Economic Principles and Decision Making: Housing Affordability Report

This report provides a microeconomic analysis of the housing affordability crisis in Australia. It begins with an introduction to the problem, highlighting the steep increase in house prices, particularly in major cities, and its impact on affordability. The report then examines the movement of house prices in Australia, explaining it through the lens of supply and demand dynamics in a free market, and the factors influencing these forces. It delves into the reasons for increased housing demand, including demographic trends, economic growth, and lower interest rates, while also exploring the factors contributing to the supply shortage, such as slow planning processes and infrastructural challenges. The report further discusses the concept of price elasticity of demand and supply in the housing market. The analysis incorporates relevant figures and data to support the arguments and concludes with a summary of the key findings and implications of the analysis, offering a comprehensive overview of the issue.

Running head: ECONOMIC PRINCIPLES AND DECISION MAKING
Economic Principles and Decision Making
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Table of Contents
Introduction......................................................................................................................................2
Economic issue of housing affordability.........................................................................................2
Analysis of house price movement in Australia..............................................................................5
Reason for increase in housing demand in Australia.......................................................................6
Reasons for supply shortage............................................................................................................9
Concept of price elasticity of demand and supply.........................................................................10
Housing price analysis...................................................................................................................11
Conclusion.....................................................................................................................................12
Reference list.................................................................................................................................13

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Introduction
Objective of the paper is to make microeconomic analysis on one of the economic issues
of Australia. Microeconomic analysis refers to the analysis of a single market using concepts of
demand, supply, price elasticity and others. Demand and supply are the two of primary aspects
describing market mechanism. Demand and supply works independently and determines market
equilibrium corresponding to which price and quantity are determined. Changes in state of
demand and supply lead to a change in position of equilibrium in the market causing market
price and equilibrium quantity to change (Perea, 2017). Affordability of houses is one of the
major problems for Australian economy. Housing price in Australia has steeply increased
making house unaffordable for most people. Increase in house prices is faster in the capital cities
of Australia. Prices have been increased at a greater magnitude than income resulting in an
increase in price to income ratio. The problem of housing affordability due to steep rise in house
prices has been examined in light of housing demand, housing supply and elasticity of demand
and supply. Increase in price of a good is triggered by existence of a shortage in the market.
Higher demand of houses and lack of supply of houses causes shortage of houses (Gurran &
Phibbs, 2016). There are different factors that cause housing demand to increase. Supply of
houses however has not increased at the same pace as demand. The paper investigates different
demand and supply side factors. The responsiveness of demand and supply determines elasticity
in the market. These issues have been discussed in the report using relevant concepts of market.
Economic issue of housing affordability
In Australia, one of the growing problem is increase in homelessness heading the
economy towards a national housing crisis. One significant factor contributing to a nationwide
housing problem is the negative gearing that have encouraged people belonging to middle and

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higher income groups to buy properties. With this demand side pressure house prices in Australia
are on steady surge. Undoubtedly properties in Australia are the most expensive ones in the
world. The five biggest cities in Australia are suffering from severe housing affordability
problem (Killeen, 2019). Sydney, one of the capital cities of Australia was ranked as the second
worst cities in terms of housing price affordability where prices are nearly 13 times more than
median income of household. In Melbourne, house prices are nearly 10 time higher compared the
median income. In other capital cities such as Adelaide, Perth and Brisbane prices were nearly
six times above the median income.
Figure 1: Nominal house prices in Australia
(Source: oecd.org, 2020)

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Figure 2: Median house prices in different caporal cities of Australia
(Source: Lowe, 2020)
As shown by the two above figures that housing price in Australia has increased
continuously both at the national level and in different capital cities since 2000. The rising house
price to income ratio has added to severe housing affordability problem in Australia (Chau,
2018). Almost 30 years’ decline in housing affordability in Australia is considered as the worst
among the advanced countries in the world. After continuous increase in house prices since
2000, price began to decline somewhat since 2017. Despite a fall in house prices, housing
affordability in Australia still remains one major problem for the economy even in 2019. Prices
are even rebounding in Melbourne and Sydney indicating that possibility of reinforcement of
housing affordability in 2020.

