Economic Profile of Housing Industry - Essay Example

Running Head: ECONOMIC PROFILE OF HOUSING INDUSTRY Axia College 06/08/09 Introduction The housing market has been severely hit by the potentially catastrophic collapse of the banking, credit and financial markets. The housing market is deeply impacted by the demand elasticity, positive and negative externalities, wage inequalities and monetary and fiscal policies. The external factors influence the elasticity of demand which is based on prevailing market condition and substitutes available in the market. Housing market is critically depending on credit market conditions and monetary policy. Shift and Price Elasticity of demand and Supply When an influencing factor changes, other than the price, it can result in a shift in demand curve. Generally, a shift in demand curve occurs due to a change in the income of buyers, change in the price of other goods and change in the taste of the goods. A shift in supply curve occurs because of change in the cost of production, change in price of other goods and a change in the technology etc. If demand increases due to the influencing factor other than the price, the demand curve will shift to the right and when demand decreases due to an influencing factor, the demand curve will shift to the left. When other things being unchanged, an increase in people’s income typically increases the demand for houses and hence the demand curve will shift to the right and as a result, the equilibrium quantity of houses bought will increase. In the existing housing market condition, it is obvious that the availability of credit is an influencing factor in shifting the demand curve for houses. If more credits and loans are available for less interest, the quantity demanded for houses will increase and hence the demand curve will shift to the right. The supply curve of houses will be affected by a number of factors like cost of production and technology used in house construction. Lipsey and Chrystal (2007) explain that a fall in carpenter’s wages will reduce the cost of production of the houses, thus shifting supply curve of houses to the right. In such a case, construction firms may plan to increase construction and hence increase the quantity of carpenters demanded if the price of the houses did not change (p. 214). The demand curve for houses is negatively sloped. An increase in the output leads to a fall in the market price of houses. Price Elasticity of demand is a measurement of the responsiveness of demand for a product or service to a change in its own price. Price elasticity of demand for houses measures the responsiveness of demand for houses to a change in its price. The demand for housing is expected to be inelastic because, housing is a necessity and there are very few substitutes available. The price elasticity of demand for house is depending on the availability of substitute like supply of rented houses. Grant and Vidler (2000) emphasizes that the following factors will have the strongest effect on the elasticity of demand for a product. The existence or otherwise of substitutes The proportion of disposable income spend on the product Consumer knowledge, awareness and time. (p. 36). The demand for particular branded houses can be, often, elastic because other companies may produce similar houses and there exists competition. When customers have substitutes, the demand for that product will be elastic. When a customer sets his housing need in a particular way that he needs to stay in a specific area of a town, or near to family or friends or he prefers to live near to his workplace area, then he is far less sensitive to the market price and the demand can be said to be inelastic. Income elasticity of demand for housing in almost all countries is positive because the market demand for houses continues to increase when real income increases. Properties like expensive vehicles and expensive bungalow have the highest income elasticity as they are luxury properties. Elmendorf and Summers (2009) find out that housing market is entirely different from other markets because of that housing market is heterogeneous, prices are subject to bubbles and housing market is depending on credit market and monetary policy (p. 171-172). The concept of market price in the housing market is slippery as each and every house is at least slightly different from others. Elmendorf and Summers (2009) argue that a significant aspect of the housing market is that the prices tend to be sticky downward. In most markets, when there are excess supplies, prices tend to fall quickly to adjust the market condition. But, housing downturns have been characterized by sticky prices. Even when sales drop prices are slow to respond (p. 174). Case and Shiller (2003) find out from the respondents of the survey conducted that supply of houses is comparatively inelastic in those areas where “there is just not enough land available” (p. 359). Growth in income per capita may be expected that it may have a greater effect on home prices in one place than the other. It is because more people may prefer one place for housing than the other. Case and Shiller (2003) argue that “with sticky prices, even a demand shock that shifts the long run equilibrium level of prices would be expected to lead to a higher rate of growth of prices over the short run” (p. 359) Positive and negative externalities An externality in Economic point of view is the effect of a transaction between two parties on another party who is not involved in the transaction. Externalities can be said to be present when the activity of one person or firm directly impacts the welfare of another person or firm. Externalities can be either positive or negative. When external benefits are generated for third parties, it is called positive externalities. When external cost is created, it is said to be negative externalities. In the housing marketing conditions, there are a number of factors that affect welfare of the community in both positive and negative ways. Poterba (2003) describes that a positive externality of the home building and housing market is that people perhaps enjoy looking at fancier homes. Same time it can generate a negative externality that people by seeing fancier homes may be induced to consume such large and fancier homes (p. 52). The positive externalities include the urban advancements so that people live in more advanced houses with more facilities. In areas where more homes have been constructed in, more economic activities take place. It is a positive externality that more business opportunities will be created in urban areas. A house owner planting garden and small farm near to home may provide benefits to other living in the area. Better homes for people is an economic well being and a sign that standard of living is getting better. New homes create towns and as a result more businesses and more job opportunities. The negative externalities of home building industry include depletion of resources. Home building industry continues to deplete forests and hence the positive benefits of forests to the welfare of the community like biodiversity are destroyed. Another negative externality of home building industry is that more and more undeveloped areas become developed and animals are pushed out of its habitats. Animals and forests play vital role in human’s nature in providing better healthy atmosphere. Constructing homes create pollution of both air and water that create nuisance