The House Rental Market Before and After an Increase in the Interest Rate

A) 

Rental
Prices Equilibrium is defined as

When SUPPLY and DEMAND are in

Supply
balance. At the equilibrium PRICE, the
quantity that buyers are willing to buy
exactly matches the quantity that sellers
are willing to sell (The Economist). In the
graph illustrated in figure one, it can be
seen that the supply of rental
accommodation is extremely inelastic.
This is due to the fact that there are a
large number of limiting factors in place
in providing rental accommodation:
some areas are protected and can’t be
built on; land in certain areas is very
expensive, and there is also extremely
limited availability of land to build upon.
Demand As well as this, landlords are unlikely to
want to renovate or reform the purpose
of these buildings, and hence te supply
Quantity
of rental accommodation is relatively
unreactive to a change in price. In this
Figure graph, we have also assumed that there
One are no limiting factors such as price
Rental
Prices ceilings imposed on the market.
S2 Similarly, demand is relatively inelastic.
S1 This is due to the fact that, for the vast
majority of people in a society, housing,
and therefore rent is viewed as a
necessity good, and is therefore
unresponsive to a change in price. We
must also assume that the population is
remaining constant, whilst in reality, the
exponentially increasing population

Following an increase in interest

rates we would likely see a shift in
the supply curve, due to the fact that
after this point, the landlords
themselves must now pay more on
D1 mortgage payments, as well as a
variety of other factors. For example,
Quantity an increase in interest rates also
Figure Two makes borrowing money more
expensive, meaning for some
people, buying houses in order to
Similarly, whilst in theory one would generally expect an increase in interest rent them to consumers is now
rates to lead to a decrease in demand, due to the cross elasticity of considered too expensive. A new
demand between mortgages and rented accommodation, and the fact that equilibrium would then ultimately be
the goods are substitutes for one another, one must consider the reality reached, shifting from the original
that increase in interest rates may lead to a decrease in demand for equilibrium at S1D1 to S2D1, with a
mortgages, which in turn may lead to increased demand for rented higher price and lower quantity
accommodation. Similarly, one must consider which are the real demanded. Of course, we are also
determinants of demand and supply in this market, and the time scale in assuming Ceteris Paribus, which is
which we could expect to see results such as these: “Rent markets are not true to reality.
long-term markets, where impacts of certain decisions or events might only
be visible years later” (Björn Egner, Katharina J Grabietz, 2017). It is
unclear, therefore, whether or not an increase would indeed have the
results predicted in the graph in figure two.
 In conclusion, the market is initially at an equilibrium of S1D1 as illustrated in Figure Two. Economic theory
dictates that an increase in interest rates will lead to a negative shift in supply, whereby a new equilibrium
will be reached, with a lower quantity and higher price. However, it is important that we evaluate this theory
- Ceteris Paribus is not true of the real world, and of course, more research is needed into the depth of the
impact that an increase in interest rates will have, and the timescale in which we could expect to see these
results.

Price of Rented
Accommodation
S1
B) When a government introduces policy that stops
suppliers from raising their prices above a certain
point, this is known as a price ceiling. According
to John Bennett and Ioana Chioveanu, “One CS
rationale for price ceiling regulation is to correct
inefficiency stemming from insufficient
competition, while another is the protection of DWL
consumers.” In the case illustrated in figure
three, it would be argued that a price ceiling has
been introduced as the government has deemed Price Ceiling
that the initial free market price was too high and
thus a price ceiling has been introduced to PS
counter-act this. As can be seen in figure three,
this has lead to the quantity demanded far
outstripping the quantity that can be supplied at D1
Quantity
this given price level. As a result, there is now a
greater consumer surplus, but the producer Figure Three
surplus is now considerably smaller than it was
at the equilibrium price and quantity - this in turn,
leads to a deadweight loss - a cost which society
must bear due to market inefficiency. It is
arguable that this is in fact a damaging policy - it
leads to a shortage for those looking to buy
houses, as the supply cannot possibly keep up
with demand at this price level. Conversely, if a
price ceiling is set above the equilibrium price, it
will simply have no effect at all, due to the fact
that people are not willing to pay an amount
greater than this equilibrium point anyway, so a
price ceiling can only be considered effective, if it
exists below the current equilibrium price, but as
we have previously stated, this creates
deadweight loss.

“An externality is a cost or a benefit associated with

one person’s activity that impacts others who did not
choose to incur that cost or benefit.” (Jenine R. Leal
et al. 2017.) As a result of the price ceiling illustrated
in figure three, one may expect some negative
externalities at the extreme ends of the spectrum -
potentially increased rates of homelessness; which
may in turn lead to increased crime rates and more
government spending needed for local benefits and
welfare schemes. At the other end of the spectrum,
we may see an increase in rates of home ownership
which is generally seen as a sound financial
investment, and if achieved en masse, may lead
ultimately to economic growth.
Bibliography

Egner, B and Grabietz, K, 2017, In search of determinants for quoted housing rents: Empirical evidence from
major German cities, Urban Research & Practice, 11:4, 460-477

.. 2020 The Economist

Bennett, J. and Chioveanu, I. (2019), Pro‐Consumer Price Ceilings under Regulatory Uncertainty*. Scand. J.
of Economics, 121: 1757-1784. doi:10.1111/sjoe.12298

Leal, J.R., Conly, J., Henderson, E.A. et al. How externalities impact an evaluation of strategies to prevent
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