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Analysis of house price movement in Australia
Under microeconomic analysis pricing movement in a market is explained by analyzing
the demand and supply scenario in the market. In free market, it is the forces of demand and
supply that determine price of a good. The two group of participants in the free market are
buyers and sellers (Vohra, 2020). The self-interest of buyers and sellers leads to equilibrium in
the market. The behavior of buyers in the market is reflected from demand while the behavior of
sellers is reflected from supply. Willingness of consumers to purchase a good at the given market
price is termed as demand. Willingness of producers to supply a good at the given price is termed
as supply. The independent interaction of supply and demand achieves balancing state in the
market which is known as equilibrium. With no external force, market by itself achieves a stable
equilibrium. Prices in the market work as invisible hand to always restore equilibrium in the
market (Pouw, 2017). The mechanism of equilibrium in a free market is shown in the figure
below.
Figure 3: Equilibrium mechanism in the market

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However, if demand and supply changes due to changes in factors other than price
equilibrium moves from one position to another. With change in equilibrium position
equilibrium price and quantity changes as well. Prices in the market increases because of
existence of a shortage in the market created by inability of existing supply to meet the demand
(Mochrie, 2015). In the context of housing market in Australia, rapid increase in housing price is
explained by the shortage of dwelling supply in comparison to demand pushing the prices the
above. The fast increase in dwellings demand and inability to increase in supply creates a severe
shortage in the market and increases house price.
The factors contributing to rapid increase in demand for housing and restricting supply of houses
are discussed below.
Reason for increase in housing demand in Australia
There are number of different favorable factors that have stimulated demand of home
ownership in Australia. The primary factor boosting demand among Australian residents is the
demographic trend of Australia. In comparison to other advanced countries in the world,
population of Australia has grown at a faster rate. A significant portion of this population is
immigrants. High rate of immigration adds to the pressure on housing demand especially due to
the fact that most of immigrants are young adult (Paris, 2017). In capital cities most immigrants
are coming because of availability of better job opportunities leading to an increase in housing
demand and prices. Another demographic feature causing an increase in housing demand is the
decrease in size of household. Factors causing squeeze of household size are late marriage,
increase in divorce and separation and fewer number of children.

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Uninterrupted economic growth of Australia is one factor contributing to a higher
demand for housing. Demand for a good is determined from income of household. In case of
normal good, people has a tendency to increase demand when demand increases and vice-versa.
An improvement in productivity and boost in export the economy has realized a high rate of
growth. As the economy expands, there is an increase in average income of people. With
expansion of income and wealth there is greater tendency of people to invest in housing (Morris,
2018). The higher income has led to an increase in demand foe dwellings.
The house rent in Australia is growing at a rapid pace. Renting is an alternative of buying
own house. Demand for a product tends to increase the when price of substitute good increases.
The increase in rent has encouraged many renters to purchase their own dwelling. This results in
an increase in demand for houses.
Another factor that adds to an increase in housing demand is the lower interest rate. There
is fall in standard home loan interest rate in Australia. In order to achieve the inflation target
RBA has maintained a very low cash rate (Birrell & McCloskey, 2016). This has led to a fall in
home loan interest rate as well. The low interest rate encourage household to borrow more
money and invest in houses and boosts demand.
Besides lower home loan interest rate another supporting factor stimulating demand for
houses is ease of credit availability. The financial deregulation in Australia has eased the
availability of credit. Besides banking institutions, thee are non-bank institutions supplying loans
for housing. This has helped the residents to boost their demand for houses.
In addition to above factor, in case of housing demand of Australia there is a component
of speculative demand for housing. Houses in Australia are priced as speculative assets. People

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tend to borrow to buy second investment property (Dufty-Jones, 2018). A significant portion of
home loans are accounted by and property investors. Increase in speculative demand for houses
add to an increase in house prices.

