The determination of price in the housing market is based on demand and supply, therefore the price the seller is willing to sell the property to the buyer and the price the buyer can afford and willing to purchase the property. If there is a great demand for property in a locality then the seller has a greater amount of power than if there is a large supply of properties with little supply then the power shifts to the buyer. Demand can be affected by internal and external factors which will be mentioned later.
Demand and supply (Increase in demand)
Diagram 1.
Housing demand can increase, due to an increase in the local population, rise in incomes from lower unemployment. Supply of housing is relatively inelastic because of the time lag between a change in price and an increase of supply of new property becoming available or sellers deciding to put their house up for sale. When demand moves outwards and the supply is inelastic, then there will be an increase in the market price over a small expansion in the number of houses.
The Terrorist attacks on 11th September 2001 had little to no impact. Despite many predictions by economists of a slowdown, low interest rate policy of the Bank of England, headed by Sir Edward George, kept housing in demand. This highlights the importance of interest rates in regards to demand for housing.
Slow economic growth and weak financial markets, has meant interest rates will unlikely move significantly upwards from their twenty-five year lows in order to promote growth within the UK. One reason why people were attracted to buying a house at the moment is because of the low interest base rate. As the interest rate has increased recently (November 2003) due to an increase in economic growth will this have an impact on house prices.
The cut in interest rates from 7.5% in October 1998 to 5% in June 1999 was said to be a major factor in the acceleration in housing market activity during the summer of 1999. Equally the series of increases in interest rates from 5% in June 1999 to 6% by February 2000 helped to take some of the excess demand out of the market, and to curb the steady house price inflation during the summer of 2000.
When there is a cut in interest rates the lower mortgage rates should stimulate an increase in new mortgage approvals and generally cause an expansion in housing market activity.
Interest rates can affect consumer expenditure. If we have low interest rates we are more inclined to borrow money for buying houses (mortgage). From the AD graph you can see that if we spend more then GDP rises. If the government increases the interest rates we will get more money back when we save. This will slow down the economy because consumer does not spend as much.This can be seen on the AD graph if we decrease consumer expenditure the AD goes down and so does GDP.
This graph shows that the interest rates affect the economic growth through supply and demand.
Diagram 2.
Diagram 2. shows the proper pattern that the theory suggests between inflation and GDP or output. This is because interest rates directly control investment. Investment controls supply and demand. When interest rates goes down demand goes up and output goes up.
Diagram 3.
Diagram 3 shows a positive correlation between employment and economic growth. This is that as the GDP increases although not on the same level all the time employment increases as well. This is obvious because when economic growth increases firms are producing more so therefore there are more jobs. On this graph there’s one large exception during the boom years of 1988 to 91. During the years 88 to 93 the levels of employment rose at a much higher rate than the GDP. This is where the boom bust economic cycle did not create true employment, because GDP did not increase with the increase in employment.
Diagram 4.
“New house building peaked at over 414,000 in 1968. In 2002 only 170,000 new homes were built in Britain, slightly above the 2001 figure, which was the lowest total of new homes built in any year since 1947.”
Nationwide press release 2002
Wales (89%) and East Anglia (70%) have the greatest number of new detached houses being built, new detached homes in Greater London account for less than 1% of new homes. Halifax estimates that if the current low level of new house-build continues, there will be a major shortage of homes in the UK by the year 2020.
Diagram 5.
These figures from Nationwide show from 1982 there has been a steady growth in UK house prices. In 1999 and 2000 there was a jump in house prices in the UK. House price inflation rocketed to over 15% by the early summer of 2000 before beginning to soften as higher interest rates and increased taxes on house purchase started to have their effect.
Diagram 6.
Diagrams 5 and 6 show that as interest rates decrease over time, the price of housing increases. Therefore it seems that interest rates have a direct link on demand for housing.
Diagram 7.
Diagram 7. shows a negative correlation between the base interest rates and the housing market. High interest rates increase the cost of a mortgage (if not fixed) if variable with the base rate and reduce the demand for types of housing. Low interest rates should stimulate higher market demand and would increase house prices.
This should increase consumption associated with house buying and the rise in prices will increase total housing wealth. You can only see this when you take into account the time lapse between a change in interest rates and the change in house prices. In 1995 there was little change in house prices however a steep decline in the base rate meant a jump in house prices. There is a time lag between the two variables as it takes time for demand to increase.
Real income is a key determinant as living standards increase, the total demand for housing increases, as does the demand for more expensive properties. Employment levels have a significant impact on housing demand as low income levels provide a barrier to enter the housing market.
Government policies affect the demand for housing .Stamp duty puts a tax on a property when you sell it. It depends on how much you pay according to the value of the property, which is mainly affected on properties that are worth over a certain amount (£250,000), this would increase demand in some regions mainly poor areas where you do not need to pay stamp duty as an incentive or would reduce demand if the 3% level was increased to deter people from expensive properties. .
