American Economic Association

A Competitive Theory of the Housing Market

Author(s): Edgar O. Olsen
Source: The American Economic Review, Vol. 59, No. 4, Part 1 (Sep., 1969), pp. 612-622
Published by: American Economic Association
Stable URL: http://www.jstor.org/stable/1813226
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 612 THE AMERICAN ECONOMIC REVIEW

elasticity of substitution is greater than zero 4. W. M. CORDEN, "The Structure of a

and shown the bias in the computed measure
of each assuming CES production functions.
A better understanding of the role of sub-
stitution in effective protection theory is
thereby attained. At the same time, since
information on substitution parameters is
hardly available, care has to be exercised in
interpreting empirical results.
REFERENCES
1. B. BALASSA, "Tariff Protection in Indus-
trial Countries: An Evaluation," J. Polit.
Econ., Dec. 1965, 73, 573-94.
2. G. BASEVI, "The U.S. Tariff Structure
Estimate of Effective Rates of U.S. In-
dustries and Industrial Labor," Rev. Econ.
Statist., May 1966, 158, 147-60.
3. J. S. CHIPMAN, "A Survey of the Theory
of International Trade, Part 3," Eco-
nometrica, Jan. 1966, 34, 18-76.
Tariff System and the Effective Protec-
tive Rate," J. Polit. Econ., June 1966, 74,
221-37.
5. H. G. GRUBEL AND H. G. JOHNSON, "Nom-
inal Tariffs, Indirect Taxes and Effective
Rates of Protection: The Common Mar-
ket Countries, 1959," Econ. J., Dec. 1967,
77, 761-76.
6. J. C. LEITH, "Substitution and Supply
Elasticity in Calculating the Effective
Protective Rate," Quart. J. Econ., Nov.
1968, 82, 588-601.
7. R. SOLIGO AND J. STERN, "Tariff Protec-
tion, Import Substitution and Invest-
ment Efficiency," Pakistan Develop. Rev.,
summer 1965, 5, 249-70.
8. W. P. TRAVIS, "The Effective Rate of
Protection and the Question of Labor
Protection in the U.S.," J. Polit. Econ.,
May/June 1968, 76, 443-61.

A Competitive
CompetitiveTheory
Theoryof
ofthe
theHousing
HousingMarket
Market
By EDGAR 0. OLSEN*

In his article on the demand for nionfarm these translations. More importantly, this
housing, Richard Muth [11] rigorously de- theory has implications for a number of
veloped a competitive theory of the housing
market.' Muth used this theory in the sta- 1 There
There are
are clearly
clearly two
twohousing
housingmarkets.
markets.ThereThere is is
a a
tistical estimation of the demand functioin demand
demand for for and
and supply
supplyof ofa aconsumer
consumergood goodwhich
which wewe
for housing service and of the speed of ad- shall
shall call
call housing
housing service.
service.There
Thereisisalso
alsoa aderived
derived demand
demand
justment to long run equilibrium in this for and
and supply
supply of
of ananinvestment
investmentgood
goodwhich
whichwewe shall
shall
call
call
housing
housing stock.
stock. These
Thesetwotwomarkets
marketsare areintegrally
integrally re-re-
market. His theory also makes possible the lated. Indeed, Muth [11, p. 321 defines one unit of
translation of some of the idiosyncratic con- housing service to be that quantity of service yielded
cepts used by housing, specialists into the by one unit of housing stock per unit of time. Thus, he
familiar terms of microeconomic theory. A assumes that housing stock is the only input in the
production of housing service. Although all buyers of
secondary purpose of this article is to make
housing stock are also sellers of housing service, there
are many people who participate in one market but
* The
The author
author isis on
onthe
thestaff
staffofofthe
theRAND
RAND Corpora-
Corpora-
not in the other. Consumers who occupy rental housing
tion. However, this paper was written while he was a are not typically in the market for housing stock. They
postdoctoral fellow in The Institute for Applied Urban are not buyers or sellers of this capital asset. Builders
Economics at Indiana University. He is indebted for who construct housing for sale are sellers of housing
helpful criticisms of earlier drafts to H. James Brown, stock but not of housing service. This paper will focus
David Greytak, W. David Maxw-ell, J. W. Milliman,primarily on the market for housing service. Finally, it
Richard F. Muth, and R. L. Pfister. The author is also must be emphasized at the outset that this paper ab-
grateful to Resources for the Future for the grant stracts from consideration of the land on which dwelling
which financed his postdoctoral fellowship. units stand.

