What Affect the Housing Supply and Demand?

One of the natural behaviors of humanity is that everyone hopes to be perfect in life. To makes life become easier and perfect, human tends to have unlimited wants. Due to the limited resources, we can’t fulfill all the unlimited wants. Market equilibrium point is formed when the demand curve equals to supply curve, which is the best determinant to fully utilize or avoid wastage of the resources that satisfies the plans of buyers and sellers. According to an article “Housing supply and demand – are we nearing equilibrium?” from Star Online, published on 26^th November 2011 (http://biz.thestar.com.my/news/story.asp?file=/2011/11/26/business/9974676&sec=business), the article states that the main determinants of the demand for housing are demographic whereby the core demographic variables are the population size and population growth. An increase of population will affect the demand and supply of houses in a market. How does it really affect the market equilibrium in both short-term and long term? As we know, land is getting scarce and it is not easy to get a permitted license for house development as well. It takes time for the developer to look for lands to build houses; procedures are needed and it takes time for developer to get a permitted license from government as well.

Graph above is showing the relationship between quantity of house (x-axis) and price of house (y-axis) in Malaysia. Initially, the market equilibrium point is set at the point e1 with the equilibrium price P1 and the equilibrium quantity at Q1. When there’s an increase of population, people will demand more for the house because everyone needs a shelter. Therefore, demand curve will move to rightward which is from D1 to D2. New market equilibrium point is formed at e2 with the increasing of both equilibrium price and equilibrium quantity, which is from P1 to P2 and Q1 to Q2. This is because the demand of house has increased but the supply of house is remained due to scarcity of land as well as insufficient of house developer in the short-run. Things might be happened differently in the long-run. Let’s assume that the government gives more licenses to the developer and quantity demanded for the house is still remained high in the long-run. Due to an increase of price of houses in the short-run, more suppliers come into the market as they believe that this is a good opportunity to earn more revenue. Hence, supply in the market will increase. Let say when the supply increase is less than the increased of demand due to the scarcity of land. In this situation, supply curve will shift to left which is from S1 to S2, whereby the shifting is not as big as the demand curve because of the limited of land available. Eventually, new market equilibrium point will be formed at e3 whereby the equilibrium price will decrease from p2 to p3 and the equilibrium quantity of house will increase from Q2 to Q3 after the increase of supply.

Besides the changes of population in a country, change in income is also one of the factors that will affect the market equilibrium point. An increase of personal income able to increase the purchase power of an individual and vice versa. In other words, a change in income will affect an individual’s buying plan, which is also called as income effect. Figure below is an assumed example of increased in price of house itself because of the greediness of developer tends to makes more money while the income of the citizen remain unchanged.

Initially the price of houses is set at P1 and the quantity demand of houses is set at Q1. Supposed that the developer set a higher price for the houses because they want to earn more while the income of the citizen remain the unchanged. An increase in price of houses itself will only result a movement along the curve whereby price of houses will increase from P1 to P2. Some of the buyers are not affordable to buy the houses after the changes because their income is still remain unchanged. Therefore, the quantity of demand for the houses will decrease from Q1 to Q2.

Besides the changes of demand, changes of supply will also affect the market equilibrium. As for supply, the typical factors that change supply of houses are the cost of production, price of existing stock of houses, and the technology used in the construction. For example, an increase of cost of production will reduces the revenue of the supplier. Hence, supplier will decrease the supply of house to solve the issue. Eventually, this will affect the market equilibrium because equilibrium of price and quantity will no longer the same after the increased of housing price. On top of that, short-run supply tends to be price elastic whereby increase in cost will have more effect to the supply. When the cost of production for building houses is higher, firms will cut down the supply of houses. If this is the case, problem such as lack of house due to the cut down of supply will happened.

According to the article, due to the factors that keep affecting the demand and supply for housing, policy intervention is needed to ensure the majority of the population has equal access to own homes. Nevertheless, I disagree with this statement as policy intervention will bring a negative effect to the market too. Below is an example in an economical graph. Assume that if government imposed price ceiling on the housing market.

A price ceiling occurs when government set a legal limit on the highest price of a good that can be in a market. An effective price ceiling will be set below the natural market equilibrium point. From the figure above, the price ceiling is set below the equilibrium market price (P2) which is at P1. Any price above P1 is illegal. This action will increase the quantity of housing demanded. Due to the exceeding of quantity demanded over the quantity supplied, there is a shortage on the housing market which is at the range from Q1 to Q3 stated above (QD>QS). When there’s a shortage in the housing market, search activity increases and it is costly when this activity is involved. It will be a loss for both consumer and producer which is located at the box B on the above figure. This is because the total of surplus for the consumer and producer had been cut down from the area A,B,C,D to C,B,D; they have to bear the losses in the area A. Furthermore, a shortage of housing creates an illegal trading in black market housing. This is because most of the sellers are not willing to sell their house at the price set by the government as it is too low for them and it’s a loss to them. Therefore, buyer and seller will make an illegal arrangement whereby the price of house will be higher than the price set by the government, which is at the price P2, P3, and P4. A price ceiling set below the equilibrium price leads to an inefficient underproduction of housing service. The marginal social benefit (DD) of housing exceeds the marginal social cost (SS).  As a result, both consumer surplus and producer surplus will be decrease and it is called as deadweight loss in the shaded area A.

To avoid market inefficiency in the housing market when the policy intervention is involved, I suggest solution such as deregulation to be proposed. This can avoid thing like black market happens in the housing market. Nevertheless, when there’s a government intervention on the housing market, it is preferable to carry a research towards the housing market accurately. This is to ensure the supply and demand in the housing market is checked before any decision is made by the government. By doing this, objective of increasing home ownership among the majority of the population can be achieve.