Managerial Economics - Essay Example

Managerial Economics Introduction The drastic decline in the prices of the US housing investments was the reason that led to the financial crisis that affected the entire world. Housing is that asset which is endowed with services flow. An asset like housing can either provide for consumption or for letting out which would in turn supply with cash which can be used for buying other consumption good (Varian,2010 , p.203). Thus the housing would provide an implicit rental return which in turn could also generate money that could rent a house of the same value. There are several factors that contribute to the pricing of houses in a free market. The Basic Principle of demand and supply This basic principle of demand and supply would chiefly govern the housing market, i.e. when the demand for housing increases the prices will tend to go up in order to reach equilibrium at the present level of supply. This is a typical example of demand and supply. The equilibrium is determined when the price at which the buyer would like to make purchase coincides with the price at which the seller would like to make the trade. Now the value of the housing properties is determined by both the supply side and the demand side factors which include the price at which the seller would like to go for the transaction with a prospective buyer and the actual price which the buyer would like to pay (Ngai and Tenreyro, 2009, p.7). Now when the demand for residence in a particular locality is high then the dearth of supply would cause the market power to shift from the buyers to the sellers and hence prices would be determined by the seller. Thus, when there is excess demand in the housing market the sellers may hoard the residential unit in order to create a price differential and make more profits. On the other hand when the demand for housing is low the sellers might compromise on the prices and it would be a buyer’s market where the buyer would have a lot of control over the settlement of the prices. The demand for housing at a particular area may increase due to demographic reasons as well. Suppose a new industry is set up in a place where previously there was no human establishment, then labour migration will take place in that particular area and those people would need residential investments. Again as the number of divorces is increasing people these days need more residential units separately and hence the demand for housing increases. In the above figure we see that the initial demand for housing in a particular area id D1 and the initial supply is S1. The vertical axis would represent the prices of the housing units and the horizontal axis would represent the quantity of houses traded in the market of that particular area. The initial equilibrium price and quantity is at P1 and Q1 respectively. Now due to population inflow, the demand for housing units increases to D2. The supply remaining constant at S1, the new equilibrium would be at the point P2Q2. A point to be noted in this context is that due to an increase in demand the quantity supplied is increasing but at the lesser rate than that of the prices, i.e., P1P2 would be greater than Q1Q2. It should be noted that the supply here is relatively inelastic. The reason behind this is that there is a lag in time in between the price change and the augmentation of supply in housing in that area. When the supply of housing becomes more elastic as in the above figure, the supply curve would move in the rightward direction indicated by the arrow. The new supply curve will be S2. Now if we assume that the demand is unchanged then the prices would tend to go down to P3 which is a price that is higher than P1 but lower than P2. On the other, the equilibrium quantity would further move upwards to Q3 which is higher than both Q1 and Q2. Aggregate Demand for Residential Units: Interest Sensitivity of Housing Investment: With the rise of the rates of interest, the banks generally increase the costs of mortgage loans which in turn lead to a fall investments in housing less attractive. Since a lot of these loans set at a floating rate of interest most of the buyers become less interested while buying homes (Wheaton, 1990, p.1273). Growth in Income Levels of the buyers: As the income levels of the buyers increase the, they try to expand their housing investments or want to aim the upmarket for making such investments. Such a situation leads to increase in total demand of the houses. Buyer’s Confidence: If the future expectations of the buyers about the growth of the economy become optimistic then they would go for buying housing properties. This phenomenon can be referred to as Buyer’s Confidence over the market. This would lead to an increase in the demand for housing which in turn would lead to an increase in the prices (Klyuev, 2008, p. 28). Changes in Taxes and Subsidy imposed by the government: Various policies of the government might affect this market because in a variety of ways. The buyers may get subsidy on stamp duty or the low income population may be subsidised. For example during the 80’s and the 90’s the government of UK had offered the people interest rate subvention to the mortgage loan takers. Employment Scenario: A lot of demand in the housing depends on the employment scenario of the time and place. If the job market is undergoing a boom then the people would invest more parts of their disposable income in buying residence (Burdett, and Mortensen, 1980, p.663). Hence the change in the unemployment level would impact the housing market explicitly. Location: Most people try to look for houses which are nearby their office locations. Hence the prices of houses in cities nearer to workplaces and malls would be more compared to the houses located in the country side and in offbeat locations. Conclusion Thus we see that there are several factors which implicitly and explicitly contribute to the pricing of housing in a particular place. When the correct equilibrium price is determined all these factors have to be taken into consideration to get an accurate statistic. References: Burdett, K. and D. Mortensen, 1980: Search, layoffs, and labor market equilibrium. Chicago: The Journal of Political Economy, University of Chicago Press. Klyuev, V., 2008. What Goes Up Must Come Down? House Price Dynamics in the United States. Washington D.C.: IMF Working Papers 08/187, International Monetary Fund. Ngai, L. R. and S. Tenreyro, 2009. Hot and Cold Seasons in the Housing Market, CEP Discussion Papers dp0922. London: Centre for Economic Performance, LSE. Varian, H.R., 2010. Intermediate Microeconomics: A Modern Approach. New York: W. W. Norton & Company Incorporated. Wheaton, W., 1990. Vacancy, search, and prices in a housing market matching model. Chicago: Journal of Political Economy, University of Chicago Press. Read More