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 COMMUNICATIONS 613

crucial issues in government housing policy. housing market. This paper presents a
The primary purpose of this article is to de- theory with a very different view of the
rive these implicatioins, and use them to sug- good being traded. An understanding of this
gest additional tests of the competitive theory of the housing market requires an
theory of the housing market. In order to elaboration on its conception of housing
achieve these purposes, it is first necessary Therefore, we will now focus our attention
to explain the crucial sinmplifyinga assutmp- on this crucial simplifying assumptioni.
tioni which makes it possible to viewN the In order to view the housing market as one
miarket for housing service as a competitive in which a homogeneous commodity is
market in which a homogeneous good is sold. bought and sold, an unobservable theoretical
entity called housing service is introduced.3
I. The Assumptions
Each dwelling (or housing) unit is presumed
Let us assume that the following condi- to yield some quantity of this good during
tions are satisfied in miarkets for housing each time period. It is assunmed to be the
service: (1) both buyers and sellers of hous- only thing in a dwelling unit to which coni-
ing service are numerous, (2) the sales or sumers attach value. Consequently, in this
purchases of each individual unit are small theory there is no distinction between the
in relation to the aggregate volume of trans- quantity and quality of a dwellilng unit as
actions, (3) neither buyers nor sellers col- these terms are customarily used.
lude, (4) entry into and exit from the market This conception of housing is bound to
are free for both producers and consumers, raise objections. It will be argued that hous-
(5) both producers and consumers possess ing is a complex bundle of technically inde-
perfect knowledge about the prevailing pendent attributes. However, since housing
price and current bids, and they take advan- service is not observable directly, it is not
tage of every opportunity to increase profits possible to argue for or against this assulmlp-
and utility respectively, (6) no artificial re- tion directly.4 Hence, it is not possible to test
strictions are placed on demands for, sup- this theory other than by reference to its
plies of, and prices of housing service and implications. The competitive theory of the
the resources used to produce housing ser- housing market does contain bridge princi-
vice, and (7) housing service is a homogene- ples which relate housing service to observ-
ous commodity. able phenomena and it does have testable
This set of conditions is nothing other than inmplications in terms of these phenomena.
a conventional statement of one set of con- Muth [11] has already tested some of these
ditions sufficient for a perfectly competitive implications. Other implications will be de-
market.2 While objections to all of these rived in this paper. Eyesight is not a satis-
assumptions can be found in the housing factory judge of the question of lhomogene-
literature, most scholars would probably ity. The assumption of a homogeneous good
find (7) to be the least plausible assumption. called housing service can onlyl be rejected
Noting the great variations among resi- if theories of the housing market without
dential structures as to size, type of con- this assumption have greater explanatory-
struction, and other characteristics to which power.
consumers attach value, many presume that
a very heterogeneous good is traded in the 8 Carl Hempel [5, pp. 70-841 gives an elementary but
lucid explanation of the role of unobservable theoretical
2 This set is a composite taken from three standardentities in scientific theories.
price theory textbooks. See Richard Leftwich [7, pp. 4 Intuitively, it does seem more reasonable to con-
23-251, George Stigler [14, pp. 87-891, and James ceive of the difference between an apartment renting for
Henderson and Richard Quandt [6, pp. 86-891. As $50 and one renting for $100 in the same city as more
Stigler clearly explains, this is by no means the weakest akin to the difference between $50 and $100 worth of
set of assumptions sufficient for perfect competition. oranges than to the difference betwveen $50 worth of
A strong set of assumptions is used in order to obtain oranges and $100 worth of golf balls. However, argu-
clear cut implications of the competitive theory. nients of this sort are not scientific.

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614 THE AMERICAN ECONOMIC REVIEW

II. The Translation, of Concepts compare the relative amounts of housing

service yielded by different dwelling units.
Based on the assumptions of the preceding
What is a slum dwelling unit? A slum
section, four concepts-dwelling unit, slum,
dwelling unit is one which yields less than
filtering, and shortage-traditionally used in
some arbitrary quantity of housing service
housing market analysis, can be translated
per time period. Using the relationship es-
into the jargon of conventional microeco-
tablished between total expenditure and
nomic theory.
quantity, we might decide to call all dwelling
What is a dwelling unit? A dwellinig unit is
units in a particular locality renting for less
a package composed of a certain quantity of
than $60 per month slum dwelling units.
a capital asset called housing stock. Some
What is a slum area? A slum area is a con-
dwelling units will contain 10 units of hous-
tiguous area which contains a high (but
ing stock, other dwelling units will contain
arbitrary) percentage of slum dwelling units.
20 units of housing stock. By definition, these
It would be possible to give the word
dwelling units will be said to yield 10 and 20
"slum" a welfare economics definition in
units of housing service per time period re-
which a slum dwelling unit would necessarily
spectively.5 In long run competitive equi-
represent suboptimal resource allocation.
librium only one price per unit applies to all
Otto Davis and Andrew Whinston [3, pp.
units of housing stock and another price to
111-12] have provided such a definition. At
all units of housing service regardless of the
least one other distinctly different definition
size of the package in which these goods
of this sort is possible.6 However, the def-
come. Hence, if we observe that one dwell-
inition provided above is more in keeping
ing unit sells for twice the amount of an-
with the use of this word in both popular and
other dwelling unit in the same market, then
scholarly writings.
we say that the more expensive unit contains
What is a housing shortage? The most fre-
twice the quantity of housing stock and,
quently used unit of quantity for housing
hence, involves twice the total expenditure.
market analysis has been the dwelling unit.
This distinction between price, quantity,
As a result, a housing shortage has usually
and total expenditure is not usually made
been defined as a situation in which every-
in housing market analysis where it is sim-
one who is willing to pay the market price
ply said that the price of the one dwelling
for a separate dwelling unit is not able to ob-
unit is twice that of the other dwelling unit.
tain a separate dwelling unit. This is an
Similarly, if we observe that one dwelling
unnecessarily narrow definition of a shortage
unit rents for twice the amount of another
which results from the acceptance of the
dwelling unit, then we say that the more ex-
dwelling unit as the unit of quantity. The
pensive dwelling unit yields twice the quan-
unit of quantity introduced by Muth allows
tity of housing service per time period and,
us to take a broader view of a housing short-
hence, involves twice the total expenditure
age. To be precise, a short run housing short-
per time period. Here again, traditional hous-
age is said to exist if, and only if, the quan-
ing market analysis uses a price theory con-
tity of housing service demanded at the
cept, in this case "rent," in a way far re-
existing market price is greater than the
moved from its original meaning. Despite
quantity of housing service supplied. Short
the fact that housing service and housing
run shortages will be eliminated by a rise in
stock are not directly observable, the com-
petitive theory of the housing market con- 6 Some people care about the housing occupied by low-
tains bridge principles which permit us to income families for altruistic and more selfish reasons.
The market will not properly account for these prefer-
ences and, hence, low income families may consume too
5 Dwelling unit means the same thing as housing little housing service by the criterion of efficiency. We
unit. Therefore, a housing unit is quite different from might call the dwelling units occupied by these low in-
a unit of housing stock or housing service. The term come families slum dwelling units. Clearly, with this
dwelling unit is used throughout this paper to avoid definition slumness is not a characteristic of the housing
this natural confusion. alone.

