Maximum Price | A-Level Economics Model Paragraph

Maximum prices

One way to correct the market failure in the market for rented housing is through maximum prices. A maximum price is a price above which it is illegal to sell, and a maximum price should be set below the free-market equilibrium to have any effect on the market. In New York City, around 30,000 apartments are subject to rent control, with an average controlled rent of roughly $1,300 per month compared to an average market rent of around $2,500 per month. The diagram shows that a maximum price causes an expansion in demand and a contraction in supply, and the price decreases from P1 to P2. As a result, there is an increase in the amount of housing consumed by those able to access it, therefore a movement closer to the socially optimal level of output in the market.

However, a maximum price can cause government failure in the form of a distorted market. As mentioned, a maximum price causes a contraction along the supply curve whilst causing an expansion along the demand curve. This means that there is a shortage of homes on the market. As a result, there is likely to be an under-consumption of housing relative to the socially optimal level, worsening the market failure it was intended to correct.

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