverse effect on the tenants. It will create following problems in the market.

In the long run scenario, there can be a possibility of occurring a black market (See Appendix
A) if landlords & housing companies create an artificial shortage to increase their profit. In this
case, the number of houses supplied will be decreased to 250. The yellow shaded area is the
shortage (300-250 = 50,000). Now the tenants will be forced and willing to pay $400 per month
due to shortage of houses. Now we can answer, who bears the heaviest cost in the long run
when rentals are kept down by rent controls. That is, the tenants who are worse off as
rents are not only high but the number of apartments are also low.

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As a result, the grey shaded area ($400-$200 = $200) will turn to black market (See
Appendix A) for the landlords. Thus, the tenants will be in more trouble.

It will also cause a significant change in Consumer and Producer Surplus. Such as:-

Before Rent Control After Rent Control Change ∆

Consumer Surplus +1 +2 +6 (Area) +1 +2 +3 (Area) +3 -6 (Area)

Producer Surplus +4 +3 +7 (Area) +4 +5 (Area) +5 -3 -7 (Area)

However, we can see that area 6, 7, 8, 9, 10, 11 is not claimed by any party. It indicates
deadweight loss (See Appendix A). Any intervention in the market by the government which
creates deadweight loss, is not social beneficial.

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 Situation of Housing Market after “Rental Subsidy”

In the second strategy to control the housing market, government granted subsidy to some
fraction of their rent. It is a type of consumer subsidy (See Appendix A). To understand the
after effects, we can use the following graph.

The diagram above shows the market for housing. At the original equilibrium E,

Equilibrium Rent = R2

Equilibrium Quantity = Q1

Now government introduces specific portion of rental subsidy. This causes an upward shift of
demand curve. This new demand curve is also called the subsidy laden demand curve. At the
new equilibrium point E’,

New Demand Curve = DD’

New Equilibrium Rent = R3

New Equilibrium Quantity = Q2

After the introduction of the rental subsidy, the market rent increased to R3. As a result, the
quantity supplied rises to Q2. The rent tenants pay is R1. Even though the market rent rises, it
includes the benefit of the rental subsidy, which is intended to benefit the tenants.

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Interpretation:

After analyzing the situation of rental subsidy, we can see the tenants are better off. Moreover,
this benefit leaks to the landlords or housing companies in form of rentals (R3 - R2).

In this case, government bears the cost. According to the graph the cost of government to fund
the rental subsidy is the shaded rectangle area

Cost of Government = (R3 - R1)

We have also found noticeable change in consumer & producer surplus:-

Before Rental After Rental Change ∆ Situation

Subsidy Subsidy
Consumer +2 +3 (Area) +1 +2 (Area) +1 -3 (Area) Better off
Surplus
Producer +4 +5 (Area) +3 +4 +5 +6 +3 +6 (Area) Better off
Surplus (Area)

Cost of Government -3 -4 -6 -7 -8 -9 (Area)

It should be noted that, the gains to landlords and tenants do not entirely match the cost of the
government. Area 7, 8, and 9 are lost by the government for providing rental subsidy, and are
not claimed by any parties. Therefore, it is deadweight loss, which is again socially not
expected.

So, when a subsidy to tenants are given, everyone is better off except the taxpayers who
fund the rental subsidy project.

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 Situation of Housing Market after “Low-cost Public Housing”

In the case, the final strategy that government used to keep the rentals down, is establishing
public housing facility with low cost. The housing project are set in such a way that it could
drive down the rent from the equilibrium rent of the housing market. Graph 5 shows the
graphical scenario of housing market.

In above diagram, the original equilibrium point is E. At E,

Equilibrium Rent = R4

Equilibrium Quantity = Q1

Later on, government introduces low-cost public housing plan. As a result, the overall, supply
of houses in the market increases by the number of houses built by the government. This will
cause a right shift of the supply curve in the market constructing a new equilibrium point E’.

At point E’,

New Supply Curve = SS’

New Equilibrium Rent = R3

New Equilibrium Quantity = Q2

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The increased number of the houses in market, will eventually decrease the rental charges.
Moreover, government funded public housing will be more preferable to the tenants for cheap
rental & other security by the government. So, the landlords and private housing companies
will also charge lower rent in order to stay in the market.

Interpretation:

When government introduces low-cost public housing, it increases the supply driving down
rent, consumers are better off. We can see, previously they used to pay R4 rent for Q1 houses
but now they are paying less rent R3 for more houses Q2.