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 COMMUNTICATIONS 615

the price of housing service for bundles of
the size which are in excess demand ini-
tially. A lontg run housi;tg shortage is said to
exist if, and only if, the quantity of housing
service demanded at the long run equilibrium-
price is greater than the quantity of housing
service supplied. Long run shortages are
eliminated by maintenance, repairs, altera-
tioIns, and additions as well as by new con-
struction. Clearly, a housing shortage can
exist by these definitions even if everyone
who wants to occupy a separate dwelling unit
at the relevant price is doing so because
everyone may want to occupy better housing
(i.e., to consumne a greater quantity of hous- then we would say that this particular unit
ing service) at this price than they presently
occupy and none may be available.
Although the concept of filtering has been
used in housing economics for many years,
a rigorous definition of this term has only
recently been proposed. Ira Lowry [8, p.
363] defines filtering, as" . . . a change in the
real value (price in constant dollars) of an
existing dwelling unit.i" Lowry uses this
definition together with a theory of the
housing market to demonstrate that filter-
ing is not a process which necessarily results
in all families occupying housing above cer-
tain minimum standards. With the competi-
tive theory of the housing market, it is
possible to define filtering slightly more
rigorously and in a manner which signifi-
cantly clarifies the mieaning of the concept
and the method of detecting the process.
Using this new definition and a competitive
theory of the housing market, it is easy to
demionstrate the result which Lowry showed
with great difficulty.
A dwelling unit has tfiltered if, and only if
definition is the same as the new definition
if he intended to deflate money values by the
cost of construction. This is true because in
a perfectly competitive housing market in
long run equilibrium the price per unit of
housing stock equals the minimum long run
average cost of production and, hence, the
quantity of housing stock contained in a
particular dwelling unit is equal to the mar-
ket value of this dwelling unit divided by the
cost of production.8 For example, if the cost-
of-construction index was 100 in 1960 and
110 in 1962 and if a particular dwelling unit
sold for $6000 in 1960 and $6050 in 1962,
has filtered down between 1960 and 1962 be-
cause our index of quantity of housing stock
fell from 60 to 55.9
To determine whether particular dwelling
uI-its have filtered is of far less importance
than understanding the function of filtering
in the operation of the housing market. In
essence, Lowry set out to demonstrate that
filtering is not a process that insures that all
consumers will purchase greater than an
arbitrarilv chosen quantity of housing ser-
vice per time period. If the housing market
is perfectly competitive, then this result is
trivial since there is nothing- in the operation
of such a market which insures that all in-
dividuals will consume greater than an arbi-
trary quantity of the good.10 As will be
shown in the next section, filtering is a pro-
cess by which the quantity of housing service
yielded by particular dwelling units is ad-
justed to conform to the pattern of consumer
8 Lowry does not say what he intends to use as a
deflator.

the quantity of housing stock contained in 9 This method abstracts from changes in the price
paid for a particular structure attributable to changes in
this unit has changed. A dwelling unit has
the relative desirability of its location. Since I do not
filtered up if, and only if the quantity of wN-ant to include these changes in my concept of filtering,
housing stock contained in this unit has in- the market value of the land must be subtracted from
creased. A dwelling unit has filtered down if,the total price of structure and land in determining
whether a dwelling unit has filtered. Practically, this
and only if the cquantity of housing stock might be done by observing the sale price per square
contained in this unit has decreased.7 Within foot of nearby vacant land and assuming that the land
the theory presented in this paper, Lowry's containiing the structure of interest has the same market
value per square foot.
7 In these definitions, "housing stock contained in" 10 For any given positive quantity, there exists a set
could be replaced by "housing service yielded per time of admissible indifference curves, relative prices, and
period by." These definitions are stated in stock terms income such that the consumer associated -x ith these
to facilitate the comparison with Lowry's definition. will choose less than the given quantity.

