2.0 Higher inflation graph 13
2.1 Gradual recovery in the market graph 13
2.2 Sustained economic graph 14
TABLE OF CONTENTS
- Effect on demand for houses 12
- Impacts of income change 14
- Impacts of costs in renting 15
- Impacts of costs of labour 16
INTRODUCTION
This essay will outline the key factors of supply and demand in the market for new owner occupied housing in the UK and how this forms a market price and quantity sold. It will also analyse how changes in average income, costs of rented housing and costs of tradesmen affect the market for new homes in the UK. Lastly it will give its analysis on why elasticity of demand would be of interest to a local house builder. There will be descriptive material covering all the facts through extensive research of the internet, newspapers, journals and authors recognised within their fields. Where credit is due these will be referenced throughout this piece of work. The material has been scrutinised and then analysed to give my interpretation of supply and demand. Included in this essay will be diagrams, graphs and photo evidence to back up my findings with written explanations where required. Key points considered throughout this essay will be facts that determine supply and demand i.e. price, labour, government initiatives, incomes, social trends, financial influences and economic issues.
The main factors of supply and demand for new owner occupied housing
New owner occupied housing in the UK is at present in a volatile market, mainly to the uncertainties that people are experiencing with their future prospects. “[T]he persistent imbalance in housing supply and demand…is finding intense competition and pricing pressure among homebuilders and other participants in the new home and resale markets.” Mezger J, 2007, CEO ,KB Home. Housing Supply Demand Imbalance. Available at:http://www.calculatedriskblog.com. There concerns regarding their employment on top of income tax increases being implemented next year i.e. the 2.5% increase on VAT or the possibility of interest rates increasing. These and many more considerations have an adverse effect on peoples spending power. Overall concerns have an impact on supply and demand of new owner occupied housing. Contractors and local builders have then to decide when it is feasible and profitable to build. A wrong misinterpretation can cost as little as a few thousand pounds for the local builder or millions for a large contractor. Without demand for housing there will be no need for supply.
See diagram 1.0
The diagram illustrates normal supply and demand.
When supply shifts (Blue Arrow) then price falls from Po to P1
When demand shifts due to people spending habits (Red Arrow)
Prices fall again this time P1 to P2
The housing market in the UK is in a recession at this period in time. This is no different from any other market where supply and demand is the main concern. Supply and demand of property is where the buyer agrees with the seller on the price of the property. Supply within the housing market will always stay inelastic as prices are always fluctuating. Demand depends on many variables which have different outcomes depending on their outcome. When purchasing a property in the UK housing market three options are available 1/ Housing sold from seller to buyer,2/ Purchasing a new property direct from a housing contractor 3/ Building your own (purchases the land, apply for planning permission and supplying your own labour and materials). The latter option had been cost saving too many people as well as well as getting what they wanted. All these options were available throughout the housing boom of 2004 – 2007, until the second quarter of 2008 when the UK entered a period of recession. Of which we are now still feeling the effects of today. Some economists are predicting that we could return to this recession. The reason why the UK and many other countries fell into the recession was the global collapse of the banking system. It was revealed that UK banks in particular had been frivolous with their investments. They were in fact out of control, in issuing loans and mortgages with no thought for their actions. Cases were brought to light on some of these banks, i.e. HBOS being the main offender. Equity of up to 125% of the value of the house was given out. With these loans now highly unlikely to be paid off in the near future, government intervention was introduced. This now means we own our own banks because of the amount of money which was loaned £700million to be precise. Causing difficult times for first time buyers getting mortgages or loans, except for those who could afford to give deposits of up to 25%. It is now understood to be the price of elasticity and demand for housing is elastic.
Diagram 1.1 Table: Illustrates the North South Divide in Property prices.
