Question

Assume that the City Council in Prescott, Arizona is considering implementing price ceilings on rental units based on the number of bedrooms in the unit. The demand function for rental units (on a single bedroom equivalent basis) is given by QD = 120 – 4P and the supply function is given by QS = 2P, where P is price and Q is quantity. The Council is considering imposing a ceiling price on rental units of Pmax = 16.

1) Suppose now that the proposal before the City Council contemplates imposing a price ceiling on apartment rentals, but not on house rentals. Would owners of rental houses in Prescott be likely to support this proposal, or would they prefer the status quo (i.e., no price ceilings)? Provide the economic rationale for your answer. (In answering this question, you should ignore all supply-side considerations. In other words, just assume that supply adjusts fully to accommodate demand.)

Answer 1

First calculate equilibrium rental rate by equating demand and supply

That is,

120-4P = 2P

120 = 6P

P* = $20

Q* = 40 units

When a price ceiling of $16 will be imposed,

QD = 120-4(16) = 56 units

QS = 2(16) = 32 units

Shortage = QD - QS = 56-32 = 24 units

If this price ceiling is imposed only on apartment rentals and not house rentals, then the house rentals would support this legislation because apartment owner's loss would be house owner's gain.

That is, the shortage of 24 units that would arise in apartment rentals would be met by house rentals and people will switch to demanding more houses for rent instead of apartments because of shortage.

This would increase house owner's rental income.