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616 THE AMERICAN ECONOMIC REVIEW
demand. The profit incentive leads producers
to make these adjustments.
None of the definitions in this section cor-
responds exactly with previous usage of the
terms. No simple definitions could. These
definitions have been offered in order to
bring housing market analysis within the
realm of standard microeconomic theory
where advantage can be taken of the ac-
cumulated knowledge in this field. The value
of this transformation should be strongly
emphasized. Even as eminent a price theorist
as Milton Friedman [4, pp. 178-80] reaches
an undoubtedly fallacious conclusion about
public housing simply because he did not
apply the conventional distinction between
the very short run and the long run to the
housing market."
III. The Workings of the Market
The workings of the market for housing
service under the set of assumnptions intro-
duced in Section I can best be illustrated by
beginnin(y from a situation in which the
price per unit of housing service for bundles
of all sizes but one is equal to the long run
average cost of production. For the one
followed had all bundle sizes been equally
11 Friedman t4, p. 179] concludes that ". . far from
improving the housing of the poor. as its proponents
expected, public housing has done just the reverse. ducers of smaller bundles of housing service
The number of dwelling units destroyed in the
will follow a higher maintenance policy
course of erecting public housing projects has been far
larger than the number of new units constructed."
Aside from the factual question of whether far more
units have been destroyed than constructed and aside
from Friedman's use of numbers of gainers and losers
rather than the values of gains and losses, Friedman
ignores the fact that the displaced families will lose
over a fev- years while housed families will gain over
the much longer physical life of the project. As will beprofits for bundles of housing service slightly
demonstrated in Section V, in long run equilibrium
the displaced families will occupy the same type of
housing and pay the same rent as prior to the public
housing project. According to Muth [11, pp. 49-52],
the market for housing service adjusts at a rate of one-
third of the difference between the present situation
and long run equilibrium each year. Hence, there is a
90 percent adjustment in six years. By comparison, the
physical life of public housing projects is likely to be
far in excess of 50 years. From Edgar Olsen's calcula-
tions [12, pp. 83-87] it can be estimated that the average
public housing tenai t received benefits from public
housing which he valued at $263 in 1965. This benefit
would be received each year by some poor family during
the entire physical life Of the project.
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bundle size, the price is assumed to be greater
than the long run average cost. In this situa-
tion, producers will be making profits (i.e.,
they will be making more than a normal rate
of return on capital) only on this one size
bundle of housing service.
Owners of housing stock can change the
quantity of housing stock contained in and,
hence, the quantity of housing service
yielded bv their dwelling units through main-
tenance, repair, alteration, and addition.'2
In the absence of maintenance, dwelling
units deteriorate with use and over time
which means that they yield smaller and
smaller quantities of housing service per
time period. Normally, producers of housing
service find it profitable to invest in main-
tenance (although not enough to halt dete-
rioration completely). If bundles of some
particular size become more profitable than
bundles of other sizes, then some producers
with larger bundles of housing service will
allow their housing units to deteriorate more
than they would otherwise. That is, they
will allow their dwelling units to filter down
to the bundle size which is most profitable.
This is accomplished by following a lower
miaintenance policy than would h'ave been
profitable. Bv the same token, some pro-
than otherwise resulting in a filtering up of
their dwelling units.
The supply of the most profitable size
bundle having iincreased, the price per unit
of housing service for bundles of this size
will decrease. Since initially there were zero
greater and slightlv less than the profitable
size bundle, the filtering down of larger
bundles and the filtering up of smaller oundles
will create short run shortages, higher
prices, and profits for bundles of these sizes.
This will result in filtering down of still
larger bundles and filtering up of smaller
bundles. Eventually the process will reach
bundles of sizes which can be provided by
12 In the remainder of this paper. the word "main-
tenance" will be used to denote all four of these phenom-
ena.
 COMMUNICAT'IONS 617