House Price Index report -
Greater Manchester Council vs Greater London Council
for April in every year
Diagram 1.2
The increased interest in owner occupation came to head in the UK in the late 1980s under Margaret Thatcher’s government who paved the way for social housing tenants to have the right to buy their own home. Owner occupancy within the UK increased by 25% between the years 1961 – 2008, that period of time also saw a decline in rented homes. Falling from 33% to just 14%. These social trends also saw some shifts of change in the way people were choosing to live. In 1971 fewer than one in five (19%) households were single occupancy owned. The figures showing for today is one in three (33%). Married coupled households declined from 70% in 1971 to 42% in 2009 but is still the biggest contributor to occupancy of housing. So looking at those statistics we can assume that personal choice and social trends have a say in supply and demand of new build housing.
Average house prices within the UK have increased by 273% since 1959 equating to an average annual rate of 2.7%, where the average rate for income earnings was 2%. The biggest rise in house prices were in the 2000s where they increased by 62% previously beating the 1980s with 61%. The 1990s were the worst on record where they fell by 22%. Key determinant for demand of housing is low interest rates if they are high then this will suppress the demand. The other is income that is being earned. If income rises then more equity becomes available.
Diagram 1.3 Diagram 1.4
Increase in costs
Diagram 1.3 shows the effects of an increase in costs in the short-run. If construction costs increase CCo to CC1 developers will find construction less profitable and will be more selective in their ventures. In addition some developers may decide not to proceed. The quantity of housing starts will decrease HSo to HS1. This will eventually reduce the level of supply from SHo to SH1 as the existing stock of housing depreciates. Prices will tend to rise from Ro to R1.
Diagram 1.4 on the right illustrates the effects of an increase on demand in the short run. If there is an increase in demand for housing, such as the shift from Do to D1 there will be either a price or quantity adjustment, or both. For the price to stay the same, the supply of housing must increase. That is, supply SHo must increase by HS.
“A change in house price affects the value of household wealth, creating a positive or negative wealth effect. A positive wealth effect means that, following rise in house prices, the ratio of the market value of the property to the debt on that property, typically in the form of a mortgage, rises creating an increase in equity. This can trigger equity withdrawal and can be a significant boost to consumer spending.”
“Changes in interest rates, which are a key policy tool regulate the UK economy, often have a more significant effect on consumer spending in the UK than in other economies. This is due to the relatively large proportion of home ownership in the UK, and the general spending sensitivity of UK consumers to interest rate changes”
The UK housing market P.2 http;//www.economicsonline.co.uk/Competetive_markets/The_housing_market.html. source ONS
Diagram 1.5 Looking at the diagram you can see the percentage of mortgages and re-mortgages given between the first quarter of 2006 and the last quarter of 2008. You can see a gradual decline in the first quarter of 2006 to the first quarter of 2007, then surprisingly a rise from the first quarter of 2007 to the third quarter of 2007. The third quarter of 2007 is very important to remember as this is period of time when the UK banking crisis came to head. It is the time when the government intervened and loaned the banks £700million to stop them from going out of business. As you can see that from that period the third quarter of 2007 saw a sharp decline in mortgages approved; from zero level % to -70% and only slightly recovered in the final quarter.
UK supply of credit for homes
Diagram 1.7
Diagram 1.6 Looking at this diagram. Illustrating the UK interest rates for the period of 1999 to 2008, you can see that in 1999 interest rates stood at 6%. Then in the second half of 2000 sharply lower until 2003, where once again began to rise up to 5.5% 2007 year end. The early part points to a low demand for first time property so incentives of lower rates were introduced. The second half points to a high demand for people to get on the property market especially when interest rates had never been better. At the end of 2007 it shows something was not right. This was the beginning of the credit crunch and ended open credit for everybody.
Recent UK interest rates
Diagram 1.8
Changes in an underlying determinant of supply will shift the supply curve.
Diagram 1.9
To illustrate how supply and demand performed over the last two decades. I have inserted a table of contents along with supply and demand graphs showing how certain periods of time performed.
