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SBLC4004 Economics For Business

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  • Course Code: SBLC4004
  • University: University Of Wales Trinity Saint David
  • Country: United Kingdom

Question:

Explore the economic issues and challenges facing individuals and firms and understand how resources are allocated in a mixed economy and a command economy

Apply the concepts of elasticity, price, consumer behaviour and utility maximisation to analyse economic issues and problems

Understand market structures and firms’ decisions to supply goods in the context of profit maximisation and gain a strong foundation for a practical problem-solving approach by using the technique of economic analysis

Explore market inefficiencies, social costs and benefits and gain a strong foundation for a practical problem-solving approach by using the technique of economic analysis.

 

Answer:

Introduction 

The United Kingdom has over the years, developed into one of the most highly developed economies in the global scenario with considerable market orientation in the economy.  Being the sixth largest economy in the world in terms of the nominal GDP as well as the ninth-largest in terms of the purchasing power parity, the country has shown impressive growth trends in all the aspects of growth (Capie and Webber 2013). The United Kingdom is the second largest economy in the European Union, with respect to the size of the economy as well as the with respect to the industrial and commercial growth the country has experienced over the years.

Of the different sectors in the economy of the country, the one which has experienced immense dynamics and fluctuations over the decades is the housing sector of the country. With the increase in the boom in the industrial sector of the country, the economic prosperity of the population of the country increased substantially, which in turn also increased the number of people migrating in the country over the years. This upward pressure in the population and income generation in the country contributed considerably in building up the housing sector of the country (Ngai and Tenreyro 2014).  

However, the housing sector of the United Kingdom has experienced immense fluctuations in the last few decades, which can be attributed to the different domestic as well as global incidents, which in turn left lasting impression on the demand and supply situations in the housing market of the country. The implications of these incidents have been more negative than positive, especially post the financial crisis of 2008, which created immense negative repercussion on the economy of the country as a whole and on the housing sector in particular (Wilcox and Perry 2014). Keeping this into consideration, the report tries to analyze the dynamics in the price levels of the housing sector of the country, in the time span of 2006 to 2016 and also tries to discuss the factors working behind the dynamics of the same. It also tries to analyze the implications of the different policies and initiatives taken by the government of the country in order to stabilize the demand supply scenario and also to maximize the overall welfare of the residents of the country, in terms of availability and affordability in the residential investment sector of the same.

 

Housing Sector of the United Kingdom: Overview 

The housing industry in the United Kingdom, as discussed above, has been one of the primary industries which has been facilitated by the economic prosperity of the country and has also contributed in the economic growth of the country (Aron et al. 2012). This can be asserted with the help of the following figure, which shows the sector wise contribution to the service sector productivity growth of the United Kingdom from 2010 to 2014:

Figure 1: Contribution of different sectors in the productivity growth of the service sector of UK (2010-2014)

(Source: Gov.uk, 2018)

As is evident from the above figure, the real estate sector (of which the housing industry forms the most crucial part) has contributed significantly in the productivity growth of the economy of the country over the last few years. However, within the time period of 2006 and 2016, the housing industry has of the United Kingdom has experienced considerable fluctuations and dynamics which have also been reflected in the dynamics of the price levels of the residential assets of the country (Nuuter, Lill and Tupenaite 2015).

Dynamics in the price levels of residential assets in UK 

To measure the dynamics in the price levels of the housing assets of a country, the most commonly used measure is the House Price Index (HPI). The HPI of a country or region usually shows the changes in the prices of single family residences (taken as a unit of measurement in the housing market) in that particular market with time. An increase in the HPI indicates towards an increase in the values of the residences of the concerned place and vice versa (Sá 2015). Taking this into consideration, the HPI of the residential market of the United Kingdom, from 2006 to 2016, can be observed as follows:

Figure 2: The House Price Index of United Kingdom (2006-2016)

(Source: Tradingeconomics.com, 2018)

As is evident from the above figure, showing the House Price Index of the United Kingdom between 2006 and 2016, the prices of the residential assets in the country have been subjected to considerable amount of fluctuations in the first half of the total time span considered. The prices of the residential assets rose impressively till 2008, followed by a massive decline in the late 2008. The decline continued till the later quarters of 2009, with the HPI falling tremendously and attaining its lowest trough in 2009 (Canarella, Miller and Pollard 2012). This was followed by a period of slight increase and stagnate trends in the HPI, with occasional peaks and troughs till 2012, after which the prices started increasing steadily. From the late 2012, till 2016, the prices of the housing assets in the United Kingdom increased impressively, with occasional slumps but with an overall positive trend, as shown by the steady increase in the HPI from late 2012 till early 2016. The HPI however, fell by a nominal 0.1 percent in the late 2016 and early 2017 and there are forecasts that the same is expected to experience even more decline in the coming years (Hilber and Vermeulen 2016).