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Reasons for supply shortage
Amid with a strong demand for housing the pace of supply growth in housing market is
relatively slow. In order to meet the increasing demand for houses, new residential though have
constructed, the relative size of dwellings to the size of population has been declined resulting in
a shortage of housing (Mulliner & Maliene, 2015). The delay in supply side responses of housing
market is the result of number of several existing issues.
The planning process related to development of new residential is slow. Each stage of the
planning procedure involves a delay which lengthen the entire process of constructing new
residential. Different agencies and departments involved in the planning process lack proper
coordination. Planning standard, policies for assessing development and state and federal
government laws involve uncertainty (Bangura & Lee, 2019) There is unnecessary delay in the
negotiation of different infrastructural requirement and delay from the end of government or
from the utility providers. Other complexity in the planning process include lack of automatic
approval for construction application and opposition against urban expansion. Complex planning
process hinders the supply side expansion of housing market.
Infrastructure has an important role in determining housing supply. Without proper
infrastructural facilities it is not possible to develop residential buildings. Primary infrastructure
required for constructing new buildings include water supply, sewage system, energy supply and
facility of transportation. Previously, state government provides the fund for developing
infrastructure to support housing construction. In the recent decades however the policy has
shifted towards the mechanism of user funding which has led to an increase in private cost of
infrastructure (Gurran & Phibbs, 2015). The high cost of infrastructure is another challenge in
expanding supply. Apart from cost, challenges from infrastructural development include

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uncertainty associated with initial charge of infrastructure. The infrastructural cost as impost of
state councils or utility council vary across the state making is difficult to predict supply of new
houses at the national level.
Supply of land in a nation is limited by its geographic boundary. Therefore, to supply
more land for residential development greenfield lands needs to be converted to the market ready
form. There are impediments in converting the lands given the ownership structure at the city
fringe areas. In many of the capital cities lands are fragmented by the garden style blocks. With
expansion of these cities, the lands have multiple owners making it difficult to consolidate lands.
Another issue related to this aspect is the concentration of land ownership at the city fringe.
Attitude of people towards infill development to increase supply of houses often hiders
supply because of opposition raised by public. The infill development involves complex
procedure of planning. Besides this, proposal of development of new building often receive
community opposition (Phillips & Joseph, 2017). People living the community opposes on the
ground of possible changes that are likely to arise to the suburb character, issues related and to
environment, possibility of increasing congestion, perceived loss in terms of a lower value of
home and others.
Concept of price elasticity of demand and supply
The slope of demand and supply curve depends on the associated price elasticity. Price
elasticity of demand or supply is an estimation method capturing relative changes in demand and
supply in response to price. Greater the elasticity flatter is the demand or supply curve. Demand
or supply curve is steeper if elasticity is smaller (Serrano & Feldman, 2018) The discussion in
demand and supply help to understand the elasticity of housing demand and housing supply.

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In case of housing demand, demand can be changed quickly given change in house
prices. As discussed above people in Australia often considers housing as investment. Therefore,
people change their demand in relation to price. A substitute of home ownership is the rent. If
price of house increases people can switch their demand from home ownership to renting making
demand more responsive to price. Given the speculative demand component of demand, housing
demand is more variable to prices. The demand for houses therefore is elastic in nature indicates
the demand curve is relatively elastic.
The discussion on housing supply reveals there are several impediments in increasing
supply of houses. It usually takes a long period to increase supply of housing. This indicates
supply is relatively less responsive to price. Given several impediments to increase supply of
houses housing supply is relatively inelastic. Because of inelasticity of supply curve of housing
is relatively steep.
Housing price analysis
The analysis of demand, supply and elasticity helps to explain the movement of housing
price. The figure below explains the price movement of houses combining the demand and
supply side factor together. In the housing market the demand is shown by the flat curve dd. Due
to a higher elasticity of demand, demand curve is drawn flatter. Supply curve is the housing
market is shown by ss. Given relative inelasticity of supply, the supply curve is drawn steeper.
Initial market equilibrium is at e (Browning & Zupan, 2020) Respective equilibrium price and
quantity of houses are given as P1 and Q1. Now because of different favorable factors demand for
houses increases and shifts the demand curve right to d1d1. Development of new residences
though increases supply and shifts the supply curve to s1s1, the magnitude of supply increase is
relatively less than demand increase. New equilibrium in the housing market is at e1. As shown

