Answer to Question #1

by Don Boudreaux on May 15, 2011

in Housing, Prices, Reality Is Not Optional, Seen and Unseen

Here’s the answer to question #1 on Friday’s pop quiz:

1. Which group of persons would most likely benefit from rent control imposed in the city of Washington, DC?
a. landlords in Washington, DC
b. persons seeking to rent apartments in Washington, DC
c. landlords in the DC suburbs without rent control
d. renters in the DC suburbs without rent control

Correct answer: C. Rent control in DC reduces the number of rental units supplied in DC – reducing this number from what it would be without rent control.  The result is that a greater number of persons who would would have rented in DC (if that city didn’t have rent controls) – but discovering themselves unable to find rental units there – will spill over into DC’s suburbs in search of rental units.  The resulting increase in the demand for rental units in DC’s suburbs will raise the prices that landlords in these suburbs will fetch for their rental units.

Answer A is incorrect for obvious reasons: the rent-control legislation reduces the prices that DC landlords can fetch for their units and, more generally, ties these landlords’ hands in dealing with tenants and potential tenants.

Answer B is incorrect because, by reducing the number of rental units available in DC (while simultaneously increasing the number of these units that are demanded by potential renters), DC’s rent-control statue creates a classic sellers’ market – albeit one (1) without higher prices serving as a means of rationing supply among potential buyers; and (2) without the rising prices that call forth a greater quantity supplied of rental units.  Many people seeking to rent apartments in rent-controlled DC will be frustrated in their attempts to find suitable apartments.  Some of these frustrated would-be DC tenants will spill over into DC’s ‘burbs and, in addition to having a longer commute and less-agreeable neighborhoods (according to their tastes) than they would have had had they been able to rent in DC, these tenants will pay higher prices for their suburban apartments than tenants in those apartments would have paid if DC had no rent control.

Finally, even those persons fortunate enough to succeed in finding rental units in rent-controlled DC will have to endure apartments in the District of lower quality (such as less square-footage, or fewer amenities)  than would be available without rent control.

Answer D is incorrect because DC rent control causes rents in surrounding jurisdictions to be higher than otherwise (see above).  So even persons who from the get-go wished to rent in DC’ ‘burbs will, because of DC’s rent-control policy, have to pay higher rents for their suburban apartments.

….

I’ll post answers to questions #2 and 3 later.

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John V May 15, 2011 at 9:53 am

Thanks. But I think you know from the comments that question #2 is the one that most people debated.

C for #1 and D for #3 were pretty uniform. Most people got those right.

KD May 15, 2011 at 12:41 pm

For #2, I chose B “The price of non-BMW cars will fall” just because other firms will have to become more competitive. However, I’m tempted to switch my answer to D “Not enough info”. Just because the price of BMWs may fall dramatically, does not necessarily mean that consumer preferences will switch. Consumers may see BMWs as inferior products regardless of price.(perhaps poor safety, mileage, maintainence, etc) In other words, there is certainly a shift in the supply curve, but not necessarily in the demand curve. Also, we don’t know the starting price of BMWs. Perhaps the pre-innovation price was $500K and it fell to 250K. This would still make non-BMWs more attractive if they cost only 20K. Any number of reasons why there may not be enough info.

I’m still sticking with B, but I can see why D is also a viable answer.

SweetLiberty May 15, 2011 at 9:53 am

Those who currently occupy rentals (or seek and find rentals) in DC will consider themselves the greatest beneficiaries of rent controls – until conditions get bad enough to create dissatisfaction greater than what they perceive the benefits of superior location to be.

richard May 15, 2011 at 10:23 am

Don,

How about people who are currently renting in DC?

SweetLiberty May 15, 2011 at 11:41 am

I don’t think Don wants to acknowledge that some will indeed benefit from rent controls – it runs contrary to his ideology. Good economists are supposed to identify and weigh ALL factors – not just the ones that suit their purpose. Don’s very phrasing of the question leaves out the people already renting who will immediately benefit from rent controls, revealing his dogmatic bias. To argue that, on balance on a utilitarian scale, rent controls do more harm than good is one thing; but to completely ignore the individuals who do indeed benefit from rent control policies is to practice deception.

