b) Explain the factors influencing optimum size and the significance of demand and supply relationships.
c) Demonstrate an understanding of the relevance and limitations.
The housing market plays a crucial role in the economy. The housing market influences the economy by growth in output, financial market stability and the monetary policy related to the transmission mechanism. A large part of the income of the household can be involved in the purchase of the house which makes the transactions of the house a relevant with respect to the economy. One of the most striking features of the UK housing market is its volatility. Two major booms and busts were experienced by the UK housing market within the last few decades. (Ons.gov.uk, 2015)
Mark Carney, the governor of the Bank of England (BoE) has expressed concern regarding the boom in the property sector in an interview with Sky’s Murnaghan show. This factor is believed to pose a big threat to the economic recovery of the Britain. Then trend in house price reveals that over the past six years, the house prices rose the fastest and have escalated to 8.9% based on a year. The primary cause for the rise in the price of the house is the excess demand for houses and shortage in the supply of houses. The situation can be handled by two relevant factors. Firstly, the bank must be prepared with excess reserves with which it can counter the risks of bad loans which is the result of the deterioration of the housing market in the UK. Secondly, a proper check should be implemented while sanctioning loans and mortgages to individuals and ensure that they are able to repay back. (E-Residentials | Online Estate Agent, 2014)
Causes of changes in the housing market:
There are several factors that affect the housing industry and its pricing mechanism. Some of the causes related to such changes in the housing market are discussed below: (Pettinger, 2011)
Economic Growth- the commodity house is regarded as normal good depicting positive income elasticity. This implies that as income of the individual decreases, people are unable to purchase houses or make the mortgage payments. This leads to the situation where the banks take possession of such houses. UK has experienced a GDP growth in the third quarter of 2014 of about 0.7% which made the economy the fastest growing G7 economy despite the economic slowdown. (Allen, 2014) This implies that the incomes of the households have increased which thereby increased the demand for houses. This ultimately raised the house prices. (Positive Money, 2013)
Unemployment- the employment rate of the UK has risen to 73% which implies that the individuals are employed and are earning. This increase in the income of the individuals led to the increase in the demand for houses which again led to the hike in the prices of the house. (Monaghan and Inman, 2014)
Rate of Interest- the interest rate in the UK market was somewhat stable throughout the year 2014 at about 0.5%. The impact of low interest rate is felt by the individuals regarding their mortgage payments. If the rate of interests were low then the mortgages payment would be less. Thus lower interest would attract more individuals to buy houses. This would create a situation of excess demand in the housing market which will drive up the price. (BBC News, 2014)
Consumer Confidence- the trend in the housing prices is relevant in this respect. The confidence of the consumers regarding the purchase of the houses depends on the anticipation of the rise or fall in the price of the house. If the consumer follows the trend in the house price to be raising them they will be willing to make the purchase. This would drive up the demand.
Availability of mortgage- in the year 2014 there was substantial increase in the availability of mortgage loans. The latest credit conditions report of the BoE reveals that the rise in the mortgage loans is due to the low deposit norms. This increased the demand for houses and raised the price thereafter. (The Guardian, 2014)
Supply- the shortage in the supply of the houses ultimately led to the increase in the price of the houses. Mark Carney was of the view that problem related to the shortage of new houses remain unsolved, even Central Bank was also not able to resolve the issue. It was estimated that the rate of houses was below the count of 200,000 which can be the minimum scale. (Inman, 2015)
Factors affecting the price:
We know that the basic determinants of the changes in the house prices are the demand and supply mechanism of the houses. But these determinants are in turn affected by the macroeconomic and microeconomic factors. It is necessary to analyze different macro and micro economic factors that affect the pricing and purchasing decision in the housing market. Below are some of the macro and micro issues discussed. (Tan, 2015) (Ft.com, 2015)
1. Population growth including the foreign workforce and migration- the estimated population growth rate in the year 2014 in the UK was 0.54%.(Indexmundi.com, 2015) An increase in population always exerts pressure on the housing market. But the shortage of houses and the population growth aggravated the increase in price. According to the Malthusian theory the population is believed to grow at a geometric rate which means that even if the rate of population growth is little, there is not enough accommodation to absorb the new population. (Galor and Weil, 2000)
2. Employment and wage growth- As the employment scenario in the UK has improved; the employment rate has increased which in turn brought about growth in the wages. Thus we can say that individuals now have increased income in their hands which enhanced their credit liability. People will now have the confidence and affordability to take loans and mortgages to purchase houses. Thus creating a situation of excess demand in the economy which will drive up the price in the real estate sector.
