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Chapter 7
Chapter 7 is the second chapter to deal directly with the supply and demand model. Chapter 4 introduced the supply and demand model; now Chapter 7 shows its power in a variety of different contexts. Two chapters are devoted to the supply and demand model because of the model's importance.
One of the goals of Chapter 7 is conveying to you an appreciation for how markets work and what can happen if the government imposes controls in markets. The first section of the chapter covers the impact of rent ceilings and how they affect the response to some supply shock, like an earthquake. A natural question to pose is how rent ceilings affect the outcome from changes in demand. For instance, population growth in a city will increase the demand for housing within that city. How does a rent ceiling affect the housing market in the face of population growth?
To answer this question, let's start first by reviewing the response of a housing market without rent controls. The figure will help us understand what occurs when the demand for housing increases. In the figure, the supply curve is S0, the initial demand curve is D0, and, because of the increase in population with its accompanying increase in demand for housing, the demand curve shifts to D1. The figure shows that the initial equilibrium rent is $400 per month and the equilibrium quantity is 50,000 units rented. With the increase in demand, the rent rises to $500 per month and 60,000 units are rented.
The figure shows us that with the increase in demand, both rents and the quantity of units rented increase. But, the story does not stop here. To see what happens in the long run, click on the figure below.