Fluctuations in House Prices. Influencing Factors.

Table of Contents

  • Demand
    • Changes in real income of the buyer
    • Consumers’ confidence
    • Jobs
    • Changes to the system of housing taxes and subsidies
    • Ability to get credit
  • Supply
    • Changes in Housing Prices as a result of changes in supply and demand
  • Changes in demands
    • Changes in credit and expectations
    • Changes in housing price value
  • Changes in Supply
    • Changes in housing price value
  • Taxes and public spending
    • Taxation on government’s view
    • Taxation on Producers and Consumers view
  • Elasticity of demand on big purchase
    • Action and reaction of housing prices
  • Government Credit
    • Stimulus packages and its effect on housing market
  • Conclusion
  • Work Cited

Introduction

Housing prices like any other commodity prices fluctuates regularly with changes in demand and supply of housing. However, housing prices tend to be sticky downwards that is, a decline in price will encourage people to even wait for a further decline in the prices before commencing any transaction in the housing market. The law of demand states that an increase in price of a commodity will lead to a decline in demand for that commodity while a decrease in price will lead to an increase in demand of that commodity other ceteris paribus (British Library of Political and Economic Science, 10).

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However, though this law works efficiently in commodity markets, it has some complication in the housing market given the complicated nature of the housing market. This is because; most housing services are not portable and thus cannot be transported from one area to the other and secondly, there are reasonable substitute goods for new homes such as existing houses and rental houses. In this case, what are the factors affecting the demand and supply of US housing? This paper will discuss some of the issues involved in the pricing of U.S houses

Demand

The demand for housing like any other demand depends on various factors such prices of the houses to be purchased, location of the houses and ability to access credit for the purchase of the house among many other factors. In determining the demand for housing, it is essential to consider vital factors such as prices of the houses and the ability to access credit by the buyers. The prices of the houses are determined in the market system through the normal microeconomic interaction of demand and supply.

In the US system, the buyer and the seller interact to determine the prices of the houses with the prices being offered and negotiation taking place between these two parties before any transaction commences. In U.S, the housing transaction is a function of the following; the price that the seller is willing to sell the property and the actual price the buyer is willing to pay for the property (Carney 12). In circumstances where demand is high, the seller has the power to influence the market price of the property due to the excess demand in the market. This is always the case when the high demand is followed with a high shortage of the property.

On the other hand, when demand for properties is low, the power of determining prices shifts from the seller to the buyer who has a high bargaining power. All this affect the demand of housing. Generally, the demand for houses in U.S is determined by real income of the buyers, consumers’ confidence on the market, employment rate, expected future prices of the houses, and government policies such as taxations with regards to housing (Carney 14). These are discussed as below;

Changes in real income of the buyer

Change of real income of the buyers can either be positive or negative depending on the performance of the economy. In the U.S case, the real incomes of buyers have significantly reduced since the economy began to tumble in 2008. As a result, the buyers have been faced with shortage of credit to purchase houses and have thus led to decline in the demand for houses. Consequently, this has led to a decline in the prices of houses although not at very low prices since housing prices are always sticky downwards. However, it is expected that with the economic stimulus plan adopted by President Obama’s administration, the economy would stabilize hence stabilizing the housing market and restoring the normal prices (Gros and Frale 26).

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Consumers’ confidence

This relates to the performance of the economy especially the financial system. If the economy deteriorate and the financial position of buyers affected as was the case of US in 2008 and better part of 2009, the buyers will lose confidence in their ability to fund their expenses and will therefore cut down on their expenditures especially on long term assets such as housing. However, when the economy performs well, they will be encouraged to make investment in mortgages thus boosting the housing industry and pushing up the prices of acquiring houses (Gros and Frale 40).

Jobs

Availability of jobs defines individuals’ ability to purchase both long term and short term assets. As for the case of housing especially in US, the prices of houses will tend to increase during high employment periods and decline during recession when a large proportion of workers are laid off from their jobs. As at the moment, the US housing prices have reduced since the beginning of the recession and have pushed prices down either directly or indirectly. Prices have decreased indirectly as seen in the additional services that one gets before acquiring a house for example, valuation services and surveying services which were initially charged. However, it should be noted that this is not the case in all areas in United States as some locations have only reduced priced directly (Babich and Livoti 45).

