All demand subsidy programs have two direct and observable effects. The introduction of the subsidy alters both the quantity consumed of the good being subsidized, as well as the market price of the good. While not strictly correct, it is a reasonable rule of thumb (and entirely adequate for our needs) to view any increase in the consumption of the good being subsidized as a gain for consumers, while interpreting any increase in the market price of the good being subsidized as a gain for suppliers.

A. An Example of Supply And Demand

The impact of a subsidy on the price and quantity consumed of a good can be seen using a simple graphic analysis. Consider figure 1. The horizontal axis measures the quantity of the good being produced or consumed. The vertical axis measures the price of the good. The line labeled S represents the willingness of suppliers to produce or sell the good. The curve labeled D represents the willingness of consumers to purchase and use the good. In figure 1, demand is downward sloping. This means that, as prices increase, consumers are induced to purchase less of the good.

The reasoning behind downward sloping demand is quite simple. For example, people are willing to pay from $1,000 to $3,000 for a personal computer, depending on its capabilities. If prices are low enough, people appear willing to buy more than one computer, often a low capability system for their children or a laptop to add some flexibility. The result, in terms of market behavior, is downward sloping demand.

In figure 1, supply is vertical. That means that, as prices increase, suppliers are not able or willing to provide more of the good. This is a graphic interpretation of our conclusions from Section II. The idea that higher prices result in increased supply stems from entirely reasonable behavioral assumptions regarding the response of private suppliers to profit enhancing opportunities. In Israel's real estate market, however, supply is determined by bureaucratic fiat. The bureaucrats are not influenced by profit considerations, and ignore prices as a mechanism for guiding their decision-making.

There is a point in figure 1 where the supply and demand curves intersect. That point determines the actual market price of the good, as well as the actual quantity produced or supplied. In order to see why this is so, consider what would happen if the price was higher than the market price level depicted in figure 1. If that was so, then consumers would be consuming far less of the good than producers would be supplying. Hence, excess supply would be building up, and prices would decline. If the price was lower than the market price level depicted in figure 1, then less of the good would be produced than consumers would be interested in consuming. There would be shortages, and prices would rise. Only when the price level induces producers to supply the same quantity of the good that consumers demand at that price level is there a stable market price. That price is where the two curves intersect.

Once again, a vertical supply line does not mean that supply cannot be increased at all. It means that any change in supply is the result of factors that have nothing to do with prices. A change in ILA policy--for example, a decision to release more land for development--would be depicted as a lateral shift in the supply line, say from S to S*. As can be seen in figure 1, a shift in supply from S to S* would result in a substantial decrease in prices, hence benefiting consumers.

B. The Impact of A Demand Subsidy

Now, consider the effect of a demand subsidy. Let us say that the government introduces a subsidy in order to allow consumers to enjoy more use of the good. The subsidy is a simple one--for each unit of the good that is purchased, the consumer gets $5 back from the government. The effect of such a subsidy would be to shift the demand curve upwards by $5. The reason for this is simple. If, for example, consumers were willing to buy 20 units of the good at a price of $10 prior to the subsidy, they would now be willing to buy 20 units at a price of $15. The $5 subsidy would assure that actual price being paid by consumers was $10, and hence, consumers would perceive the price as $10 when the market price was $15. Consider figure 2. The line labeled D + Sub represents the new set of demand price/quantity relationships created by introduction of the subsidy.

As can be seen in figure 2, the D + Sub line intersects the supply line at a point where prices have risen by $5, while the quantity consumed is unchanged. Consumers have not benefited at all from the subsidy. They end up paying just as much as they did prior to the subsidy, and consume just as much housing. Suppliers, however, benefit considerably. The real estate that they desire to sell or rent now commands much higher prices. As long as supply is insensitive to prices, suppliers will always be the only beneficiaries of a demand subsidy.

Part IV