Day 16 Apply microeconomics knowledge

Apply microeconomics knowledge

Recently, we finished the renovation of an old apartment in a University in China. The apartment was fully decorated, and we have been looking forward to rent it. There was an applicant called yesterday, said he would like it to rent the apartment for a five-year contract. However, he was asking for a discount that may reduced the monthly fee to 7,300 CNY. Which our original quote was 7,300 CNY. In order to practice my recent learning on microeconomics and to evaluate the problem, I will try to provide a basic analysis under economic perception.

The problem is whether we rent the apartment to the applicant or refuse him. The scarcity principle stated there always a trade-off when we take actions, because the resources are always limited. As a consequence, we need to act if, and only if, the extra benefit associated to the activity is at least great as the extra cost. In our case, the costs allocated are basically the opportunity costs result from our choice. So what is the opportunity cost for accepting the proposal? It is the possibility for renting at a higher price. On the other hand, the opportunity cost for rejecting to quote is the investment return of that 7,300 CNY each month. In conclusion, when the predicted return on investment overweight the proportion with an increase in the rental market, we should rent the apartment, and vice versa.

If we accept the quote, we should receive 7,300 CNY per month. We can invest this amount in the share market at China. The Chines share market is a bear market, so we will expect at least 8 percent return under the conservatism strategy. Hence the rising in rental price shall exceed this amount for us to reject the rentee. The market equilibrium appears when both customers and sellers are satisfied with their respective quantities at the market price. To carry out a prediction for the rental market in the University, we need to consider those factors that shift demand/supply curve. To illustrate:

Factors that shift demand:

Price of compliments

Price of substitutes

Income

Preferences

Population of potential buyers

Expectations (higher price in the future)

Factors that Shift Supply:

Costs of production

Technology

Weather

Number of suppliers

Expectations

The new semester is coming next year, since there will be a lot of students joining the University, senior/junior school in the university, and the kindergarten. For convenience, a lot of students’ family decide to rent inside the university. As a result, there is a large amount of potential buyers, plus we can also expect the future rent price to rise. The demand curve will shift to the right and supply curve will shift to the left corresponding to the increase. Since the quantity supplied for apartment is fixed in the university, the increase in demand will also increase the price of rent. According to historical data analysis, the normal annual rental rate adjustment is around 4.5 percent. This amount is far less than the investment return. Although it may be safer, the prudential investment strategy shall minimize the risk. Therefore, we should accept the quote because it has the competitive advantage.

Another thing I also want to briefly mention about is whether we should give the discount. The term  elasticity on demand can be used. It is a measure of the extent which quantity demanded responded to variations in price, income and other factors. In this situation, the rentee has many substitutions(other apartment available in the area). In addition, the applicant is not a high-income person, so the rental expense is a large part of his budget share. Hence they can be very elastic to the price change. The buyer is less likely to take action when the benefit from an activity decline, in other words, the increase in cost. I suggest to maintain the level of fees at first, in order to leave the allowance amount for discount.