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raises the rewards for potential smugglers crimes dramatically. When, for example,
and attracts more criminals into the “indus- was the last time you heard of a gang
try,” which shifts the supply curve back to killing connected with the distribution of
the right. The net result is that increased cigarettes or alcoholic beverages?
shipments of drugs to U.S. shores replace The argument against legalization of
much of what the authorities confiscate. drugs is largely moral: Should the state
This is why many economists believe that sanction potentially lethal substances? But
any successful antidrug program must con- there is an economic aspect to this position
centrate on reducing demand, which would as well: The vastly lower street prices of
lower the street price of drugs, not on reduc- drugs that would surely follow legalization
ing supply, which can only raise it. would increase drug use. Thus, while legal-
Some people suggest that the government ization would almost certainly reduce
SOURCE: © AP Images/Angela Gaul




should go even further and legalize many crime, it may also produce more addicts.
drugs. Although this idea remains a highly The key question here is, How many more
controversial position that few are ready addicts? (No one has a good answer.) If you
to endorse, the reasoning behind it is think the increase in quantity demanded
straightforward. A stunningly high fraction of would be large, you are unlikely to find le-
all the violent crimes committed in America” galization an attractive option.
especially robberies and murders”are drug-




2. An illegal, or “black” market often arises to supply the commodity. Usually some in-
dividuals are willing to take the risks involved in meeting unsatisfied demands
illegally. Example: Although most states ban the practice, ticket “scalping” (the
sale of tickets at higher than regular prices) occurs at most popular sporting
events and rock concerts.
3. The prices charged on illegal markets are almost certainly higher than those that would prevail
in free markets. After all, lawbreakers expect some compensation for the risk of being
caught and punished. Example: Illegal drugs are normally quite expensive. (See the
accompanying Policy Debate box “Economic Aspects of the War on Drugs.”)
4. A substantial portion of the price falls into the hands of the illicit supplier instead
of going to those who produce the good or perform the service. Example: A con-
stant complaint during the public hearings that marked the history of theater-
ticket price controls in New York City was that the “ice” (the illegal excess charge)
fell into the hands of ticket scalpers rather than going to those who invested in,
produced, or acted in the play.
5. Investment in the industry generally dries up. Because price ceilings reduce the mon-
etary returns that investors can legally earn, less money will be invested in indus-
tries that are subject to price controls. Even fear of impending price controls can
have this effect. Example: Price controls on farm products in Zambia have
prompted peasant farmers and large agricultural conglomerates alike to cut back
production rather than grow crops at a loss. The result has been thousands of lost
jobs and widespread food shortages.


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Part 1
72 Getting Acquainted with Economics



Case Study: Rent Controls in New York City
These points and others are best illustrated by considering a concrete example involv-
ing price ceilings. New York is the only major city in the United States that has contin-
uously legislated rent controls in much of its rental housing, since World War II. Rent
controls, of course, are intended to protect the consumer from high rents. But most
FIGURE 11 economists believe that rent control does not help the cities or their residents and that,
Supply-Demand in the long run, it leaves almost everyone worse off. Elementary supply-demand analy-
Diagram for Rental
sis shows us why.
Housing
Figure 11 is a supply-demand diagram for rental
units in New York. Curve DD is the demand curve and
curve SS is the supply curve. Without controls, equi-
S
D
librium would be at point E, where rents average
$2,000 per month and 3 million housing units are
Rent per Month




occupied. If rent controls are effective, the ceiling price
Market
must be below the equilibrium price of $2,000. But
E
rent
$2,000
with a low rent ceiling, such as $1,200, the quantity of
housing demanded will be 3.5 million units (point B),
Rent
whereas the quantity supplied will be only 2.5 million
C
ceiling B
1,200
units (point C).
S D
The diagram shows a shortage of 1 million apart-
0 2.5 3 3.5
ments. This theoretical concept of a “shortage” mani-
Millions of Dwellings
fests itself in New York City as an abnormally low
Rented per Month
vacancy rate, that is, a low share of unoccupied apart-
ments available for rental”typically about half the
national urban average. Naturally, rent controls have spawned a lively black market in
New York. The black market raises the effective price of rent-controlled apartments in
many ways, including bribes, so-called key money paid to move up on a waiting list,
or the requirement that prospective tenants purchase worthless furniture at inflated
prices.
According to Figure 11, rent controls reduce the quantity supplied from 3 million to
2.5 million apartments. How does this reduction show up in New York? First, some prop-
erty owners, discouraged by the low rents, have converted apartment buildings into of-
fice space or other uses. Second, some apartments have been inadequately maintained.
After all, rent controls create a shortage, which makes even dilapidated apartments easy
to rent. Third, some landlords have actually abandoned their buildings rather than pay
rising tax and fuel bills. These abandoned buildings rapidly become eyesores and eventu-
ally pose threats to public health and safety.
An important implication of these last observations is that rent
controls”and price controls more generally”harm consumers in
ways that offset part or all of the benefits to those who are fortu-
nate enough to find and acquire at lower prices the product that
the reduced prices has made scarce. Tenants must undergo long
SOURCE: © The New Yorker Collection, 1994 Richard Cline




waits and undertake time-consuming searches to find an apart-
ment, the apartment they obtain is likely to be poorly main-
tained or even decrepit, and normal landlord services are apt to
from cartoonbank.com. All Rights Reserved.




disappear. Thus, even for the lucky beneficiaries, rent control is
always far less of a bargain than the reduced monthly payments
make them appear to be. The same problems generally apply
with other forms of price control as well.
With all of these problems, why does rent control persist in
New York City? And why do other cities sometimes move in the
same direction?
Part of the explanation is that most people simply do not un-
derstand the problems that rent controls create. Another part is
“If you leave me, you know, you™ll never see
that landlords are unpopular politically. But a third, and very
this kind of rent again.”




Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

Chapter 4 73
Supply and Demand: An Initial Look



important, part of the explanation is that not everyone is hurt by rent controls”and those
who benefit from controls fight hard to preserve them. In New York, for example, many
tenants pay rents that are only a fraction of what their apartments would fetch on the
open market. They are, naturally enough, quite happy with this situation. This last point
illustrates another very general phenomenon:
Virtually every price ceiling or floor creates a class of people that benefits from the
regulations. These people use their political influence to protect their gains by preserv-
ing the status quo, which is one reason why it is so difficult to eliminate price ceilings
or floors.


Restraining the Market Mechanism: Price Floors
Interferences with the market mechanism are not always designed to keep prices low.
Agricultural price supports and minimum wage laws are two notable examples in which
the law keeps prices above free-market levels. Such price floors are typically accompanied A price floor is a legal
minimum below which
by a standard series of symptoms:
the price charged for a
1. A surplus develops as sellers cannot find enough buyers. Example: Surpluses of vari- commodity is not permitted
ous agricultural products have been a persistent”and costly”problem for the to fall.
U.S. government. The problem is even worse in the European Union (EU), where
the common agricultural policy holds prices even higher. One source estimates
that this policy accounts for half of all EU spending.7
2. Where goods, rather than services, are involved, the surplus creates a problem of dis-
posal. Something must be done about the excess of quantity supplied over
quantity demanded. Example: The U.S. government has often been forced to
purchase, store, and then dispose of large amounts of surplus agricultural com-
modities.
3. To get around the regulations, sellers may offer discounts in disguised”and often un-
wanted”forms. Example: Back when airline fares were regulated by the govern-
ment, airlines offered more and better food and more stylishly uniformed flight
attendants instead of lowering fares. Today, the food is worse, but tickets cost
much less.
4. Regulations that keep prices artificially high encourage overinvestment in the industry.
Even inefficient businesses whose high operating costs would doom them in an
unrestricted market can survive beneath the shelter of a generous price floor. Ex-
ample: This is why the airline and trucking industries both went through painful
“shakeouts” of the weaker companies in the 1980s, after they were deregulated
and allowed to charge market-determined prices.
Once again, a specific example is useful for understanding how price floors work.


Case Study: Farm Price Supports and the Case of Sugar Prices
America™s extensive program of farm price supports began in 1933 as a “temporary
method of dealing with an emergency””in the years of the Great Depression, farmers
were going broke in droves. These price supports are still with us today, even though
farmers account for less than 2 percent of the U.S. workforce.8
One of the consequences of these price supports has been the creation of unsellable
surpluses”more output of crops such as grains than consumers were willing to buy at
the inflated prices yielded by the supports. Warehouses were filled to overflowing. New
storage facilities had to be built, and the government was forced to set up programs in


The Economist, February 20, 1999.
7


Under major legislation passed in 1996, many agricultural price supports were supposed to be phased out over
8

a seven-year period. In reality, many support programs, especially that for sugar, have changed little.




Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Part 1
74 Getting Acquainted with Economics



which grain from the unmanageable surpluses was shipped to poor foreign countries to
combat malnutrition and starvation in those nations. Realistically, if price supports are
to be effective in keeping prices above the equilibrium level, then someone must be pre-
pared to purchase the surpluses that invariably result. Otherwise, those surpluses will
somehow find their way into the market and drive down prices, undermining the price
support program. In the United States (and elsewhere), the buyer of the surpluses has
usually turned out to be the government, which makes its purchases at the expense of
taxpayers who are forced to pay twice”once through taxes to finance the government
purchases and a second time in the form of higher prices for the farm products bought
by the American public.
One of the more controversial farm price supports involves the U.S. sugar industry.
Sugar producers receive low-interest loans from the federal government and a guarantee
that the price of sugar will not fall below a certain level.
In a market economy such as that found in the United States, Congress cannot simply
set prices by decree; rather, it must take some action to enforce the price floor. In the case
of sugar, that “something” is limiting both domestic production and foreign imports,
thereby shifting the supply curve inward to the left. Figure 12 shows the mechanics in-
volved in this price floor. Government policies shift the supply curve inward from S0S0 to
S1S1 and drive the U.S. price up from 25¢ to 50¢ per pound. The more the supply curve
shifts inward, the higher the price.


FIGURE 12
S1
Supporting the Price
of Sugar D
S0




50¢
Price




25¢

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