A shortage of good quality housing in the housing market would in many areas force up the value of properties. Restrictions on the supply of building land, such as the southeast where demand for housing is usually strongest.
Loughton in Essex has had large increases in house prices, according to a survey by the Halifax. Prices have increased by 75% over the last twelve months(2002/03) property now costs £298,413 on average. The Halifax found that there is a large increase in house prices outside London. Due to better communication links outside of London, improvements in technology and the changes in the way we work(telecommunication) have meant that cheaper property outside of London has become more attractive therefore increasing the demand of these properties.
Rented accommodation is the alternative to buying. If the cost of renting accommodation went down then the demand for it would rise. This would cause a fall in demand for buying houses, as people would be more inclined to buy a house rather than rent it. The price of rented accommodation is going down, while the price of housing is clearly going up. In the future this may cause house prices to crash, however rented accommodation is usually for a different market such as those who need temporary accommodation or those who cant get through the barrier to obtain a mortgage.
Diagram 8
The affordability of houses has increased due to interest only mortgages in 1992 where only the interest is paid off and so the consumer has to pay out less money. This has increased the demand for housing.
Diagram 9.
Diagram 9.shows the increase supply of consumers that are able to obtain loans to afford buying a house where with a limited supply of housing as mentioned above this will lead to an increase in housing to satisfy demand.
Diagram 10.
Diagram 10 shows that due to the low interest rates of the last decade there has been a gradual increase in house price inflation, the governments reaction to reduce this was to increase interest rates (November 2003). Based on the OPDM index, UK nominal house prices (in Q1 2003) were 99.6% higher than when they peaked in the late 1980s, whilst real house prices were 29.2% above their late 1980s peak. In London, nominal house prices were 117.9% higher and real prices 34.3% higher than their peak in the late 1980s.
Conclusion
Investment is one of the causes of a shift in aggregate demand. If aggregate demand increases then this may cause inflation. This is because more is demanded than is supplied so the price of housing goes up. Interest rates are set by the MPC to keep the balance between amount demanded and amount supplied.
Interest rates affect supply and demand. This is because investment is affected by interest rates that is directly related to supply and demand. Investment causes a shift in demand. When this happens both the price level i.e. inflation gets higher and so does the real national output or G.D.P. When inflation is changed like this it is called demand-pull inflation.
The determination of house prices is largely linked to interest rates as this can effect employment levels control inflation, and consumer expenditure. This is because if house prices increase households who want to buy houses will want higher wages to compensate for the extra cost of living thus leading to inflation.
Interest rates can be linked to economic growth, the lower the interest rates the greater the economic growth will be therefore higher levels of employment will mean increased income and therefore a greater demand in housing which will push the price of housing up. Economic growth can be slowed down simply by increasing the interest rates thus reducing consumer expenditure.
Government intervention can have an impact on house prices such as a reduction in percentage taxed on wages, lower taxes, right to buy, stamp duty, all have an effect on the types of property which will be in supply and through demand as more people will be able to afford housing.
Changes in the structure of financial institutions with there flexibility has meant that more people are able to obtain mortgages, and buying houses has become more affordable for households on average. Therefore if there is a lack of supply of new housing this will mean that demand will increase.
In general the price of housing has gradually gone up in the last decade at about the same level as real GDP. The problem with predicting house prices is that there will always be a time lag between a change in any of the variables mentioned above as well as fashions that can change within the housing market as consumers may want to leave cities and move to rural areas (counter urbanisation). Sudden events like terrorist attacks where economists will predict a slow down may have little effect if the economy if the economy is fertile for growth, all it will do will scare some into waiting to see what others will do.
Bibliography
Books:
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2. Mullard M., Understanding economic policy Routledge, London
3. Conway J., Housing Policy 2000 Gildredge Social Policy Series, Gildredge Publishing Eastbourne Sussex
4. Gibb K., & Munro M., Housing Finance in the UK 1991 Macmillan Education Ltd London
5. Kemp P., & Keoghan M., Movement Into and Out of the Private Rental Sector in England 2001 Housing Studies Volume 16
6. Liddiard M., Dr. Home Truths 1998 (Jones and MacGregor et al.) Social Issues and Party Politics Routledge
7. Maclennan D., Housing Supply 1982 Longman Group Harlow Essex
8. Malpass P & Murie A. Housing Policy and Practice 5th Edition 1999 Macmillan Press Ltd, London Para 5 Page 81
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Internet:
http://www.tutor2u.net/sub_economics.asp#housing
http://www.hbosplc.com/view/housepriceindex/nationalcommentary.asp