Price Ceiling for equilibrium in demand

1. hPrice Ceiling
I am today ordering a freeze on all prices and wages throughout the United States.”
In August of 1971, in an attempt to control inflation, President Richard Nixon
simply declared that price increases were now illegal. Soon after Nixon's
declaration, the situation in many markets started to look like this. The market
equilibrium price was above the current price, but it was illegal to raise prices.
Prices were hitting the ceiling, the maximum price allowed by law. With a price
ceiling, buyers are unable to signal their increased demand by bidding prices up.
And suppliers in turn have no incentive to increase the quantity supplied because
they can't raise the price.
The result is a shortage, shortage. The quantity demanded exceeds the quantity
supplied. For example, in the 1970s, price ceilings on gasoline meant that it was
common to have no gas at the gas station.
However, the story doesn't end there. More people want to buy gasoline than there
was gasoline available. So who gets the gasoline? Rather than compete for gasoline
by bidding up the price, buyers now competed by waiting in longer and longer
lines, in effect bidding up their time. In the '70s, people would wait for hours at the
gas station to fill up. So while the monetary price of gasoline doesn't rise, the price
paid in people's time did increase. Moreover, when buyers pay for gasoline with
money, the seller gets the money. When buyers pay for gasoline in time, the seller
doesn't get the time. The time just gets wasted.
Do you recall from the previous videos how the price system coordinates the
actions of thousands of people all over the world in order to deliver flowers? Well,
with price controls in place, the economy became dis-coordinated. Shortages of
steel meant that construction workers had to be sent home and new building
construction delayed. Factories and offices had to close when shortages meant they
couldn't operate. And when they closed the firms relying on them had to close too.
In perhaps the most ironic case, a shortage of steel drilling equipment made it
difficult to drill for oil even as the United States was undergoing the worst energy
crisis in its history. And other odd things started to happen. In a market economy,
when it gets cold on the east coast and the demand for heating oil increases,
entrepreneurs ship oil from where it has low value, here in sunny California, and
ship it to where it has high value in cold New Hampshire. Buy low, sell high. With

2. price controls in place, high-value consumers of heating oil couldn't bid up the
price, and so there was no incentive for entrepreneurs to bring oil to where it was in
greatest demand.
As a result, in the harsh winter of 1972 to 1973, people were freezing on the east
coast even as people elsewhere in the United States had enough oil to heat their
swimming pools. And then, the chickens started to drown. A price ceiling had been
imposed on the price of chickens, but not on the price of feed. Farmers realized that
at the controlled price, they would actually lose money if they fed their chicks to
fatten them up and bring them to the market. So the farmers drowned millions of
baby chicks. “Thanks, price controls.” The list of strange, unintended consequences
like these go on and on.
n this section, we'll be explaining, well, what happens when that signal, that price,
is not allowed to do its work? When the price is not allowed to rise or fall, what
happens when that signal is not sent? What happens when that incentive is taken
away? A price ceiling is a maximum price allowed by law. So for example, if the
price ceiling on gasoline is $2.50, it is illegal to buy or sell gasoline at above that
price. It's called a ceiling because you cannot go above the ceiling. So a ceiling is a
maximum price. It has five important effects. It's going to create shortages,
reductions in product quality, wasteful lines and other search costs, a loss in gains
from trade -- or a deadweight loss -- and a misallocation of resources. We're going
to go through each of these -- let's begin with shortages.
We can easily show that price ceilings create shortages using our standard demand
and supply framework. We'll use the price of gasoline as an example because
governments often have imposed a maximum price on gasoline. Now, ordinarily,
we would know that the market equilibrium would be found where the quantity
demanded is equal to the quantity supplied. But suppose that the government
imposes a maximum price which is below the market equilibrium. So, this is a
controlled price, a maximum price above which it is illegal to buy or sell this good.
What we want to do now is simply read off the diagram what happens. So at the
controlled price, we can read that the quantity demanded given by the demand
curve, is here. At the controlled price, the quantity supplied is given by the supply
curve and is read here. Notice that at the controlled price, the quantity demanded
exceeds the quantity supplied, and that's the shortage.
Now, ordinarily, if the quantity demanded exceeded the quantity supplied, buyers
want more of this good than they're able to get at the current price. Ordinarily, the

