Project Case for Managerial Economics

Assume there is a well-defined geographic area of a city.  The area is composed exclusively of apartments and is populated by low-income residents.  The people who live in the area tend to stay in that area because (1) they cannot afford to live in other areas of the city, (2) they prefer to live with people of their own ethnic group, or (3) there is discrimination against them in other areas of the city.  Rents paid are a very high percent of peoples' incomes.

(1)  Would the demand for apartments in this area be relatively inelastic or relatively elastic?  State why.

I feel that the demand for apartments would be relatively inelastic because there are few options for this well-defined area and due to the population type (low income; desire to live amongst their own ethnic group to avoid discrimination).  Therefore, they desire to remain in this specific town/area and their options outside of this area would be limited because rents would be (presumably) higher elsewhere. Since we are also considering renters’ incomes, the demand could be relatively elastic. That said, if/when rents rise, then there would eventually be a higher-price rent level that would cause many of these residents to be ‘priced out’ due to affordability issues. In other words, it is relatively inelastic up to a certain price point – and then becomes more rapidly more elastic at higher price levels.

 (2) Would the supply of apartments in this area be relatively inelastic or relatively elastic?  State why.

The supply of apartments in this area would also be relatively inelastic.  Since this is a low-income area and heavily populated I would imagine that there is not much area left for development since it most likely saturated with other housing/buildings.  However, it can be argued that – in the event rents increased significantly in the area – then there would be a greater likelihood of new construction in order to add more housing, because the margin for profit (for housing providers) would be more attractive as a result.

(3) Draw the demand and supply curves as you have described them, showing the initial equilibrium price and quantity.  

The DEMAND curve and SUPPLY curve should both be sloped at steep angles because both appear to be relatively inelastic – i.e., no major changes in supply or demand resulting from changes in price (assuming not excessive price changes, of course). The red line represents housing supply and the blue line represents housing demand.

[pic 1]

 (4)  Now assume the government creates a rent supplement program.  Under this program, the renter is required to pay 30% of income in rent.  Any additional rent is paid by the government --- up to a limit.  For example, a low-income person with an income of $1,000 a month would be required to pay $300 in rent (30%).  If the rent is $500, the other $200 would be paid by the government.  Analyze the results of this program.  Show the changes on the graph and explain what will result.  Who gains and who loses from this program?

Since the government added a program to supplement the cost of the rent this, in return appears as if it increases the renter’s income since they can now afford a greater rent payment. A rent supplement program paid by the government would cause an upward shift in demand.  In fact, it may lead to an inflow of people from other towns/areas looking to take advantage of this very attractive ($) subsidy.  The supply curve, on the other hand, would rise at a relatively lesser pace – because space and opportunity to build new housing is limited, given that it’s already a densely populated area that is (presumably) maxed out in terms of available housing units.  The shift (up to the right) in demand would then cause the equilibrium price to rise higher – a price increase driven mainly by increased demand for the housing.  Both the renters and the landlords are winners – renters can afford better housing (at same out-of-pocket costs), and landlords put more money in their pocket (from higher rent prices – but fixed/similar costs otherwise).  The government loses, so to say, because it would be the one essentially paying for these benefits.