Methinks1776 May 15, 2011 at 11:58 am

Can you not read?

Don does acknowledge that some people will benefit from price controls. He identified the “most likely” beneficiaries as suburban landlords.

The only dogmatic bias here is yours.

SweetLiberty May 15, 2011 at 6:01 pm

My bias is against rent control. But it is clear that the group of persons that “would most likely benefit from rent control imposed in the city of Washington, DC” are current renters willing to sacrifice quality for lower prices and location. Like Sam Grove says below, “After all, the greatest advocates for rent control are current renters.” Suburban landlords come in second, at least until new developers can fill the increased demand.

dan May 15, 2011 at 6:16 pm

Now the dynamics of went wrong with this apartment complex is more than just rent-controlled (rent-stabilized) legislation, but the inability for the owners to raise rents to cover costs of upgrades or cover costs of paying mortgage on property, along with taxes and maintenance.
http://online.wsj.com/article/SB10001424052748703806304576245103257562460.html

dan May 15, 2011 at 6:18 pm

I can’t remember which complex had this problem, also. A very big rent-controlled complex was in big trouble last year. I could see the complex being razed and newer, higher density complexes going up in its place. But, if it is subject to rent control, then nothing will come to fruition.

Methinks1776 May 15, 2011 at 6:31 pm

But it is clear that the group of persons that “would most likely benefit from rent control imposed in the city of Washington, DC” are current renters willing to sacrifice quality for lower prices and location.

No.

What’s clear is if those renters don’t value their current apartments at their current rental rate and upkeep, they are currently free to seek out less well maintained rat-infested hell holes at cheeper prices. Since that option exists today and they are not exercising it, we can reasonably assume that they do not consider a more disgusting residence at a cheaper price a good trade-off. You are engaging in some mental gymnastics to assert that they are.

Of course the current renters are the biggest supporters. They believe they will be able to extract a free lunch. That fantasy in no way changes the reality to which they will soon be introduced. They will be net losers. Not only will they not get the free lunch, but they will lose the OPTION to rent an apartment to their liking in the location of their choice at a higher price than the decrepit and cheaper apartments.

Options are valuable.

Sam Grove May 16, 2011 at 12:02 am

But that is not the point of the test question.
Your preferred response is too obvious to be a real test.

dan May 15, 2011 at 6:41 pm
Sam Grove May 15, 2011 at 12:18 pm

I suspect you underestimate Don’s understanding.

That selection is too obvious to include in the multiple choices.
Tests are supposed to include some difficulty to provoke thought.

Sam Grove May 15, 2011 at 12:22 pm

After all, the greatest advocates for rent control are current renters.

LowcountryJoe May 15, 2011 at 1:27 pm

It’s already understood that those lucky enough to get into a place do benefit. No one would dispute this. It takes a teacher to explain to a young person (or even an older person who hasn’t thought enough about the UNSEEN) that there will be costs as a result of price controls [e.g. less upkeep, needless scarcity, below-the-surface non-pecuniary pricing, etc.].

To not discuss these costs of the supposed free lunch does a great disservice to properly learning Economics. To not teach this would be deceptive and reveal, through omission, a bias of a more heinous type.

dan May 15, 2011 at 3:24 pm

The benefit is short term.

John V May 15, 2011 at 4:33 pm

“Good economists are supposed to identify and weigh ALL factors – not just the ones that suit their purpose.”

That says a lot about your thinking here.

Firstly, Don did acknowledge that. So, you’re fishing. Secondly, does a benefit to some somehow make Don’s observation incorrect?

No. It doesn’t.

basically, you are creating an argument out of nothing by putting words in his mouth and you look silly for it.