3. buyers would compete to push the price up, and the price would increase to the
market price, and we would get the usual equilibrium. In this case, however, it's
illegal to push the price up. So as a result, the quantity demanded exceeds the
quantity supplied, and we get this shortage which doesn't go away. The shortage is
defined simply as the amount by which the quantity demanded exceeds the quantity
supplied at the controlled price.
Let's give some examples. When goods are in shortage, that is when the quantity
demanded exceeds the quantity supplied, sellers have more customers than goods.
Usually, sellers have to compete to get customers, but when goods are in shortage,
sellers have more customers than they need. As a result, when we have shortages,
the sellers can cut quality, cut their costs, and still sell everything they want to sell
at the controlled price.
As a result, price controls reduce quality. We saw this in the 1970s. Books were
printed on lower quality paper. Two-by-four lumber shrank to one and five-eighths
by three and five-eighths. Automobiles were given fewer coats of paint. Throughout
the U.S. economy, quality began to fall.
Here's another example -- the great matzo ball debate. In 1972 union leader George
Meany complained that his favorite soup, Mrs. Adler's, had shrunk from four to
three matzo balls. So serious was this that the Chairman of the Wage and Price
Commission had his staff buy up a bunch of cans of Mrs. Adler's soup and count in
each one of them how many matzo balls were in the soup. He said there were still
four. Whoever was right, however, the lesson is quite correct. Price controls reduce
quality.
When the quantity demanded exceeds the quantity supplied, when there's a surplus
of buyers, sellers have less of an incentive to give good service. So another way to
reduce quality is to reduce service. And indeed, full-service gasoline stations
disappeared in 1973. The owners would simply close up shop whenever they
wanted to take a break. More generally there's a reason why the baristas at
Starbucks are pleasant to us. It's because they want more customers. Customers are
profitable, but when you can't raise the price, when there's a shortage, when a seller
has more customers than they need, it doesn't pay to be pleasant to customers.
Indeed, it may pay to be unpleasant to drive some of them off, so you don't have to
serve them. This is another reason why the workers at the DMV are on average
probably a little bit less pleasant to us than at stores which require our service, than

4. at stores which want us to come into the store. This is a reason why in communist
countries like the ex-Soviet Union, the workers at the stores were much more
unpleasant than workers at McDonald's are. Because McDonald's has an incentive
to get more customers, they want to create a pleasant experience. They want to
make it easy to buy goods from the store. But when there's shortages, when there
are more customers than you need, it no longer pays to be pleasant.
Okay, price ceilings, let's remember five important effects. Shortages and
reductions in product quality -- that's what we covered today. Next we will be
covering wasteful lines and other search costs, a loss in gains from trade, and a
misallocation of resources.
we're going to take a look at another effect of price ceilings: wasteful lines and
other search costs. Let's get started.
It's important to understand that price controls do not eliminate competition.
Competition for scarce goods is an ever present force under all forms of social
organization. What price controls do is they change the form that competition takes.
So in a market, demanders compete by pushing prices up. Suppliers compete by
pushing prices down. When we have price controls, that shifting of prices is no
longer possible. But competition remains -- it just takes other forms. Here's an
example of musical chairs. The quantity demanded exceeds the quantity supplied.
There's a shortage. But there's still lots of competition, lots of scrambling to get
hold of those goods which are in short supply.
So let's take a closer look at some of the forms that competition takes when we have
price controls and shortages. So suppose there's a price control on gasoline and oil,
making it illegal to compete for these goods by pushing the price up. Nevertheless,
there are other ways of competing. Some buyers, for example, might try bribing the
station owners. This is not necessarily the first thing which would happen in the
United States, but in other places and countries this is extremely common.
Having a cousin who works in the factory which is producing the good which is in
shortage is extremely important. Using one's political connections, being part of the
political elite is extremely important for obtaining goods, which are in shortage.
Even in the United States, remember that firms also need oil and gasoline in order
to operate. And in the 1970s when there was a shortage of oil, firms appealed to the

