The Social Costs of Rent Control Revisted
The textbook graphical analysis of price control (see Figure 1) is inappropriate any time there is substantial consumer heterogeneity. In cases such as rental apartments, where one unit is usually the maximum bought per customer, and the downward slope of the demand function comes exclusively from consumer heterogeneity, this analysis misses a primary source of welfare loss. A major social cost of rent control is that without a fully operational price mechanism the 'wrong' consumers end up using apartments. When prices are set below market price, many consumers want to rent apartments even though they receive little utility from those apartments. Unless apartments are somehow allocated perfectly across consumers, rental units will be allocated to consumers who gain little utility from renting and rental units will not go to individuals who desire them greatly. The social costs of this misallocation are first order when the social costs from underprovision of housing are second order. Thus for a sufficiently marginal implementation of rent control, these costs will always be more important than the undersupply of housing. Figure 2 shows the losses graphically.
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