Don Boudreaux May 15, 2011 at 12:02 pm

Some of these people will, of course, benefit – but it’s not as obvious as it seems at first blush. Landlords have weaker incentives, with rent-control, to maintain the quality of their apartments. So even renters getting below-market rates for their units will also get lower-quality units.

vidyohs May 15, 2011 at 1:40 pm

Nor is it inconceivable that a landlord might just use such tactics as non-maintenance or slow response to maintenance problems to drive good renters out.

Methinks1776 May 15, 2011 at 1:49 pm

This is exactly what NY landlords do. They try to make living in rent controlled apartments unbearable. When the old tenant moves out, the landlord is permitted to raise the rate to current market rates (or something close to) for the new tenant. Then, the cycle is started all over again with the new tenant. It’s ugly. Renters and landlords in RC buildings in NY are in almost constant pitched battles with each other.

Don Boudreaux May 15, 2011 at 2:00 pm

‘xactly right. Rent-control – especially the way it’s administered in NYC – causes suppliers to abuse their customers.

jjoxman May 15, 2011 at 3:13 pm

This reminds me of a lecture in ’09 or ’10 by Walter Block. He showed pictures of neighborhoods after bombing and after rent control. Rent control was like a milder form of bombing.

Methinks1776 May 15, 2011 at 3:57 pm

While the landlords (suppliers) abuse their customers, the renters a full of tricks themselves. It’s just ugly from every angle.

The joy of rent control:

http://www.nypost.com/p/news/local/last_tenants_standing_TPu5wISOT7w7GUZSSCJptI

n2k May 16, 2011 at 10:53 am

@ Methinks1776

Which are worse, the abuses of rent control(s) or the abuses from home ownership subsidies?

In the subprime crash investors, issuers, and intermediaries speculated and then scrambled to stay ahead of the impending tsunami of bad debt. This was not so much the perfect economic storm as the search for the ultimate free ride. The act of giving property rights to renters via no-money down, NINJA mortgages was exacerbated by investment banks given regulatory impunity to become highly leveraged casinos. Societal subsidies such as the tax deductibility of mortgage interest that had been a form of forced savings became a form of forced speculation for teaser-rate mortgages that became wasting assets.

Seems that we need a systematic approach that addresses both sides of the equation.

Methinks1776 May 16, 2011 at 11:10 am

n2k,

I don’t care that investment banks were highly leveraged casinos. I have zero confidence that regulators can assess the appropriate level of leverage for anything. What I care about is that government bailed them out. That is the only issue for me. The rest is between the I-banks and their creditors.

We have a systemic approach in the form of regulators. They have been systematically making the system more fragile by divorcing consequences from actions, shifting risk and imposing a Frankenstein market structure for decades.

The best systematic approach is to can the systematic approach. Markets will never be perfect, but they’ll be a hell of a lot less imperfect than this hot mess.

John V May 16, 2011 at 12:32 pm

“We have a systemic approach in the form of regulators. They have been systematically making the system more fragile by divorcing consequences from actions, shifting risk and imposing a Frankenstein market structure for decades.

The best systematic approach [is] the systematic approach. Markets will never be perfect, but they’ll be a hell of a lot less imperfect than this hot mess.”

Therein lie the real…yet subtle…libertarian/free market perspective on this matter and many others. It’s also the argument that is ignored in the typical and ignorant “anarchic chaos” strawman criticism from the busy-body wing of politics.

N2K May 18, 2011 at 5:11 pm

@ Methinks 1776 and John V

I am not advocating the “better/smarter governance” argument, rather the consequence of not considering making one change changes the entire system.

vidyohs May 15, 2011 at 1:46 pm

I worded that very poorly. Let me try again.

Nor is it inconceivable that a landlord might use such tactics to drive out holders of rental agreements that are advantageous to the renter and not the landlord.

richard May 16, 2011 at 3:28 am

Don,

How about people who want to buy a property? Since renting out is not attractive anymore, less property will be bought/kept for renting out. Property prices should fall?