5. Department of Energy, they lobbied their Congressman and their Senator to obtain
an allocation of oil for their firm.
For consumers, another way to obtain the good is to be willing to wait in line. Now
time waiting in line is also a cost. So let's ask, "How long will the line get?" We can
use our model to understand willingness to wait in line and how long the lines will
get. Let's take a look. So here's our supply and demand diagram of the shortage.
Remember that at the controlled price we read the quantity demanded off the
demand curve, Qd, and at the controlled price we read the quantity supplied off the
supply curve, Qs. So Qs is the actual amount of gasoline supplied given the
controlled price of $1.
Now, here is the key question: How much are buyers willing to pay for a gallon of
gasoline, when Qs is the amount which is being supplied? How much are buyers
willing to pay? What is the most they are willing to pay for a gallon of gasoline?
Well remember, we can read that off the demand curve -- that's what the demand
curve tells us. So at the controlled price, when the quantity supplied is Qs, buyers
are willing to pay $3 per gallon of gasoline. They're only allowed to pay in money
$1. So, if a buyer were to obtain a gallon of gasoline at a controlled price of $1,
that's actually worth to them $3.
That explains why people are willing to wait in line for a long time in order to get
gasoline, because the shortage has reduced the quantity supplied. It's raised the
willingness to pay for gasoline, but it hasn't raised the price of gasoline. Therefore
people are willing to wait in line. And, in fact, the line will grow until on the margin
the time price plus the money price will be equal to the willingness to pay.
So the line will grow until the money price, which is $1/gallon, plus the time price,
the time wasted in line, which will grow up until it's $2/gallon, until the total price
equals the willingness to pay. Why is that? Well, imagine that that were not the
case. Imagine that you could obtain a gallon of gasoline which is worth $3 for you.
And you only had to pay a dollar plus 50 cents in waiting time. Well that would be
a great deal. So people will be willing to wait in line so long as the total price, the
money price plus the time price, is less than the willingness to pay. This means that
the line will continue to grow until the total price is equal to the willingness to pay.
So, if we now take the time price, which is the difference between the willingness to
pay and the controlled price, times the quantity -- that gives us the total value of
wasted time. So, another effect of price controls -- it creates long lines in order to

6. compete to get the good instead of bidding the price up, they bid in terms of being
willing to wait in line. And those lines are wasteful, creates a lot of wasted time.
Let's take a look with a numerical example.
Okay, here's a simple numerical example to bring this home. Suppose that buyers
value their time at $10/hour, and that the average fuel tank holds 20 gallons. Now
imagine that a buyer arrives early at the gasoline station and they wait one hour.
The total cost of the gasoline is then $20, $1/gallon times 20 gallons in money cost,
plus $10 in time cost. They waited an hour and they value their time at $10/hour. So
the total cost of the gasoline is then $30. It took $30 worth of time and money in
order to get 20 gallons. So the implied cost per gallon is $1.50/gallon.
However, remember that given the quantity supplied, given the shortage, the value
of gasoline is $3/gallon. So this buyer managed to obtain something which is worth
$3/gallon for only $1.50 per gallon. That's a good deal so other buyers are going to
bid up the price by arriving earlier and earlier. And this is going to push up the time
cost. The money cost is fixed because of the price control, but the time cost can still
increase. In fact, the line will lengthen until the total cost of obtaining 20 gallons of
gasoline equals $60 or $3/gallon. In other words, the buyers will end up spending
$20 in money cost plus $40 in time cost, or four hours of waiting.
So we're able to calculate approximately how long the line will get. It will get four
hours worth of time. So this again illustrates that competition does not go away
when we have price controls. Instead, competition takes different forms, and one of
those forms is -- instead of bidding up the money price, the time price is bid up and
we get long and wasteful lines. So what we've just seen is that in a free market,
buyers compete to obtain goods by bidding up money prices. And when we have
price controls, one way that buyers compete to obtain goods is by bidding up time
prices, by being willing to wait in line.
So what's a better form of competition? Bidding or paying in money or paying in
time? Does it make a difference? After all, some people have got more money,
some people have got more time, is it just a matter of preference? No. It is much
better to have an economic system where competition takes the form of bidding in
money than it takes the form of bidding in time. Why? Paying in time is much more
wasteful.
When you bid in terms of money, the money goes to the station owner. The money
does not disappear. That purchasing power is transferred from the consumer to the