3. Construction costs- Several government policies are initiated when the building projects are introduced by the developers. This creates a consciousness among the developers about their project and these delays the building projects. This momentary delay causes a shortage of houses and the ever increasing population puts forward a situation of excess demand which raise the property price.
4. Financing properties- when there is increased availability of mortgages and loans, and then there must be easy and smooth access to it. This can be done by the banks and other financial companies. If the facilities of loan and mortgages are offered through a simple and easy process then people will have easy access to monetary resources to purchase houses. This will enhance the demand and thus cause a hike in the price of the houses.
5. Land scarcity- the ratio of land area to the population explains the fact that there is too much of population and the availability of land area is not that great. This scarcity of land arising due to population growth results in a increase in demand for houses. Thus price of the housing market increased. (McGrath, 2014)
6. Exchange rate- the depreciation of the exchange rate causes the price of the foreign house to rise and an appreciation causes the price of these houses to increase in the foreign countries. Thus there is substantial influence of exchange rate on the price of the housing market.
1. Location and amenities- the accessibility of highways, expressways, hospital, school, banks, markets, shopping mall etc. has a greater influence on the purchase decision of the buyers of the house. A proper and refreshing locality along with required amenities will automatically drive up the price of the house. if the location of the house is not that attractive then the buyer would not be willing to pay higher price for the house.
2. Government planning- government sometimes have greater plans for a particular locality by enhancing the infrastructure. The prices of the house in those areas can be anticipated to increase.
3. Building style- the architectural structure of houses influence the price of the house. The building style which is believed to be unique drives up the price of the house.
4. Taste and preferences- the preference of the house being on countryside or near a mountain hill or across a river can influence the price of the house.
The price of the house is sensitive to the macroeconomic factors but the aspect of the microeconomic influence cannot be ignored.
Challenges of the property market:
The demand and supply conditions determine the level of equilibrium in the housing market. The rise in the price is depicted by a shortage of supply of houses. This aggravated excess demand which caused a hike in the price of the houses in the UK. To drive down the price there is an urgent need to increase the building of houses so that the new population is accommodated. In this regard the macroeconomic factors like economic growth, employment rate, location, government planning was to be considered while making pricing decision of the houses. Thus the problems and challenges in the property markets are affected by the macroeconomic variable as well as the demand and supply side of the market. (Economicsonline.co.uk, 2015) (UK Parliament, 2015)
The report is formulated based on the interview of the governor of Bank of England, Mark Carney and his concern regarding the housing market in the UK. The rise in the price is due to the shortage in the supply of houses. Thus measures should be taken to increase the supply of houses in the country by offering subsidies to the private property developers, relaxing the regulations of the house building, providing tax concession for certain house building areas etc. It is also important to regulate the demand of the houses in order to maintain equilibrium in the economy. To stabilize the housing market other macroeconomic factors are also required to be maintained. (Galati, Teppa and Alessie, n.d.) (White, 2014)
Allen, K. (2014). UK on track to be fastest growing G7 economy despite slowdown. The Guardian. [online] Available at: https://www.theguardian.com/business/2014/oct/24/uk-economic-growth-slows [Accessed 21 Feb. 2015].