The fluctuations in the price trends of the housing properties in the United Kingdom between 2006-2010, the stagnation in the price levels from 2010-2012 and the consistent rise in the price levels in the housing market of the United Kingdom post 2012 till 2016, can be attributed to different economic and socio-political reasons, which are elaborated in the following sections of the concerned report.

 

Factors determining the price levels of housing assets in the United Kingdom 

To analyze the different exogenous as well as endogenous factors influencing the buying and selling behaviors in the residential asset market of the country, thereby affecting the price levels of the concerned assets, the total time span of 2006-2016, is divided into two major parts, one before the financial crisis of 2008 and another post the crisis of 2008, taking into consideration the huge fluctuation which occurred in the price of the housing assets of the country, owing to the acute recession and credit crunches at that point of time (Gallent, Mace and Tewdwr-Jones 2017).

Factors affecting house prices before Financial Crisis of 2008:

a) Significant economic growth-One of the major factors behind the continuous increase in the residential asset prices till 2008 can be attributed to the steady increase in the economic growth of the country which reflected in the increase in the amount of income of the residents of the country and in their higher standard of living.

Figure 3: Country wise growth of per capita Real GDP (1997-2007)

(Source: Blogs.lse.ac.uk, 2018)

The rate of increase of the per capita Real GDP of the UK between 1997 to 2007, also attracted people from all parts of the world to migrate to the country in search of higher economic welfare. These factors together contributed in increasing the demand for housing assets in the country, especially in the highly industrial metropolitan areas of the country.

b) Demand and Supply Gap-The increase in the demand for housing assets in the United Kingdom, in the periods prior to the Great Recession of 2007-2008, was followed by a not so huge increase in the supply of the housings. In the short run there was no significant increase in the supply of housings and in the long run also the increase in the supply of housings could not match up with the increase in the demand for the same, which led to an increase in price of the assets, as can be explained with the help of the following figure:

Figure 4: Demand and Supply in the housing market of the UK prior to 2008

(Source: As created by the author)

This less the proportional increase in the supply of housings in the country during that period led to a steady increase in the prices of the residential assets, as can be seen from the increase in the HPI during that time (Hodkinson, Watt and Mooney 2013).

c) Consumer’s Confidence-The increase in the housing assets values, led to the increase in the confidence of the customers of these assets as they started perceiving housings as one of the most fruitful form of long term investments, with the notion that the prices will never go down. This encouraged them to take out more risky mortgages from the lending institutions to buy new residential properties (Farmer 2012). The low rates of unemployment also had positive contributions in increasing the confidence of the consumers, thereby creating a investment bubble in the housing market of the country, exerting even more upward pressure on the price levels of the residential assets.

 

Period of Recession and Stagnation 

Thus, the hike in the prices of the residential before 2008 can be explained with the help of the above factors, which in turn led to higher inflationary pressure in the economy due to a continuously increasing aggregate demand and price levels in the housing market of the United Kingdom at that point of time. The investment bubble did burst in early 2008, owing to the subprime mortgage crisis, which initiated in the USA at that time and percolated to the United Kingdom rapidly. This, in turn led to an acute recession and stagnation in the economy of the country, which led to immense credit crunches in the financial sector (Felstead, Green and Jewson 2012). The unemployment in the country also increased substantially during that point of time, which can be seen from the following figure:

Figure 5: Unemployment Rate in the United Kingdom (2006-2016)

(Source: Tradingeconomics.com, 2018)

As is evident from the above figure, the rate of unemployment, which was substantially low in the economy of the country before the Financial Crisis set in, started rising consistently and remained high till 2013, before the same started decreasing slowly. This in turn led to the fall in the demand for the new housing assets in the country during the period of high recession and economic stagnation, which reflected in the falling HPI of the country during that time (Anundsen and Jansen 2013). The HPI remained at a low level till late 2012 and early 2013, due to the presence of the effects of economic stagnation at that point of time, which can be explained with the help of the demand supply framework of economics, shown in the following figure:

