Economics for Managers: Housing Price Analysis

This report analyzes long-run trends in housing price growth, focusing on the Australian market and Melbourne specifically. It examines factors influencing housing prices, such as inflation, debt-to-income ratios, and population growth. The report assesses whether Melbourne's housing market is overheated, considering demand and supply dynamics. It also explores the impact of a buyer's tax on equilibrium prices, consumer and producer surplus, and social welfare. Furthermore, the report discusses housing policies in other countries and suggests measures to stabilize Melbourne's housing market, such as adjusting credit standards and regulating rental properties. The analysis includes graphical representations of market equilibrium and surplus changes due to taxation.

ECONOMICS FOR MANAGERS
Article: Long-run Trends in Housing Price Growth
Student
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Question 1: Summary of the article “Long-run Trends in Housing Price Growth”
This article (Kohler, 2015) examines all the factors that drive the long-run trends in the housing
price growth of Australian market over the past three decades. Growth was observed in the 1980s
in the housing prices and this growth was in line with the general price inflation in the Australian
economy. Then, in the next decade of 1990-2000, the housing price growth was relatively strong.
This was due to the significant rise in the debt-to-income ratio of the households in Australia.
Finally, since the mid of 2000, the housing price growth has been explained by the strong growth
in the population of the country.
The article (Kohler, 2015) says that one of the most important assets that the Australians hold is
the housing. When the prices of the houses change, there are many economic variables that are
affected in the economy. This is because; any change in the price of the houses affects the
balance sheets of the households as well as the balance sheets of the banks. The writer of the
article has found that in the past 30 years, there has been increase in the housing prices of
Australia by almost 7 percent. Since the 1980s to the 2000s, the prices have increased and there
are different reasons for this growth. For instance, in the 1980’s, the prices rose due to high
inflation, in the 1990s, the prices rose due to the significant rise in the debt-to-income ratio of the
households in Australia and in the 2000’s, the increase in the prices can be attributed to the
growth in the rate of population of the country. Therefore, it is clear that there are some factors
or drivers that have an impact on the long-run housing price growth.
One of the drivers that this article (Kohler, 2015) talks about is the demand and the supply of
houses that determines their prices. The prices of the housing depend on the interaction of
demand and supply. When the demand of the houses is more than the supply, then the prices
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increase. This happened in the 2000s when the population of the country increased. With the rise
in population, the demand grew more than the supply and hence the prices rose. Another driver is
the rate of inflation. This is simple and straightforward because inflation is the rise in general
price level and with the rise in the price level, the prices of the houses rise too. Opposite to the
inflation, there is disinflation, which is also one of the factors affecting the prices of houses.
These are the long run factors that affect the housing prices. The article also talks about the
short-run drivers that affect the housing prices for the shorter periods. These are the cyclical
factors. These factors include the monetary policy, the mortgage interest etc.
Thus, the article has analyzed the factors that influence the growth of housing prices in Australia.
The writer has mentioned that with the general inflation, the prices of the houses got inflated in
1980s and the prices were relatively high and volatile. Then, in the next decade, the people got
easy access to the finance which led to rise in the debt to income ratio of the households.
Finally, in the 2000s, the population grew, the immigration was high and thus the demand for the
new dwellings exceeded the supply.
In the end, the article predicts that the situation in which increase in the household debt
supported the rise in the housing price growth is very unlikely to happen. But, the factor of the
supply of house can become a reason for the inflated prices if the supply starts to respond to the
changes in the demand of houses.
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Question 2: Assessing the housing prices of Melbourne as being overheated or not
The economy is said to get overheated when it has such a high productive capacity, that it cannot
keep a pace with the growing aggregate demand (Keynes, 2015). The overheated economy gets
identified when the rate of economic growth of the country is above the general trend and the
growth is happening at the unsustainable rate. Also, in the overheated economy, the rise of
inflation rate is observed as a result of the prolonged growth rate of the economy. At this time,
the production happens in the excess capacity and thus they create the excess production
capacity. The main thing due to which this overheating occurs is the insufficient allocation of the
supply because when the people spend excessively and the consumer’s wealth increases, then the
demand increases more than the supply (Vohra, 2016).
