Tax Incidence in the Northport Rental Market
Northport has 10,000 rented apartments. The city council imposes a levy of ₹1,000 per apartment per month, legally payable by landlords. Before the levy the average rent is ₹20,000 and 10,000 units are rented. Twelve months later the average rent is ₹20,600 and 9,700 units are rented; landlords receive ₹19,600 net of the levy. A councillor claims the levy is paid by landlords because they remit it, and proposes extending it. Tenant groups counter that the levy has been fully passed through and demand rent controls. The finance department asks you to separate statutory from economic incidence, to infer what the quantity response implies about demand and supply elasticities, and to advise on the long-run effect if the rental stock can adjust. Assume the market is competitive and the levy is a specific per-unit tax.
1. Compute the share of the levy borne by tenants and by landlords. Using the quantity response, infer the demand elasticity and the implied supply elasticity.
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The levy is t = ₹1,000 per month. Rent rises from ₹20,000 to ₹20,600, so the tenant price change is ΔP = +₹600, or 3% of the initial rent. The landlord's net receipt falls from ₹20,000 to ₹19,600, a change of -₹400, or -2%.
Tenant share = 600 / 1,000 = 0.60. Landlord share = 400 / 1,000 = 0.40.
Quantity falls from 10,000 to 9,700, a change of -300 / 10,000 = -3%.
Demand elasticity: Ed = (% change in Q) / (% change in tenant price) = -3% / 3% = -1.0.
Supply elasticity: Es = (% change in Q) / (% change in producer price) = -3% / -2% = 1.5.
Check with the pass-through formula: tenant share = Es / (Es + |Ed|) = 1.5 / (1.5 + 1.0) = 0.60, which matches. The more elastic side of the market bears less of the tax; here supply is more elastic than demand, so tenants bear the larger share.
2. Evaluate the councillor's claim that landlords pay the levy because they remit it. Predict the long-run outcome if the supply elasticity rises to 3.0 while demand elasticity stays at -1.0.
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The councillor confuses statutory incidence with economic incidence. The legal obligation to remit does not determine who bears the burden. Because landlords can adjust rents and quantities, the burden is split according to relative elasticities. Here landlords bear 40% even though they write the cheque.
If the long-run supply elasticity rises to Es = 3.0, the tenant share becomes Es / (Es + |Ed|) = 3.0 / (3.0 + 1.0) = 0.75. The ₹1,000 levy would raise rent by about ₹750, to roughly ₹20,750, and landlords would receive about ₹19,750 net, bearing ₹250 or 25%.
The quantity response is found from demand: a 750 / 20,000 = 3.75% rent increase with Ed = -1.0 implies a 3.75% fall in quantity, to about 9,625 units. Supply confirms this: producer price falls 250 / 20,000 = 1.25%, and with Es = 3.0 quantity falls 3.75%.
So in the long run tenants bear even more of the levy, and the rental stock shrinks. The councillor's claim becomes less defensible, not more.
3. A tenant group proposes a binding rent ceiling of ₹19,500 per month. Using your short-run elasticities, assess the immediate shortage and the long-run effect. Would you recommend the ceiling?
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At a ceiling of ₹19,500, the tenant price is 2.5% below the original ₹20,000. With Ed = -1.0, quantity demanded is 10,000 × (1 + 0.025) = 10,250. With Es = 1.5, quantity supplied is 10,000 × (1 - 1.5 × 0.025) = 9,625. The immediate shortage is 625 units.
In the long run, if Es rises to 3.0, quantity supplied falls to 10,000 × (1 - 3.0 × 0.025) = 9,250, so the shortage widens to about 1,000 units. The ceiling transfers surplus to tenants who obtain a unit, but it excludes others, encourages queuing and side payments, and may reduce maintenance quality.
The ceiling is therefore poorly targeted. Tenants as a group are not unambiguously better off, and the efficiency loss grows over time. A better policy would combine supply expansion with targeted cash assistance to low-income tenants, rather than suppressing the price signal that determines how many units are offered.