Supply and Demand Scenario - Essay Example

?Economics 513569 What is the main issue presented in the media report? Discuss what has actually happened Highlight the reason for the issue being raised Outline what possible impacts this change could have A classic supply and demand scenario is emerging as housing stocks increase while fewer buyers seem to be interested in actually closing on a home. With fewer buyers willing to actually purchase new or existing homes, the new homes being added to the market will certainly cause prices to go down over the aggregate. Much like the US market, the larger urban areas will see larger concentrations of stalled and long-term homes in the inventory and the trend will continue to increase the numbers in the inventory according to the media report. This has caused concern for a number of factors in the market to include the banking and construction industry. When a low turn-over of homes occurs, new construction stalls and peters out and older pre-existing homes may cause a short burst in refurbishment industries but inventory movement remains stale. According to the media report, trust in real estate as an investment vehicle has declined by half since 2003. As with all complex phenomenon, a number factors explain why it is happening the way it is. Over time, the housing industry will find equilibrium as housing prices drop to a level the market deems sufficient for decreased prices and buyers may start purchasing again. One can anticipate the construction trades getting hit the hardest and see lay-offs and smaller contracting companies going under. Home improvement goods and services may see an uptick in business as more homeowners seek to repair or improve present dwellings instead of buying another home. Who are the key stakeholders that are impacted by the issue outlined in the report? Include a discussion of all groups that may be impacted by the issue raised in this report Highlight what you believe the main impacts will be in outline who you believe will be impacted most The construction companies and potential homeowners are the most severely affected groups here. The bankers will suffer only in the departments directly related to issuing and maintaining mortgage notes and securities. Of course, if the loans are packaged and leave the local lenders to be securitized in bundles of investments, the effect will only be on the amount of loan traffic coming into the local lending institutions. The construction trade tends to attract both unskilled and skilled laborers whose seasons of employment will most severely affected by the downturn of sales. Entire swaths of the industry will suffer a dearth of employment especially affecting the unskilled laborer. The skilled laborers do have the opportunity to move directly to providing services to remodel and refurbish existing homes for homeowners who find the prospect of buying a new home burdensome right now. What economic theories can be drawn from this media report? List and discuss what economic theories you can find in this article Provide a brief outline of the theory you are highlighting Provide evidence from the article to support these theories. Remember there may be more than one theory to discuss The Law of Supply and Demand is the most important economic theory to be considered in this media report. In its simplest form, it demonstrates that limitations or constraints on either supply or demand will have an effect on price (Kirzner, 2000). Prices, when unfettered, are the clearest signals for how to rationally allocate scarce or abundant economic resources. Economics at its most basic is the examination of the rational (or sometimes irrational, as in bubbles) allocation of goods and services. One important note, it is relevant in a market or mixed economy but not necessarily in central planning or socialist economies where the Law of Supply and Demand tends to be fogged by irrational price signals and gross misallocation since the end-users don’t have a vote with their feet. The Law assumes that there is a price equilibrium at which producers and buyers settle on a market price for a given commodity. In the case of houses, the more homes that are produced in a market where the number of buyers does not increase tend to flatten in price or become less in price over time. The article is very clear in showing that a “50 percent [increase] over a 12-month period” is significant in the way it will affect prices. The real estate industry is fond of the admonition that price cures all defects which means that a downward trend in prices will continue to manifest itself. Elasticity and inelasticity do a play a part in certain circumstances when it comes to real estate. The former simply means that a commodity is easily tradable or fungible for substitution such as a large quantity of like tract houses in a neighborhood so the price tends to have a terrific effect on whether folks will purchase homes there or not. In certain parts of the United States such as Manhattan and San Francisco, real estate tends to command high prices no matter how the economy is faring. Not only are geographical constraints a factor but certainly the cache of the area and the concentration of higher paying jobs ratcheting up the ability of individual buyers to command higher payments for mortgages. These locations tend to have neighborhoods where the prices are rather inelastic. Again, the lion’s share of the housing market in Australia and around the world tends to fall in the category of elastic. Sunk costs are also a relevant factor. These are the costs incurred already that cannot be recovered. Some of these costs may be in the interest paid and being paid on mortgages by sellers who are attempting to sell their homes. It may be the home improvement such as a kitchen remodeling or the addition of a garage. While the latter costs may have provided an infusion of work to the refurbishing outfit that provided the service, with few exceptions, the homeowner may not get the return on the expense once they sell the house. As far as the mortgage interest paid, this certainly not a gain for the homeowner and simply increases the bottom line profit of the bank providing the service. When one looks at a thirty year note on a home, depending on the interest rate, the debtor can pay almost twice the original price of the home over the life of the loan. These are sunk costs. Inflation is also a factor. When the monetary unit is issued by the government, the currency tends to become inflated over time. Inflation is defined as: “Economists use the term “inflation” to denote an ongoing rise in the general level of prices quoted in units of money. The magnitude of inflation—the inflation rate—is usually reported as the annualized percentage growth of some broad index of money prices. With U.S. dollar prices rising, a one-dollar bill buys less each year. Inflation thus means an ongoing fall in the overall purchasing power of the monetary unit.” (White, 2008) Let’s suppose a home was purchased in 1991 and a home is being sold today, if you were in the United States, part of the factor in increased sale prices on home would be the diminished value of the dollar over time which would basically mean that more dollars have to be used for now over the purchasing power two decades ago. A number of sources place the dollar at about ten percent of its value in 1970. Price signals are among the keenest ways to rationally allocate scarce resources (Mises, 59). Homes are complex devices when it comes to prices. Not only is the existing structure a factor in valuation but the location, amenities and desirability of the neighborhood also pay into the sophisticated calculus. In the United States up until the 1930s, most homes for sale were paid for with cash. Then seven year mortgage notes emerged and over time these went on to the now traditional 30-year notes. For a time, 40-year and 50-year notes were entertained which one could interpret as a sign that home prices were suffering from significant inflation in value. A variety of commentators have also speculated that the massive Federal subsidy of home ownership in the past thirty years has led to a disproportionate number of owners who under other circumstances would merely rent. While this may be a positive step, deteriorating economic conditions and job prospects tend to have a much more deleterious effect on those who find themselves in homes living on marginal incomes and circumstances. As pressure increases on government sources to provide subsidies and assistance to homeowners in distress, too many in the hazard could collapse or seriously cripple bureaucratic organizations chartered to help. Are there any other issues in the article that you believe to be relevant? For the longest time the Western public has been led to believe that homes are a store of value and will never stop increasing in investment potential. This has been a prime opportunity to create a bubble in the market with these unrealistic expectations. Couple these factors with the securitization of loan bundles and the absence of stewardship by the originating banks over the loans and it has been a recipe for disaster. There is not much hope for the housing crisis to resolve itself anytime soon. WORKS CITED White, Lawrence H. 2008. "Inflation." Concise Encyclopedia of Economics. 2nd Edition. Viewed 20 March 2011. . Kirzner, Israel. 2000. "The Law of Supply and Demand” The Freeman". 50. 1. Viewed 20 March 2011. http://www.thefreemanonline.org/featured/the-law-of-supply-and-demand/. Mises, L 1912 The Theory of Money and Credit. LibertyClassics, Indianapolis. Read More