The article shows the signs that the housing prices of Melbourne are overheated. This is because
in the 1980’s the inflation of the economy was high that increased the demand and thus increased
the prices of the houses. Also, the supply was not able to adjust to the demand shocks when the
demand for the houses rose due to growth in the population as well as due to the growth of the
wealth of the consumers. The main cause of the overheated prices is the increase in the levels of
aggregate demand. In Melbourne, the demand was high which overheated the prices. Also, in the
short run, the aggregate demand exceeded the long run aggregate supply which is again a cause
for the overheated prices. When the demand for the houses rises more than the supply, there is
need for over employing the resources like the workers are required to be employed for extra
shifts (Girouard, 2006). But, this is unsustainable because the over employment of the resources
cannot be supported till an indefinite period. The housing prices in Melbourne are rising and they
cause a threat to the economic and financial stability of the country (Ge, 2015).
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The data of Melbourne shows that over the past 20 years, the inflation was low and stable here
and the target of the inflation was 2-3 percent. But, the growth in the housing prices outstripped
the inflation in the prices in the economy that included the cost of new houses as well. In the
1990s, the growth in the housing prices was more than that in 1980s. One of the reasons behind
the rise I the houses price was the improvement in the quality of the houses. But, the prices have
increased by a considerable faster pace than even the value of the new dwellings, including the
improvements in the quality. In the past 25 years in Melbourne, there has been increase in the
demand for the housing more than the supply. Thus, both the points, i.e. the rise in the process of
the houses and the rise in the demand more than the supply shows that the prices of the houses
are overheated.
Also, from the 1990s to the mid-2000s, the growth of population in Australia was very low as
compared to the previous few decades. But, after the mid-2000s, the immigration in Australia
increased, many people started to walk in Melbourne. This increase in the population increased
the demand for the new houses. There was also a gap between the demand and supply of the new
houses, the demand as higher than the supply which made the prices of houses rise further.
Thus, the economy shows all signs of overheating. The growth in the demand for houses in
Melbourne was such that the productive capacity could not keep its pace with that, there was
high level of economic growth in the country and the allocation of the supply of houses was
insufficient to meet the demands of the people. But in future, the country can expect a decline in
the average economic growth, the demand pull inflation may happen, the increase in the prices
may reduce the aggregate demand and that will lead to a reduction in the level of consumption of
the houses by the people.
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Question 3:
a. The impacts of buyer’s tax on the equilibrium housing prices, consumer surplus,
producer surplus, and total surplus (or social welfare).
The Melbourne’s housing market is perfectly competitive (i.e., there are many real estate
developers). The city government decides to levy a buyer’s tax (specific tax) on housing
purchases. This will have an impact on the equilibrium housing prices, consumer surplus,
producer surplus, and total surplus (or social welfare).
Impact on the equilibrium housing prices:
In the below given figure 1, the demand and supply of the houses in Melbourne intersects at
point A. this is the equilibrium point where the quantity of the houses and their prices are fixed.
The price of the houses is ‘P’ and the quantity is ‘Q’. Now, when the tax is levied, the demand of
the houses will fall because it will become expensive for the people to buy the houses as the tax
will increase the prices of the houses (Varian, 2014). But, the supply of the houses will rise
because when more tax will be collected by the government, the construction will rise and the
producers will create more houses. So, in the figure given below, the LM tax is levied which has
shifted the demand curve ‘D’ to ‘D1’ and the supply curve ‘S’ to S1’. So, the new equilibrium
has moved from ‘A’ to ‘A1’, the quantity of the houses demanded has reduced and the prices
have increased. This shows that when the buyer’s tax is levied, there is rise in the level of
equilibrium housing prices.
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The consumer surplus, producer surplus and the total surplus
The figure given below shows the consumer and the producer surplus as well the total surplus.