7. producer. On the other hand, when buyers bid in terms of time, when they wait in
line, that waiting in line is just lost. It's not transferred to the producer. When you
wait in line for four hours to obtain gasoline, the seller of gasoline doesn't get to add
four hours to his lifespan. So that waiting in line is just a total loss. When you pay
in money, the purchasing power is transferred to the station owner. When you pay
in terms of time, the value of that time is simply lost. It benefits no one.
Okay, quick reminder of where we are. Price ceilings have five important effects.
We've looked at shortages and reductions in product quantity. We've just completed
wasteful lines and other search costs. Up next, a loss in gains from trade, and then a
misallocation of resources.
Today we'll be looking at how price ceilings create what economists call a
"deadweight loss." This video will be short since the ideas ought to be pretty
familiar by now. Let's dive in.
So let's remind ourselves that when we have a free market, all of the mutually
profitable gains from trade are exploited. That's another way of saying that a free
market maximizes producer plus consumer surplus. Now, when the mutually
profitable gains from trade are not fully exploited, there's lost consumer and
producer surplus, or a "deadweight loss." The basic idea -- as long as the price the
consumers are willing to pay exceeds the price that sellers are willing to accept,
there are mutually profitable trades that can be made. And what we're going to
show is that price ceilings create a deadweight loss. Not all of the mutually
profitable trades will be made.
Let's take a look. Okay, here's our standard diagram. I've just labeled some things
we talked about in earlier lectures, mainly, the shortage of the controlled price and
the total value of wasted time. The key point for understanding the reduced gains
from trade is that at the free market equilibrium, at this price and this quantity, Qm,
we have more units exchanged than at the price controlled equilibrium. So with a
free market, we get Qm units exchanged, with a price control, only Qs units are
exchanged -- a smaller amount.
Now notice that these trades, which fail to take place, they are mutually profitable.
That is, the buyers are willing to pay more for these units than the sellers require to
sell those units. So, because of the price control, buyers and sellers are not allowed

