Case Study The Housing Market This case study illustrates Law of Demand and Law of Supply in the context of housing market at equilibrium. Victoria Housing Market 1200-0 5 5 5 5 5 g 5 5 S1; Landlords 1100.0 5 5 5 5 5 5 5 5 2 5 1000.0 900.0 000.0 700.0 E1 000.0 500.0 Price [$5'month] 400.0 5 i 5 300.0 D1 -.+ Rerilters 200.0 100.0 0 3 0 0 12 15 10 2'1 20 21' 30 Quantity of Total Rental Units (thousands) In above case, landlords supply the housing units, hence they represent the supply side of the market, which is labelled as 51. Since Renters demand the housing units, they represent the demand side of the market, labelled as 52. The equilibrium E1 occurs at the intersection of supply and demand, in this case @ EP1 = $600, EQ1 = 15,000 rental units. In a perfect equilibrium, the housing market would have no vacancies. However, one of the requirements of a perfect equilibrium is a instant transmission of information. In the real market, this is not the case. Because of this, even if there is an equal amount of supply and demand, it is difcult for renters to match up with landlords. This means that when someone leaves the rental market, it takes time before that vacancy is filled. Therefore even when supply Managerial Economics Law of Demand/Supply Equilibrium Case StudyII = demand there can be a positive vacancy rate in the market. Depending on the speed of information transfer, there will be an equilibrium vacancy rate that represents healthy market conditions without further information we could assume this rate is around the Canadian average of 3.3%. This means that a vacancy rate of 0.6% would have to represent a shortage of housing from disequilibrium. Victoria Housing Market 52 1200.0 1 1 00.0 1 000.0 900.0 800.0 700.0 600.0 500.0 Price ($Imonth) 400.0 300.0 200.0 1 00.0 0.0 6 9121513 2124 27 30 Quantity of Total Rental Units (thousands) The decrease in landlords causes a decrease in supply. We can nd the exact magnitude of the shift by looking at how much quantity supplied decreases for each price level. If we are told to assume that quantity supplied decreases by 3000 rental units at every price then this would causes a shift from 51 to 52. The new equilibrium E2 results from the intersection between $2 and D1, in this case @ EP2 = $650, EQ2 = 13,000 rental units. Managerial Economics Law of Demand/Supply Equilibrium Case StudyII Victoria Housing Market 32 1 200.0 S1 1100.0 1000.0 900.0 800.0 700.0 600.0 9000 0m: increase 500.0 Price ($lmonth) :D2 400.0 300.0 200.0 1000 D1 . I I I I I I I I I I I I I I 0.0 0 3 6 9 12 15 18 21 24 27 30 Quantity of Total Rental Units (thousands) The increase in renters in the market causes an increase in demand. Again, the magnitude of the shift is given to us. We are told that quantity demanded increases by 9000 rental units at every price. This causes demand to shift from D1 to D2. The new equilibrium E3 results from the intersection between 52 and D2, in this case @ EP3 = $800, EQ3 = 18,000 rental units. We can see that compared to EP1 = $600, EQ1 = 15,000 rental units, E3 has seen a increase in price and quantity. Breaking down the two effects: - The decrease in supply caused price to rise and quantity to fall. - The increase in demand caused price to rise and quantity to rise. Managerial Economics Law of Demand/Supply Equilibrium Case StudyII Victoria Housing Market 32 1200.0 1100.0 1000.0 900.0 800.0 700.0 600.0 : 12,000 unll shonpgo 500.0 Price ($Imonth) 400.0 300.0 200.0 100.0 0.0 ' ' ' ' ' ' o 3 6 9 12 15 1a 21 24 27 30 Quantity of Total Rental Units (thousands) We can see that the effects on price worked together, but the effects on quantity opposed. The end result of an increase in quantity is because the demand shock was greater than the supply shock. In this topic we explained that unless you know which effect is greater, the result of opposing shocks is inconclusive. In this case we can say with certainty that quantity has increased because we know the exact size of the shocks. If price remains at the original equilibrium E1 of $600, Quantity Demanded @ D2 is 24,000 and Quantity Supplied @ $2 is 12,000. This means that there will be a 12,000 unit shortage in rental housing (24,000 12,000). As mentioned in the case study, this will cause pressure for prices to increase. Since landlords cannot raise prices for existing tenants, they will be incentivized to nd ways to evict tenants. For the spots that are up for rent, bidding wars will ensue. Managerial Economics Law of Demand/Supply Equilibrium Case StudyII Victoria Housing Market 52 1200.0 1100.0 1000.0 900.0 800.0 700.0 600.0 ' Have to Subsidlzd 500.0 ' Build 12,000 unit Price ($lmonth) 400.0 300.0 200.0 100.0 0.0 0 3 6 9 12 15 18 21 24 27 30 Quantity of Total Rental Units (thousands) In order to shift supply from $2 to a supply curve that intersects with D2 at an equilibrium price of $600, the government has to find a way to increase the supply of rental housing by 12,000 units. If it costs $50,000/unit, this would cost the government $600 million. The ABCS white paper draws attention to the fact that universities are currently restricted from accruing debt to build more students housing. They recommend that the government remove this restriction, explaining that the increase in housing for students will take them out of the competitive market above. Depending on how you view the market this could be explained as an increase in supply or a decrease of demand. If you consider student housing as a separate market, this effect would decrease demand as it takes student out of the market. If you consider it as the same market, it would increase supply as it increases the amount of housing available. ********