the construction of new dwelling

ket would units.
not allow this situation toThis
persist.
new construction will continue until there Suppose that owners of bundles of housing
are no profits to be made on bundles of any stock yielding quantities of housing service
size. This requires the price per unit of hous- less than x received a higher price per unit
ing service for bundles of all sizes to be the for their production than owners of bundles
same. which yield greater than x units of housing
IV. The Poor-Pay-More Hypothesis
service. These slum landlords would be mak-
ing higher profits per dollar invested than
A popular claim in current policy dis- other landlords. In this case, some owners of
cussions is that the poor pay more for manydwelling units yielding slightly more than x
goods including housing. If the housing mar- units will follow a lower maintenance policy
kets are perfectly competitive and if it is than otherwise, allowing the quantity of
neither more costly to provide small quan- housing service yielded by their units per
tities of housing service nor to provide hous- time period to fall below x. The supply of
ing service to low income families, then the dwelling units yielding less than x units of
poor will not pay more for housing service. housing service per time period will increase
It is instructive of the workings of a per- and the price per unit for these small bundles
fectly competitive housing market to dem- will fall. Eventually, new construction will
onstrate this result. be induced. Only when the price per unit of
We begin by interpreting the poor-pay- housing service for bundles of all sizes is
more hypothesis in terms of the theory pre- equal to the minimum long run average cost
sented irn this article. For some reason the of production will there be no incentive for
price per unit of housing service is greater change.
for dwelling units yielding small quantities If we actually observe that the poor con-
of housing service than for dwelling units sistently pay more per unit of housing ser-
yielding large quantities. This price differ- vice than the rich and that it is not more ex-
ence is not attributable to differences in cost.'3 pensive per unit to provide small packages
For large bundles of housing service, the of housing service or to provide housing
market works efficiently. The price of hous- service to low income families, then we have
ing service tends towards the minimum long evidence contrary to the assumption that the
run average cost of production of housing housing market is competitive. This is one
service. Consequently, the price per unit of of the testable implications of the competi-
housing service for small bundles exceeds tive theory.'4
the minimum average cost. As a result,
owners of dwelling units yielding small lo A recent study by the BLS [161 has shown that the
quantities of housing service make economic quality of housing occupied by richer families is superior
profits. For some reason, these profits do not to that occupied by poorer people in the same rent
range. Unfortunately, it is almost certainly true that
stimulate an increase in the supply of these
within each rent range the higher the income range, the
small bundles of housing service. As a result, higher the average rent. The higher rent may completely
the consumers of these small bundles (i.e., explain the differences in quality. This author is trying
primarily the poor) consume a smaller quan- to obtain the BLS data to check this possibility with
tity of housing service than required for regression analysis. Finally, the BLS study does not
consider the possibility that it is more costly per unit of
officient resource allocation.
housing service either to provide small bundles or to
Participants in a competitive housing -mar- sell to low-income families. For example, it is reputed
to be much more difficult to collect rents from low
13 If the price difference is solely attributable to income tenants. This involves extra costs in time and
differences in cost, then no market imperfection is in- nonpayment. Furthermore, the existence and enforce-
volved and government action on grounds of efficiency ment of building and occupancy codes with penalties
is not required. A recent study by the U.S. Bureau of for violations increase the long run equilibrium price
Labor Statistics [15] has shown that the poor do pay of low quantity housing in a competitive market be-
more for food, but that this difference is fully explained cause there exist some producers and consumers who
by difference in cost. The poor tend to shop in small will have an incentive to violate the code. (I owe this
stores where merchandising cost per unit is high. point to Richard Muth.)

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618 THE AMERICAN ECONOMIC REVIEW

V. IVill Slum Clearance and Urban Re- however, is only the very short run impact
newal Result in a Net Reduction in of slum clearance.
Slums? In the long run the owners of slightly
better than slum dwelling units will allow
Slum clearance is the destruction of slum their dwelling units to filter down to the level
dwelling units by government with or with- of slum dwelling units in order to take ad-
out compensation to the owner. It is required vantage of the profits to be made on such
by the Housing Act of 1937 as part of the units. This adjustment will continue until
public housing program. It is undertaken the rate of return on capital invested in
independently by many local governments. bundles of housing stock of all sizes is the
Finally, slum clearance is the first stage of same. In long run equilibrium the price per
urban renewal. Slum clearance and urban unit of housing service must be the same for
renewal have been premised in large part on bundles of all sizes. Since neither slum clear-
the naive belief that the physical destruction ance nor urban renewal subsidizes housing
of slum dwelling units results in a net reduc- consumption by low income families, and
tion in the number of families occupying such since neither results in a lower cost of pro-
units. Many writers have questioned this duction of housing service, therefore, neither
presumption and have suggested that slum results in a lower price of housing service to
clearance merely results in the transfer of the former residents of slum clearance or
slums from one location to another."5 Indeed, urban renewal sites in the long run. Neither
this argument should suggest itself to all slum clearance nor urban renewal results in
economists since slum clearance does not change in the incomes of, or the prices paid
increase the incomes of or decrease the prices for nonhousing goods by the former residents.
of any goods to the former residents of the Consequently, the former residents of the
cleared areas. If the market for housing ser- cleared area will, in long run equilibrium,
vice is perfectly competitive, then this argu- consume exactly the same quantity of hous-
ment can be made completely rigorous. ing service as before slum clearance or urban
We have defined a slum dwelling unit as a renewal. Slum clearance and urban renewal
dwelling unit yielding a flow of less than x do not result in a net reduction in the oc-
units of housing service. Starting from a situ- cupancy of slums in the long run.
ation of long run equilibrium in the housing This implication of the competitive theory
market with normal vacancy rates, the im- is testable. To conduct this test, we might
inediate effect of slum clearance is to de- observe the characteristics of the housing
crease the supply of slum dwelling units. occupied by former residents of slum clear-
Some of the former residents of the destroyedance sites and their incomes just prior to
dwelling units will move into vacant dwell- slum clearance and for six years afterwards.
ing units providing the same quantity of With respect to each characteristic, we shall
housing service. Others will have to move probably observe that the percentage of
into dwelling units which provide slightly families occupying housing with that char-
more or slightly less housing service than acteristic is different immediately after slum
they prefer to buy at the long run equili- clearance from what it was immediately be-
brium price. The owners of slum dwelling fore. For example, the percentage of families
units will realize that they can both charge in dilapidated dwelling units might have
higher prices and have lower vacancy rates been 90 percent before slum clearance and
than before slum clearance. They will take 50 percent afterwards. The competitive
advantage of the short run shortage to raise theory suggests that in long run equilibrium,
prices in order to increase their profits. This, we will again find 90 percent of these families
in dilapidated dwelling units if these families
experience no change in real income. There-
16 For example, see Martin Bailey [2, p. 291], Davis
and Whinston [3, p. 112] and Martin Anderson [1, pp. fore, if we determine the percentage of
8-91. families occupying dwelling units with each