Sandre May 15, 2011 at 10:57 am

What about black-market in rentals, especially in poor neighborhoods? Isn’t that a possible outcome of rent control?

Sam Grove May 15, 2011 at 12:21 pm

Another consequence of rent control is the bribing of landlords by those seeking apartments.
Also, landlords in rent controlled areas will select renters based upon credit worthiness to reduce the costs of collection.

shawn May 15, 2011 at 12:39 pm

credit worthiness….preferred race…preferred gender…etc.

like blondes? redheads? asian girls? asian dudes? rent to ‘em! just don’t make it too obvious. you’re doing them a huge favor, because the process of getting an apartment is so difficult.

this is the same reasoning behind why the minimum wage was initially championed by the apartheid regime in SA (and racist systems everywhere): it lowers the cost of discrimination. In fact, the more interesting thing about rent control is when you’ve got it in a city like NYC, where only sections are rent controlled. A developer might agree to provide some portion of rent controlled properties alongside the mega-luxury offerings, all the while championing the plight of the poor (and his own hard-scrabble upbringing) with his support for rent-control. In fact, his profits (rents, in both senses of the word) could go up because through his political efforts he’s got the rent control system buttressed.

So, we’ve got unintended consequences, yandle’s bootleggers and baptists, and a dash of public choice: the perfect storm for stupid zombie ideas.

Brian May 16, 2011 at 2:18 pm

I seem to remember a Law and Order episode about rent control and the unintended consequences.

Seth May 15, 2011 at 12:38 pm

I agree. I also agree with your answer to SweetLiberty. Control price and things get pushed to other margins, like quality.

The one other constituency that benefits are the bureaucrats who administer rent control.

jorod May 15, 2011 at 3:34 pm

I wish you were my kids’ professor. These TA’s here leave something to be desired.

dan May 15, 2011 at 7:09 pm

Thomas Sowell columns with educated opinons on rent control

http://www.jewishworldreview.com/cols/sowell082100.asp

http://www.nationalreview.com/articles/220039/pricing-101/thomas-sowell
This one is half way down….

Washington Examiner piece from May 2011-http://washingtonexaminer.com/opinion/editorial-dc-rent-control-means-less-affordable-housing

And, I think Walter Williams was quoted as saying “short of aerial bombardment, Rent control is the quickest way to destroy a city”….. disabuse me of that one, if necessary.

dan May 15, 2011 at 7:10 pm

Moderation?!?!?!?!?

dan May 15, 2011 at 7:12 pm

Thomas Sowell columns with educated opinons on rent control

http://www.jewishworldreview.com/cols/sowell082100.asp

http://www.nationalreview.com/articles/220039/pricing-101/thomas-sowell
This one is half way down….

Washington Examiner piece from May 2011-http://washingtonexaminer.com/opinion/editorial-dc-rent-control-means-less-affordable-housing

And, I think Walter Williams was quoted as saying “short of aerial bombardment, Rent control is the quickest way to destroy a city”….. disabuse me of that one, if necessary.

W.E. Heasley May 15, 2011 at 10:13 pm

Dr. B.:

Sticking with my answer: (e) politicos.

Steve S May 15, 2011 at 10:30 pm

Don – “C” is only short term. “D” is better for the long term because that is the area where new apartment inventory will be build.

Jeff Neal May 15, 2011 at 10:31 pm

I suggest that stating categorically that Landlords in DC do not benefit from the rent control laws “for obvious reasons” is an oversimplification. (I’m a landlord in DC, by the way.)

There are owners of rent-controlled rental apartments in DC who are worth hundreds of millions of dollars. Lack of new construction would limit competition. Lack of competition enables landlords to lease their rent-controlled units for a price that is below the legal limit but well above the market price of that unit – landlords would do very little in terms of maintenance and the like, so the units deteriorate even while the rents remain constant (or even increase, as is often the case in rent control laws that allow for CPI adjustments, for example). The landlords get increasing returns on their original investment, are sheltered from competition and alleviated from any need to maintain their properties at a market standard that otherwise would be imposed upon them.

