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Worksheet

6 GOVERNMENT
ACTIONS IN
MARKETS

1. Properties in the city of Mumbai (formerly Bombay) in India are still subject to rent-control regulations that
were imposed in 1947. At that time, thousands of people migrated into Mumbai as a result of the partition of
the country into India and Pakistan. Rents were frozen at levels that prevailed in 1940, in order to prevent
spikes in rental rates that might have resulted from this rapid increase in demand for housing. The questions
below ask you to analyze the motivation and the consequences of rent control laws. All quotes are taken from
a 2006 Wall Street Journal article. (Bellman, Eric. Tenants in Mumbai Will Endure a Lot For an $8.50
Flat; Why Sojatwala Family Stayed In Rent-Controlled Digs After a Building Collapse, Wall Street
Journal. Jun 5, 2006. pg. A.1.)
a. The author points out that the result of the rent control law in Mumbai is that landlords are leaving
prime parcels of property to decay. The dearth of new apartments means that half of the city 12 million
residents live in slums. Explain the economic logic of this outcome.
Landlords have no incentive to improve their properties. They cannot recoup their
investment, and the rents they do receive dont generate enough revenue to finance
improvements.

b. Rent control laws that keep rents below market in some districts have an impact on the unregulated sector
as well. Meanwhile, (in Mumbai) the tight supply of high- end residential properties has pushed rents to
$2 to $3 a square foot -- higher than rents in some neighborhoods in New York or Singapore. A good
two-bedroom apartment in Mumbai can easily go for $3,000 a month. Some people fear that the removal
of rent controls would cause the equilibrium price to rise to these stratospheric levels. Explain why this
concern is mistaken.
Removal of rent control laws would raise rents on formerly controlled properties, but the
prices would not rise all the way to $3,000 a month. When rent control is abolished, the supply
of units in the unregulated sector would rise above its current level, so the equilibrium price
would be lower than $3,000.
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c. In Mumbai, the rent-control measures, meant to be temporary, have been extended more than 20
times and currently apply to roughly 35,000 buildings, or about 60 percent of the real-estate market in the
city center, the property owners association says. Explain why elected officials would choose, repeatedly,
to extend a regulation that causes egregious misallocation of resources. (Hint: Consider this quote from the
same article: Unlike China, where residents regularly make way for new skyscrapers, the beneficiaries of
Mumbai's rent controls flex political muscle to stay.)
Incumbent tenants resist any attempt to eliminate rent controls because abolishing rent
controls would harm them. Elected officials, who want to be re-elected, cannot risk the voters
ire because to do so would make re-election more difficult. So even though the rent controls
result in a huge deadweight loss and a severe misallocation of resources, the temporary rent
controls have achieved a great deal of permanence. By way of contrast, in China, elections are
often less free and so Chinas officials do not have the same incentive to bow to tenants
wishes.