Sep 06 2007

A supply and demand mystery… to be solved by you!

Demand Down, but Rents Up – washingtonpost.com

Alright, AP students… you are economics detectives and you’ve been assigned your first case. The mystery is thus: how can decreasing demand cause prices to go up? In chapter three, we are reading about product markets, the interaction of supply and demand, and market equilibrium price and quantity. You’ve read that prices are affected by the interaction of supply and demand. Clearly, if demand for a product rises, prices should go up unless supply increases a certain amount. On the other hand, if demand falls, then prices should fall unless supply falls at the same time.

So what’s happening in the article above? The headlines seems to proclaim an economic impossibility is occurring: as demand falls, prices rise! How is this possible? Is it? Is the market for apartments in the D.C. area defying the laws of demand and supply? Read the article and see if you can solve this economic mystery!

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

11 responses so far

11 Responses to “A supply and demand mystery… to be solved by you!”

  1. timothysunon 07 Sep 2007 at 1:12 am

    My take on this is that the shift in the supply counteracts and even surpasses the shift in demand. The decrease in supply could be caused by the limited amount of houses left being bought one-by-one.

  2. emilyyehon 07 Sep 2007 at 11:03 pm

    The demand shifter of "customer expectations" is shifting the curve more favorably for better quality apartments, which there is a high demand for. The overall high pricing of these pricey apartments averages the overall rent rates to rise, as it states in the article "In building categories, Class A, the premier, most expensive office space, showed net gains in occupied space, while Class B and C buildings recorded net losses, CoStar said." Consumer expectations are changing, and hence the demand is greater for more quality products

  3. yunqimokon 08 Sep 2007 at 3:57 pm

    This probably has to do with the expectations of the consumer. Class A, luxury apartments are becoming more popular, and becacuse the prices are exorbitant, the demand does not need to be overly high to make a profit. Hence, the prices are rising because in general the market is growing, even though the demand at this present moment is decreasing.

  4. Helenon 08 Sep 2007 at 6:59 pm

    If I'm not mistaken, demand here is based upon vacancy rate. Their conclusion that demand has gone down is drawn from the fact that vacancy rates have gone up. But since this rise in vacancy rate can be attributed to the surge of new office space, this phenomena is not one of a decrease in demand, but an increase in supply.

    Naturally, if supply increases but demand stays the same, the equilibrium price would drop. But in this case there has been also an increase in demand. Consumer income has most likely gone up, as demand for "quality, high-end" Class A space has increased, while Class B and C buildings, "inferior goods" have experienced a decrease in demand. This change in the determinant of demand caused a shift of the demand curve to the right.

    Now the increase in price can be explained – the increase in demand is greater than the increase in supply, and therefore the price has gone up in this situation where "demand" has gone down.

  5. Katherine Yangon 08 Sep 2007 at 9:47 pm

    Price increases even as deman falls occurs because people are buying "Class A" apartements versus "B" or "C". This flocking towards class A apartments causes an increase in prices whilst less people are buying other apartments, putting a decrease in demand. Overall, the economy does not suffer because people are still buying and it encourages landlords to up their buildings of "Class A" quality which is better for all.

  6. Nicole Wongon 09 Sep 2007 at 1:53 pm

    Although there is a general decline in demand, the consumers' demand is actually targeted at a specific good: Class A space. This "Class A space" is experiencing a high demand, whereas the other Class B and C spaces are not. As consumers do not want the class b and c spaces, the general demand decreases, but the demand for class a space in particular, rises. It is for this reason that the price of Class A space is rising, though the price of class b and c spaces is not rising. The article misleads the reader into thinking that the demand for a certain space is experiencing a decrease, though its rents are increasing, but in actuality, it is separate types of "space" that are experiencing the decrease in demand and the increase in rent.

  7. robertwangon 09 Sep 2007 at 6:35 pm

    I believe that in this case, the statistics should not be grouped together as it will result in the article's title of demand dropping, but rent goes up. What actually is happening is the demand for class A apartments is increasing when the demand for class B and C apartments is decreasing. However, the rise in rent for class A apartments due to the increase in demand is large enough to carry the decreases in rent for class B and C apartments to allow the overall statistic to conclude that rent is going up. Thus, I don't feel an economic impossibility has been reached, this is just a situation similar to when an outlier causes the mean of a data set to be skewed to the right.

  8. Christina Huon 09 Sep 2007 at 9:39 pm

    The title here is misleading- Demand Down, but Rents Up. What is should say is, "Demand for inferior living spaces down, rents for higher-quality spaces up." What's happening in Washington may illustrate the concept of substitutive goods- or in this case, housing. The relative price of higher-quality, "Class A" living areas may seem to be the better deal in comparison to the price of Class B or C apartments. For example, you wouldn't buy a Ford for $25,000 if somebody offered you a new Mercedes for $30,000.

  9. Teemar Ratanasirigulon 10 Sep 2007 at 9:27 pm

    Although not an AP student and disregarding the example for a while, it is possible for a product demand to drop, but the price to increase. This is due to a change of the production cost. Because the demand is less, the producer would produce less. The price must increase because of the fixed cost, otherwise, the company will lose money.

    Regarding the real estate example, the "product" is within the Real Estate market. Agreeing with Christina, the demand for different Classes would cause the price of the other classes to fluxuate. For example, a decrease in demand for Class C would cause an increase in price for Class A. Another possibility for the raise in prices, is the market change from a rental market to capital gain market. The owners would raise the price of the building, land, or apartment in order to stimulates selling rather than renting. This also occurs in Shanghai, which is why the government has to intervene to stop the buy-sell system.

  10. Elaine Lungon 11 Sep 2007 at 9:39 pm

    This isn't an impossible scenario at all; the title is a bit too general, too overarching with its use of "demand." Demand for lower cost, class B and C space has decreased – this much is true. However, demand for class A space, which is more expensive, has actually gone up. In this case, it makes sense that price – the price of class A space – has gone up because demand is indeed increasing for it. This may be due to an increase in income, so demand for inferior goods – class B and C properties – has dropped.

  11. Tim Chuon 13 Sep 2007 at 1:19 am

    obviously,the title of the article is not enough information. The article itself elaborates and explains how the costs of higher priced houses are rising and how the lower priced houses, which also happen to be decreasing in demand, are lowering their rents. The law of demand holds.