Business and Administrative Studies – Supply and Demand Curves

Business and Administrative Studies – Supply and Demand Curves
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 provided 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. Using the given functions, draw corresponding demand and supply curves. Properly
   label the equilibrium price and quantity. Then show what will happen to
   equilibrium if the City Council imposes a price ceiling of 16.
   To plot the supply and demand curves, the following equations are plotted on a graph with
   quantity (Q) on the X-axis and price (P) on the Y-axis:
   Demand function: QD = 120 – 4P
   Supply function: QS = 2P
   Qd (Quantity
   demand)

Price
(P)

Qs (Quantity supplied)
120 0 0
100 5 10
80 10 20
60 15 30
40 20 40
20 25 50
0 30 60

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051015202530

Price

0
20
40
60
80
100
120
140

Qd (Quantity demand)Qd (Quality supplied)

Graph 1. Demand and supply curve (and the quantity and prince equilibria)
From the graph, the equilibrium quantity and price occur at the point the supply and
demand curves intersect (cross each other). From the chart, the equilibrium quantity of rental
units is 40, and the equilibrium price is $20. If the City Council in Prescott, Arizona, imposes a
price ceiling (Pmax) of $16, the price cannot exceed the $16 mark. The graph below
demonstrates this phenomenon.

051015202530

Price

0
20
40
60
80
100
120
140

Qd (Quantity demand)Qd (Quality supplied)
Graph 1. Demand and supply curve at a $16 price ceiling (Pmax=16)

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At a price ceiling (Pmax) of $16, the quantity demanded (Qd) outweighs the quantity
supplied (Qs), yielding a temporary rental unit shortage. The quantity of rental units demanded at
Pmax=16 is 56, while the quantity supplied is 32. This translates to a gap of 24 rental units. This
means there are potentially 24 renters who cannot access rental houses (units) in Prescott,
Arizona when the City Council sets the price ceiling at $16. Rental shortages can lead to housing
and socioeconomic problems, including overcrowding, homelessness, etc.
The supply and demand principle can better explain the logic of housing shortages and
potential homelessness. Setting the price ceiling below the equilibrium can increase demand
beyond the quantity the market can supply (Anderson, 2023). The excess demand automatically
results in shortages.

2. Are consumers of rental housing in Prescott well-served by this price ceiling policy?
   Provide a careful economic analysis in support of your claim. In particular, discuss
   what happens if a regulated price is set that is not equal to the equilibrium price.
   From price and demand graph 2, it is evident that rental-housing consumers are
   underserved by the price ceiling policy (Pmax of $16). Although the policy might initially seem
   to advantage rental-housing consumers by capping the price they have to pay (which is lower
   compared to the equilibrium market price of $20), it results in multiple unintended ramifications
   that, in due course, harm renters.
   When a price ceiling is capped below the equilibrium or regular market price or value, it
   creates a scenario whereby the quantity of units demanded supersedes the quantity of units the
   market can supply (Welch & Welch, 2009). For the rental housing market in Prescott, this
   implies that more people are seeking rental units than the market can supply, creating a shortage.

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The impact of the scarcity is that property owners are likely to start selecting tenants based on
factors like credit scores, favorable features, and higher earnings. This can cause discrimination
by leaving lower-income renters with poor credit scores homeless.
Additionally, the housing shortage can create less incentive among property owners to
improve and maintain their houses. Renters are desperate to secure any rental units available,
irrespective of. This can negatively impact the quality and safety of rental units in Prescott.
Furthermore, setting a price ceiling below the market price equilibrium can demoralize new
players from entering the market since the profits or gains from the market are restricted by the
policy (Silla, 2013). This can further exacerbate the housing shortage in the long run, creating
substandard living conditions, overcrowding, and other negative impacts for consumers.

3. Suppose that the Council is concerned that landlords will allow the quality of their
   rental units to deteriorate following the imposition of the ceiling price. What can
   you infer about the level of quality that landlords’ provision will allow if consumers
   are worse off following the imposition of the ceiling price? Provide a careful
   economic analysis in support of your claim.
   If renters are worse off after the new price ceiling policy is imposed, there is a high
   chance that property owners or landlords will lower the quality of their houses or rental units.
   According to American Institute for Economic Research, lowering price ceilings can negatively
   impact the quality of products and services (Boudreaux, 2022). Imposing a price ceiling means
   landlords cannot charge more than the set price limit or the price of the rental units in a free
   market. This implies landlords earn less revenue to cover their expenditures and outlays,
   including repairs and maintenance. Therefore, to profit from their investments, landlords might
   be forced to lower the quality of their houses by avoiding expensive maintenance and repair

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costs or by cutting back on extras like parking spaces, swimming pools, and air conditioning
(Dean et al., 2016). All these factors combined can worsen the situation; renters pay lower prices
but receive low-quality services and products. When a shortage exists because of a price ceiling,
property owners might feel less pressure to improve, maintain, or better their units, perhaps
because renters have few options. This can force renters to stick with low-quality units, as they
have no choice.

4. Suppose now that the proposal before the City Council contemplates imposing a
   price ceiling on apartment rentals but not on house rentals. Would rental house
   owners in Prescott likely support this proposal, or would they prefer the status quo
   (i.e., no price ceilings)? Provide the economic rationale for your answer.
   Owners of rental houses in Prescott will likely prefer to maintain the status quo (live
   without price ceilings) if a proposal to impose price ceilings on rental apartments and not rental
   houses are being contemplated by the City Council. A price ceiling on rental apartments can
   distort the market, increasing the demand for rental homes. This can substantially translate to
   higher rental rates for house landlords. Consequently, if the City Council imposes a price ceiling
   on rental apartments, the outcome is a shortage of rental units because the demanded quantity
   overrides the quantity of units supplied. Since some renters might fail to secure apartments, their
   only option would be to look for rental houses as an alternative or substitute. Therefore, an
   increase in rental house demand would automatically translate to a rise in rental rates if no price
   ceilings are imposed.

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References

Anderson, S. (2023, Apr 7). Price ceiling types, effects, and implementation in economics.
https://www.investopedia.com/terms/p/price-ceiling.asp
Boudreaux, D. J. (2022). Five negative consequences of price ceilings. American Institute for
Economic Research. https://www.aier.org/article/five-negative-consequences-of-price-
ceilings/
Dean, E., et al. (2016). Principles of economics: Scarcity and social provisioning (2 nd ed.).
OpenStax Economics.
Silla, B. S. (2013). The general economic impact of price ceilings; violating the law of supply
and demand, a Tanzanian experience. International Journal of Science and Research
(IJSR), 6(14). https://www.ijsr.net/archive/v5i9/ART20161907.pdf
Welch, P. J., & Welch, G. F. (2009). Economics: Theory and practice. John Wiley & Sons.