JPJC H2 Prelim 2024 P2 Solutions

2024JPJCJC2PrelimH2P2SuggestedAnswer Question1:Rental pricesacrosstheUShavesoaredoverthepast year. Asthepandemicwearson,incomesstart torise, andmorepeoplearelookingfortheirownspace. At thesametime,pandemic-relatedsupplychaindisruptionsthatledtoshortagesofbothworkersandmaterialshaveresultedinwidespreadconstructiondelays.Asrentalpricessoaracrossthecountry,morelocalgovernmentsareturningtorentcontrolmeasurestohelpcontainhousingcosts. (a)ExplainhowtheabovementionedeventscausedrentalpricestosoarintheUS.[10](b)DiscusswhetherrentcontrolisthebestpolicytoaddresstherentalcrisisintheUS.[15] SuggestedAnswer (a) TheequilibriumrentalpriceintheUSisdeterminedbythedemandandsupplyofhousinginthemarket. Ariseinincome, morepeoplelookingfortheirownspaceandshortagesof bothworkersandmaterialshavecausedrentalpricestosoarintheUS. TheriseindemandandfallinsupplyofhousinghavecausedrentalpricetoincreaseintheUS.Asthepandemicwearsoff,incomesstarttorisewitheconomiesreopeningandjobcreation.ThisincreasesthepurchasingpoweranddemandfornormalgoodsthatincludehousingintheUS.Inaddition,thereisachangeintasteandpreferenceasmorepeoplearelookingfortheirownspaceasapersonallifestylepreference,increasingdemandforhousing.HencedemandcurveshiftsrightwardsfromDD0toDD1, causingashortageat original P0andariseinequilibriumrentalprice. Inaddition,pandemic-relatedsupplychaindisruptionsthatledtoshortagesofbothworkersandmaterialshaveresultedinwidespreadconstructiondelays.Theseresultinariseinlabourandmaterials cost, increasing the cost of production of housing. Hence profits fall andprofit-maximisingproducershavelessincentivetoproduce,causingafallinsupplyofhousing.HencesupplycurveshiftsleftwardsfromSS0toSS1,causingashortageatoriginalP0andariseinequilibriumrentalprice. Boththecombinedeffectofariseindemandandfallinsupplycausedamutuallyreinforcingeffectontheriseinequilibriumrentalprice,causingrentalpricestosoarintheUS. 1

ThesoarinrentalpricesintheUScanalsobeattributedbytheconceptsofpriceelasticityofdemand(PED)andpriceelasticityofsupply(PES). Demandforhousingispriceinelastic(PED<1)asitisabroadlydefinedgoodthatlacksclosesubstitutes. Demandcurveisrelativelysteeperandtheriseinpricewill causealessthanproportionatefallinquantitydemanded.Hencealargerriseinequilibriumrentalpriceisneededtocleartheshortagegiventhefallinsupplyofhousing. Supply of housing is price inelastic (PES<1) asit hasalongconstructionperiodthat isfurthermoredelayedduetosupplychaindisruptions.Supplycurveisrelativelysteepandtheriseinpricewillcausealessthanproportionateriseinquantitysupplied.Hencealargerriseinequilibriumrentalpriceisneededtocleartheshortagegiventheriseindemandforhousing. Hence,giventhatbothdemandandsupplyofhousingispriceinelastic,therewillbealargeriseinequilibriumrentalpricetocleartheshortage,causingrentalpricestosoarintheUS. Inconclusion,theriseindemandandfallinsupply,togetherwithpriceinelasticityofdemandandsupplyhavecausedrentalpricestosoarintheUS. SuggestedAnswer (b) Ariseinincome,morepeoplelookingfortheirownspaceandshortagesofbothworkersandmaterialshavecausedrentalpricestosoarintheUS.Asrentssoaracrossthecountry,morelocalgovernmentsareturningtorentcontrolmeasurestohelpcontainhousingprices.WhetherrentcontrolisthebestpolicytoaddresstherentalcrisisintheUSdependsonitsbenefits,costsandunintendedconsequences.Rentcontrolreferstoapriceceilingonrents,whichisthehighestpermissiblerentthatlandlordscanlegallycharge.Inorderforrentcontroltobeeffective,theymustbesetbelowtheequilibriumpriceofrentedaccommodation.Theimpositionofrentcontrolseekstoensureaffordableaccommodationforthosebelongingtothelowerincomegroup. 2