In fact, the actual laws in DC are even worse in that they do NOT apply to NEWLY constructed units (any built after 1986). So the older inventory that naturally would be the inventory that lower-income renters would seek due to affordability, is even more isolated from market forces and deteriorates even more from wear and tear as the market has become very bifurcated with a huge gap between the quality of rent controlled product and non-controlled inventory.

jcpederson May 15, 2011 at 11:04 pm

Isn’t an apartment a little like a gallon of gas, though? If the demand in an area is increased, the price will increase, leading to more people seeking to bring supply to the market?

Methinks1776 May 15, 2011 at 11:14 pm

Aren’t markets magnificent? But, I think you’ve forgotten that rent controls mean the price is capped. So, demand will increase, but suppliers will be unwilling to supply additional units as the price they’re able to charge won’t budge. Instead of more units, you can expect shortages. That’s why the unrestricted suburban landlords benefit.

jcpederson May 16, 2011 at 9:16 am

I was talking about 1D, where people who rent in the DC suburbs might benefit. Not in the first step, of course, where DC’s price controls will bring more demand to the suburbs, raising the price of existing apartments. But in the second step, that raised price, in an environment where price is not controlled, will cause more developers, landlords, people with an extra room to rent in their house, to the fore to increase supply.

rpl May 16, 2011 at 9:40 am

You’re confusing “supply” with “quantity supplied”. Nothing in the problem (nor in everyday life) suggests that supply would increase; rather, the quantity supplied would increase according to the new price and the existing supply curve. The end result is that even after the new units are built the price is higher.

jcpederson May 16, 2011 at 7:54 pm

I appreciate you helping with the terminology. My formal economics education consisted of one micro class back in ’93 (I got a B).

Mohammad May 16, 2011 at 1:35 am

I got this one wrong. Without thinking it all the way through, i would of said that it would have benefited those looking to rent in DC. But as you stated, with rent controls, a price ceiling, the suppliers of rental property would reduce their supply and use their property for something else. With less available accommodations in DC, people would go looking to the suburbs, thus raising the demand for apartments in the suburbs. And we all know with higher demand comes higher prices! Lucky suburban landlords.
Good question, keep em coming.

Mandar May 16, 2011 at 9:16 am

@ Don, Sure, I agree with c. as an answer to your rent control hypothetical.

Might it be said nonetheless, that Seen through a public choice prism, the rent control laws will leave the current Landlords better off because being a smaller group than diffuse renters they may be able to lobby the rent control administering-bureaucrats better than the latter— who will face the familiar collective action/ free rider issues and therefore underinvest in lobbying them?

In other words, can a public choice frame of reference countenance (a.)?

Slappy McFee May 16, 2011 at 9:18 am

As time reaches infinity, it should be shown that no group benefits from the price controls. The seen vs unseen.

Bud May 17, 2011 at 12:25 pm

Agreed questions #1 and #3 there does seem to be a lot of agreement. A few points per question #2 worth considering – since I haven’t seen as much discussion on it.
Answer A – On one hand you could say that other cars will lower price to remain competitive (Answer B – the blog consensus), but on the other hand, BMW is such a small luxury segment of the market, that it may not have an impact on the market as a whole. Also, it depends on how much it lowers the price. BMWs are expensive, unless prices are lowered a lot, they’re probably still out of reach of average consumers in the U.S. and thus not really competing with Ford et al.

Therefore Answer D – If BMW lowers its price, it may no longer be viewed as a luxury good and could therefore end up competing with firms like Ford. Or that firms like Ford believe they have to maintain a distance in price from BMW in order not to lose business to folks on the fence between regular and luxury cars. But for any of that to be analyzed, we have to know what cost structures the competitors face.

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