How People to Make Choices between Housing and Other Wants by Using Opportunity Cost Approach - Research Proposal Example

How people to make choices between housing and other wants by using opportunity cost approach? Introduction        Consumer’s decision making is a complicated procedure under scare resource condition. In his or her daily life a consumer has to make a number of decision regarding what to consume and what to not. These decisions in no way are taken randomly by a rational human being. A rational consumer goes through a systematic, yet complex process of decision making. Needs and wants of human beings are infinite, but resources that are necessary to fulfill all those needs or wants are limited at the hands of the consumers. In the words of microeconomics, it can be said that every consumer faces a budget constraint while making a decision regarding purchases of required commodities or services.  It is known that the more one consumes, the better he is. Utility of a rational human being always gets enhanced with the level of consumption. There is no doubt that if a consumer is able to buy every thing that he or she wants by the amounts adequate enough to fulfill his or her desires, then he or she would receive a very high amount of ratification. But in practice, an individual is constraint by his or her given resources and he or she has to make a wise decision regarding his or her consumption choice in such a way that his or her utility is maximized. (“Scarcity and Choice in Resource allocation”, n.d.; Dolan and  Lindsey, 1991) Since needs are infinite, given the income constraint it will not be possible for a consumer to fulfill all the needs the way he or she would have done under no constraint situation. Human beings always wants to have a better quality of life by consuming better food, better housing, better transport and communication, better health facilities and better educational opportunities.  But under scare resource condition, a consumer is required to rank his or her priorities on the basis of the extent by which he or she needs each of the commodities or services available in the market. The aim of a consumer when he is constraint with inadequate resources and infinite needs is to fulfill those needs first as well as adequately which he or she needs or wants most. In fact, very often people needs to make trade offs between different types of choices at the time of his or her decision making process. The term ‘trade off’ implies that if a consumer choose to consume one particular commodity or service by more amounts then he or she will have o give up or reduce the level of consumption of some other commodity or service in exchange as resources are limited. Unlimited desires, but limited income force consumers to make choices. (“Scarcity and Choice in Resource allocation”, n.d.; Varian, 2000; Nicholson, 1998)        As far as the basic need of housing is concerned, there has been a great debate regarding what type of housing – ownership or rented- will be best suited to the need of the consumers. While deciding on the type of housing a consumer does not only take into account the observable prices, but also a number of factors that are associated with the decision and affect the consumers utility. Every decision making process of a consumer involves a cost benefit analysis. Here comes the concept of opportunity costs. While measuring costs associated with the consumption of certain good, it is not sufficient enough to take into account observable prices only, but the consumer also needs to take into account the opportunities of consuming other products that will foregone if the consumer choose that certain product. At the time of making a decision regarding buying a house a consumer needs takes to account the costs associated with the opportunities relating to the fulfillment of other desires that will foregone if the house is bought. (Perloff, 2009; Varian, 2000)  Aim and Purpose of the present paper        Consumers need to make choices regarding each of their needs. Choices are not only about the quantity of certain commodity or service, but also about the variety of that commodity or service. In the market most of the commodities and services are available in different varieties with their own costs and benefits. For example in case of the basic needs of the consumers which a consumer needs to fulfill for attaining a minimum quality of life, they have to make a range of decisions regarding what variety of each of these basic needs they will consume. There is no doubt that everyone wants to for a better variety of each product, but under scare income it might not possible to consume the better variety of each of the commodities or services required to fulfill their basic needs. Consumers therefore have to make a trade off between their needs. (Nicholson, 1998).        The present paper aims at analyzing how a consumer makes a choice between the needs of housing and his or her other needs. This analysis can be conducted in a better way if the process of making the choice between the type of housing and other wants is explained applying the concepts of opportunity costs.       