A real estate agent is considering renting an apartment Two

A real estate agent is considering renting an apartment. Two potential tenants are available. One is an old-age pensioner who will take care of the apartment, but who can only afford a low rental. The other is a group of university students, who are prepared to pay more for a ‘group house’ rental. It is costly for the agent to continuously monitor the behaviour of the tenants (especially the students), and how well they care for the apartment. With this in mind, she wants to offer the two tenants contracts so that, whichever one is successful, the tenant takes care of the apartment. The following facts are pertinent:

×The agent remembers when she was a student in a group house. A party got out of hand, causing $3000 damage, but the students thought it was $5000 worth of fun, and left the state before the owner could recoup the costs. She assumes it is possible that young students may behave in a similar way.×If she lets the apartment to the pensioner, there is no risk of property damage, and the annual rental (the reservation price for the pensioner) is lets the apartment to the students, the annual rental is $7000

×An option open to the agent is to require the students to post a bond, which is fully refundable if there is no party and therefore no damage (ignore any interest on the bond).

Question: Complete the decision tree below, showing the two sets of payoffs if the students rent the apartment, including the value of a non-refundable bond sufficient to induce good behaviour by the students. Explain your reasoning. The entries for the pensioner have been completed – the agent’s return is equal to the pensioner’s reservation price.

Aront Students- careful paity Agente Students* Pensioner- Agent $5000 Pensioner $5000 ensoner

Solution

It is a problem of taking decision on the renting of house. There are two potential tenants. First one is a group of students. Second one is pensioners. Characters of the two groups are opposite. Pensioners are not able to pay higher rent, but they can take proper care of the house. So it will be maintained well without damage.

But students are comparatively more risky. They may be carefull and good. But they can be also different without caring the house. In that case possibility of loss is there. However they can pay higher amount.

Here in decision tree three possibilities are available.

1. Pensioners: To them as stated agent will charge rental of $5,000. It is affordable to them. It implies that they will get satisfaction to the extent of $5,000 from staying in the house. Also agent will receive $5,000.

2. Students who are careful: As they are ready to pay $7,000, it implies that students are getting satisfaction of $7,000 by staying in the house. Also agent will get same amount from them.

3. Finally consider the party students. As they are capable of paying $7,000, this amount will be charged. But students are believing a satisfaction of $5,000 from party. So their satisfaction is $5,000. Here agent will get $7,000 but there is a chance of suffering a damage of $3,000. Thus agent is expected to get a net amount of $4,000. All such alternatives are shown below -

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Value of a bond to be taken is $3,000. If there is no damage then it will be refunded in full.