150,000
75,000
Demand
100 200 300 400
Quantity Demanded and supplied
When the price is at 75,000 the demand will be at 350, however the supply will be only 125, which will result in an excess of demand. When the price is at 225,000 the demand will be at 150, but the supply will be at 375, which will result in an excess of supply. The point at which demand equals the supply, is the point at which we get the equilibrium price. On the diagram we can see that the equilibrium price is at 150,000.
The prices of houses can also be changed if the demand or supply curve shifts. Firstly the demand curve will shift if there is a change in the conditions of demand, which are:
- Real income or/and its distribution
- Population or/and its distribution
- Price of substitute goods and complementary goods
- Tastes and fashions
- Price and availability of credit
The supply curve will shift if there is a change in the conditions of supply, which
are:
- Nature and abnormal circumstances
- Taxes
- Technical progress
- Price of factors of production
To find out why house prices have been rising over the last 5 years I will need to look at a number of factors. Such factors will be changes in real income, growth of GDP, population size and the costs of factors of production. I will take each factor and explain how it effects the price of houses.
Average house prices over the last 5 years
This table shows average house prices over the last 5 years in the UK.
The average house prices have risen consistently over the last five years, this is shown in the table above. House prices generally work on a 'boom and bust' cycle. This is where there the house prices are high and the market is said to be in a 'boom', as we saw in the late 1980s. Suddenly, the house prices will fall and there will be a lot of negative equity ( this is where mortgage debts exceeds the market value of the property) and the market will be in a 'bust' period, as we saw in the early 1990s. Slowly the market will build up again and the house prices will rise and then fall, this is the 'Boom and Bust cycle'. The period in the table is leading up to the climax of a 'Boom' and will surely 'Bust' in the near future.
Real income and its effects on demand for houses
Real income is the buying power of the wage. If a worker was getting £100 a month and inflation was 2%, the worker's real income would be £98. The demand for houses will go up because houses are a normal good, which means that demand for the good increases when incomes increase. We can see on the table that incomes have increased which means that demand for houses must have increased.
This is a table to show the growth of GDP and incomes.
The link between incomes and mortgage lending
To buy a house you normally need to borrow money by taking out a mortgage. The amount of money you can take out is determined by the mortgage-income multiple. This is a multiple of someone's annual income. Therefore, if incomes increase, which they have been, the amount of money someone can borrow is higher and demand for houses is increased.
Population size
People need places to live, so if there are more people there will more demand for places to live, this is shown in the table. It is not only the population size that affects house prices, it is also its composition. In the 21st Century, people want to move away from the city centres and move into the suburbs, with a lot of people wanting to do this it will increase prices for houses in these areas. Another factor that would increase demand for houses would be a decrease in household numbers, which is fewer people living in the same house. This has been the case in the last 20 years, mainly to the high divorce rate, which we can see in the table below.
Population of the United Kingdom
Divorce numbers for the years 1981, 1991 and 1999.
Divorces mean that the number of people living in houses are lower, which means that more houses are needed for the people to live in, so that rises prices of houses.
Price and availability of credit
Interest rates for the last six years
The table shows that, generally, interest rates have been falling over the last six years, so that people will spend more and save less. This has lead to an increase in demand for houses because with interest rates lower it encourages people to take out a mortgage to buy a house and most people do take out mortgages, as shown in the chart below. Interest rates vary due to there being a large number of banks and building societies offering mortgages, which causes banks and building societies to lower interest rates in order to compete with the others. The bank of England changes the interest rate in order to counter act inflation.
The buy-to-rent ratio of all dwellings in millions
The table shows that the number of rented dwellings have been going down. This means that more people are buying rather then renting and the price of houses will go up with this increase in demand. This relevant because renting houses is a close substitute for buying houses.
Sale of Council houses
When the government sell council houses it means that there are more houses coming onto the market. Although, this was a big factor in the 70's the sale of council houses have gone down so this is not that important.
Land prices and factors of production
The prices of land are rising because of the 'green belt policy'. Building contractors are not permitted to build on large specified areas around cities. These areas are dedicated to nature and greenery, hence the name 'green belt policy'. This makes the land prices rise because with a limited supply of land the price will naturally rise. Land is one of the factors of production in making houses, so when the price of land goes up so will the price of houses. Another factor of production in building houses is labour. Builder's wages have risen over past few years this has also pushed up the price of houses.
Conclusion
The conditions of demand all have an effect on house prices, but how relevant are each of the conditions of demand. Real income is important to house prices because your income will decide if you can have a mortgage and how big it can be. Although it is an important factor in the price of houses, it is not the most important because it depends on affordability and the mortgage repayment against income.
Population has weak relevance to house prices because the population has been increasing slowly over the last 5 years and if there was a strong link between house prices and population then house prices would be rising slowly as well.
Tastes and fashions is considerably important because it includes the factor of the number of people living in a house. This number of people living in a house has decreased due to divorces.
The most relative condition of demand is the price and availability of credit. This is because the mortgage rates can decide if someone buys a house or not, for example if the repayments are too high and not affordable the person will not take out a mortgage and not buy a house. Also the interest rate can decide on whether people spend money or save it.
To a certain extent, my hypothesis was correct, although that is not the only reason why house prices have been rising. House prices have risen due to number of reasons, such as changes in real income, population size, price of renting accommodation and mortgage rates.
I could have improved my investigation in many ways. I was unable to attain information about the cost of renting accommodation, I rang several estate agents but they could not provide the information. I also could not find figures for the sale of council flats or the number of new houses built in the time.
Bibliography
- GCSE Textbook by A.Anderton
- Handout from economics by A. Anderton
