A decrease in price from P2 to P1 results in a decrease in quantity supplied from Q2 to Q1 so there is a downward movement along the demand curve. This is sometimes called a contraction in supply.
This is a supply and demand diagram which shows how an equilibrium market price is determined.
Graph showing the Equilibrium market price
The equilibrium price is the price of a good or service when the quantity demanded is equal to the quantity supplied.
At prices above the equilibrium (P*) there is excess supply while at prices below the equilibrium (P*) there is excess demand. The effect of excess supply is to force the price down, while excess demand creates shortages of goods and services and forces the price up.
Elasticity
Here are the definitions of price elasticity:
- Price elasticity of demand is the responsiveness of changes in quantity demanded to changes in price.
- Price elasticity of supply is the responsiveness of changes in quantity supplied to changes in price.
They affect the price of houses in certain ways.
Demand for houses is relatively elastic. This means that the demand for houses is relatively responsive to a change in price. This is shown by the diagram below.
Price Elasticity of Demand for Houses
Price
D
Quantity
Supply for houses is relatively inelastic. This means that the responsiveness of demand to a change in price is very small. This is because there are not many builders and not much space to build the houses needed, so supply cannot change much. This causes situations like housing booms and the supply does not increase with demand.
Price Elasticity of Supply for Houses
Price S
Quantity
This is a table showing the main determinants for the demand and supply of houses:
Supply and demand are very important in the house market and affect prices vastly.
We have already recognized the laws of demand and supply and now they are used to investigate how it affects price of houses. If we took these into account we could make a satisfying conclusion:
- If demand for houses increased, the price for houses also increase because a higher profit will be gained. If demand of houses decreased, then price of houses would decrease because a lower profit can be gained.
- If supply of houses increased, the prices of houses decrease because a lower profit is gained. If supply of houses decreased, then price of houses would increase because a higher profit can be gained.
Here is an article explaining how the sale of houses has increased in the last four years and is at its fastest.
Business: The Economy
Houses selling in record time
Demand is outstripping supply in the housing market
House sales in the UK are going through at their fastest rate for four years, a report says.
The average home is sold in 10 weeks whereas, four months ago it would take 12 weeks and June last year it was taking 13 weeks, according to a report by estate agents Bradford & Bingley.
It is the fastest rate recorded by the firm since it started monitoring the figures in 1995.
Some homes are finding buyers "within hours", according to the estate agency.
The survey underlines the disparity between supply and demand which has been helping to drive up house prices in recent months
The report said nearly every house sold for its asking price, and on average the shortage of homes is so great there are five buyers for one every property on the market.
Properties are moving slowest in the North West where it takes 14 weeks.
The market is being driven by a shortage of homes for sale, with up to 13 people chasing each one in the south.
Inflation
Inflation is a general rise in prices. The value or purchasing power of money refers to the amount of goods or services one pound can buy. Inflation means the value of money is falling because prices keep rising. It is very important in the economy as it affects many aspects including house prices.
Although you would think that house prices would increase with inflation. Inflation causes a devaluation of money, which decreases the price of houses in real terms. This is because there is a reduction in demand for houses due to the following reasons:
- Due to the financial uncertainty caused by inflation, people aren’t willing to spend such a large amount of money on a house. This is because with the value of money changing at such a fast rate it is hard for people to work out if buying a house would be a good investment.
- Also, if people have fixed incomes or fixed pensions, they lose a lot of money, as there income doesn’t adjust for inflation, therefore the demand for houses would decrease as less people can afford to buy houses.
- Also, some economists argue that inflation causes unemployment as it encourages people to buy from overseas imports, leading to a loss of British jobs. This means less people can afford to spend such a large amount of money or take on a mortgage. This decreases demand.
Recently there has been house price inflation in the UK but it is now ‘cooling down’ as said in an article recognising this.
House prices rises 'cooling'
Soaring UK house price inflation is showing the first signs of cooling down, according to the Halifax.
