Credit Crunch and Extended Housing Slump - Dissertation Example

of the of the Concerned 5 December 2009 Business Economics Introduction In the free market economies, the decisions taken by buyers and suppliers are mostly based on the dynamics of self-interest. While taking decisions in an economic scenario, people readily respond to the involved incentives and harms, thereby taking into consideration important parameters like cost of a thing or a service and the accrued benefits from a specific commodity. If the cost of a specific service or a commodity is increased, mostly people tend to desist from subscribing to such products. In addition, when the benefits accrued to the potential customers from a particular product are curtailed, they again tend to desist from purchasing such goods. Economists took notice of this commonsensical and straightforward dynamics based on the study of human behaviour in the realm of cost and incentives, to propose the theory of supply and demand, that not only stands to be the fundamental model that explains the working of real economies, but qualifies to be the backbone of economics . The theory of supply and demand, though being very basic and simple, successfully explains the working of the world in general and the real economies in particular. Though, various pioneers in the realm of economics like Adam Smith, John Stuart Mill and David Ricardo do alluded to the words ‘supply’ and ‘demand’ in their writings, it is a surprise that one fails to find any systematic theory of supply and demand related fluctuations in the real economies in any of their works. Eventually it was Alfred Marshall, who propounded a well-meditated model of supply-and-demand in 1890, in his seminal work ‘Principles of Economics’. Since then, the supply-and-demand model has been successfully able to explain the correlations existing between incomes of buyers, prices of commodities and services, prices of inputs, prices of substitutes, demand of a commodity and the quantity demanded and supply of a commodity and the quantity supplied. Supply and Demand Simply speaking demand stands to be the quantity of a commodity desired by the customers at any time (Pass & Lowes 1993). The quantity demanded is actually the amount of a particular commodity that the customers are willing to purchase at a specific price (Pass & Lowes 1993). Supply of a commodity stands to be the quantity of a product that the suppliers can bring to a market (Pass & Lowes 1993). The quantity supplied means the amount of a product or a commodity that the suppliers are ready to supply when a specific price is offered to them (Pass & Lowes 1993). Hence, demand relationship actually connotes the relationship existing between the price of a commodity and its quantity demanded. In the same way, supply relationship means the link existing between the price of a commodity and the quantity of that commodity that is brought to the market by its producers. In the real economies, the allocation of resources is eventually determined by the impact made by the alterations in demand and supply. The underlying logic behind this premise is that supply and demand and the related factors always tend to allocate the resources existing in the markets in the most efficient way possible. As per the law of demand, the demand of a commodity is always inversely proportional to its price. This is aptly depicted by Figure 1.Thus, higher the price of a commodity, the lower will be the quantity demanded. Similarly, as per the law of supply, the supply of a commodity is always directly proportional to its price. This is aptly exhibited in Figure 2. Figure 1 (Pass & Lowes 1993, pp. 116) Figure 2 (Pass & Lowes 1993, pp. 515) Thereby, the producers are always willing to enhance the quantity supplied of a commodity, provide they be offered a higher price. However, discernibly speaking, the supply-and-demand model may seem to be too direct and simplistic in its scope, there is no denying the fact that many interesting economic events could be well explained through elementary supply and demand analysis. In that context, it will be interesting to grope into the mechanisms of some popular and current events through simple supply and demand analysis. The Effects of the ‘Credit Crunch’ on the Housing Market The housing market got highly constrained as the banks and financial institutions got more apprehensive while extending loans. The housing boom was stimulated in the past owing to an unrestrained access to easy credit (The Baltimore Sun 2007: Online). Going by the fact that to begin with, banks became a readily available and irresponsible source of credit, it gave way to a boom in the housing sector (The Baltimore Sun 2007: Online). Considering the fact that too many people were facilitated loans to invest in housing sector, irrespective of their unhealthy credit rating, the market got the message that there existed abundant demand for houses, thereby creating a boom like situation. Encouraged by the increasing demand for houses and the commensurate rise in the prices of property, people felt that the time was conclusively propitious to make investments in the real estate, even at the cost of subscribing to costly loans. They did not hesitate from securing loans at higher interest rates, believing that the eventual and inevitable rise in the prices of the houses purchased by them will make it feasible for them to repay their loans and