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 COMMUNICATIONS
particular characteristic by income groups,
then we should observe that within each in-
come group the percentage of families oc-
cupying housing having the particular char-
acteristic should, over time, approach the
before slum clearance percentage. This con-
vergence provides a weak test of the competi-
tive hypothesis. As mentioned before, Muth
[11, pp. 49-52] estimates that we get a 90
percent adjustment in the housing market in
six years.'6 Consequently, we expect that the
difference between the percentage at the
end of six years and the percentage imme-
ately after slum clearance will be roughly
90 percent of the difference between the per-
centage immediately before slumii clearance
and the percentage immediately afterwards.
A test of the statistical significance of the
difference between these two variables is a
strong test of the competitive theory.'7
There have been, and continue to be,
many instances of slum clearance, especially
associated with urban renewal. It is quite
feasible to conduct studies of displaced
families at least partly for the purpose of
testing this implication of the competitive
theory of the housing market. Since the na-
ture of the housing market is very relevant
to the choice of government housing policies,
these data might reasonably be collected by
the U.S. Department of Housing and Urban
Development in conjunction with urban re-
newal and public housiag.
If the housing market is perfectly com-
petitive, then slum clearance and urban re-
newal result only in a shift in the location
of slums rather than in a net reduction
in slums. Consequently, we should expect
neither urban renewal nor slum clearance to
lead to a reduction in the social costs of slum
living or to net beneficial spillover effects for
16 Specifically, Muth's estimates indicate that indi-
viduals seek to add about one-third of the difference
between desired and actual stock during a year, which
implies that for the adjustment of the actual housing
stock to be 90 percent completed, six years are required.
17 If there is much variation in the speed of adjust-
ment among the housing markets in the United States,
then it would be desirable to estimate Muth's equation
with data from the particular local housing market to
obtain the speed of adjustment for that market and to
use this estimate for our test.
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619
properties not on the slum clearance site.
Cost-benefit analyses of urban renewal typi-
cally find that measured benefits are far less
than measured costs.'8 The authors of these
studies usually do not attempt to calculate
the alleged benefits from these two sources,
but they claim that the benefits from the re-
duction in social costs of slums and the net
beneficial spillover effects on neighboring
properties might well overcome the excess
of measured costs over measured benefits.19
If the housing market were perfectly com-
petitive, then the expected value of these
alleged benefits would be zero and, hence, al-
most all slum clearance and urban renewal
projects would be extremely wasteful.
VI. The Effect of Rent Certificates on the
Housing Occupied by their Recipients
If it is desired either to decrease the num-
ber of occupied slum dwelling units or to im-
prove the housing occupied by low income
families and if the housing market is com-
petitive, then slum clearance and urban re-
newal are not the answers. They would have
neither of these effects. The most direct
ways of obtaining these results are to tax
(or prohibit) the occupation of slum dwelling
units or to subsidize the housing of low in-
come families. The former method would
make the occupants of slum dwelling units
worse off as they judge their own well-being.
Consequently, to the extent that the desire
to decrease the amount of slum housing and
to increase the housing consumption of low
income families is motivated by a desire to
help these people, to that extent the tax (or
prohibition) alternative can be dropped from
consideration.
Probably the most efficient method of sub-
18 For example, see Jerome Rothenberg [13, p. 341,
Table 41 and Stephen Messner [9, p. 78, Table 13]. In
each study, costs and benefits for 3 projects were cal-
culated. Total benefits for the six projects were only 27
percent of total costs. The highest benefit-cost ratio
was .37 and the lowest was .05. Rothenberg's calcula-
tions were intended to be illustrative only, but Mess-
ner's calculations based on Rothenberg's framework
are very careful and detailed.
19 See Rothenberg [13, p. 3401. Messner [9, p. 78] takes
a much more guarded view of the likelihood of signifi-
cant benefits from these two sources.
620 THE AMERICAN ECONOMIC REVIEW