Changes to the system of housing taxes and subsidies

This is mainly done by the government and significantly affects the prices of houses. If the government decides to induce heavy taxes on this sector, especially on the inputs of constructing houses, prices of houses will certainly go up. However, when the government subsidizes the acquiring of mortgages as was the case in 1990’s in US, the purchasing power of buyers will increase thus acting as a reduction in prices (Labonte 20).

Ability to get credit

Ability to get credit to purchase a house is a very crucial point in discussing the demand of houses in U.S. It should be noted that in U.S, most homes and houses are bought through mortgages. These mortgages are funded mainly by credit acquired from banks and various financial institutions. Therefore, availability of credit defines individuals’ purchasing power in US. The occurrence of the recent credit crunch in US as a result of the collapse of major financial institutions greatly affected the housing industry in the United State by reducing access to credit funds for purchasing houses.

The collapse of major lending financial institution meant that there was inadequate cash for credit creation and as a result, the demand for houses significantly reduced thus pushing the prices of down either directly or indirectly. However, with the economic stimulus package and the bail out to various financial institutions in the United States, the financial sector is projected to get back on track in the near future and thus creating availability of credit to house buyers (Babich and Livoti 60).

Supply

In microeconomic perspectives, the supply of existing housing is relatively inelastic in nature due to the time lag between the construction of new houses and the already available houses. It takes considerable time before a house is built and therefore, during the time of construction, the supply of the available houses will relatively be inelastic in nature and thus prices will tend to be high in the short run before the coming up of new houses in the long run to create excess supply.

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In situations when demand for housing shifts outside and supply is inelastic, the market price of houses will increase and relatively low levels of trading in the market as few people would purchasing the houses. However, as supply becomes more elastic in the long run, it is expected that prices will tend to reduce given the demand conditions remains constant. As a result, the demand will increase that would further attract more sellers into the market in the long thereby increasing supply of housing (Labonte 16).

Changes in Housing Prices as a result of changes in supply and demand

The housing prices always fluctuate constantly with the changes in demand and supply of the property. When supply goes up, it is common to notice that the prices will tend to reduce or rather various means would be adopted by sellers to attract more buyers in the industry.

Services such as valuation would be adopted without necessary reducing the price to attract more buyers. However, it is vital to note that housing prices rarely goes below the market price and would tend to be constant at some level if demand reduces significantly. This is mainly because of the inelastic nature of housing prices. Increase in demand on the other hand will push the housing prices up and with persistent increase in demand, prices will move up beyond the market price. As a result of the fluctuation in prices that impacts on housing supply and demand, it is common to notice a boom or a bust in the real estate industry (International Monetary Fund 30).

Housing supply normally changes from time to time therefore acts as an important measurement to keep housing prices constant. It can either be planned or occur as a natural phenomena. For example, supply changes due to factors such as demolitions of existing houses, abandonment, natural disasters such as earth quakes that may destroy enormous proportion of houses, and constructions intended to increase on the number of houses.

Therefore, depending on the factors affecting housing supply, supply can either increase or reduce thereby causing a decrease or an increase in prices of housing. Therefore, to keep supply at a constant level that is always equivalent to demand, experts propose that the construction rate of new houses should be at 3% of the current supply. Therefore, if the number goes beyond this figure, there might be a housing bust while if the figure goes below 3%, there may be a boom.

As a result, to ensure stability in housing supply and prices, it would be essential to keep construction rate at this percentage. In the U.S case, supply was maintain at a constant level but due to the credit crunch, it became difficult for people to acquire mortgages through loans as most banks had become bankrupt and could no longer issues out credit. Therefore, the excess supply in the U.S housing industry at the moment is not as a result of new houses being constructed but the as result of shortage in demand for the houses caused by lack of credit to purchase the houses (Case and Fair 69).

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On the demand side, it can be said that demand is also an important contributory factor towards the determination of prices since in the absence of demand, supply would mean nothing. As had been mentioned earlier, demand for housing depends on a number of factors. In this section, other factors determining housing demand will be examined and how they contribute towards price determination in the real estate market.

