A Rent Cap, Two Elasticities, and a Councillor's Choice
Marwar municipality has 20,000 rented flats at a stable market rent of ₹12,000 a month and a vacancy rate of 2%. In June the council caps rents at ₹8,000. A consultant's estimates for this market: price elasticity of demand for rented housing is about −0.4, and price elasticity of supply is about +0.15 in the short run and +0.60 in the long run. Within a year landlords have served notice on 900 flats to convert them into paying-guest rooms and shops; the housing office's waiting list grows by about 60 households a month; informal 'key money' payments of ₹1.5–2 lakh reappear. The council claims the policy 'has kept rents affordable for sitting tenants'. A councillor wants to know whether to extend the cap to commercial premises as well, or to spend the same budget on a rent voucher for low-income households instead.
1. Using the elasticities, estimate the short-run change in quantity supplied and quantity demanded at the capped rent, and state the direction of the resulting gap.
Read the worked answer
The cap cuts rent from ₹12,000 to ₹8,000, a fall of one-third, or about 33.3%. Applying point elasticities: quantity supplied falls by about 0.15 × 33.3% ≈ 5%, from 20,000 to roughly 19,000 flats. Quantity demanded rises by about 0.4 × 33.3% ≈ 13.3%, to roughly 22,700. The gap is therefore roughly 3,500–3,700 dwellings, against a pre-policy vacancy of only about 400. Two cautions belong in a good answer: elasticities are approximations, and a linear extrapolation over a one-third price change overstates the response, so an arc elasticity would give a smaller gap. The direction, however, is unambiguous - supply falls, demand rises, and the short side of the market decides how many flats are actually let. Roughly 19,000 households are housed; the rest queue, pay key money, or leave the rental market.
2. Explain why the gap widens over time, and what the 900 conversion notices tell you that the official claim hides.
Read the worked answer
In the short run landlords cannot easily convert or demolish, so supply is inelastic at +0.15. Over years they can, and the 900 conversion notices are exactly that margin being used. Applying the long-run elasticity, a one-third rent cut reduces supply by about 0.6 × 33.3% ≈ 20%, to roughly 16,000 flats, while demand stays near 22,700 - a gap above 6,000. The conversions also signal that the controlled rent badly understates the true return. When money rent is capped, price reappears as key money, larger deposits and deferred maintenance. So 'rents kept affordable for sitting tenants' is partly an accounting illusion: sitting tenants are protected precisely because newcomers pay key money or cannot enter at all. Expect quality decay too - a landlord who cannot raise rent has little reason to repair, and the flats that leave the market are often the cheapest ones.
3. Evaluate the councillor's two options, and recommend what should be done instead.
Read the worked answer
Neither option addresses the supply side. A rent voucher raises household income, which raises demand; in a market where supply barely responds, much of the voucher is capitalised into higher rents rather than into more housing, so it works only where supply is responsive. Extending the cap to commercial premises repeats the error on a larger scale: it would reduce the supply of shops and PG rooms, erode the commercial tax base, and push activity further into the informal market that already charges key money. The defensible package is a targeted cap or means-tested voucher for sitting low-income tenants, paired with measures that raise the long-run supply elasticity - waiving conversion charges, releasing public land for rental housing, and tax treatment that rewards new construction. The test to apply to any instrument is simple: does it change the quantity supplied, or only who pays?