econ2010

• Market Failure and the housing bubble, Wall Street Journal, Opinion, July 2009,

“A Government Failure, Not a Market Failure”

http://online.wsj.com/article/SB124631486277570583.html

• Wall Street Journal, October 2009, “Apartment Glut Expands; Vacancy Rate

Rises to 7.8% as Unemployment Dents Demand; Monthly Rents Slip”

http://online.wsj.com/article/SB125479559237566623.html

Answer the questions below in as much detail as possible. All answers must be typed

neatly (See the directions above) .

1. How would you characterize the opportunity cost of interest rate deduction

(subsidy) for house owners? (Hint: Think about this; What if the government

ended interest rate deduction (subsidy) for house owners and used that additional

tax money to build public goods like roads, parks, educational institutions,

hospitals etc.? How would that affect the demand for housing, demand for

apartments, national productivity, income distribution, etc.?) (Limit: 2 pages;

Ideally, between 1 - 1.5 pages)

2. Interest rate deduction (subsidy) for house owners may reduce the price for

house ownership but it may also make renting less attractive thereby reducing

the demand for apartments and slowing growth in rents. Given this tension

between the two markets (owner occupied housing and apartments for rent),

discuss how government policies may lead to market distortions and can

potentially misallocate resources. Pay special attention to the trade-offs involved

here. (Limit: 2 pages; Ideally, between 1 - 1.5 pages)

3. Think about the following experiment: Let’s say that the government adopts a

new tax code where all housing expenses (mortgage payments, rents etc.) can be

deducted from one’s taxable income thereby effectively reducing the taxable

income and hence, the amount of income taxes. How do you think the new tax

code will affect the (a) Owner occupied housing market and (b) Rented

apartment market? Do you think that the loss in revenue will be offset by higher

tax collection because of higher disposable income (lower taxes) and hence,

higher growth rate? Explain your answers in detail. (Limit: 2 pages; Ideally,

between 1 - 1.5 pages)