One of the factors is the population found within a given town, city or county. If the population is high, the demand would be high and as a result, sellers would be encourage to charge high prices for houses due the inelastic nature of demand. As population grows in a given area, demand for housing also grows but the land for expansion is always constant. Consequently, this scarcity will encourage the sellers of already existing houses to charge high prices for their properties. As had been mentioned earlier, demand will also depend on purchasing power of the buyers. In American settings, the purchasing power of consumers is determined using one of the following methods; Gross Domestic Product, wage levels, consumer price index and disposable incomes (Case and Fair 71).

Changes in demands

Housing demand changes from time to time depending on the performance of the economy. For example, during a boom in the economy, the housing demand normally tends to increase as people have access to cash and credit is easier unlike during recessions where people are faced with shortage of cash and credit thereby reducing on their housing demands. Let’s take an example of the U.S current situation where the economy had just fallen into recession following a slow down in economic activities in the country.

What emerged is that people lost their job thus reducing on their disposable income while those who are still working, a large proportion have been faced with a reduction in their perks thus reducing on their disposable incomes. In the long run, a large proportion of people were faced with credit crisis and thus had little to spear for purchasing a house and as a result leading to a decline in aggregate housing demand (Bamford, Grant and Walton).

Changes in credit and expectations

As had been mentioned, changes in credit in form of difficulty in accessing credit by buyers will affect their demand for housing. In the US situation, access to credit became difficult thus leading to decline housing demand. On the other hand, expectations of future price movements would also lead to changes in demand. In cases where buyers form speculative mentality towards purchasing of houses, there is a great chance of a boom to occur in the real estate industry. In this case, the buyer’s demand is based on a speculative mentality that the property will again value in future and that he/she would gain when he/she sells it in future. Therefore, buyers purchase these properties as investments (Gros 120).

Changes in housing price value

House price value refers to the how much the property would be worth in future. Demand for housing would change in cases where buyers perceive that the value of housing will either go up or down. Where they speculate that the value of the houses will be high in future, housing demand would increase in the present period whereas in circumstance where they perceive a lower value in future, demand would be low in the present period. Therefore, this changes the demand for housing from time to time.

Changes in Supply

Changes in supply are often as a result of changes in demand so as to maintain stability in the real estate industry. If demand increases, they are high likelihood of an increase in increase in the supply. Similarly, decrease in demand will discourage investors from investing in this industry thus leading to low supply.

Changes in housing price value

Changes in house price value also affects supply both in the short run and in the long run. In the short run, if sellers perceive the value to be high in future, they will supply less at high prices in the current period in order to gain more in future. However, if they speculate a decline in the value of housing in future, which is normally a rare occasion, they will supply more in the current period. Therefore, depending supply will change according to the changes in the value of the houses (Nelson, Bowles, Juergensmeyer and Nicholas 140).

Taxes and public spending

Taxation on government’s view

Due to the inelastic nature of housing, the government will find it profitable to tax the real estate industry so as to earn extra revenues. Though the real estate demand is elastic, demand for housing is inevitable since at one particular time one will need a home and therefore it’s profitable for the government to earn revenue in this industry by increasing the taxes levied on houses. However, the government can extend subsidies to the buyers in situations where it feels that the industry has been highly taxed and the economy is performing poorly so as to encourage buyers to continue purchasing properties and sellers to continue investing in the industry (Case and Fair 68).

Taxation on Producers and Consumers view

Consumers and producers view the government taxes on housing as to high to attract either new buyers or new sellers into the industry. Consequently, they are of the view that for the industry to be promoted and new buyers and sellers attracted into the industry, it would be vital for the government to reduce on the taxes charged in this industry.

Elasticity of demand on big purchase

The elasticity of demand on big purchase is normally inelastic in nature. This is basically due to the fact that individuals involved in big housing purchasing tend to have a lot of cash to spend and their demand would be rarely affected by changes in factors such as housing prices. Buyers with inelastic demand will always purchase houses irrespective of the housing prices (Case and Fair 136).

