Rent Ceiling in Valdora
In the city of Valdora, median monthly rent rose from 800 to 1,150 pesos over three years. The city council imposes a legal rent ceiling of 900 pesos. Before the ceiling, the vacancy rate was 4%; six months later it is 1.2%. Landlords withdraw 18% of rental units for owner-occupation or short-term letting. Prospective tenants report key money payments of 200–300 pesos and waiting lists exceeding 2,000 households. New residential construction permits fall by 35% year on year. The council argues the policy protects low-income tenants; landlord associations say maintenance has been deferred and some buildings are being converted. The local university estimates that demand is price-inelastic in the short run but more elastic after two years, while new supply is very inelastic within one year. The mayor asks whether the ceiling should be kept, raised, or replaced with a targeted housing benefit.
1. Using supply and demand, explain how the rent ceiling creates a shortage and non-price rationing.
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At a ceiling of 900 pesos, quantity demanded exceeds quantity supplied. The shortage is the horizontal gap between the demand and supply curves at that price. Supply falls because landlords withdraw 18% of units and permits fall 35%, shifting the supply curve left as well as moving along it. Because price cannot adjust, rationing is non-price: waiting lists, key money, landlord screening, and conversion to short-term letting. Key money of 200–300 pesos means the effective rent is close to or above the old market rent, so tenants may not gain. In the short run, inelastic demand and supply keep the shortage relatively small; after two years, demand becomes more elastic and supply remains inelastic, so the shortage can widen. Allocative efficiency falls because units are not allocated to those with the highest willingness to pay, and deferred maintenance reduces quality. The policy creates winners (sitting tenants) and losers (new entrants and landlords), so the welfare effect is not one-sided.
2. Evaluate whether replacing the ceiling with a targeted housing benefit would improve welfare.
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A targeted housing benefit raises low-income tenants' ability to pay without fixing a legal price. If the rental market clears, the benefit improves equity and avoids queues and key money. But with very inelastic short-run supply, landlords can capture much of the benefit through higher rents; the incidence depends on supply elasticity and benefit design. A benefit also has fiscal and administrative costs and may create poverty traps if withdrawn sharply. Raising the ceiling gradually reduces the shortage but exposes tenants to rent rises. Supply-side policies-releasing permits, taxing vacant units, converting short-term lets-address the cause. Judgement: replace the ceiling with a means-tested benefit plus supply expansion, phased in to avoid a rent spike; if fiscal space is limited, a higher ceiling with tenant protection is second-best.