Question 2: Property and Capital Market Dynamics (20 points) Consider the following model for the office space and the capital market:

( ): =(11.42950.07%)

=

( ):=60000+781909.9

( )=

=+

where R= annual rent per square meter; r is the annual capitalization rate; is the annual depreciation rate of stock of space.

Suppose the initial stock of space (S) is 12 million square meters, the employment level E is 1.8 million employees and the capitalization rate is 3.4%, the depreciation rate of the stock of space is 1.4933%.

a) Determine the equilibrium rent level (R*), price level (P*), construction (C*) and the ending stock of office space (S*). (10 points)

b) Suppose the capitalization rate next period decreases from 3.4% to 3.0% and stays at that level for the indefinite future. What is the short-term effect on the construction level, the ending stock, the rent and the price level? What is the corresponding long-term effect? (10 points)