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Posts Tagged ‘demand and supply’

The housing market: feeling the pinch

According to the Halifax house price index, house prices fell in the UK in the three months to April. This is the first quarterly fall since 2012. The Nationwide index (see below), shows that prices in April were 0.4% lower than in March (although the 3-month rate was still slightly positive).

The fall in house prices reflects a cooling in demand. This, in turn, reflects a squeeze on household incomes as price rises begin to overtake wage rises. It also reflects buyers becoming more cautious given the uncertainty over the nature of the Brexit deal and its effects on the economy and people’s incomes.

The fall in demand is also driven by recent Bank of England rules which require mortgage lenders to limit the proportion of mortgages with a mortgage/income ratio of 4.5 or above to no more than 15% of their new mortgages. It is also affected by a rise in stamp duty, especially on buy-to-let properties.

Despite the fall in prices, this may understate the fall in demand relative to supply. House price movements often lag behind changes in demand and supply as people are reluctant to adjust to equilibrium prices. In the case of a falling market, sellers may be unwilling to sell at the lower equilibrium price, believing that a lower price ‘undervalues’ their property. Indeed, they may not even put their houses on the market. This makes prices ‘sticky’ downwards. The result is a fall in sales.

Eventually, such people will reluctantly be prepared to accept a lower price and prices will thus fall more. Once people come to expect price falls, supply may increase further as vendors seek to sell before the price falls even more. So we could well see further falls over the coming months.

Lower house prices and falling sales is a picture repeated in many parts of the UK. It is particularly marked in central London. There, estate agents have begun to offer free gifts to purchasers. As The Guardian puts it:

London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a ‘burnt-out core’ according to buying agents Garrington Property Finders, prompting developers to offer ever greater incentives to lure buyers.

… Land Registry figures show that in the heart of the city’s financial district, average property prices plummeted from £861,000 at the time of the EU referendum to £773,000 in February, a decline of 15%, although in London’s outer boroughs prices are still up over the year.

But lower property prices are good news for first-time buyers, although some of the biggest falls have been in the top end of the market.

The fall in property prices may continue for a few months. But population is rising, and with it the number of people who would like to buy their own home. Once real incomes begin to rise again, therefore, demand is likely to resume rising faster than supply. When it does, house prices will continue their upward trend.

Articles
UK house prices in first quarterly fall since 2012 BBC News (8/5/17)
UK house prices fall again in April as buyers feel the pinch The Guardian, Angela Monaghan (28/4/17)
Buy a home, get a car free: offers galore as London estate agents struggle to sell The Guardian, Patrick Collinson (3/5/17)
London is now one of the five cities with the lowest house price growth in the UK City A.M., Helen Cahill (28/4/17)
London Housing Market Property Bubble Vulnerable To Crash The Market Oracle, Jan Skoyles (3/5/17)
A key indicator of a healthy housing market is flashing red in London Business Insider, Thomas Colson (29/5/17)

House Price Data
UK House Prices – links to various sites Economic Data freely available online – Economics Network

Questions

  1. Why are UK house prices falling?
  2. What determines the rate at which they are falling? How is the price elasticity of demand and/or supply relevant here?
  3. How does speculation help to explain changes in house prices? How may speculation help to (a) stabilise and (b) destabilise house prices?
  4. Draw a demand and supply diagram to show how house transactions will be lower if the market is not in equailibrium.
  5. Why are house prices falling faster in central London than elsewhere in the UK?
  6. Why are rents falling in central London? How does this relate to the fall in central London property prices?
  7. How has the Help to Buy scheme affected house prices? Has it affected both demand and supply and, if so, why and how?
  8. How do changes in residential property transaction volumes relate to changes in property prices?
  9. What market imperfections exist in the housing market?
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The housing market: an Australian case study of demand and supply

Many countries have experienced soaring house prices in recent years. To find out why, you need to look at demand and supply.

Low mortgage interest rates and more relaxed lending rules in the last couple of years have stimulated demand. In some countries, such as the UK, demand has been further boosted by governments providing increased help to buyers. In others, various tax breaks are given to house purchasers.

Typically the rise in demand has not been matched by an equivalent rise in supply. Social house building has slowed in many countries and building for private purchase has often be hampered by difficulties in obtaining appropriate land or getting planning permission.

The articles linked below look at the situation in Australia. Here too house prices have been soaring. Over the past 30 years they have grown by 7.25% per year – way above the growth in incomes. As the second article below states:

So expensive are homes becoming that the share of median household income devoted to mortgage payments for Australians aged 35 to 44 has more than doubled in 30 years. Incredibly, it’s happened at a time when mortgage rates have slid to their lowest on record.