Figureillustratestheeffectsoftheimpositionofrentcontrol.Withoutgovernmentintervention,theequilibriumpriceofrentedaccommodationwouldbeat0Peandtheequilibriumquantityat0Qe.Whenthegovernmentimposesrentcontrolbyfixingthepricebelowtheequilibriumlevel,sayat0Pmax,producersproduceatalowerquantity,0Qs,whileconsumersarewillingandabletopurchaseamuchlargerquantity,0Qd.Duetotheexcessdemandat0Pmax,ashortageofQsQdresults. Consumers(0Qs)whoareabletoenjoythegoodatthelowerpriceof0Pmaxarebetteroff.Itmaybebeneficialforequityreasons,toallowlow-incomehouseholdstohaveaccesstoabasicnecessitysuchasshelter.Producersarealsoworseoff,becausetheynowselllessofthegood,andatalowerperunitpriceof0Pmax,resultinginafallinrevenuefromOPeEQetoOPmaxAQs.Assumingceterisparibuscondition(i.e.nochangeincosts),thisresultsinlowerprofits.Inaddition,someconsumers(QsQe)areworseoffbecausetheyarenotabletoconsumethegoodeveniftheywerebothwillingandabletopayahigherpriceofPe.ThiscouldleadtotheemergenceofblackmarketwhichmayresultinconsumersrentingatapriceevenhigherthanPeatPb,causingthemtobeworseoff.Furthermore,giventheshortage,landlordsalsolosetheincentivetomaintaintheir propertiesknowingthat demandwill outstripsupplyduetotheartificialceilingonrent.Asaresult,consumerswhorentareultimatelyharmedasthehousestheyrentwillbeoflowerquality,havingfallenintodisrepair.Withlowerrentalrevenue,landlordsareincentivisedtoconvertrentalunitsintohousingunitsforsaleasthiswouldgeneratemorerevenueforthem.Thiswouldfurtherreducethesupplyofrentalunitsandworsentheshortagefurther.Thisreducestheavailabilityofrentalunits,forcingconsumerstomoveelsewhere.Furthermore,governmentsmayfaceariseinadministrativecostsduetotheneedtomediateanincreaseinconflictsbetweenlandlordsandtenantsarisingfromrentcontroldisputes.Theymayalsoincurcostsshouldtheyneedtomanageriotsandsocialproblemsstemmingfromhighrents.Hence,rentcontrolmaynotbethebestpolicytoaddresstherentalcrisisintheUSduetotheseverecostsandunintendedconsequences. Abetterpolicyinthelongtermcouldbeimplementedtoincreasethesupplyofhousingandreduceitsequilibriumprice. TheUSgovernment couldprovidesubsidiestohousebuildingfirms, reducingtheircost ofproduction.Thisfinancialsupportwouldincreasethefirms'profits,providinggreaterincentivetoconstructnewhousing.Asaresult,theriseinsupplyofnewhousingcausesthesupplyofrentalhousingtoincrease,shiftingthesupplycurvefromS0toS1.Thisshiftcreatesasurplusattheoriginal rentalprice,P0.Consequently,theequilibriumrentalpricedecreasesfromP0toP1,makingrental housingmoreaffordableforconsumers. ThisincreaseinthesupplyofrentalhousingdirectlyaddressestherentalcrisisintheUSbymakingmoreunitsavailableatlowerprices. 3

The benefit of providing subsidies to producers is that it isrelativelyeasytoimplementassumingthat theUSgovernment hassufficient funds. Inaddition, it doesnot distort andpreventthepricemechanismfromfunctioningproperly. However,subsidyalsohavelimitations.Ittakestimetoconstructhouses.Thus,suchapolicycanonlyworkinthelongrun.Itisalsoverycostlyandposeastraintothegovernment’sbudget.TheUSgovernment islikelytoborrowtofinancethesubsidyduetoitsbudget deficitandgovernmentdebtproblems.Suchabudgetconstraintmayrendersubsidytohousebuildingfirmsnotfeasible.Opportunitycostisstillincurredastherearenotlesserfundsavailableforotherareassuchaseducationandhealthcare.Inaddition,byallocatingmorelandforhousinghasunintended consequences in theformof risingopportunitycostsfor other aspectsof theeconomy.Morelandforhousingwouldimplylesslandforcommercialorindustrialpurpose.Theopportunitycostscouldbeintermsofeconomicgrowthlost.Moreimportantly,producersmaybecome reliant on the government for subsidies andmaynot havetheincentiveremaincompetitiveandlowercost.Thismeansthatpriceswillcontinuetoremainhigh,andthesubsidycannotberemoved.Thus,thepolicyisnotsustainableinthelongrun. ThoughincreasingthesupplyofhousingviasubsidisingthehousebuildingfirmstoreducetherentalpricemaybeabetterpolicytoaddresstherentalcrisisintheUS,italsoposescertaincosts,constraintsandunintendedconsequences. RentcontrolisnotthebestpolicytoaddresstherentalcrisisintheUSbecauseitfailstotackletheroot causeof highrents, whichistheimbalancebetweensupplyanddemandforrentalhousing.Rentcontrolcanprovidetemporaryreliefbycappingrentalprices,butitdistortsmarketforcesandcanexacerbatehousingshortagesinthelongterm. Theprimaryissueisthat thedemandfor rental housingexceedstheavailablesupply. Toeffectivelyaddressthis, theUSgovernment shouldfocusonsub