The purpose of the present study is to find out under what circumstances a consumer will prefer home ownership over living in rented house while the decision of the consumer is not only about deciding the pattern of housing, but to decide on the pattern of housing while there also exists a number of other needs that are required to be fulfilled. Literature Review        To explain how a consumer would make a choice between housing and other wants, it will be first necessary to find out the factors that are associated with the decision making process of a consumer regarding his choice between a particular type of housing and other wants. Once the factors that are involved in the decision making process is discussed appropriately, it will be necessary to conduct a cost benefit analysis of housing choice by applying the concepts of opportunity costs.       Among the series of expenses that a household needs to incur for the purpose of fulfilling its basic needs, expenditure on housing is the largest one, no matter whether the household chooses to live in a rented house or in own house. When a household takes the decision regarding housing, it needs to take into account a number of factors that are related to the process of fulfillment of other basic needs. The two main issues that a household considers to be of prime importance are the prices and location. A rational consumer always chooses to expend in such a way that it suits his or her income structure. Given the income constraint, whether a consumer will decide to own a house rather than living in a rented house will depend on how a consumer value his or her home ownership given the needs of fulfillment of other basic needs. (Kleinman, Matznetter and Stephens, 1998)       The value of home ownership to an individual depends on the benefits that are conferred by the owner of a house and the costs that are associated with buying a home. It would now, therefore, be interesting to discuss different kinds of benefits and different types of costs that are associated with home ownership.       The benefits are as follows:       First, homeownership is a mean of accumulating wealth. As the value of homes increases over time with decrease in the burden of debt, the value of equity of homeowners also increases. The value of equity is generally defined as the difference between the present value at which the home owner can sell his/her house now and the remaining amount of debt that the home owner still has to pay back to his creditor. To any household, home becomes a wealth for lifetime. As a result it confers huge long term benefits. (Cox and Utt, n.d.)       Second, home ownership provides a permanent shelter which confers positive effects on the growth of children. If a family occupies a permanent house, then the probability of providing schooling to the children from a same place would become quite higher. Researches show that academic performances of children have been much higher for those for whom the extent of shift from one school to another is far less. There is no doubt that when a family has a permanent place to live in, the probability of going to a permanent school is also higher for the children. (Cox and Utt, n.d.)       Third, increase in home ownership helps in bringing in social stability as home ownership increases the feeling of responsibility of the home owners towards their duties to the society. ((Cox and Utt, n.d.) Now the costs associated with home ownership are both direct and indirect: Direct costs: Direct costs of buying a home are the amount of money that an individual is required to pay to own a house. In other words to say it is the nominal price of the house that the individual is buying. The price can be paid in two ways, either from the savings of the individual, or by taking loan. When the price of the house is paid from the owner’s own savings, then only one-time payment has to be made. But in case of buying a house by taking loan from a bank or any other mortgage house, the individual has to repay the loan on a monthly basis over a particular period of time. (Kleinman, Matznetter and Stephens, 1998)  Indirect costs: Indirect costs associated with home ownership can be defined as the opportunity costs of housing. Opportunity cost of housing is made up of the value of rent and searching costs. The term opportunity cost is used to measure the cost of a particular choice of a consumer in terms of the value of the next best possible alternative forgone. In case of housing, an individual can either buy a house or can go for a rental apartment. In case of a rental house, he has to pay rent every month. (Waller, n.d.) Opportunity cost of housing can also be seen in other way also. Opportunity cost of housing can also be defined as the cost of not owning a house. When an individual own a house, he or she no longer need to pay monthly rent out of his monthly earnings. If the house is bought from personal savings by making a one-time payment, then by owning a house an individual can save monthly rent that he or she would have to pay other wise. On the other hand, if the individual buys a house by taking loan, then he or she can save some amount of money only when monthly rent exceeds monthly payment to the debt. The amount of money that a person is able to save through home ownership can be treated as the opportunity costs of not buying a home. (Waller, n.d.; Kleinman, Matznetter and Stephens, 1998; Buchanan, 1987)  Up to now, only the value of rent has been incorporated in the accounting of opportunity costs. But apart from rent a number of other factors are required to be taken into account in the calculation of opportunity costs of not owning a house. Opportunity costs of not buying a house also incorporate the value of long term benefits from home ownership.  