still make substantial profits. The banks also got mislead by this bubble in the housing sector, extending easy subprime loans following the logic that since the prices of houses were on the rise, it made sound sense to extend easy loans to the creditors interested in buying houses. These banks genuinely believed that the people buying and owning houses in a scenario, where the prises of property were continually on the rise, stand to be potential customers. Such creditors were deemed to be in a position to pay higher interest rates, courtesy the expected rise in the prices of the property purchased by them in the near future. Hence, the demand for houses kept on increasing, as there existed too many buyers who had managed to secure the wherewithal to pay higher prices by securing subprime loans (The Baltimore Sun 2007). Figure 3 elaborately explains the dynamics of housing bubble in the UK. Figure 3 (Money Week 2009: Online) The purchasing power that fomented demand for houses was based on shaky foundations. The buyers securing subprime loans not only had dubious credit rating, but also were investing, driven by to the misconception that the prices of their property will skyrocket. This resulted in a vicious demand and supply spiral in the housing market were subprime loans positively stimulated the demand for housing and in turn the prices of real estate. On the other hand, the perceived rise in the prices of property encouraged the banks to increase the supply of credit, as they stood to get higher returns from the customers investing in the real estate. The problem arose, when the banks threatened by defaulting creditors, got more cautious in their lending approach. This gave way to a situation where the supply of houses increased, but the demand started to dwindle, resulting in a domino effect. The scarce credit started to discourage people from buying houses, leading to a shrinking of demand. Contrary to this, the supply of saleable property increased, with an augmentation in the number of foreclosures. Now, the situation is that the supply of houses is increasing, irrespective of a drastic fall in demand, giving way to a weird market that is not in consonance with the principles of economics. This unrestrained increase in supply is bound to further hit the prices of property. The creditors are not left with any option to refinance their loans or to sell their property at higher prices. The Influence of the Major Supermarket Chains on the Pub Industry The excursion of the major supermarket chains in the liquor sector stands to be the most apt example of ramifications of the supply-and-demand model in the real economy. While the pubs placed all around the country are closing, the super markets are in a way destined to be the major and perhaps the most potent player in the beer market (Hamilton 2008: Online). The pub industry is facing challenges from many sides. The rampant economic meltdown is making the regular customers unable to spend money in the pubs, thereby giving way to a fall in the demand of beer throughout the country (Hamilton 2008: Online). Figure 4 depicts the falling demand for beer in an essentially recessionary economy. Therefore, survival in the beer business is all about securing a major share in the falling demand for beer in the essentially recessionary economy. To attract more customers and to hold on to the existing customers, the pubs are immensely under pressure to lower the prices of the beer sold by them. That stands to be the only plausible way; the pub industry can expect to increase the demand for beer at its premises. However, the pub industry cannot afford to do so owing to an increased beer duty, making it practically impossible for it to resort to any considerable changes in the price of beer (Hamilton 2008: Online). In such a scenario, the things are being made even more debilitating for the pub industry by the supermarket chains resorting to aggressive pricing of beer (Hamilton 2008: Online). Figure 4 (FiveThirtyEight 2009: Online) These supermarkets having access to vast resources stand to be in a position to convince the breweries to sell beer to them at competitive prices, considering the large volumes of beer bought by them. Hence, they are able to offer beer to the potential customers at a lower price. Therefore, while the demand for beer in the pubs is on the decline, the disheartened customers are increasing the demand for beer sold at the supermarkets, encouraged by their lower prices. Heavy discounting has enabled the supermarket chains to sustain a high demand for beer in these tough times. As far back in August 2008, the sale of beer sold at the pubs dwindled by 8.3 percent, while the sale of beer in the major supermarkets chains augmented by 5.3 percent (Hamilton 2008: Online). If this trend is allowed to continue unhindered, the retail outlets at most of the major supermarket chains are expected to be lead players in the beer business, leaving the pubs far behind. Various official and private pressure groups are stiffly resisting any move to impose any form of price control on the supermarket chains. The plain fact is that the consumers do look for lower prices while buying beer and the enticing discounts offered by the retail outlets at the super market chains encourages them to shift their demand for beer from pubs to the supermarkets. The pubs industry is facing the toughest sustainability crises since the last