8. to come to a mutually profitable deal at a price above, in this case, $1. They would
like to, however. The buyers are willing to pay $3 for another gallon of gasoline.
The sellers are willing to sell that gasoline for $1. So there's a mutually profitable
trade. This trade would be worth $2 in mutual profit, to the buyers and sellers. They
would like to make this deal. But it is illegal, it is illegal to sell at a price above $1.
So these trades between Qm and Qs do not occur. In a free market they would
occur, and because they would occur, they would generate additional gains from
trade. So compared to the free market equilibrium, under the price control, we have
lost consumer surplus, in the amount of area A. And we have lost producer surplus
in the amount of area B. Together, A + B is the lost gains from trade. These are the
mutually profitable exchanges which fail to take place because they're illegal,
because of the price control. So price ceilings reduce the gains from trade, creating
a deadweight loss.
Welcome back. Another cost of price ceilings is that they misallocate resources.
This is actually a point not covered in most textbooks, but it's very important. And
it's going to be important not just to understand price controls, but also to give us
real insight and deeper understanding into how the price system works. Let's get
started.
Let's begin with an intuitive, but a real and important example. Suppose that over
here on the west coast of the United States, we're having a very mild winter.
Temperatures are high. The sun is shining. No problems. Let's suppose however,
that on the east coast the winter is really bad. It's cold. There's a lot of snow and so
forth. As a result of the weather, the people on the east coast are going to be
demanding a lot of home heating oil. So the demand for heating oil goes up, and
because of that increase in demand we get a higher price of heating oil.
Now, what are entrepreneurs going to do? Seeing this signal of a higher price,
they're going to be incentivized to take oil from where it has low value, over here
on the west coast, and bring it to where the oil has high value on the east coast. So
oil will flow from the west to the east. It will flow from areas where it has low
value. In response to the signal of the higher price, it will flow to areas where it has
higher value. Now, let us suppose, that as in the 1970s, we now have a price control
on oil. So it is illegal for the price of oil to increase. Well, as before, with the price
control, we're going to get higher demand but no higher price. There will not be that

9. signal of a higher price, and because there isn't a signal there won't be an incentive
to bring oil from where it has low value to where it has high value. So the oil will
no longer flow.
As a result, people over here on the west coast, they're going to be using that oil for
low-value items, things like heating their swimming pool. At the same time, people
on the east coast may not have enough oil to heat their homes. In fact, this is exactly
what happened in the 1970s. There was a misallocation of oil because of the price
controls. Oil was used in some low uses, some low-value uses such as heating
swimming pools, at the same time when there wasn't enough oil for the high-valued
uses. That's what we mean by misallocation of resources. Let's take a look at how
we can show this in a diagram.
Here's our standard diagram of the shortage. Let's remember from chapter three that
we could read the demand curve in the following way. At the top of the demand
curve are the highest-valued uses for the good. This is Air Force One, if you recall
the example from chapter three. Down here, are the lower-valued uses of the good.
This is the rubber ducky, was down here. Now, at the controlled price of $1, Qs
units are going to be supplied. Given that Qs units are going to be supplied, the
most valuable uses for those units are these uses up here. These are the high-valued
uses. In a free market, these uses or users would outbid the other uses. Goods would
flow from the low-valued uses to the high-valued uses, and these would end up
being the uses which would be supplied in a free market.
Here's the key point -- the price control prevents the highest-valued uses from
outbidding the lower-valued uses. As a result, some oil will flow to lower-valued
uses. In other words, as a result of the price control, some rubber duckies will end
up being produced even when we don't have enough oil to fly jet aircraft. These
uses or users will not be able to outbid these guys down here because of the price
control, because the price is limited to $1. By the way, these guys have the really
low-valued uses, but they're not even willing to pay the controlled price. They're not
even being willing to pay the dollar, so they won't get any oil at all, which is a good
thing, because they have very low-valued uses. On the other hand, the high-valued
uses, they're not going to be able to outbid these guys, so some of the oil is going to
be misallocated. It's going to go to low-valued uses even when there's not enough to
satisfy all of the highest-valued uses.
The most important point is the one I just gave -- that with price controls prices no
longer serve their signaling and incentive function, and as the result, we get the