and harm to the welfare of other people. Housing conditions have an influence upon health, attitudes, educational and employment opportunities and quality of life that seem to be positive externalities. Inequalities in housing conditions in turn are reflected in educational, cultural and economic opportunities that form to be negative externalities. Wage Inequality Wage inequality is emerging as a controversial and important policy issue in America. The level of wage inequality in the US has increased dramatically over the last three decades. The economists observe that wage inequality today is much higher than the wage inequality rate of 1970. According to Moretti (2008), wage inequality is measured as the difference between the wage of skilled and unskilled workers or wage difference between the workers at the top and at the bottom (p. 1). In his paper, he examines how wage inequality is measured and how it can be interpreted. Moretti (2008) uses nominal wage in order to measure the wage inequality that is prevailing in the US. Skilled and unskilled workers are not distributed uniformly in US cities and changes in housing costs are different in cities. He focused on changes between 1980 and 200 in the difference of average hourly wage for workers who are qualified with some high school degree and workers who are qualified with graduation or more. Moretti (2008) analyzed that many of the college graduated workers stay in metropolitan areas that have high initial expenditure of housing. It was observed that the college graduates are highly exposed to a high cost of living and hence the relative increase in their relative wage would be smaller than the relative increase in their nominal wage (p. 1) Technical innovation has considerably affected the wage distribution in the United States. Various innovation and technical advancements had the effect of compressing the wage structure among workers. Economists observed that wage dispersion was also caused by increased use of information technology. When more and more skilled labors- college graduates or those with higher studies- move to expensive cities due to increased demand for skilled labor in those cities like San Francisco and New York, the relative supply of skilled workers in those cities is automatically being adjusted. The amenities provided in those cities may attract skilled labors to such expensive town areas. This scenario explains that cost of living in such expensive towns is more and hence it represents the price to pay for the consumption of amenities provided. Some Economists argue that globalization, to an extent, plays vital role in creating wage inequality. International trade and immigration are the factors that may create wage inequality. Monetary and Fiscal Policies Monetary policy is a government procedure taken to control supply and costs of money. Fiscal policy refers to the type of government policy that influences the economy straight through taxes and fiscal spending. Money supply is controlled by monetary policy by increasing its supply which in turn leads to inflation. The supply of money is increased when there is a need to combat unemployment especially in a recession time. Housing markets tend to invest more in the time of increased money supply and thus it may increase employment. Fiscal policy attempts to achieve full employment or higher employment by adjusting government spending and taxation. Taylor (2007) argues that there is a remarkable secular change in the United States over the past half century. Specifically, the volatility or average fluctuations in residential constructions have been declined considerably. By comparing two periods of before 1980s and after 1980s, the standard deviation of the residential investment shows greater difference as 13 % and 5 % respectively. According to his view and interpretation, this volatility is largely affected by monetary policy and it is directly related to Great Moderation of the volatility of real GDP and inflation that has been attributed to monetary policy (p.1- 4) The fiscal policy brings up with a good rate of capital formation that in turn improves home construction and its marketing. The fiscal policies would be helpful for balancing productive and unproductive resources and hence unproductive can be utilized in a more useful areas. When supply of money has been increased by the monetary policy, credit may become cheap and as a result housing prices will tend to increase slightly as the housing demand increases. Economy, Housing market and negative influences The economy is suffering from the turmoil created by credit crunch and it seems claiming more victims day by day. The housing industry has been severely hit by the economic crisis. The housing contractors suffer and they do their best in order to survive in the challenging market. The financial crisis and less availability of credit decreased demand for the houses. As demand for new houses is low, housing prices have been declined in the US market and quantity supplied also was declined. Johnson (2009) emphasize that “a downturn in new construction directly equates to a decrease in the generation of construction debris that is recycled or headed to landfills (EBSCO). According to researches, new housing construction is accounted to fall by more than a half million units this year as compared to the 2007 figures of 1.34 million homes (Johnson). Truini (2007) identify the most significant economic effect prevailing in the US market that people are becoming aware of environmental issues and there is a growing need for environmentally preferable products (EBSCO). It means that the negative externalities of housing market are becoming an issue among the public. Be it houses or any other construction, there is a growing concern on the issues of environmental pollution and people prefer environmentally safe houses. Conclusion This paper presents the economic profile of housing market with emphasis on price elasticity of demand and supply of houses and monetary and fiscal policies. This is the completion of industry research of housing market that details what are the positive and negative externalities of the housing industry. References EBSCO references Case K.E and Shiller R.J (2003) “Is There a Bubble in the Housing Market?” Brookings Papers on Economic Activity, 2003 Issue 2, p299-362, 64p Johnson J (2009), Home building expected to decline further, Waste News, 1/5/2009, Vol .14, Issue 18, Master File Premier, EBSCO host, Moretti E (2008), Real Wage Inequality, Social Science Research Network, September 2008, University of California, Berkeley - Department of Economics, Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1278906 Taylor J.B (2007), “Housing and Monetary Policy”, Stanford.edu, Retrieved August 26, 2009 from http://www.stanford.edu/~johntayl/Housing%20and%20Monetary%20Policy--Taylor--Jackson%20Hole%202007.pdf Truini J (2007), The housing bubble that didnt burst, Waste News, 4/30/2007, Vol. 12, Issue 26 Master File Premier, EBSCO host Other References Elmendorf D.W and Summers L.H (2009), Brookings Papers on Economic Activity: Fall 2008 Brookings papers on economic activity, Brookings Institution Press Grant S and Vidler C (2000), Economics in Context, Illustrated Edition, Heinemann Lipsey R.G and Chrystal K.A (2007), Economics, 11th Edition, Illustrated, Oxford University Press, Poterba J.M (2003), Tax Policy and the Economy, Volume 17, Conference report, Illustrated Edition, MIT Press Read More