sidizing the housing of low income run, the owners of the smallest bundles of
families
is to allow these families to buy certificates housing stock will either increase their main-
which they could use to pay the rent tenance
or makeexpenditures (and thereby increase
mortgage payments up to an amount the quantity
equal of housing service yielded by
to the face value of the certificate.20 The low their units) or convert their buildings to
income family would purchase this certificate other uses. There would no longer be any de-
for an amount less than the face value. mand for dwelling units which provide less
housing
These certificates would be redeemed by the service than can be purchased with
government from sellers of housing service. rent certificates of the smallest face values.
It would be illegal to exchange these cer- Some owners of dwelling units presently
tificates for other than housing service. providing bundles of housing service larger
Given the amount of public money likelythan could be purchased with rent certi-
to be spent for such a program and the ficates of the highest face value will allow
amount that might be reasonably charged their units to filter down to the relatively
for these certificates, the face values of rent more profitable sectors initially affected by
certificates will not be large enough to in- rent certificates. As a result, there will be
duce many low income families to move to shortages and, hence, economic profits for
newly produced housing because new hous- these larger bundles of housing service.
ing typically comes in relatively large bundles Owners of dwelling units yielding still larger
of housing stock. Since a rent certificate plan quantities of housing service will allow their
does not directly increase the supply of newly units to filter down. Eventually shortages
constructed housing and since few of the will result for bundles of housing stock which
recipients are likely to demand new housing, can be provided by new construction. Con-
many people wonder how a rent certificate struction of new dwelling units will continue
plan could result in an increase in the total until there are no more excess profits in the
quantity of housing stock. They suggest that market for housing service. In long run com-
since there will be no increase in housing petitive equilibrium all consumers must pay
stock, the only result of the increase in the de-same price per unit of housing service.
mand stemming from the rent certificate Consequently, purchasers of rent certificates
plan will be higher prices for housing service with a face value of x dollars per month
purchased by the low income families who should be able to consume the same quan-
use rent certificates.22 tity of housing service as individuals who
By now it should be clear that if the mar- spent this much per month for housing ser-
ket for housing service is perfectly competi- vice prior to the program.
tive, then this is only the very short run This result leads to yet another testable
effect of a rent certificate plan.23 In the long implication of the competitive theory of the
housing market. If the competitive theory is
20 Olsen [12, pp. 69-1161 has made estimates which correct, then we should observe that the
strongly suggest the rent certificate plan to be signifi- buyers of rent certificates with a face value
cantly more efficient than public housing. of x dollars will occupy housing as good as
21 Under the principle of benefit taxation, each re-
the housing which rented for x dollars prior
cipient should be charged an amount equal to average
expenditure on housing service prior to the program by to the rent certificate plan.24 This is the long
families of the same size and with the same income. See
Olsen [12, pp. 110-16]. This result follows primarily ing service who would find it profitable to adjust their
from Muth's finding [111 that the price elasticity of maintenance policy in advance of passage. Conse-
demand for housing service is roughly constant and quently, there might be little price inflation immediately
unitary. after implementation.
22 For a lucid statement of this position taken by 2 It would be necessary to correct for changes in
many housing specialists, see Martin Meyerson, Barbara the general price level, but we should not expect the
Terrett, and William Wheaton [10, pp. 71-721] relative price of housing to rise in the long run because
23 Indeed, since a rent certificate plan would un- of the increase in the total demand for housing service
doubtedly be discussed by Congress for some time be- which is a result of the rent certificate plan. Muth [11,
fore passage, it would be anticipated by sellers of hous- pp. 42-461 finds the supply curve to be perfectly elastic.