Figure 6: Fall in demand and fall in price of housing assets during Recession in UK

(Source: As created by the author)

Factors affecting house prices in UK post stagnation period (2013-2016) 

With the economy recovering from the recessionary state the HPI again started increasing considerably, with the trend increasing in a decreasing rate in the late 2016. The different factors affecting this dynamics in the housing prices of the country are discussed in the following section:

a) Inflationary Pressure-In the last few years, the overall price level in the country has increased substantially with the fall in the unemployment level and a subsequent increase in the aggregate demand of the economy. This has in turn exerted an upward pressure in the overall price levels in the economy of the country, which is also reflected in the increasing HPI in the housing market of the United Kingdom (Pwc.co.uk, 2018).

b) Fall in the real wage rate-With the increase in the inflationary pressure, the real purchasing power of the domestic currency of the country has been decreasing, which in turn has affected the real wage rate in the country negatively.

Figure 7: Real average weekly earnings in UK (In pounds)

(Source: Hill, 2018)

This fall in the average real wage, has resulted in a widening gap between the house prices in the country and the real wages of the potential customers, the customers being primarily the residents in the country itself, which can be seen from the following figure:

Figure 8: House price to real earnings ratio in UK over the years

(Source: Pwc.co.uk, 2018)

This has, in turn raised the concern of affordability of the housing assets in the country, in the periods post 2013, with the house price to average real earnings ratio rising substantially. The ratio considerably explains the consistent increase in the HPI in the country till the late 2016.

c) Deliberate constraints in the supply of housings-The supply side players in the housing market of the country as well as the financial institutions have become highly skeptic in indulging in increase in the investments in increasing the supply of the housings, after the huge recession which hit the economy in 2008 and which saw huge negative implications on the overall housing market. This skepticism has even increased post the announcement of Brexit, in 2016, which if becomes applicable, will led to walk out of Britain from the European Union. This speculation has led to even more constricted supply side investment in the residential sector of the country, though there is no such evidence of decrease in the demand for housings. This in turn has increased the level of prices of the housing assets in the country even more in the concerned period (Hilber and Vermeulen 2016).

 

Impact of Government Schemes 

The issue of affordability in the housing sector can be considered as one of the primary issues of concern to the policy makers in the country. The primary reason behind the same is that affording a private residence all by oneself has become an immensely costly affair in the country. This can be seen from the following figure:

Figure 9: Age wise percentage of home owners in UK (1981-2014)

(Source: Ough, 2018)

As is evident home ownership has been consistently decreasing in the young age residents and increasing steadily among the residents aged 65 years and above. This in turn indicates towards the problems of affordability, especially among the young residents and the first time buyers.

Keeping this into consideration, the government of the country introduced  various schemes like Help to Buy or Shared Ownership schemes, especially for the first time buyers. Under the former scheme, these buyers are allowed to borrow 20% of the purchase price of a new build house (price not exceeding 600,000 pounds), interest free for the initial 5 years. The percentage of this borrowing is as high as 40% in London specifically. The Share Ownership scheme, on the other hand, helps the residents to buy a share of a home (25% to 75%) and pay rent for the rest of the share (Moneyadviceservice.org.uk, 2018).

These schemes were specifically designed with the objective of reducing the burden of loans and affordability issues of the first time buyers in the housing market of the country. The schemes have however resulted in mixed outcomes for the economy as a whole. On one hand, while the number of first time buyers in the housing market of the country has considerably increased under these schemes, on the other hand these schemes have actually contributed in increasing the prices of the housing assets in the UK even more. This is because with the increasing loan availability and assistance of the government, the demand has also increased considerably, which can be explained with the help of the following figure:

Figure 10: Increase in price due to increase in demand

(Source: As created by the author)

The burden of loans has also increased for the government of the country in the process, which may have negative implications on the economy in the long term, if not addressed efficiently.

Conclusion 

The housing market of the United Kingdom, being one of the considerably significant sectors of the economy of the country, has experienced immense dynamics in terms of demand, supply and price fluctuations, in the time span of 2006-2016. There have been various factors responsible for these fluctuations and for the consistent increase in the average price levels of the housing assets post the recessionary period. This in turn has raised the issues of affordability of the same, especially among the young population and the first buyers in the country. The address the situations, the government has launched several schemes, especially for the first buyers. However these schemes are observed to have mixed implications on the overall well being of the economy of the country in the short run as well as in the long run.