Research and investigation As mentioned earlier a number of issues are involved in the decision making process regarding making a choice between housing and other wants of consumers. For the purpose of the present study, the following sub-sections will analyze how an individual will make a choice between housing and alternative wants other than housing. In the present case, two alternative wants will be taken into consideration- transportation, and education. Housing and transportation: The two most costly items in the consumption basket of a household are housing and transportation. As far as transportation is concerned, a consumer can either use public transports or private vehicle. Suppose a situation where an individual has to decide between two consumption choices- buying a house and buying a car. In both of the cases apart from direct costs, huge indirect costs are related. As mentioned earlier by buying a house an individual can save some money which would have otherwise been paid in the form of house rent. Similarly there also exists an opportunity cost of not buying a car which is nothing but the total amount of money that an individual has to pay for using public transports. Now net opportunity costs can be calculated for not buying a house as well as for not buying a car. If net opportunity cost of not buying a house is found to be less than opportunity of not buying a car, then the individual will decide to buy a house rather than a car even if opportunity cost of not buying a car seems to be higher than direct costs of buying a car. (Waller, n.d.)       Housing and education: A household also has to spend a huge sum of money on the education of children. Suppose a situation where an individual is confronting two choices- either to buy a house or to enroll the children to a better school which is more expensive. In this case the household is required to compare net opportunity costs of not buying a house and of not enrolling the children in better school. In this case, it is necessary to incorporate long term benefits from owing a house and from enrolling students in better schools in the opportunity costs of not buying a house and not enrolling children in better school. One interesting thing here is that, permanent housing also helps in enhancing academic performance of students by providing schooling from a permanent place. Now opportunity costs of not enrolling children in better schools is the foregone opportunity of better academic performance which in turn can translate into attainment of good jobs in future. Now if net opportunity cost of not enrolling children in better school ( net of enrolling costs) is higher than the net opportunity costs of not buying a house, then the individual will prefer to stay in a rented house an enroll his or children into better school. (“Making Trade-Offs: Perspectives on Affordable Housing, Transportation and Quality of Life in King County”, n.d.) Conclusion  While making a choice between different alternative wants, an individual needs to set his or her priorities first. Then on the basis of the value of opportunity cost that the individual has to bear if a particular need is not fulfilled, the individual makes his choice. Whenever an individual confronts a situation of making a choice between housing and some other wants that belong to his or her priority lists, then the individual will go for the option of home ownership if net opportunity costs associated with not owning a house seems to be larger than net opportunity costs of not fulfilling the other need.   Recommendations: If for a particular person opportunity costs (including short run as well as long run benefits) of not buying a house seems to be higher than the opportunity costs (including short run as well as long run benefits) of not owing a car, then the person should buy a house rather than staying in a rental apartment. If  for an individual opportunity costs (including short run as well as long run benefits) of not buying a house is greater than the opportunity costs (including short run as well as long run benefits) of not enrolling children in better school, then the person should buy a house rather than staying in a rental apartment.     References: 1. Buchanan, J.M. (1987). Opportunity cost. The New Palgrave: A Dictionary of Economics, v. 3, pp. 718-21. 2. Cox, W.  and Utt, R. D. Smart Growth, Housing Costs, and Homeownership. Available at http://www.heritage.org/Research/SmartGrowth/bg1426.cfm [accessed on 5th June, 2009]. 3. Dolan, E. G. and  Lindsey, D. E.  (1991). Economics. Dryden Press. 4. Kleinman, M. Matznetter, W. and Stephens, M.  1998. European Integration and Housing Policy. Routledge. 5. Making Trade-Offs: Perspectives on Affordable Housing, Transportation and Quality of Life in King County. Available at: www.communitiescount.org/uploads/pdf/archives/2008%20Report [accessed on 5th June, 2009]. 6. Nicholson, W. (1998).  Microeconomic theory: basic principles and extensions. Dryden Press. 7. Perloff, J.  M. (2009). Microeconomics. Pearson. 8. Scarcity and Choice in Resource allocation. Available at http://tutor2u.net/economics/revision-notes/as-markets-scarcity-and-choice.html[accessed on 5th June, 2009]. 9. Varian, H.R. (2000).  Intermediate Microeconomics – A Modern approach. East-West Press. 10. Waller, M.  High Cost or High Opportunity Cost? Transportation and Family Economic Success.  Available at http://www.brookings.edu/papers/2005/12poverty_waller.aspx [accessed on 5th June, 2009]. Read More