Explain how you would characterize the opportunity cost of interest rate deduction (subsidy) for house owners?

Your answers must be typed neatly in a Microsoft Word document (Times New Roman Font, 12pt, Single Spaced with 1 inch margin all around).
• Chapter Topic – First Principles
• Chapter Topic – Economic Models
• Chapter Topic – Supply and Demand
Market Failure and the housing bubble, Wall Street Journal, Opinion, July 2009, “A Government Failure, Not a Market Failure” http://online.wsj.com/article/SB124631486277570583.html
• Wall Street Journal, October 2009, “Apartment Glut Expands; Vacancy Rate Rises to 7.8% as Unemployment Dents Demand; Monthly Rents Slip” http://online.wsj.com/article/SB125479559237566623.html

Answer the questions below in as much detail as possible. All answers must be typed neatly (See the directions above).
1. How would you characterize the opportunity cost of interest rate deduction (subsidy) for house owners? (Hint: Think about this; What if the government ended interest rate deduction (subsidy) for house owners and used that additional tax money to build public goods like roads, parks, educational institutions, hospitals etc.? How would that affect the demand for housing, demand for apartments, national productivity, income distribution, etc.?) (Limit: 2 pages; Ideally, between 1 – 1.5 pages)
2. Interest rate deduction (subsidy) for house owners may reduce the price for house ownership but it may also make renting less attractive thereby reducing the demand for apartments and slowing growth in rents. Given this tension between the two markets (owner occupied housing and apartments for rent), discuss how government policies may lead to market distortions and can potentially misallocate resources. Pay special attention to the trade-offs involved here. (Limit: 2 pages; Ideally, between 1 – 1.5 pages)
3. Think about the following experiment: Let’s say that the government adopts a new tax code where all housing expenses (mortgage payments, rents etc.) can be deducted from one’s taxable income thereby effectively reducing the taxable income and hence, the amount of income taxes. How do you think the new tax code will affect the (a) Owner occupied housing market and (b) Rented apartment market? Do you think that the loss in revenue will be offset by higher tax collection because of higher disposable income (lower taxes) and hence, higher growth rate? Explain your answers in detail. (Limit: 2 pages; Ideally, between 1 – 1.5 pages)

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