But why? Again, to understand this it is necessary to look at demand and supply.

Strong population growth combined with easy availability of mortgage loans, low interest rates and tax breaks for both owner occupiers and property investors have stoked demand, while new building has lagged behind. As far as investors are concerned, any shortfall of rental income over mortgage payments (known as negative gearing) can be offset against tax – and then there is still the capital gain to be made from any increase in the property’s price.

But in some Australian towns and cities, price rises have started to slow down or even fall. This may be due to a fall in demand. For example, in Perth, the ending of the commodity boom has led to a fall in demand for labour in the mining areas; mine workers often live in Perth and fly up to the mining areas for shifts of a week or more. The fall in demand for labour has led to a fall in demand for housing.

House price changes are amplified by speculation. People rush to buy houses when they think house prices will rise, further pushing up prices. Landlords do the same. This speculation fuels the price rises. Speculation also amplifies price falls, with people with houses to sell keen to sell them quickly before prices fall further. Potential purchasers, including property investors, hold back, waiting for prices to fall.

Articles
House prices are surging because of low supply – it’s Economics 101 The Guardian, Stephen Koukoulas (27/10/16)
Who’s to blame for rising house prices? We are, actually. Sydney Morning Herald, Peter Martin (27/10/16)
The Price of Australia’s Real Estate Boom The New York Times, A. Odysseus Patrick (17/10/16)
Solutions beyond supply to the housing affordability problem The Conversation, Nicole Gurran (24/10/16)

Data
Residential Property Price Indexes: Eight Capital Cities Australian Bureau of Statistics (20/9/16)

Questions

  1. Identify the specific demand factors that have driven house price rises in Australia.
  2. How are the price elasticities of demand and supply relevant to explaining house price rises? Use a diagram to illustrate your analysis.
  3. What determines the rate of increase in house prices?
  4. Explain what is meant by ‘negative gearing’. How is the tax treatment of negative gearing relevant to the property market?
  5. What are the arguments for and against giving tax breaks for house purchase?
  6. Why are rising prices seen as politically desirable by politicians?
  7. What practical steps could a government (central or local) take to increase the supply of housing? Would such steps always be desirable?
  8. Does speculation always amplify house price changes? Explain.
  9. How are house prices related to inequality?
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Why did so many people buy vacuum cleaners in August?

The Office for National Statistics (ONS) reported that the quantity of retail sales in the UK was 3.9% higher in August than it had been in July. However strong price competition meant that the value of these sales increased by only 0.4%. What were the key factors driving the big increase in the quantity of sales? Was it simply the response of consumers to falling prices?

The data indicated that there was strong demand for goods associated with the housing market such as carpets, fridges and cookers. Spending on furniture increased very rapidly with sales rising by 24% over a 12 month period. Flat packed furniture proved to be particularly popular with consumers.

There was also strong demand for electrical goods and more specifically vacuum cleaners. The ONS estimated that a boom in the sale of vacuum cleaners in August was responsible for 25% of the increase in retail sales.

Why did the sales of vacuum cleaners increase so rapidly in August? Did UK households suddenly decide to keep their houses cleaner? The sales data shows that certain types of vacuum cleaners sold in much larger numbers than others.

For example, Tesco reported a 44% increase in the sales of 2,000 watt vacuum cleaners in the last two weeks in August while the Co-op reported an increase of 38%. Referring to the last weekend in August, the head of small domestic appliances at the on-line retailer ao.com stated that

We saw a huge surge in sales of corded vacuums over 1,600 watts over the weekend, with sales quadrupling.

There were also reports that a significant number of customers were buying more than one vacuum cleaner with these larger motors.

The key reason for the sudden surge in demand was the implementation of new regulations by the European Union as part of its energy efficiency directive. The ultimate objective of this directive is to reduce climate change. The specific policy that appears to have had such a big impact on consumers in the UK was the ban imposed on firms in the EU from making or importing vacuum cleaners that have motors above 1600 watts. This ban came into effect on the 1st September 2014.

A spokesperson for the consumer group Which? stated in August that

If you’re in the market for a powerful vacuum, you should act quickly, before all the models currently sell out. A Best Buy 2,200-watt vacuum costs around £27 a year to run in electricity – only around £8 more than the best scoring 1,600-watt we’ve tested.

The EU plans to reduce the maximum permitted wattage in vacuum cleaners to 900 watts in 2017. Restrictions have already been imposed on bigger electrical appliances such as televisions, washing machines and refrigerators. The EUs Ecodesign directive may also be extended to a range of smaller electrical appliances such as toasters and hair dressers in the future. It’ll be interesting to see if consumers respond in the same way to regulations imposed by the EU in the future.

