Question

Consider the market for rental apartments. The price elasticity of demand for rental apartments is estimated to be 0.15

a. What impact would higher home prices have on the market price and quantity of rental apartments?

b. What would happen to the revenue going to landlords? Identify the revenue going to landlords before and after the increase in home prices using supply-and-demand diagrams..

Answer 1

The price elasticity of demand for rental apartments is estimated to be 0.15 which is less than 1 and it signifies that the demand is fairly inelastic. When there is an increase in price, quantity demanded doesn't reduce drastically. Price elasticity formula is Percentage change in quantity demanded / Percentage change in prices. Thus for example when prices increases by 13%, demand reduces by only 1.95% ( 13% * 0.15). Even if the price increases drastically, demand stays almost the same.

a. Thus when home prices increase, market prices increase while the quantity demanded and supplied of rental apartments reduce by a small amount.

b. The revenue going to landlords will increase as the prices rise drastically but as the quantity demanded doesn't reduce drastically, it leads to greater scope of revenue generation.

Thus previously the revenue going to landlords was P1 * Q1.

After the increase in home prices, the revenue is P2 * Q2 which is greater as price increase doesn't reduce quantity demanded drastically.