 

References 

Anundsen, A.K. and Jansen, E.S., 2013. Self-reinforcing effects between housing prices and credit. Journal of Housing Economics, 22(3), pp.192-212.

Aron, J., Duca, J.V., Muellbauer, J., Murata, K. and Murphy, A., 2012. Credit, housing collateral, and consumption: Evidence from Japan, the UK, and the US. Review of Income and Wealth, 58(3), pp.397-423.

Blogs.lse.ac.uk. (2018). The UK’s sustained growth between 1997 and 2008 was fuelled by the importance of skills and new technology. Rather than just austerity, the government should focus on building human capital and innovation to support long-term growth. | British Politics and Policy at LSE. [online] Available at: https://blogs.lse.ac.uk/politicsandpolicy/uk-growth-and-productivity-1997-to-2008/ [Accessed 16 Mar. 2018].

Canarella, G., Miller, S. and Pollard, S., 2012. Unit roots and structural change: an application to US house price indices. Urban Studies, 49(4), pp.757-776.

Capie, F. and Webber, A., 2013. A Monetary History of the United Kingdom: 1870-1982. Routledge.

Farmer, R.E., 2012. The stock market crash of 2008 caused the Great Recession: Theory and evidence. Journal of Economic Dynamics and Control, 36(5), pp.693-707.

Felstead, A., Green, F. and Jewson, N., 2012. An analysis of the impact of the 2008–9 recession on the provision of training in the UK. Work, employment and society, 26(6), pp.968-986.

Gallent, N., Mace, A. and Tewdwr-Jones, M., 2017. Second homes: European perspectives and UK policies. Routledge.

Gov.uk. (2018). Budget 2016 - GOV.UK. [online] Available at: https://www.gov.uk/government/publications/budget-2016-documents/budget-2016 [Accessed 16 Mar. 2018].

Hilber, C.A. and Vermeulen, W., 2016. The impact of supply constraints on house prices in England. The Economic Journal, 126(591), pp.358-405.

Hilber, C.A. and Vermeulen, W., 2016. The impact of supply constraints on house prices in England. The Economic Journal, 126(591), pp.358-405.

Hill, D. (2018). London housing crisis: what is it, exactly?. [online] the Guardian. Available at: https://www.theguardian.com/uk-news/davehillblog/2013/oct/28/london-housing-crisis [Accessed 16 Mar. 2018].

Hodkinson, S., Watt, P. and Mooney, G., 2013. Introduction: Neoliberal housing policy–time for a critical re-appraisal. Critical Social Policy, 33(1), pp.3-16.

Moneyadviceservice.org.uk. (2018). Government schemes for first-time home buyers and existing homeowners. [online] Available at: https://www.moneyadviceservice.org.uk/en/articles/help-to-buy-homebuy-and-other-housing-schemes [Accessed 16 Mar. 2018].

Ngai, L.R. and Tenreyro, S., 2014. Hot and cold seasons in the housing market. American Economic Review, 104(12), pp.3991-4026.

Nuuter, T., Lill, I. and Tupenaite, L., 2015. Comparison of housing market sustainability in European countries based on multiple criteria assessment. Land Use Policy, 42, pp.642-651.

Ough, T. (2018). The state of the UK housing market in five charts. [online] The Telegraph. Available at: https://www.telegraph.co.uk/property/house-prices/the-state-of-the-uk-housing-market-in-five-charts/ [Accessed 16 Mar. 2018].

Pwc.co.uk. (2018). 3 – UK Housing market outlook. [online] Available at: https://www.pwc.co.uk/assets/pdf/ukeo/ukeo-july-2016-housing-market-outlook.pdf [Accessed 16 Mar. 2018].

Sá, F., 2015. Immigration and House Prices in the UK. The Economic Journal, 125(587), pp.1393-1424.

Tradingeconomics.com. (2018). United Kingdom House Price Index | 1983-2018 | Data | Chart | Calendar. [online] Available at: https://tradingeconomics.com/united-kingdom/housing-index [Accessed 16 Mar. 2018].

Tradingeconomics.com. (2018). United Kingdom Unemployment Rate | 1971-2018 | Data | Chart | Calendar. [online] Available at: https://tradingeconomics.com/united-kingdom/unemployment-rate [Accessed 16 Mar. 2018].

Wilcox, S. and Perry, J., 2014. UK housing review. Coventry: Chartered Institute of Housing.

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