5.1 A model of the housing market

Maximise

Figure 14 The model here is a simplified version of the housing market.

Show description|Hide description

The image shows a row of identical newly built houses.

Figure 14 The model here is a simplified version of the housing market.

Because a model is a simplified picture of some aspect of the real world, when we model the housing market here, we are going to ignore many of the complexities of the actual markets for housing. These complexities include:

• regional variations
• the distinction between new-build homes and currently occupied properties offered for sale
• the divisions that in reality exist between the markets for properties in widely different price bands.

We ignore these complexities in the interests of gaining insight into the general principles of the impact of demand and supply on property pricing.

However, in order to give a realistic sense of such a simple model, you could imagine a medium size, relatively newly built town where all the houses are the same, with all potential buyers paying an identical price – which can however vary up and down at different times. On the supply side, there might be a number of sellers wanting to move out, depending on average market prices and some new houses could be built if conditions are favourable.

Activity 15 Identifying equilibrium price and quantity

Timing: Allow about 30 minutes

Video 3 is the first part of an explanation of the model step by step, in order to build your understanding of the main concepts used in a demand-and-supply model. Watch the video now, then answer the question that follows.

Download this video clip.Video player: Video 3: Using a model of demand and supply to understand house prices – Part 1

Show transcript|Hide transcript

Transcript: Video 3: Using a model of demand and supply to understand house prices – Part 1

Using a model of demand and supply to understand house prices – Part 1

NARRATOR

The model of demand and supply looks at the relationship between the price and the quantity of something that buyers will want to buy and sellers will want to sell.

The amount of property that people are willing and able to buy will depend on current prices.

If prices are high (measured on the vertical axis), relatively few people will be willing and able to buy (measured on the horizontal axis).

If prices are lower, far more people will be willing and able to buy.

The relationship will hold across the whole range of prices – the lower the price, the greater the number of people who are willing and able to buy.

Each dot in the diagram is an example of a price and the corresponding quantity demanded. If we join up the dots, we have a line that traces the relationship between every price and quantity demanded. This is called the demand curve.

Because we are looking at the market for housing as a whole, it’s called the market demand curve.

The next step in building our model of the housing market is to consider the supply side of the market.

If prices are low, relatively few properties will be offered for sale. If prices are higher, more potential sellers will appear.

This relationship will hold across the whole range of prices – the higher the price, the greater the number of people who are willing to sell. Each dot in the diagram is an example of a price and the corresponding quantity for sale.

If we join up the dots, we have a line that traces the relationship between every price and quantity for sale. This is called the supply curve. And since we are looking at the market as a whole, it is called the market supply curve.

Now we can bring together the demand curve and the supply curve onto a single diagram. We can now see that there is only one price at which the quantity people are willing and able to buy equals the quantity people are willing to sell.

This is the equilibrium price, to which we can give the convenient shorthand label P (for price) subscript e (for equilibrium).

The quantity demanded and supplied at this price is the equilibrium quantity, which, using the same convention, we can label Q (for quantity) subscript e (for equilibrium).

Before we go further, it’s important to note that the demand curve is not a record of the quantity of homes that have actually been bought at different prices over time. Similarly, the supply curve is not a record of the actual quantity of homes that have been sold at each price. Rather, they are the amounts that people would like to buy or would like to sell at each price. We cannot observe these amounts; we can only estimate them.

This means that every buyer who was only willing to buy at a lower price than the equilibrium price is out of the market.

Similarly, every seller who was only willing to sell at a higher price than the equilibrium price, is also out of the market.

To summarise what you have learned so far about the demand and supply model, you now know that: • The demand curve usually slopes downwards from left to right. • The supply curve usually slopes upwards from left to right. • The equilibrium price is the price at which the amount people want to buy equals the amount people are willing to sell – in other words, at the equilibrium price, demand equals supply.

End transcript: Video 3: Using a model of demand and supply to understand house prices – Part 1

Download

Video 3: Using a model of demand and supply to understand house prices – Part 1

Interactive feature not available in single page view (see it in standard view).

Open the interactive figure below in a new tab or window.

Drag and drop the letters to the corresponding point of the diagram that fits best the description.

View interactive version

How buyers and sellers interact

Show description|Hide description

The diagram shows a vertical axis labelled ‘Price’ and a horizontal axis labelled ‘Quantity’. A line representing the market demand curve runs from top left to bottom right of the graph. Intersecting it at right angles, to form an ‘X’, is a line representing the market supply curve, which runs from bottom left to top right of the graph. There are four points indicated on the graph. One is at the intersection of the curves. Another is above and to the left of the intersection, higher up the market demand curve. The third point is above and to the right, higher up the market supply curve. The final point is below and to the right of the intersection, lower down the market demand curve.

How buyers and sellers interact

Interactive feature not available in single page view (see it in standard view).

Discussion

Point B corresponds to the equilibrium price that satisfies the same quantity (number) of buyers and sellers.

The excess number of potential sellers (quantity D minus B) have dropped out as they would have liked to sell at a higher price than at B and the excess number of potential buyers (quantity A minus B) have also dropped out as they wanted a lower price than at B.

Potential buyers at C would have been happy to buy at price C but as there were too many potential sellers at that price (price at C and price at D is the same: same horizontal dashed line) so that the price was reduced, attracting more potential buyers and making some potential buyers drop out until the number of willing buyers increased and the number of willing sellers decreased and they reached the equilibrium position B at a lower price.