by M. Northrup Buechner

A series of essays elaborating Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics by the author.

Since my last blog was over a month ago, let me remind you of where we are. In the preceding blog, I showed how the Law of Supply and Demand can be applied to the whole economy if supply and demand are defined as simple, concrete quantities. Based on those definitions, I established a generalized tendency for supply to equal demand, if we allow enough time for businessmen to change their supply to meet the changes in demand for their products or services. Nevertheless, there are still all the cases I identified in Part II of this series, where there is no such tendency. How can we integrate those exceptions with Law of Supply and Demand defined in terms of concrete quantities?

Let us begin with the market for rental housing. This is not the most important exception identified in Part II, but it is the easiest to analyze. In Part II, I noted that, when there are no rent controls, the average vacancy rate in rental housing is about five percent. That is, in local housing markets, there usually are about five percent more apartments for rent than there are people renting apartments; that is, the supply routinely exceeds the demand by five percent. If 1000 consumers are renting 1000 units in a local market, there are another 50 units standing empty, advertised for rent in a local newspaper.

Since the price of rental housing is set by the owner/landlord, this situation appears puzzling at first glance. Why don’t landlords reduce their rents until the vacancy rate is zero? Why does the vacancy rate stop falling when it reaches five percent? The answer must be that, in the landlords’ judgment, any further reduction in rents would reduce their profits.

Suppose you have twenty identical units to rent, and 19 are rented for $2000 a month. Suppose also that to rent the twentieth unit, you estimate that you could ask $1850. Suppose further that you expect your other tenants would demand an equal price break when they see your ad in the local paper. Then you will end up renting 20 units @ $1850 for a total of $37,000 a month, versus the $38,000 a month you were making renting 19 units @ $2000. Note also that this case ignores the additional costs that may be associated with “no vacancies.” For example, you now have no place to put a family if a water pipe breaks in their apartment.

In fact, an average vacancy rate of five percent is proof that landlords do not find it in their interest to charge a rent at which every last apartment is rented. At the same time, the five percent vacancy rate creates a rental housing market that is geared to the interests of the renters. First, it means that at current rental prices, tenants are not easy to find. This means that the landlord’s current tenants are a value to the him and he does not want to lose them. When a tenant has a problem or a complaint, the landlord is eager to rectify it. At the same time, the five percent vacancy rate means that alternative apartments are easy to find. If a tenant is dissatisfied with his landlord’s service, or he wants to move to a larger (or a smaller) apartment for whatever reason, he  can find the apartment he wants.

This is the way the rental housing market works wherever it is allowed to work. Landlords and their tenants typically are friendly; they have no reason to hate each other; instead, each of them benefits from an exchange of values. Their interests are the same: the tenant wants to be happy in his apartment and the landlord wants him to be happy. The contrast with the relations between tenants and landlords under rent controls could not be more stark (see New York City).

But what about the law of supply and demand. The quantity of rental units available for rent (the supply) exceeds the quantity of rental units that people want to rent (the demand). How can we square that with the Law of Supply and Demand? We can square it by putting aside the meaning of the law that supply always equals demand. This traditional, very narrow interpretation of the law has vitiated the Law’s most important consequence.

In the rental housing market, it is normal for the quantity supplied to exceed the quantity demanded. But this condition is a virtue of the market for rental housing, a virtue created by the interaction of supply and demand—that is, when the demand for rental housing rises, landlords will raise their rents and construct more rental housing—while the vacancy rate continues to fluctuate around five percent. And vice versa for a decrease in demand.

The meaning of the Law of Supply and Demand—its value, virtue, and goal—is not that demand always equals supply. The meaning of the Law of Supply and Demand is that the market conditions (such as price, quality, service, etc.), whatever they are, in whatever market, reflect the facts of the market. The most prominent of these facts are supply and demand, and in reflecting those facts, the market generates a harmony of interests among all the market participants.

That harmony of interests is the overriding value the Law of Supply and Demand confers on a free economy. Usually it takes the form that supply equals demand, so that at the price the seller sets, the buyers can buy all they want to buy and the seller can make a profit. But sometimes, as in the case of rental housing, supply does not equal demand, and the harmony of interests arises nevertheless.

This note has reinterpreted the Law of Supply and Demand to mean that the Law creates a harmony of interests in every market. The most important exception to the traditional interpretation that supply always equals demand is the market for workers and employees. Workers routinely spend weeks, months and sometimes years looking for jobs. Can an economy’s labor markets be understood as an expression of the Law of Supply and Demand? I will take that up in my next blog.

P.S. The last several weeks have been exceptionally busy for me as I have been winding up the Spring semester, among many other things. In addition, this particular blog presents a major new insight which it has taken me a long time to figure out.

Now I am on a full year’s sabbatical, and I plan to publish this blog on a weekly basis. Thank you for your patience. I do not think you will have to wait so long again between messages. MNB