10. misallocation of resources. Resources no longer flow from their high-valued uses to
their low-valued uses, and as a result of that, we get less use out of our resources.
We get less value from our resources. I want to show also, that you can use the
diagram to quantify this a little bit, to show this on a diagram.
Let's ignore the wasteful time in search costs from price control, and what we want
to do is to compare the maximum consumer surplus given Qs, given Qs is supplied,
with a loss under, say, random allocation. So suppose that any use which is willing
to pay the controlled price is equally likely to be allocated a unit of the good, in this
case, a unit of the gasoline. How much will that reduce value? How much will that
reduce total consumer surplus? Let's take a look at how to do this.
Let's just remind ourselves that if the gasoline goes to the highest-valued uses, that
is there are Qs units, and if these Qs units were to flow to the highest-valued uses,
then consumer surplus would be given by the area underneath the demand curve
above the price. So it would be given by this green area. This is the maximum
consumer surplus available from Qs units. This is the way we would get the most
out of these Qs units. We would get the most value by allocating it to the highest-
valued units, and then the total consumer surplus created would be this amount right
here.
Let's now compare with random allocation. Because the good is not necessarily
allocated to the highest valued uses with a price control, consumer surplus is going
to be less than the amount which we just showed. How much less? Let's do some
calculations, and to do that to build our intuition, we're going to consider how one
gallon of gasoline might be allocated under the best and worst conditions for
random allocation. So we're going to take one gallon of gasoline, and we're going to
allocate it randomly. Suppose we were really lucky. What's the best case for
random allocation? Suppose we're really unlucky. What's the worst case for random
allocation? Let's take a look.
The best case scenario for random allocation, is that this one gallon of gasoline goes
to the buyer with the highest-valued use. Which buyer is that? It's this buyer up
here. In that case, $4 of value is created, and consumer surplus is $3. The $4 of
value created minus the $1 for the price. What's the worst case? The worst case
scenario, is that the buyer with the lowest-valued uses randomly ends up with the
good, with the gallon of gasoline. In that case, the value created is $1. This is the
buyer with the lowest-valued use, but this buyer's still willing to pay the controlled
price. So that's $1 of value created or consumer surplus of zero. It costs them a

11. dollar. They get something which is worth a dollar to them. So the consumer
surplus is zero.
Those are the best and worst cases for randomly allocating one gallon of gasoline.
Using that intuition, let's look at a scenario where a gallon of gasoline is randomly
allocated with equal probability to any user who is willing to pay the controlled
price. That is the gallon of gasoline is randomly allocated to any user between $4
and $1, with a value between $4 and $1. In this case, because it's an equal
probability, a uniformed distribution, the average value, turns out we can calculate
it easily, it's just one half times the maximum $4, plus one half times the minimum
possible value, which is $1. The average use to which gasoline will be put will be
$2.50. Let's in fact put that on the diagram. When the good is randomly allocated to
any user between a value of $4 and $1, the average use will have a value of $2.50.
That means that the consumer surplus is this green area right here -- the difference
between the average value and the controlled price.
Here's the key point. Remember, earlier we showed that the maximum value would
have been the area underneath the highest-valued users, underneath the demand
curve for the highest-valued users, up to the quantity supplied. The maximum value,
the maximum consumer surplus from Qs units, if all those Qs units went to the
highest-valued users, is the red plus the green. When the gasoline is instead
allocated randomly, sometimes it goes to a high-valued user, but sometimes it goes
to a low-valued user. Then on average, the value of that gasoline is less. We get less
value out of that gasoline when it is allocated randomly than when it is allocated by
the price system. As a result, consumer surplus is considerably lower under random
allocation than it is when it's allocated by the price system, which maximizes the
consumer surplus.
That's just a diagrammatic way of illustrating our first example of what happens
when we don't have the price system. Oil no longer flows from its low-valued uses
to its high-valued uses, so we get less value from the same resources. The resources
become worth less than they were before, because they're no longer allocated to the
highest-valued uses.
We've now covered all the five important effects of price controls: shortages,
reductions in product quality, wasteful lines and other search costs, a loss in gains
from trade, and a misallocation of resources. Next, we're going to apply all of these
ideas to rent control. Since we understand the ideas, we should move through that

12. fairly quickly. And then we're going to look at price floors. What happens when the
government says you cannot sell a good for less than a certain amount?
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

13. 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, they're not going to mow the lawns as often. After all, you can still sell
just as many units 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

14. 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

15. 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.