Answer to Question #143297 in Macroeconomics for 12164

Question

Suppose the government is planning to subsidize τ fraction of the cost of renting capital
such that 0 < τ < 1. How would this affect real wage rate, real rental rate, real interest rate and price level
in long run and very-long run in a closed market economy?

Answer 1

Suppose the government decides to subsidize a fraction of the cost of renting capital. In that case, the cost of renting will drastically go down due to low price levels, in the long run, increasing tenants' real income and lowering the income of the landlords. This method is usually implemented in low-income neighborhoods to increase access to housing and decrease the poverty level. This method also leads to geographic moves, but it has little effect on employment. The decrease in earnings by landlords also reduces in the long and very long term. Studies have shown that rental subsidy recipients exhibit less work effort, thus driving the wage rate downwards in the short run. This changes significantly in the long run, where recipients exhibit more work effort leading to positive earnings. Rental subsidy decreases the real rental rate, thus driving the price level down. This increases the demand for housing. The introduction of subsidy in renting reduces the need for borrowing mortgages since more people will prefer rental housing. The low demand in borrowing will, in turn, reduce the interest rates to make homeownership affordable.