During an interview with Sky’s Murnghan Show, Mark Carney, current governor of Bank of England expressed that the rise in house prices was the biggest threat to the UK economy. He further expressed that the increase in the approval of house mortgages to the large number of buyers resulted in the need of new buildings in UK. So a study has been made to analyze the different microeconomic and macroeconomic factors affecting the rise in house prices.
In this case of rise in house prices, two most important microeconomic factors are Demand and Supply. By demand we mean the willingness that the consumer wants to buy a particular quantity of good and supply is the production of goods and services that the producer will sell in the market while the other factors remaining same.
Different factors affect demand. Some of the important factors are
1. Income – Increase in income will enable consumers to buy more goods.
2. Quality- Better quality of the goods will encourage consumers to buy more goods.
3. Price- There is an inverse relationship with the demand. As price increases demand would fall and vice versa. For example in case of complement goods like bread and butter if price of one increases demand for the other will decrease.
4. Advertisement- Advertising of goods or commodity can increase the demand of a particular commodity or good.
5. Expectation- One can expect future prices to rise (Blanchard & Johnson, n.d.).
Some of the important factors affecting supply are
1. Price- Supply and price are positively related .This means that the increase in price will lead to an increase in the quantity supplied.
2. Prices of the factor inputs – This is inversely related to the supply i.e. increase in the supply would lead to a decrease in the factor inputs leading a decrease in cost of production (Pindyck & Rubinfeld, 2013).
3. Taxation policy - Increase in taxes reduces supply and increases the production cost due to low profit. On the other hand if there are subsidies, it will lead to the increase in supply and it would be very profitable for the firms (Krugman & Wells, 2013).
However, in this case of rise in house price indicates that the demand for houses is very high.To meet this rising demand, high house price should act as a boost to the builders to increase the supply. This will also lead the owners of houses to spend more and they will have confidence in the economy. If the house price falls, the economy will slow down. In UK, after a long period of recession during the period of 2007, house prices rose at a record level. However there were certain disadvantages as well. It created income inequality and widen the gap between the high income group and the low income group. People, generally with high income can afford to buy expensive houses but those people with low income have to go for a rented house. However the person owning a house will have a much higher rate of return than the economic growth rate which leads to the increase in inequality (Ellis & Price, n.d.). The average house in UK costs around £272,000 (Ons.gov.uk, 2015). It indicates people born in a particular area are unable to buy the houses in that area and have to migrate from one area to another for an affordable home. So the demand here is not sustainable. The laws of demand and supply do not get applied here and there is shortage of supply in the economy. The house builders should have got benefitted due to the increase in price but that is not the case here. Due to scarcity of land, supply here is inelastic which means that the goods and services do not change with the responsive changes in price (Bbc.com, 2015).
These are the changes that can take place from microeconomic point of view.
Macroeconomic factors also play an important role in this scenario. The important factors her are
1. Economic Growth – Increase in income will lead to increase in the economic growth as people will be able to spend more to buy houses.
2. Rate of unemployment – If this rate increases unemployed people would not be able to afford an own house. During recession in UK, a major number of people got unemployed and a fear generated among them to enter into property market.
3. Interest rates – An increase in the interest rate will increase the mortgage payment and ultimately results into lower demand. If there is high interest rate then the owners of the houses will have variable mortgages and this rise resulted into very less fall in the house prices (Mankiw, 2013).
4. Mortgage – It is basically an agreement for a certain period of time specified by the bank the borrower has to repay the money borrowed. Nowadays issuing of mortgages is very easy. It has no as such complication. The easier availability of mortgages has made it easier to buy houses but there are some disadvantages as well. During the time of economic downturn, bank charges high deposit and the lending criteria becomes also very strict (Price, 2008).
In case of UK, during a period of 1996-2006, mortgages were easily available. The bank was ready to give people large amount of money at low deposits. This actually attracted many people to buy their own houses. But however after a period of economic boom UK faced an economic downturn i.e. recession during 2007. So the banks and the builders faced many difficulties in raising money and so they demanded large deposit. This resulted in fall in demand of buying the houses. Another factor which is important here is the confidence of the consumer. If he is not comfortable with the risky nature of mortgages then he won’t be able to buy houses (Rosenthal, 1989).
From this analysis the idea that can be made is that the microeconomic factors are comparatively more important than the macroeconomic factors. Normally microeconomics deal with prices and it is used in determination of prices. So to determine the house prices it is better to use the factors used in microeconomics theory (Jolls, 2010).
Nature of UK’s economy is very unpredictable. Sometimes there is a boom sometimes there is an economic downturn. The government has to overcome the shortage of supply. UK is hugely populous and if this rising house prices continue and it will have an adverse affect on the people who don’t have any kind of residential property. So the property market challenges more to supply than to demand. For a certain period of time if the house prices are raising then it will help the economy to recover. But for a future purpose it would be a great deal of concern. There will be many people who will face a lot of difficulties to pay the housing rent (The Economist, 2015). So now if we consider the macroeconomic factors like growth, interest rate and unemployment we can see that if the interest rates are high then for the first time buyers it would be very problematic to get a house and when the interest rates are low then also the supply of the houses is very limited. The housing demand is income inelastic. An increase in income will lead to an increase of income spent on the houses. Opposite will occur at the time of recession where people earning less amount of money will not able to afford a house in UK and also they will be facing the threat of losing their jobs. They might not be able to make the payment of mortgages and have to return the house to the bank (Wall, n.d.).
From the detail analysis, it can be inferred that considering all the microeconomic and macroeconomic factors, the rising house prices in UK have resulted in the excess shortage supply of houses. So the government should take the responsibility of increasing the supply of houses and reduce the prices to bring stability in the market for the long term. Although this price rise is a positive influence on the economy but just for a shorter period of time. It should also take some measures to control the income inequality gap which will ultimately help in UK’s economic development.
Bbc.com,. (2015). UK economy - BBC News. Retrieved 4 April 2015, from https://www.bbc.com/news/special_reports/uk_economy
Blanchard, O., & Johnson, D. MACROECONOMICS.
Ellis, C., & Price, S. The Impact of Price Competitiveness on UK Producer Price Behaviour. SSRN Journal. doi:10.2139/ssrn.425761
Jolls, C. (2010). Behavioral Economics and the Law. FNT In Microeconomics, 6(3), 176-263. doi:10.1561/0700000038
Krugman, P., & Wells, R. (2013). Microeconomics. New York, NY: Worth Publishers.
Mankiw, N. (2013). Macroeconomics. New York, NY: Worth.
Ons.gov.uk,. (2015). Office for National Statistics (ONS) - ONS. Retrieved 4 April 2015, from https://www.ons.gov.uk/ons/index.html
Pindyck, R., & Rubinfeld, D. (2013). Microeconomics. Boston: Pearson.
Price, G. (2008). Housing law and practice 2010. Guildford: CLP.
Rosenthal, L. (1989). Income and price elasticities of demand for owner–occupied housing in the UK: evidence from pooled cross–sectional and time–series data. Applied Economics, 21(6), 761-775. doi:10.1080/758520272
The Economist,. (2015). British economy | Economist - World News, Politics, Economics, Business & Finance. Retrieved 4 April 2015, from https://www.economist.com/topics/british-economy
Wall, S. Microeconomics.
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