The giant mortgage lender said house prices rose at an annual rate of 18.8% in August, compared with 20.8% in July.
The number of housing transactions so far in 2002 was about 10% higher than in the same period last year, the Halifax said.
The ratio of house prices to average earnings has risen to 4.2 times.
This is up 0.6 on the same period last year, though the ratio remains well below the record peak of 5 times average earnings.
"The UK housing market has been very strong in 2002 but house price growth has gradually eased over the last three months", said Gary Styles, Halifax's chief economist.
UK house prices rose by 0.2% in August, compared to steeper monthly rises of 1.8% in July and 2.4% in June.
Consumer Confidence
The article below explains how UK’s consumer confidence is falling and the UK housing market is starting to decline.
House price confidence 'slipping'
Confidence in the UK housing market is "starting to decline" according to the Woolwich bank.
The latest snapshot of the mortgage market by the bank, found confidence had fallen for the second month in a row.
But while confidence fell, the Woolwich found that the demand for home loans continued to grow strongly.
The latest figures from the UK's fourth biggest lender, showed gross mortgage lending grew by 17% last month to £20bn.
However, Mr Gray says that there are signs that confidence amongst home buyers is subsiding: "We have seen a clear indication that people's confidence in the housing market is starting to decline."
Last month, saw the first fall in home buyer confidence since November 2001.
In July, this trend continued with 59% of those surveyed saying that they felt the market would expand, a fall from 61% in June.
However, in the two-areas of the country that have experienced the greatest rise in house prices over the last year - East Anglia and the South West - buyers are still bullish about prices.
Nearly three quarters of buyers in the South West and two thirds in East Anglia believe that prices will rise strongly in future.
Mr Gray said lower confidence would dampen demand and house price growth would be moderate over the coming months.
This article shows that home buyers are having less confidence in the housing market. This is because of many reasons:
- As the stock exchange decreases, people become afraid that the house prices will also decrease so they are reluctant to spend and are more likely to save.
- Also job security is a main aspect as people are afraid of being made redundant so they save their income.
- There are always rumours about the Bank of England increasing interest rates. This causes home buyers to save money in case they have to spend more for their property in the future if the rumour is true.
Affordability
In the UK, there is a lot of inequity in a number of different ways. One measure of horizontal inequity is the North-South divide in the UK. The table below shows average income per week per household in the UK in 1993. The South-East had the highest income whilst the North of England had the lowest. The difference in real income is likely to be less that that implied by the table because of lower prices, for instance for houses in areas outside the South.
Source: adapted from CSO, Regional Trends 1993
Interest Rates
There are four main types of mortgage rate:
- Variable Mortgages
- Fixed Mortgages
- Discount Variable Mortgages
- Capped Mortgages
Interest rates affect houses if these rates are changed. For example if interests increased, home owners will be affected in the following ways:
- Higher debts because they have to return more money to their lenders
- Less borrowing because it has become too expensive
- Increased value of mortgage
- Decreased value of houses
- Less disposable income because they have to spend their income on returning to the lenders
It is the opposite if interest rates fall.
UK rates 'to remain unchanged'
The Bank of England is expected to leave interest rates unchanged for the ninth month running this week.
The Bank's Monetary Policy Committee (MPC) will announce the decision at 12 noon on Thursday.
Earlier, the bank had been expected to raise rates during the second half of the year to cool a red-hot property market and curb persistently high consumer borrowing.
But the chances of a looming rate rise have receded sharply following a string of tepid economic data in recent weeks.
Economists now say the stock market slump and slowing retail sales are likely outweigh the MPC's concerns over galloping house prices, despite a survey from mortgage lender Nationwide showing that annual house price inflation is running at a 13-year high.
Some economists have even called on the MPC to consider cutting interest rates, citing a dip in business confidence and weak economic growth prospects.
Last year, the MPC cut rates by two percentage points to their current 37-year low of 4% in an effort to stave off the worst of global economic slowdown.