Landlords bear the heaviest cost as they have less revenue and are made worse off. After the
government’s housing policy, they have to charge R3 rent for Q2 houses, which is originally
costs R5 to them.

To execute the policy government has to bear some cost. The cost to the government is the
vertical distance of the two supply curves SS & SS’. According to the graph,

Cost of Government = (R2 - R1)

Following table shows the change is consumer & producer surplus due to the low-cost public
housing policy-

Before Low-cost After Low-cost Change ∆ Situation

public housing public housing

Consumer Surplus +1 (Area) +1 +2 +5 +6 (Area) +2 +5 +6 (Area) Better off

Producer Surplus +2 +3 (Area) +3 +4 +7 (Area) -2 +4 +7 (Area) Worse off

It can be seen from the graph that, all the area 1 to 7 are distributed among the tenant and
landlords. Which indicates there is no deadweight loss caused by this government intervention
strategy. So, low-cost public housing policy generally do not create social welfare loss, which
makes it the best strategy to control rent in the housing market. In this case the producers bears
the heaviest cost, because now they have to keep housing price low to keep up in the
competition with low cost government housing.

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 Conclusion

At the end we can conclude with our basic lesson. The burden of rent control comes from those
who only consider their imagined short-term benefits, but if we look at the long-term effects
on tenants, we can see that lease control is not only useless, but also has damaging
consequences. If the government invests in the housing corporation, the supply will be high
and people can buy them with controlled prices that have been set by the government.

And there are reason why sometime it necessary for government to intervene housing market.
According to a report drawn up for G15 and the National Housing Federation, government
investments in affordable housing also affect the social objectives of general people in society.
Such as:-

Health: People moving to affordable homes resulted in improved health, including anxiety and
depression.

Well-being: People are satisfied with their housing, which has led to higher satisfaction with
life and a higher standard of living.

Community cohesion: In the literature changes are found in the socialization of adults and the
development of the child after improvements of the home, as well as an increased sense of
security.

Crime: People have seen that decent, affordable housing can contribute to crime prevention,
especially for young homeless people. A significant number of households would be legally
homeless if it were not about affordable housing and the majority of homeless people are
singles.

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 Reference

Ellen, I. G. (2007). Spillovers and Subsidized Housing: The Impact of Subsidized Rental
Housing on Neighborhoods. Joint Center for Housing Studies.

Ellen, I., & Turner, M. A. (1997). Does Neighborhood Matter? Assessing Recent Evidence.
Housing Policy Debate, 8(4): 833-866.

Frontier Economics. (2014). Assessing the social and economic impact of affordable housing
investment. London: Frontier Economics Limited.

Kiel, K., & Jeffrey E, Z. (1996). House Price Differentials in U.S. Cities: Household and
Neighborhood Racial Effects. Journal of Housing Economics, 5: 143-165.

Malpezzi, Stephen, & Vandell, K. (2002). Does the Low-Income Housing Tax Credit Increase
the Supply of Housing? Journal of Housing Economics, 11 (4): 330-59.

Murray, M. (1999). Subsidized and Unsubsidized Housing Stocks 1935-1987: Crowding Out
and Cointegration. Journal of Real Estate Economics and Finance, 18(1): 107-24.

Sinai, Todd, & Joel Waldfogel. (n.d.). Do Low-Income Housing Subsidies Increase the
Occupied Housing Stock? Journal of Public Economics.

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 Appendix A: Theories and concepts used during the case study-

Consumer Surplus It is the difference between the total amount that consumers
are willing and able to pay for a good or service and the total
amount that they actually are paying.

Producer Surplus It is the difference between the market price and the production
cost of a specific quantity.

Deadweight Loss / Is cost to society created by market deficiency caused by

Social Welfare Loss inefficient allocation of resources?

Black Market A market occurs where transactions take place without the
knowledge of the government.

Black Money Money transacted in black market that does not produce any tax
for the government.

Demand Curve Graphical representation of the relationship between the price of

a good and services and its quantity demanded by the consumers.
Price and quantity demanded are negatively related.

Supply Curve Graphical representation of the relationship between the price of

a good and services and its quantity supplied by the producers.
Price and quantity supplied are positively related.

Equilibrium Price / Equilibrium price or market clearing price is the price at which
Market Clearing quantity demanded will be equal to quantity supplied. In the
Price, Equilibrium equilibrium point, the demand curve & supply curve will intersect
Point each other

Consumer Subsidy A subsidy in form of cash or tax reduction which is given to the
consumers. Example- Rental subsidy.

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