seven decades. Almost two dozen pubs wind up their business every week and this trend is expected to get worst with time (Hamilton 2008: Online). Since the advent of 21st century, more then 3600 pubs have closed in the UK (Hamilton 2008: Online). In fact, minor pubs; simply do not stand a chance before the supermarket chains. They do not have the money power or resources that could enable them to play any proactive role in the supply-and-demand dynamics of beer industry. As per the will of the free market, the demand and supply forces are certainly on the side of the big supermarket chains. Shifting of the demand from pubs to their retail outlets is further empowering them to negotiate for better prices with the breweries. The Impact of the Price of Oil on the Market for New Cars There exists a discernable and direct link between the volatility of oil prices and the market for new cars. The markets are still not over with their efforts to absorb and assimilate the crises ushered in by the volatility in the oil prices in the last few years. Until now, most of the major automobile companies like Ford, General Motors and Chrysler in the United States and Jaguar Land Rover and Nissan Motors in Europe had focused their efforts and resources in manufacturing and marketing gas guzzling big cars like SUVs (The Auto Channel 2009: Online). With the oil prices being relatively stable, the consumers preferred to go for big cars, as the stable oil prices translated into affordable operating costs. However, with an unexpected and steep rise in the price of oil, the consumers started to find really dearer to ply big cars. As a result, the demand for big cars eventually began to fade away, giving way to crises in the automobile industry. The major automobile manufacturers found it difficult to sustain demand for the big cars manufactured by them, as the cost of oil in a way added to the overall price of the vehicles manufactured by them. Of course, the total price of a vehicle is always in a way, the sum of the price of that vehicle and the cost of operating it. As a result, the rise in the overall price of the big cars augmented by the rise in oil prices directly translated into a fall in demand. The situation was further spoiled by the ongoing economic slowdown and credit crunch, making the customers shy away from big cars. The major car manufacturers in the United States and Europe started to report massive losses and begged for bailout packages from their respective governments. Once the customers realized that oil stands to be a finite resource whose price is expected to increase continually owing to an increasing demand and a price inelastic supply, they shifted towards more fuel-efficient cars manufactured by foreign companies like Suzuki and Toyota (The Auto Channel 2009: Online). This shift in the consumer preference from large cars to small fuel-efficient cars gave boost to the demand for small cars. The manufacturers of such vehicles managed to charge satisfactory prices owing to a high demand. This also enabled them to divert the revenue generated by high demand to R&D efforts, hence allowing them to supply vehicles, which are more restrained in their fuel consumption. The volatile and increasing oil prices also gave way to a new genre in the car industry that is hybrid and electric cars. However, the prices of such cars are still high owing to the lack of cost effective technologies, thereby leading to a highly constrained demand. The supply of such cars is also price inelastic for the time, owing to the inability of the manufacturers to augment demand through mass production. However, once the technology behind such cars gets more affordable, the demand is expected to pick up. Conclusion The crux of the matter is that the consumers always prefer to buy products at the least possible price. In the consumption driven real economies, the suppliers also desire to so adjust their supply patterns as to assure optimum profitability. The supply-and-demand model is nothing, but a formal recognition of this reality within the discipline of economics. Thus, the elementary demand and supply analysis stands to be a basic and fundamental tool that enables the interested groups and individuals to attempt a rudimentary yet reliable analysis of the markets of various products and commodities. Supply and demand definitely deserve to be classified as the cardinal determinants of price in the real economies. The supply-and-demand model is not only relevant to general commodities, but is equally viable in speciality markets. This model assures a deft understanding of even the macroeconomic variables in the free markets. The influx of refined statistical tools has further added to the reliability and effectiveness of the demand and supply analysis. Works Cited ‘Delinquencies increase among subprime loans: Credit crunch could bring extended Housing slump’, The Baltimore Sun, HighBeam Research, viewed 6 December 2009, ‘Figure 4’ 2009, FiveThirtyEight, viewed 6 December 2009, Hamilton, Fiona 2008, ‘Supermarkets spell last orders for the pub’, Times Online, viewed 6 December 2009, ‘Main Stages in Bubble’ 2009, Money Week, viewed 6 December 2009, Pass, Christopher & Lowes, Bryan 1993, Collins Dictionary of Economics, Harper Collins Publishers, London. ‘Oil Prices Change Auto Sales Landscape Permanently, KPMG Survey of Automotive Executives Says’, The Auto Channel, viewed 6 December 2009, Read More