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in the graph below corresponding to the new equilibrium price of house increases to P2 and the
equilibrium quantity of houses decreases to Q2 (Hutchinson et al., 2017).
Figure 4: Price movement in housing market
Conclusion
Research into housing market of Australia finds that housing price in Australia follows an
upward rising trend. House price in Australia though started to fall since 2017 prices still remain
at a high level. This makes housing affordability a big problem in Australia. On the demand side,
factors pushing demand for houses include increase in population growth, higher income, lower
interest rate, greater credit availability and speculative demand of houses. These factors boost the
demand for houses. In response to higher demand for houses, supply of houses has not increased
at the same pace. On the supply side there are some factors that are hindering supply of houses.
Factors causing supply side restrictions holding back the supply of houses include complexity in
the planning process, lack of infrastructural development and high private cost, problem of land
ownership and communal opposition. Quick responses from demand side make the demand
relatively more elastic. Delay responses on the supply indicates inelastic supply. Increase in

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elastic demand and relatively smaller increase in inelastic supply creates an upward pressure on
housing price in Australia creating housing affordability crisis.

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Reference list
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Sydney: a disaggregated approach. Australian Geographer, 50(3), 295-313.
Birrell, B., & McCloskey, D. (2016). Sydney and Melbourne’s housing affordability crisis report
two: No end in sight. Canberra: The Australian Population Research Institute.
Browning, E. K., & Zupan, M. A. (2020). Microeconomics: Theory and Applications. John
Wiley & Sons.
Chau., D (2018) Australian property 'severely unaffordable' by global standards. (2018). ABC
News. Retrieved 26 March 2020, from
https://www.abc.net.au/news/2018-01-22/australian-housing-unaffordability-experts-
disagree-on-extent/9349796
Dufty-Jones, R. (2018). A historical geography of housing crisis in Australia. Australian
Geographer, 49(1), 5-23.
Gurran, N., & Phibbs, P. (2015). Are governments really interested in fixing the housing
problem? Policy capture and busy work in Australia. Housing studies, 30(5), 711-729.
Gurran, N., & Phibbs, P. (2016). 'Boulevard of Broken Dreams': Planning, Housing Supply and
Aff ordability in Urban Australia. Built Environment, 42(1), 55-71.
Hutchinson, E., Nicholson, M., Lukenchuk, B., & Taylor, T. (2017). Principles of
Microeconomics. University of Victoria.

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Killeen, O. (2019) Australia’s housing crisis is everyone’s problem | PBA. Pro Bono Australia.
Retrieved 26 March 2020, from https://probonoaustralia.com.au/news/2019/08/australias-
housing-crisis-is-everyones-problem/
Lowe, P. (2020). The Housing Market and the Economy. Retrieved 26 March 2020, from
https://www.rba.gov.au/speeches/2019/sp-gov-2019-03-06.html
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from https://data.oecd.org/price/housing-prices.htm
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Pouw, N., 2017. An Introduction to Gender and Wellbeing in Microeconomics: Foundations,
Concepts and Policies. Routledge.
Serrano, R., & Feldman, A. M. (2018). A short course in intermediate microeconomics with
calculus. Cambridge University Press.

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