How a maximum price below equilibrium causes a shortage and a minimum price above it a surplus, who gains and loses, and when they are worth it. Through Scotland’s rent freeze.
In September 2022, during the cost-of-living crisis, the Scottish Government froze most private rents, then capped rises at 3% a year until 2024. Tenants were protected from sharp rises. But landlords’ groups warned some owners would sell up, and new tenancies, which were not covered in the same way, saw large increases.
What happens when the law holds a price below what the market would set?
Source: Scottish Government, Cost of Living (Tenant Protection) (Scotland) Act 2022.
A maximum price (price ceiling) is a legal limit on how high a price can be. It only has an effect if set below the equilibrium. Examples: rent controls, energy price caps.
A minimum price (price floor) is a legal limit on how low a price can be. It only has an effect if set above the equilibrium. Examples: minimum unit pricing for alcohol, the National Minimum Wage, guaranteed prices for farmers.
Aims: a maximum price protects consumers and makes necessities affordable; a minimum price protects producers’ incomes or cuts consumption of a harmful good. The model assumes the control is enforced.
The government caps rents below what landlords would charge.
Tenants are delighted: rents are lower.
What is likely to happen to the number of homes available to rent?
At a lower rent, more people want to rent but renting out is less profitable, so some landlords sell up or do not invest. Demand is greater than supply: a shortage. That is the trade-off with any maximum price below equilibrium.
The market clears at Pe, with 12 thousand traded.
A maximum price of £6, below equilibrium. Demand extends to 14 thousand; supply contracts to 8 thousand. Excess demand of 6 thousand: a shortage. Only 8 thousand are actually traded.
Check: A maximum price is set below equilibrium. Compared with equilibrium, quantity supplied:
At a lower price, supplying is less profitable, so supply contracts.
Who gains? Buyers who get the good, at a lower price. Who loses? Buyers who now cannot get it, and sellers. The shortage has to be rationed somehow: waiting lists, first come first served or illegal black markets where the price is above the maximum.
A minimum price of £10, above equilibrium. Supply extends to 16 thousand; demand contracts to 10 thousand. Excess supply of 6 thousand: a surplus.
Check: A minimum price is set above equilibrium. What results?
At a higher price, supply extends and demand contracts.
To keep the price at £10, someone has to take the surplus.
Check: The government buys the surplus of 6 thousand at the minimum price of £10. What does it spend, before storage costs?
It buys the surplus at the minimum price: 6 thousand × £10 = £60 thousand, plus the cost of storing it.
For farm products, the government may buy up the surplus to keep the price at the minimum: 6 thousand × £10 = £60 thousand, plus storage, from taxpayers. Or the surplus is wasted. For alcohol, the aim is the lower quantity demanded, Qd.
A maximum price above equilibrium has no effect: the market price is already below the ceiling, so no shortage is created. To bite, a maximum price must be below equilibrium.
Using a diagram, explain the likely effects of a maximum rent set below the equilibrium rent.
A maximum price is a legal limit on how high a price can be. It only has an effect if it is set below the equilibrium price.
[Diagram: D and S with equilibrium rent Pe. A horizontal maximum rent below Pe, with quantity supplied Qs and quantity demanded Qd marked and the gap labelled a shortage.]
At the lower maximum rent, renting becomes more affordable, so the quantity of rented homes demanded extends to Qd. But renting out is less profitable, so some landlords sell up or do not buy more homes, and the quantity supplied contracts to Qs. The result is excess demand: a shortage of homes to rent.
Tenants who find a home gain from paying less. But others cannot find a home at all, so homes are rationed by waiting lists or by landlords choosing tenants, and some deals may happen illegally above the maximum. Landlords may also cut spending on repairs, lowering quality.
Scottish rent freeze and cap: Scottish Government (2022 to 2024). Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.