Mae101 Economic Principles For Rental Assessment Answers

(Label your diagram fully and use realistic axes labels. Give your diagram a title. Note – you do not need to use actual data for this question).

2 – Rental Market Analysis

i. Using a demand and supply diagram for the market for rental properties, illustrate and explain the effect of a (binding) rent ceiling. (Label your diagram fully and use realistic axes labels. Give your diagram a title).

Your analysis should discuss the welfare effects on this market and the changes to quantity demand and supplied.

ii. List and briefly discuss 2 alternative mechanisms that may help to ration the rental stock when the free-market price is prevented from achieving a market-clearing equilibrium.

iii. Discuss how the quality of the rental stock may be affected by the implementation of a rent ceiling? 

Answers

1: Article Analysis

Part i) 

Article 1: “RBA governor Philip Lowe only sees one way to solve Australia's housing affordability problem”

The rising housing problem in Australia has landed Lowe on a certain solution of limit interest mortgage lending to 30% that could not only reduce the financial risks but also reduce the imbalances of demand and supply. Moreover, RBA has listed some issues of higher prices in Australian housing like strong population growth, underinvestment and demand has been not been able to meet the supply, lower borrowing costs with continuous capital gains and also the cuts in interest rates. As a result, the loop increases the investor activity with existing tax arrangements leading to availability of credit for increased demand (Scutt 2017). Although, RBA is reluctant to cut interest rate despite poor labour conditions by improving housing affordability through loan serviceability due  to increased demand. However, this can be met by increasing supply by building large scale transport infrastructure and housing supply.

Article 2: “Sydney squeeze: Is rent control the answer to the housing affordability crisis?”

Sydney has been going through housing affordability crisis where the tenants have been charged higher prices by the private landlords as they have no benchmarks. As a result, City West Housing has been developed in 1994 to provide affordable homes based on annual income inclusive of family tax benefits. The main issue resolves around the basic problem of supply and demand where the tenants are in need of affordable homes as they cannot risk losing their jobs. The council has been accommodating every kind of tenant based on their asset value, increased income over a period of time, etc. The council has been existing its roots to Darlinghurst, Potts Point to attain a target of meeting the demand of 7.5% affordable housing by 2030 and also to meet the gap between affordable purchasing as well as renting as per Ms Mc-Kenzie Low (Hoh 2017).

Part ii)

Three factors in unaffordability of housing

• Population Growth – Australian population in largest cities like Sydney and Melbourne has increased as there is no response of supply to the initial demand since 2009.
• Underinvenstment – There is no proper investment taking place as they tenants are only encouraged in case of higher prices.
• Cuts in Interest Rates – The availability of credit with the people will increase the demand as market dynamic differ across countries in Australia.

Three approached by policy makers to address the issue

• Rent Control – To save from private landlords as well as leasing the accommodation based on their annual income started by in 1994 as City West Housing.
• Loan serviceability to the buyers to create soft inflation and splutter household sector based on market conditions.
• Limit interest mortgage lending as most of the lending comes from housing sector by proposing negative gearing to existing arrangements of tax.

Part iii)

The factor that has been considered in population growth as increase in population in largest cities have led to more demand of housing affordability in Australia with no actions undertaken for the initial housing supply . The same can be depicted through a diagram of demand and supply.

As per the diagram given above, we can say that the demand has been increasing based on affordable housing for the tenants and initially there had been no change in supply. As a result, demand curve has shifted to right creating a hike in prices for the tenants to pay for the house they purchase/ take on lease. However, demand keeps on growing with the available supply curve.

2: Rental Market Analysis

Part i)

The demand and supply diagram for the rental properties with the effect of rent ceiling.

As per the diagram, the price ceiling has been applied to rental properties such that welfare effects have been analyzed. When the Australian rental market is on equilibrium then the consumer as well as producer surplus is divided equally. However, when price ceiling is imposed (max rent = P2) in the market then the producer surplus is decreased and consumer surplus increases. Moreover, excess demand is created as Q2-Q3 creating shadow market so that the people willing to pay P3 (Palmer and Childs 2014).

After price ceiling scenario, consumer surplus = 1+2+4, producer surplus = 8, dead weight loss = 3+5 (welfare loss to the society)

Part ii)

The two alternate mechanisms that can help in ration the rental stock when to equilibrate supply and demand are substitution of tenant for maintenance of landlords, spillovers in the uncontrolled sectors. Firstly, a lot of tenants can be used for rent control induces in such a way that with a bargain, it might be difficult for tenants to find similar yet affordable priced accommodation making a tenant to ‘stay put’. Secondly, to reduce mobility of the tenants by reducing the inflow in vacancy to create equilibrium allocation supplementing in long-run (Jenkins 2009).

Part iii)

Price ceiling reduces the rental stock because initially supply of low quality property is increased as there is less high quality rental properties which further diminishes the incentive to hold profits for development. As a result, this not only increases the cost of capital but also leads to conversion of rental properties into self-owned offices or flats. Lastly, there is decline of supply for rentable accommodation making it unambiguously negative (Bourne 2015).

References

Bourne, R. 2015. 5 The Flaws in Rent Ceilings. Ceilings, 72.

Hoh, A. 2017. Is rent control the answer to Sydney's housing affordability crisis? ABC News. Retrieved 4 May 2017, from https://www.abc.net.au/news/2017-03-21/sydney-squeeze-affordable-housing-rent-control-options/8370364

Jenkins, B. 2009. Rent control: do economists agree?. Econ journal watch, 6(1).

Palmer, J., & Childs, J. 2014. The Allocation of Costs under Rent Control. SOP Transactions on Economic Research, 1(2), 49-53.

Scutt, D. 2017. RBA governor Philip Lowe only sees one way to solve Australia's housing affordability problem. Business Insider Australia. Retrieved 4 May 2017, from https://www.businessinsider.com.au/lowe-housing-affordability-2017-4