Rent or buy? The challenge of access to housing
Rent or buy? The challenge of access to housing

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Rent or buy? The challenge of access to housing

5.2 The housing market – external influences

Now that you have examined how house prices and quantities of buyers and sellers influence each other, it is also possible to look at external factors affecting either prices or quantities demanded and supplied, which may change the equilibrium position.

Activity 16 The effect of selected changes on the housing market

Timing: Allow about 30 minutes

Watch Video 4, which is the second part of an explanation of the model step by step. It looks at additional factors that may affect the market equilibrium, starting from where we left the model at the end of Video 3. Once you have viewed the video, answer the following question.

Download this video clip.Video player: Video 4: Using a model of demand and supply to understand house prices – Part 2
Skip transcript: Video 4: Using a model of demand and supply to understand house prices – Part 2

Transcript: Video 4: Using a model of demand and supply to understand house prices – Part 2

Using a model of demand and supply to understand house prices – Part 2

NARRATOR
So far, our model has looked at the effect of price alone on the quantity demanded or supplied. To do this, it assumes that everything else that could influence the quantity of housing demanded or supplied is held constant. Economists call this the ceteris paribus condition.
So what happens if we relax the ceteris paribus condition in order to look at the effect that factors other than price might have?
Suppose interest rates in the economy fall, making mortgages cheaper. This does not directly affect house prices in the first instance, but it encourages more people to consider purchasing for the first time or moving up-market.
The quantity of housing demanded is now higher at each and every price. This means that the demand curve shifts to the right.
I’ll call the original demand curve D1 and the new demand curve D2.
Now, more people than before want to buy homes at price Pe. But sellers still only want to sell quantity Qe if the price is Pe. In other words, there is now excess demand at price Pe.
This causes prices to rise along the new demand curve D2, progressively choking off some of the new demand but bringing more sellers into the market as the price becomes more attractive to them, until a new equilibrium price and quantity are reached.
I’ve relabelled the original equilibrium price, Pe1 and the original equilibrium quantity Qe1. The new, higher, equilibrium price is labelled Pe2. The new equilibrium quantity is labelled Qe2 and is higher than Qe1.
So, to summarise, a rise in demand causes upward pressure on prices; the demand curve shifts to the right, meaning that equilibrium price and equilibrium quantity both rise.
Now let’s look at another example of how non-price factors could affect the housing market.
Suppose housebuilders, speculating that house prices will be much higher in five years’ time, decide to halt building new homes for now and just sit on the land that they’ve already bought until the price rise happens.
As a result, the quantity of housing potential sellers are willing or able to supply is now lower at each and every price. This means that the supply curve shifts to the left.
I’ll call the original supply curve S1 and the new supply curve S2.
The number of potential buyers hasn’t changed, so there is again excess demand at the previous price, Pe1.
This time, it’s because not enough sellers can supply houses equal to Qe1 even though that’s the amount buyers want at price Pe1.
This causes prices to rise, progressively choking off some of the existing demand but also stimulating some extra supply – drawing in some of those potential sellers who had dropped out of the market at the previous equilibrium price, which was deemed too low – until a new equilibrium price and quantity are reached at the increased price Pe2 and decreased quantity Qe2.
Notice that, unlike the rise in demand in the previous example, which led to an increase in the equilibrium quantity, the decrease in supply has led to a decrease in the equilibrium quantity.
So, to summarise, a fall in supply causes upward pressure on prices; the supply curve shifts to the left meaning that the equilibrium price rises but the equilibrium quantity falls.
I’ve looked at factors that put upward pressure on prices, but some changes have the reverse effect.
Starting with our original situation with S1 (before the developers withdrew their supply), now suppose the government decides to require firms to use land more efficiently by building homes at a higher density than before – for example, requiring 100 homes per hectare instead of, say, 60. Since land is a large part of the cost of supplying a home, building firms are now willing to provide more homes at every price (the supply curve shifts to the right).
This means there is a rise in supply and this causes downward pressure on prices; the supply curve shifting to the right means the equilibrium price falls but the equilibrium quantity rises.
Equally, downward pressure on prices might be caused by a fall in market demand. You saw before how reduced interest rates may attract more buyers. So, conversely, increased interest rates will reduce the number of buyers as mortgage repayment becomes more expensive.
At every price, there would be fewer people wanting to buy, and so the demand curve would shift to the left.
So, the fall in demand has caused downward pressure on prices; the demand curve shifting to the left means the equilibrium price falls, and so does the equilibrium quantity.
Here is a summary of the four ways non-price factors affect the market.
Notice that a shift in the demand curve causes the equilibrium price and quantity to change in the same way – in other words, both rise or both fall, but, a shift in the supply curve causes the equilibrium price and quantity to change in opposite ways. In other words, if price rises, the quantity falls; but, if price falls, the quantity rises.
End transcript: Video 4: Using a model of demand and supply to understand house prices – Part 2
Video 4: Using a model of demand and supply to understand house prices – Part 2
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Look at Figure 15. The three statements on the right are positioned against the wrong diagrams. Drag each of the statements to the correct demand-and-supply diagram. When you are happy with your answers, select Submit.

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Figure 15  External effects on house prices and quantities demanded and supplied
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