Ten days left to vacuum up a powerful cleaner BBC (21/08/14)
Housing boom, food discounting and vacuum ban boost UK spending The Guardian, Larry Elliott, Phillip Inman, Lisa Bachelor (18/9/14)
UK retail sales boosted by vacuum cleaner sales BBC (18/9/14)
Retailers sell out of vacuum cleaners ahead of EU ban The Telegraph, Elliot Pinkham (30/8/14)
Power surge! Fourfold rise in sales of super vacuums: Some customers buying two or more models to beat new EU regulations Daily Mail, Andrew Levy (1/9/14)
Energy Efficiency Directive European Commission (accessed on 24/9/14)
Vacuum cleaner splurge pushes up UK retail sales The Guardian, Phillip Inman (18/9/14)

Questions

  1. Using a demand and supply diagram, illustrate what has happened in the market for high wattage vacuum cleaners in August. Pay particular attention in your answer to the role of expectations.
  2. What did your previous diagram predict would happen to the price of high wattage vacuum cleaners in August? Did this in fact happen?
  3. A fully informed rational consumer may purchase a higher wattage vacuum cleaner if they consider that the improvement in cleaning performance is greater than the extra cost of purchasing and using the cleaner. Can you provide an economic rationale for banning the sale of these machines in these circumstances?
  4. Using a demand and supply diagram illustrate the impact of banning the sale of a product in a competitive market.
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Commodity prices fall to four-year low

Commodity prices have been falling for the past three years and have reached a four-year low. Since early 2011, the IMF overall commodity price index (based on 2005 prices) has fallen by 16.5%: from 210.1 in April 2011 to 175.4 in August 2014. The last time it was this low was December 2010.

Some commodity prices have fallen by greater percentages, and in other cases the fall has been only slight. But in the past few months the falls have been more pronounced across most commodities. The chart below illustrates these falls in the case of three commodity groups: (a) food and beverages, (b) agricultural raw materials and (c) metals, ores and minerals. (Click here for a PowerPoint of the chart.)

Commodity prices are determined by demand and supply, and factors on both the demand and supply sides have contributed to the falls.

With growth slowing in China and with zero growth in the eurozone, demand for commodities has shown little growth and in some cases has fallen as stockpiles have been reduced.

On the supply side, investment in mining has boosted the supply of minerals and good harvests in various parts of the world have boosted the supply of many agricultural commodities.

But in historical terms, prices are still relatively high. There was a huge surge in commodity prices in the period up to the financial crisis of 2008 and then another surge as the world economy began to recover from 2009–11. Nevertheless, taking a longer-term perspective still, commodity prices have risen in real terms since the 1960s, but with considerable fluctuations around this trend, reflecting demand and supply at the time.

Articles
Commodities Fall to 5-Year Low With Plenty of Supplies Bloomberg Businessweek, Chanyaporn Chanjaroen (11/9/14)
Commodity ETFs at Multi-Year Lows on Supply Glut ETF Trends, Tom Lydon (11/9/14)
What dropping commodity prices mean CNBC, Art Cashin (11/9/14)
Goldman sees demand hitting commodity price DMM FX (12/9/14)
Commodity price slump is a matter of perspective Sydney Morning Herald, Stephen Cauchi (11/9/14)
Commodities index tumbles to five-year low Financial Times, Neil Hume (12/9/14)
Commodities: More super, less cycle HSBC Global Research, Paul Bloxham (8/1/13)
Commodity prices in the (very) long run The Economist (12/3/13)

Data
IMF Primary Commodity Prices IMF
UNCTADstat UNCTAD (Select: Commodities > Commodity price long-term trends)
Commodity prices Index Mundi

Questions

  1. Identify specific demand-and supply-side factors that have affected prices of (a) grains; (b) meat; (c) metal prices; (d) oil.
  2. Why is the demand for commodities likely to be relatively inelastic with respect to price, at least in the short term? What are the implications of this for price responses to changes in supply?
  3. Why may there currently be a ‘buying opportunity’ for potential commodity purchasers?
  4. What is meant by the ‘futures market’ and future prices? Why may the 6-month future price quoted today not necessarily be the same as the spot price (i.e. the actual price for immediate trading) in 6 months’ time?
  5. How does speculation affect commodity prices?
  6. How does a strong US dollar affect commodity prices (which are expressed in dollars)?
  7. How may changes in stockpiles give an indication of likely changes in commodity prices over the coming months?
  8. Distinguish between real and nominal commodity prices. Which have risen more and why?
  9. How do real commodity prices today compare with those in previous decades?
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