Action and reaction of housing prices

This involves changes in housing prices as a result of changes in the elasticity of demand. When the elasticity of demand is elastic, housing prices often fluctuates with little changes in demand. However, in circumstances where the demand is inelastic in nature, housing prices tend to remain stable throughout. Therefore, housing prices often reacts to changes in elasticity of demand and automatically takes appropriate action to stabilize the market (Tyson and Brown 65).

Government Credit

Government’s credit comes in various forms. However, the main credit that the US government often issues is the tax cut or reduction in the interest rate charged on repaying loans for mortgage. For example, the government proposed a plan in 2008 to issue a $7500 tax cut to home buyers thereby making housing prices affordable. These credits issued by the government are not absolutely free but acts as a cheaper way of acquiring homes in durations when the country is in either in an economic or financial crisis. The credits provide buyers with ability to purchase homes at zero interest level. This policy is quite beneficial to first time home owners since they will be not required to make a down payment (Carney 09).

Stimulus packages and its effect on housing market

Stimulus packages refer to the government’s efforts in stabilizing the economy by offering credit to the vital sectors of the economy in situations of economic crisis in the country. One of the vital sectors of the economy is the real estate industry which provides homes for millions of US residents. Therefore, during the economic recession of 2008, the government bailed out the housing industry to protect it from collapsing due to shortage of demand.

This stimulus package is a form of tax credit and is expected to encourage more buyers to enter the real estate market and as a result, there would be an increase in the housing demands. With interest rates remaining constant, the power to determine the market price will remain with the seller due to the huge demand for housing. The stimulus package will have a positive impact on first time home owners who under the package will be provided with $8000 credit to purchase a house. This credit is available to first time home owners between the periods of January to December 2009.

In addition, the credit is only available to individuals who have not owned a house in the past three years. These measures were adopted so as to reduce excess demand in the market due to high purchasing power facilitated by the stimulus package. Therefore, the stimulus package is expected to stimulate the real estate industry which was affected by the recent economic crisis by bringing in new buyers in the industry. This will increase demand for houses and consequently increase the supply of housing in the long as more sellers will now be encouraged to join the industry. This will not only have positive impacts on real estate industry but will produce positive impacts to the whole economy through the multiplier effects (Gros 110).

Conclusion

The discussion seen above indicates that the demand and supply for housing is similar to that of other commodities. However, the housing price unlike other prices for other commodities is sticky downwards and takes a considerable amount of time for it to actually decline. Therefore, the assertion is that determination of prices in the housing industry is determined by forces of demand and supply in the market. This paper therefore concludes by stating that the housing sector in the United States is very essential in maintaining the economic stability of the country and the peoples’ welfare.

Work Cited

Babich, Phillip., Livoti, Laura and National Radio Project. Shrinking Supply Low-income Housing in the U.S. National Radio Project, 2000.

Bamford, Colin., Grant, Susan. And Walton, Stephen. AS Economics for OCR Pearson Education, 2008.

British Library, British Library of Political and Economic Science, International Committee for Social Science Information and Documentation (COR). International Bibliography of the Social Sciences: Economics, 1987. Routledge.

Carney, Michael J. Changing Demand for U.S. Housing. SRI International, Business Intelligence Program, 1981.

Case, Karl E., Fair, Ray C. Principles of Microeconomics. Pearson Prentice Hall, 2006.

Gros, Daniel. Bubbles in Real Estate, A Longer-Term Comparative Analysis of Housing Prices in Europe and the US. CEPS 2008.

Gros, Daniel and Frale, Cecilia. The US Housing Bust and Soaring Oil Prices: What next for the world economy? CEPS, 2008.

Labonte, Marc. United States Congressional Research Service, Congressional Research Service, United States. U.S. Housing Prices: Is There a Bubble? U.S. Congressional Research Service, 2003.

Nelson, Arthur C., Bowles, Liza K., Juergensmeyer, Julian C. and Nicholas, James C. A Guide to Impact Fees and Housing Affordability. Island Press, 2008.

Tyson, Eric K. and Brown, Raymond. Home Buying for Dummies. Dummies, 2006.

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