Thursday, December 09, 2004

The Role of Rent

My Spring 05 Classes

It is that time of year again, the end of the semester, and students' work is flooding in just as it did when I was a student turning work in just before the deadline. As in past years, this is when I see what points I should be emphasizing next semester (it is too late to push these points this semester since it is almost over).

One of the concepts I have noticed students having trouble with is the role of rent in the housing market. On one of the take home tests is a question about what is the purpose of rent and one of the choices is "to transfer wealth from renters to landlords".

Since students are more than likely renters, this may be a logical conclusion. However, the correct answer is "to allocate scarce housing resources". The frequency of this answer leads me to conclude that it may be the term "rent" rather than the concept that is the problem. The same students who miss this question have no problem correctly identifying prices as the mechanism by which scarce resources are allocated or identifying intrest as a mechanism for allocating loanable funds.

Prices, whether they be called interest, rent or whatever serve to ration scarce goods. Housing is a scarce good. At any given time there is a fixed amount of living space available and it is divided up according to who can afford to pay the most. If there is a lot of space relative to the demand rents will be low. If there is very little relative to demand rents will be high. When rents are high, landlords will be encouraged to increase the quantity of housing/living space in order to make more money. This can be done by building additional housing, buying mobile homes in other areas and moving them here, renting out extra rooms in their own home, etc. In other words, rising rents encourage people to create and make available more living space for people.

So, yes paying rent involves the transfer of money from the renter to the landlord but this is no different than transfering money from the shopper to the grocer when shopping for food or driver to car dealer when buying a car, etc. Rent is simply the price of housing.

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