Average Property Prices in Different Regions of the UK
The regions of the UK have significant affect on the price of properties. The figure below shows the average price of houses in the different areas of the UK.
Figure 1: House values for identical houses, in identical neighbourhoods, but in different parts of the UK. All of the prices in this example are relative to a £150,000 house in London.
It's not just your neighbourhood that affects the value of your house. Figure 1 shows how identical properties can change in value between different regions, i.e. the same style and size of house, in the same type of area, but in different regions of the UK. For example, if a house in London was sold, and the owner moved to an identical house in the same type of neighbourhood in Yorkshire & Humberside, they could expect to pay 60% less.
However in the UK, there are areas which are not the same and the type of neighbourhood does influence the price of the property. There are many good and bad factors in an area that can affect the price. For example, most buyers would want to move to London as there are many job opportunities, many activities and the environment is fairly well-preserved. Also the fact that it is the capital attracts many buyers which increase the price of the houses. However, houses in the east and in the north are much cheaper because there are not many high paid jobs available because they are far away in the city, crime may be high and education may be low. This lowers the neighbourhood’s rating and so demand for houses in these areas decrease. This caused prices of these houses to decrease vastly.
Size and Type of Properties
Another common factor that all buyers look into when purchasing a house is the type of property it is. Figure 2 shows the potential range in value of a property when just changing its type, leaving all other factors the same. For example, if a semi-detached property was sold, and a detached property the same size, with all the same features, in the same area was bought, it could cost 14% more.
Figure 2: The potential value of a property if only the property type is changed. All prices in this example are relative to a £70,000 detached bungalow.
There is sometimes a limited amount of a property, so the rarity of detached bungalows means that a substantial premium must be paid over other property types. For example, when selling the UK’s most common type of property, a semi-detached house, a detached bungalow with all the same features could secure a price about 17% higher.
The number of bedrooms of a house is also a key issue for property value. However, when increasing the number of bedrooms the value added is limited by the floor space available. To further increase the value, more floor area must be added. For instance, simply increasing the number of bedrooms may in some cases actually reduce the value of a property, since some people may value fewer larger bedrooms. For the country as a whole, if a 2-bedroom property has a third bedroom added, the value of the house may only increase by about 3%. In contrast, if this bedroom was added as an extension, approximately 100 square feet in size, the value of the house would rise a lot more, by around 8% in total.
Prices also become higher for properties with more bathrooms. For two identical properties in the same street, an extra bathroom could add as much as 9% to the price. However, the more bedrooms a property has, the greater the value that is contributed by a second bathroom.
Economic Growth
Economic growth also affects the price of houses. When the economy grows, the prices of houses tend to increase as the demand for houses also increases. An example of a boom in economic growth followed by increase in house prices was between 1987 and 1990.
When there is a slowdown in economic growth or recession, the demand for houses decrease that decreases the price of houses. This happened in 1990 last.
After the recession that caused reduction in house prices, there was economic recovery in the following years from 1992 onwards. However, this had no great bearing on house prices immediately as people had low confidence in a seemingly volatile house market.
The following table shows about how in recent years the economic growth has affected the house prices.
Conclusion
Through looking at my information above and all of my notes I would be accurate in saying that my hypothesis was wrong. As with all things, demand drives up prices. So, the fewer properties on the market coupled with a growing demand for homes will increase demand and buyers start to outbid each other. Also, every one wants to live in the best districts of our towns and cities - so these will always be in demand, without the demand for a product, the product would not be built. As long as there are people living there will always be a demand for accommodation of some sort.
From the project we have learnt many things about today’s economy in the UK. It is shown that consumers do not think about the far future and organise their financial duties on a short-term future basis. This is because consumers can lose confidence very easily and as their income is not getting any higher they become scared and save more instead of spending. This project also helps us to understand that properties in the UK are very important investments and there are many factors to take into account when choosing the right home.
Recent news stories show that house prices are increasing because of the high demand for these houses. The articles above show that houses are selling at their fastest and the supply of houses has also increased because of this.