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 COMMUNICATIONS
run equilibrium situation. The adjustment
of this equilibrium will take several years. As
already pointed out, Muth's evidence sug-
gests a 90 percent adjustment in six years.
Hence, we should observe that the char-
acteristics of the housing occupied by re-
cipients (e.g., whether the dwelling unit has
hot and cold running water) should approach
the characteristics of the housing occupied by
individuals who spent the same amount on
housing prior to the program.
It should not be necessary to wait until a
national rent certificate plan is adopted to
test this implication. According to Meyerson,
Terrett, and Wheaton [10, p. 71], " . . . wel-
fare agencies in many states in this country
do issue rent certificates to families on relief.
During the Depression, millions of failmilies
received such payments." There may already
be data from these experiences to test this
implication of the competitive theory of the
housing market. Given the demonstrated in-
efficiency of urban renewal and public hous-
ing, it would also seem reasonable for a city
to propose and the Federal Government to
accept a reint certificate plan in place of the
two other programs on a demonstration
basis. The experience of the buyers of rent
certificates in this city could be used to test
the competitive theory.
VII. Conclusion
In this article, the assumptions of Muth's
competitive theory of the housing market
are stated and the nature of the good called
housing service is elaborated upon. This
theory is used to translate four familiar
terms of housing, nmarket analysis-dwelling
unit, slum, shortage, and filtering-into the
standard concepts of microeconomic theory.
If the housing market is perfectly competi-
tive and if it is not more costly per unit to
provide housing to low-income families or to
provide small packages of housing service,
then (1) the poor would not pay more per
unit for housing, (2) slum clearance and ur-
ban renewal would not result in a net reduc-
tion in the number of occupied substandard
units, and (3) the recipients of rent certifi-
cates would enjoy housing just as good as the
housing occupied by others who spent as
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621
much on housing as the face value of the
certificates. These results and their implica-
tions for government policy are deduced. In
each of the three cases, testable implicationis
of the assumptions are derived and the na-
ture of the test made explicit. It is hoped that
this article will serve to bring housing market
analysis within the realm of conventional
economic theory and to suggest additional
tests of one particular conventional eco-
nomic theory of markets.
REFERENCES
1. NM. ANDERSON, The Federal Bulldozer.
Cambridge 1964.
2. M. J. BAILEY, "Note on the Economics
of Residential Zoning and Urban Re-
newal,"Land Econ., Aug. 1959, 35, 288--
92.
3. 0. A. DAVIS AND A. B. WHINSTON, "Eco-
nomics of Urban Renewal," Law aud
Contemp. Prob., winter 1961, 26, 105-17.
4. M. FRIEDMAN, Capitalism and Freedomt.
Chicago 1964.
5. C. G. HEMPEL, Philosoplhy of Natural
Science. Englewood Cliffs, 1966.
6. J. M. HENDERSON AND R. E. QUANDT,
Microeconomic Theory. New York 1958.
7. R. H. LEFTWICH, The Price System and
Resource Allocation. New York 1961.
8. I. S. LOWRY, "Filtering and Housing
Standards: A Conceptual Analysis,"
Land Econ., Nov. 1960, 36, 362-70.
9. S. D. MESSNER, A Benefit Cost Analysis
of Urban Redevelopmentt, Bureau of Busi-
ness Research, Indiana Univ., Blooming-
ton 1967.
10. M. MEYERSON, B. TERRETT, AND W. L.
C. WHEATON, Housing, People, and
Cities. New York 1962.
11. R. F. MUTIr, "The Demand for Non-
Farm Housing," in A. C. Harberger, ed.,
The Demand for Durable Goods, Chicago
1960, pp. 29-96,
12. E. 0. OLSEN, "A Welfare Economic Eval-
uation of Public Housing," unpublished
Ph.D. dissertation, Rice Univ. 1968.
13. J. ROTHENBERG, "Urban Renewal Pro-
grams," in R. Dorfman, ed.. Mleasur-
622 THE AMERICAN ECONOMIC REVIEW
inig
inigBenefits
Benefits
of Government
of Government
Investments,of SixInvestments,
Large Cities, February 1966,"
Washington 1966, pp. 292-341.
14. G. J. STIGLER, The Theory of Price. New
York 1966.
15. U.S. BUREAU OF LABOR STATISTICS, "A
Study of Prices Charged in Food Stores
Located in Low and High Income Areas
Growth in Soviet Transport and Communications: Note
By EARL R. BRUBAKER*
A primary objective of nmany recen-t stud-
ies of growth in Soviet factor productivity
has been to use the available evidence to
limit speculation on the range of plausible
numerical values. Norman M. Kaplan con-
tinues this tradition in his intriguing analysis
of Soviet transport and communications [7],
but he introduces a procedural novelty by
eschewing computation of "synthetic" fac-
tor shares,1 relying instead on factor
weights, a and 1-a for capital and labor re-
spectively that range through all possible
positive values. He finds that no matter what
the weights, growth in factor productivity
declined in 1958-63 as compared with the
rate attained in 1951-58, and that we know
the range for the quantitative extent of the
decline. Kaplan reports similar results from
calculations for other major sectors of the
economy, thereby concurring in, and in a
sense, strengthening the conclusions of others
[3] [5] [11], who, using "synthetic" factor
shares, have found declines in productivity.
The purpose of this communication is to
explore contingencies that might be appro-
priately considered in connection with
computations of factor productivitNy in the
Soviet economy. First, a question might be
raised with respect to the impact of extend-
* The author is assistant professor of economics,
UIniversitv of Wisconsin, Madison.
1 To obtain "synthetic" factor shares appropriate
for the Soviet economy, Western researchers have used
observations pertaining to employment, capital stock,
and wages along with rates of return on capital ob-
tained by judicious anology with the American economy
[1]. See also [3] [5] [8, pp. 255-57] [11] for examples of
this procedure.
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mimeo. report, June 12, 1966.
16. , "Differences in the Characteris-
tics of Rental Housing Occupied by
Families in Three Income Ranges Pay-
ing Approximately the Same Rent in
Six Cities," mimeo. report, Sept. 1966.
ing, toward zero the range of values assumed
for the elasticity of factor substitution, v.
The stanidard nuLnmerical assumptions, one
to infinity, seemn to have, if anything, even
less empirical basis than the factor weights,
so that it seems particularly appropriate
that we again experimeint with an extremiie
range of possibilities. The extension toward
zero seems desirable also in view of the
rapidly changing factor proportions in the
Soviet economny, especially in those of its
major subsectors where capital per man was
rising at an even faster rate than in aggre-
gate. Second, we might find it interesting to
entertain the possibility of variation in if it-
self from period to periodl. In fact, evidence
has been accumulating that the "true" o- in
aggregate computations often may be less
than one, and indeed less than one-half. A
provisional calculation [2] has shown that
the available data on "synthetc" factor
shares and on the growth of capital and labor
inputs in the Soviet aggregate economy are
consistent with rather low values for o-.
Then, too, there have been studies of the
American economy using more advanced
econometric techniques, often reporting es-
timates less than one-half and as low as 0.08
in the short run.2
Suppose that o'-0.2 for the Soviet econ-
omy in aggregate as well as for all sectors.3
Compare the results under such an assump-
tion with those obtained by a variety of
2 See [10, pp.
pp. 93-4]
93-4] for
for aa summary
summary and
and review.
review.
3 Strictly speaking, when assuming X1 we should
make allowance for changing factor shares over time.
In this comment the usual procedure of neglecting this
refinement is followed.