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Demand and Supply in the Housing Market - Suppose the demand function for squared meters of housing in Oslo is a standar

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1. Demand and Supply in the Housing Market (20%)

Suppose the demand function for squared meters of housing in Oslo is a standard downward sloping curve, while the supply function is a standard upward sloping curve.

(a) Draw the equilibrium in the Oslo housing market in a diagram. Explain what you show on your diagram.

(b) Suppose housing is a normal good and that income of the consumers increases sub- stantially. What happens to demand, supply, the equilibrium price and quantity? Show this on a new diagram and explain what happened.

(c) Show and explain how your answer to question “b” changes if supply was perfectly inelastic.

(d) Show and explain how your answer to question “b” changes if supply was perfectly elastic.

(e) We can formally represent the demand curve for housing in Oslo as follows D = −0.2Po + 0.1Ps + 0.5I, where D is quantity demanded, Po is the price per squared meter of housing in Oslo (downtown), Ps is the price per squared meter in Oslo’s suburbs, and I is average income of the consumers. Explain what happens to demand for housing in Oslo when Ps increases and why.

(f) Following up on the previous question, suppose the equilibrium quantity in the hous- ing market is 50, that Po = 50, Ps = 100 and I = 100. We can then find that

• The own-price elasticity of demand is εD,Po = −0.2

• The cross-price elasticity of demand is εD,Ps = 0.2

• The income elasticity of demand is εD,I = 1 Derive these results and explain what they mean.

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