Consumer Surplus = Value to buyers – Amount paid by buyers
Producer Surplus = Amount received by sellers – Cost to sellers
Total surplus = Consumer surplus + Producer surplus or = Value to buyers – Cost to sellers
The demand the supply intersects at point A which is the equilibrium price and the quantity of
the houses. This equilibrium is without any tax. So the consumer surplus is the shaded area
above the price line, i.e. the area enclosed by XPA and the producers’ surplus is the shaded area
below the price line, i.e. the area enclosed by YPA. When the tax LM is levied, then the price
that the buyer will pay as a result of this tax is P2 and the seller will receive a part of this tax
which is represented by P3.
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Impact of tax on the consumer surplus, producer surplus, and total surplus (or social welfare):
When the tax LM is levied on the buyers, they pay certain price and the sellers receive certain
price which is described in the above given figure. When the tax is levied, the government
receives a portion of the spending of the buyers (Greenleaf, 2015) which is represented by B+D
in the figure given below. Now the price that the consumers pay is P2 instead of P so the
consumer surplus has been reduced to box A. Also, the price that seller receive has been declined
from P to P1 because the government takes a share of the spending by the consumers. So, there is
decline in the producer’s surplus too which is represented by the box F in the below given figure.
Also, there is reduction in the total surplus from XOY to A+B+D+F and C+E shows the
deadweight loss.
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Thus, with the buyer’s tax, the consumer, producer and the total surplus reduces.
b. An impact of the increase in the buyer’s tax on the social welfare
It is clear that when tax is levied, there is reduction in the social welfare and the deadweight loss
occurs. Now when this rate of tax increases (as shown in the figure 4 with the LM line shifted to
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left which shows that the size of tax has increased), there has been further reduction in the social
welfare. This is because the box of consumer surplus and producer surplus has reduced in size.
The main reason for this is, when the amount if tax gets increased, there is increase in the prices
and the buyers have to pay more which reduces their surplus further. Similarly, when the buyers
pay more taxes, the government captures more of their spending and hence the sellers are not
able to earn much, which reduce their surplus. Hence, overall picture shows that increase in the
buyer’s tax has a negative impact on the on the social welfare as it deteriorates further.
c. An impact of the increase in the buyer’s tax on the city government’s tax revenue
When the tax is levied on the buyers, the government gets a portion of their spending. But, when
this tax is increased, the prices of the houses increase too and the people buy less. So, overall,
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the total revenue of the government decreases if the buyer’s tax is increased the size of the
market shrinks. In the above figure 4, LM was levied but, the rate of LM increased which shifted
it to the left and hence it can be seen that the size of the total revenue of the government B+D has
been shrinked from the previous figures. In a nutshell, for the small tax, tax revenue is small. As
the size of the tax rises, tax revenue grows. But as the size of the tax continues to rise, tax
revenue falls because the higher tax reduces the size of the market.
Thus, the increase in the buyer’s tax reduces the city government’s tax revenue
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Question 4: The countries or economies that have housing policies or measures to stabilize
the housing markets
There are many countries that have well-established housing policies that help in stabilizing the
housing markets. US and UK are two of the countries among them. In the US, the federal
government provides subsidies to the consumers for buying the houses, so the prices are
regulated (Schwartz, 2014). Also, the government in this country regulates the buildings that are
built for houses; the service provision is regulated too along with the occupancy. When the
production of the houses is regulated in the form of structure of the building, occupancy etc.,
then the demand for the houses will not be generated in the excess and the supply will also
remain constant. Thus, the prices will be regulated. Therefore, there will not be much impact of
the inflation or the economic growth on the prices of the housing in US and thus, the housing
markets will remain stabilized in the country. In the country UK, the fiscal centralization is there
and there is rigid system of planning which is extraordinary (Bromley, 2013). Due to these
policies, the supply of the housing remains unresponsive to the changes in the prices of houses.
Again, this helps in stabilizing the housing markets.
Views or suggestions on the best measure to stabilize the housing markets that could be
considered or used in Melbourne:
To stabilize the housing markets in Melbourne, the credit standards for the people who seek to
buy homes should be increased. This will make difficult for them to apply for the credit and
hence buy the houses. Thus, the demand will reduce up to the level of supply and the equilibrium
will be reached. The insufficient supply will no longer remain in the economy of Melbourne.
Then, Melbourne should also do something about the foreclosed properties. The people should
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