Rent Capping in Ashfield
In the university city of Ashfield (population 62,000), the private rental market has tightened. At the current average rent of $520 per week, landlords advertise 1,200 dwellings and tenants seek 1,650. Students report flat-viewing queues of 40 people and some landlords asking for 12 weeks' rent in advance. The city council proposes a rent cap of $380 per week on all private rentals, arguing that housing is an essential good and that students are being priced out. The local property investors' association says the cap will cause landlords to sell or convert flats to short-stay accommodation; it cites 140 dwellings already listed on short-stay platforms. Council advisers note that new dwelling consents have fallen from 310 to 190 a year, that construction costs have risen 24% in two years, and that median household income is $1,480 per week. Council research estimates that at $380, demand would rise to 1,800 dwellings while supply would fall to 900.
1. Using a supply and demand model, explain the likely effects of the $380 rent cap on the Ashfield rental market. Refer to the figures in the setup.
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At the cap of $380, quantity demanded is 1,800 and quantity supplied is 900, so there is a shortage of 900 dwellings - half of demand. The price mechanism cannot clear the market, so non-price rationing appears: queues (already 40 people per viewing), landlord selection of tenants, key money, large advance payments, and discrimination.
The fall from 1,200 to 900 is a movement along the supply curve - a decrease in quantity supplied - not a shift. Some landlords exit or convert to short-stay use. The drop in consents from 310 to 190 a year signals a shrinking long-run supply, which will worsen the shortage over time.
Welfare effects:
- Tenants who obtain a dwelling gain consumer surplus.
- Tenants who cannot are worse off, and the 900 lost tenancies create a deadweight loss.
- Quality may fall as landlords compete on non-price terms and defer maintenance.
- Allocative efficiency is reduced because the marginal tenant's willingness to pay exceeds the marginal cost of supplying the dwelling, yet the transaction does not occur.
The overall judgement depends on how much weight is placed on affordability for incumbent tenants versus access for new tenants.
2. Evaluate whether a targeted accommodation supplement paid to low-income tenants would allocate rental housing more efficiently than the rent cap. Justify your judgement.
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An accommodation supplement is a demand-side subsidy. It shifts demand right. At a capped price it simply enlarges the shortage because supply does not respond. If the cap were removed and the supplement paid, demand would rise and rents would rise; the subsidy would partly capitalise into rents, especially where supply is inelastic in the short run.
The supplement is more efficient than a cap because it preserves the price signal:
- Landlords still face an incentive to supply and maintain dwellings.
- Tenants can outbid each other, so dwellings go to those who value them most.
- The deadweight loss from suppressed transactions is avoided.
Equity: targeting by income helps low-income tenants directly, but if rents rise, part of the transfer goes to landlords. The long-run incidence depends on supply elasticity and on consents, construction costs and zoning.
Judgement: the supplement is more allocatively efficient, but it is not sufficient alone. A cap combined with a supplement would worsen the shortage. A stronger package combines the supplement with measures to expand supply - unlocking land, reducing consenting costs, and monitoring short-stay conversions.
3. Explain why the elasticity of supply matters for the size of the shortage in the short run versus the long run.
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Elasticity of supply measures the responsiveness of quantity supplied to a change in price. In the short run the rental stock is fixed - buildings take years to build - so supply is highly inelastic. A demand increase or a price cap therefore produces a large gap between quantity demanded and quantity supplied, which is the 900-dwelling shortage.
In the long run, landlords can build, convert or exit, so supply is more elastic and the same price change produces a larger supply response. The cap's effect therefore tends to worsen over time: the initial shortage may be partly absorbed by queues, but as landlords exit, quantity supplied falls further, matching the projected 1,200 → 900.
Elasticity also determines incidence: the more inelastic supply is, the more a demand subsidy is capitalised into rents rather than increasing the number of dwellings. That is why the fall in consents from 310 to 190 matters - it suggests long-run supply is contracting, making any demand-side policy more inflationary. The exam skill is linking elasticity to the size and persistence of disequilibrium, not merely drawing the curves.