BBC News, (2014). Rates 'to stay at 0.5% this year'. [online] Available at: https://www.bbc.com/news/business-25561477 [Accessed 21 Feb. 2015].
Economicsonline.co.uk, (2015). UK house prices. [online] Available at: https://www.economicsonline.co.uk/Competitive_markets/House_prices.html [Accessed 21 Feb. 2015].
E-Residentials | Online Estate Agent, (2014). E-Residentials | Online Estate Agent. [online] Available at: https://www.e-residentials.co.uk/#!Mark-Carney-House-Prices-Biggest-Risk-To-Economy-/cky5/6B899536-9302-452E-AB1E-FDCEF3931DAF [Accessed 21 Feb. 2015].
Ft.com, (2015). UK house prices: In depth news, commentary and analysis from theFinancial Times. [online] Available at: https://www.ft.com/indepth/uk-house-prices [Accessed 21 Feb. 2015].
Galati, G., Teppa, F. and Alessie, R. (n.d.). Macro and Micro Drivers of House Price Dynamics: An Application to Dutch Data. SSRN Journal.
Galor, O. and Weil, D. (2000). Population, Technology, and Growth: From Malthusian Stagnation to the Demographic Transition and Beyond. American Economic Review, 90(4), pp.806-828.
Indexmundi.com, (2015). United Kingdom Population growth rate - Demographics. [online] Available at: https://www.indexmundi.com/united_kingdom/population_growth_rate.html [Accessed 21 Feb. 2015].
Inman, P. (2015). Mark Carney: rising house prices pose biggest risk to recovery. The Guardian. [online] Available at: https://www.theguardian.com/business/2014/may/18/mark-carney-house-prices-risk-economy-bank-of-england [Accessed 21 Feb. 2015].
McGrath, M. (2014). UK faces 'significant' land shortage. [online] BBC News. Available at: https://www.bbc.com/news/science-environment-28003435 [Accessed 21 Feb. 2015].
Monaghan, A. and Inman, P. (2014). UK unemployment falls below 2 million for first time since financial crisis. The Guardian. [online] Available at: https://www.theguardian.com/business/2014/oct/15/uk-unemployment-falls-6-percent-lowest-lehman-brothers [Accessed 21 Feb. 2015].
Ons.gov.uk, (2015). House Price Index, December 2014 - ONS. [online] Available at: https://www.ons.gov.uk/ons/rel/hpi/house-price-index/december-2014/stb-december-2014.html [Accessed 21 Feb. 2015].
Pettinger, T. (2011). Factors that affect the housing market | Economics Help. [online] Economicshelp.org. Available at: https://www.economicshelp.org/blog/377/housing/factors-that-affect-the-housing-market/ [Accessed 21 Feb. 2015].
Positive Money, (2013). House prices: why are they so high? | Positive Money. [online] Available at: https://www.positivemoney.org/issues/house-prices/ [Accessed 21 Feb. 2015].
Tan, A. (2015). Macro And Micro Factors That Make The Property Market Tick | Propertylogy. [online] Propertylogy.com. Available at: https://www.propertylogy.com/knowledge/macro-and-micro-factors-that-make-the-property-market-tick/ [Accessed 21 Feb. 2015].
The Guardian, (2014). Mortgage price war expected as UK lenders fight for market share. [online] Available at: https://www.theguardian.com/money/2014/oct/07/mortgage-price-war-uk-lenders-market-share [Accessed 21 Feb. 2015].
UK Parliament, (2015). Housing supply and demand. [online] Available at: https://www.parliament.uk/business/publications/research/key-issues-for-the-new-parliament/social-reform/housing-supply-and-demand/ [Accessed 21 Feb. 2015].
White, A. (2014). Nationwide: House prices rise but so do mortgage rejections. The Telegraph. [online] Available at: https://www.telegraph.co.uk/finance/property/house-prices/11197402/Nationwide-House-prices-rise-but-so-do-mortgage-rejections.html [Accessed 21 Feb. 2015].