EXTERNALITIES:

The Regulated House Rental Market in Lisbon

Managerial Economics Section A2 - Group F
Vasco Severo, Anna Kompaniyets, Ferran Garcia, Jad Itani, Hyung Geun Oh, Arti Sinha

How to Internalize the Externality

The Regulated House Rental Market in Lisbon

Non-regulated house rental market

Supply w/ reg.

The house rental market in Lisbon is divided into two categories: Non-regulated (free) market and Regulated

Price

market. Until 1985, the house rental market in Lisbon was characterized by a command and control policy

Supply no-reg.

(regulated market). This policy regulated the annual growth

P w/ reg. P no-reg.

rate of house rental fees at a substantially lower percentage than the inflation rate. In 1985 new laws were introduced by which any new house rental agreement negotiated after 1985 was for a specified period of time. At the conclusion of this contract, the owner reserved the right to renegotiate the rental fees

Impact on price due to the regulated market

Demand
Q w/ reg. Q no-reg.

based on the annual growth rate. However, old contracts that were signed prior to 1985

Quantity

Number of houses in the regulated market

were not affected by this law; therefore, there is still a

great percentage of rented houses in Lisbon which are subject to low rents (regulated rents). Hence, a great percentage of the rents in Lisbon are considerably below the market equilibrium in terms of price. As a result, landlords are discouraged from investing in these houses leading to poor house conditions.

How to Internalize the Externality

Externalities of the Regulated House Rental Market in Lisbon

High prices on the Non-regulated (free) house rental market in Lisbon because of the shortage of available houses for rent. This is mainly due to the high number of houses with have regulated rents.

Stagnation of the local economy as young people, who are entering the employment market, have to leave Lisbon to surrounding cities due to the disparity in the rental fees of houses. As a result, the city loses inhabitants that otherwise would spend a considerable portion of their income within the city.

Degradation of the city because landlords of regulated houses are not willing to renovate their houses. As a result, the city looks old and degraded which adversely impacts tourism.

Threats to health and safety due to poor living conditions. Since the landlords do not have any incentive to improve the condition for the tenants due to low rental fees, most of the Regulated rental houses have very low levels of living conditions which threats the health and safety of the people living in these houses.

Negative impact on environment as houses that are subject to the old rent (due to regulation) are not properly insulated. As such, tenants use heating equipment that require a lot of energy and generate more pollution as opposed to using newer sustainable technologies that are available in refurbished houses.

How to Internalize the Externality

Proposals for internalizing externalities regarding the Regulated House Rental Market in Lisbon

Solutions / Policies: Subsidizing landlords with renovation costs

Analysis of internalizing externalities:

These policies partly internalize externalities such as Degradation of the city in addition to its impact on Threats to health & safety, and environmental hazard. However, it has a small impact on the overall Non-regulated house rental market.

Actual Policies
Permission to further increase rental fees in case of renovation

From 1988 (beginning of the policies) until 2003, roughly only17k houses were renovated with subsidies from the government and local authorities (RECRIA program) 1

Initial Proposal

Deregulation of the market and subsidizing tenants who are living in the regulated houses

As the regulation is removed, the landlords will have the incentive to renovate the houses in order to demand higher rental fees. This will lead to more environmental friendly houses with security in terms of health and safety for the people living in. Also, renovated houses improve the overall aesthetic look of the city, attracting more tourists in the process. However, this proposal does not internalize high rent prices and young people leaving the city because the supply and demand curves shift in the same direction; hence, quantity increases but the prices remain relatively constant.

With no subsidies to current tenants, the remaining two externalities can be successfully internalized additionally as follows:

Improved final Proposal

Total deregulation of the housing rental market

- Previously Regulated houses are absorbed into the Non-regulated market increasing the supply without significantly increasing the demand, and therefore the market moves to a new equilibrium at which the price is reasonably lower. - Under this new equilibrium at lower rental prices, the city of Lisbon can retain the draining young population who might bring some dynamic to the local economy.

Source: (1) In A Reabilitao Habitacional em Portugal - Avaliao dos Programas RECRIA, REHABITA, RECRIPH E SOLARH by Ctia Alexandra Costa and Lus Madeira