Worksheet on the Housing Market, p.3of 6,http://www.bized.co.uk/learn economics/housing /demandsupply/worksheets
Contents Table 1.0
Diagram 2.0
1989 - 1994
Higher inflation led to increases in interest rates forcing much repossession from over-borrowing. Recession and increases in unemployment also led to rapidly decreasing demand. High levels of "negative equity" by the early 1990s.
Diagram 2.1
1994 - 1999
Slow and gradual recovery in housing market. Level of negative equity reducing and lower interest rates help to give small increases in demand. Economic growth gradually increasing.
Diagram 2.2
1999 - Now
Sustained economic growth, low inflation and resultant low interest rates start to increase mortgage demand and put pressure on house prices. A low price to income ratio in the earl period helps to drive this. By 2002 house prices are again increasing at record levels - as fast as in the 1988 boom.
Impacts of change in levels of Income
When changes to income come into effect they can be quite significant in the factors of the housing market. In the case of an increase in incomes Demand will increase, Supply will stay the same and Price will increase. This tells me that when everyone is earning a good income it is good for the economy as we tend to spend more. Giving the economy time for recovery, enabling investors to have faith and invest in new buildings such as new housing. When there is new housing everyone feels secure in their lives and is prepared to be more flippant with their incomes. When incomes decrease the scenario is the opposite where effect on demand is decreased, effect on supply is decreased and effect on price is decreased.
Impacts of change in costs of Renting
When changes to rents come into effect they have opposite effects on the housing market and can influence significantly in the way Demand, Supply and Price come in place. As seen in the table above. When rents are increased it normally means that there is confidence in the economy and people are prepared to take risks. In the case of purchasing a new property there will be an increase in demand and an increase on price
Impacts of change in costs of Labour
When costs to labour come into play for housing construction they have surprising effects. In the case of increase of costs the effects of demand become noticeable they increase, effect of supply stay the same and effect on price increase. This is all good for consumer and producer who all benefit. Consumer has growth of investment and the producer with additional profits.
Analysis of Elasticity of Demand
Where do you start and how do you know when it is elasticity of demand. This is essential for anyone who is in the business of selling goods, whether it is a confectioner selling chocolate bars or a building contractor selling houses. We will be looking at the latter as Housing is a larger commodity and more equity can be gained or even lost if figures are calculated wrongly. Firstly what is elasticity of demand; it is when quantity demanded increases by a greater percentage than the price. % ∆ Qd / % ∆ P So if quantity was originally ten and original price was four pounds, what happens if quantity increases by 10 percent and price increases by five percent.
10 + 10% = 11 £4 + 5% = £4.20
10/4 = 2.50 11/4.2 = 2.619
As you see from the sum above it has increased from 2.50 to 2.619 this is known as elasticity of demand.
So if a local builder was seeking to maximise his revenue from a site he was planning to build on he would have to increase the quantity of housing he had originally planned and for the prices of the properties to increase in price also. If he had originally planned to build four houses with a price of £150,000 he would have to build one more house which would make the total of five houses making an increase of + 25% in quantity of original amount. If the price also increased by + 10% then the new price would be £165000. To work out if this elasticity of demand we have to follow the formula already used.
Qty of houses =4/ Price = 1.5 = 2.66
4 houses + 25% = 5 houses / Price = 150000 + 10% = 165000 =1.65 = 3.030
= + 0.3703 = elasticity of demand.
Profit made from this extra house in total is £225000
Sum 4 houses x £150000 = £600000
4 houses x £165000 = £660000
5 houses x £165000 = £825000
APPENDICES
A1 References 19
A2 Further reading 20
References
Mezger J, 2007, CEO ,KB Home. Housing Supply Demand Imbalance. Available at:http://www.calculatedriskblog.com.
The UK housing market P.2 http;//www.economicsonline.co.uk/Competetive_markets/The_housing_market.html. source ONS
Worksheet on the Housing Market, p.3of 6,http://www.bized.co.uk/learn economics/housing /demandsupply/worksheets
Further reading
Essentials of Economics by John Sloman
Construction of Economics by Danny Myers
Financial Times Newspapers
http://www.bbc.co.uk/news/economics
