Economics is the study of how markets work. It is based around describing the patterns and interrelations of the production, distribution and consumption of goods and services. Microeconomics is concerned with the economics of individual decision making. By understanding the rational for individual-level decisions, microeconomics helps to provide insight into the specific patterns of production, distribution and consumption that we see in society.
Two key points in microeconomics are the law of supply and the law of demand. The law of supply holds that all other things being equal, as the price of a good increases, supply of that good will increase. This is because producers can increase their profits, and produce more in order to do so. The law of demand holds that all other things being equal, as the price of a good increases, demand for the good will decrease. An important underlying factor in the law of demand is the concept of utility. Utility is the value that a consumer gains from a product or service. That value is often difficult to measure quantitatively, but is known qualitatively as utility — what the consumer gets out of the bargain. Rational consumers will only purchase a product if the utility they expect to gain from that product exceeds the cost of that product. Thus, as the price of the product increases, fewer consumers will find that the product delivers more value in utility than the cost of the good. As a result, demand for the good decreases as the price increases.
The New Housing Market — Factors to Consider
When we look at the new housing market, there are a number of different factors that go into a change in supply. Generally, supply is led by expected demand in the new housing market. Because of the high sunk costs, and the inability to move the finished product, developers only build when they expect to sell, so all three of those factors play into the supply decision. In addition, into the decision, since governments must license land for development. There is a balance between offering ample land for development (which developers like to see — ease of access to a key input) and too much access to land, which risks market saturation.
The factors that have an impact on demand are perhaps more complicated. The prevailing price of new homes is important. This means that all the costs associated with a new home purchase are a factor, including interest rates. Indeed, interest rates are a key driver in new housing demand because of their impact on total purchase cost. New home sales fell, however, , indicating that there are also other factors at work. One such other factor is the expected state of the economy. Home ownership is a long-term commitment, so buyers want to feel comfortable not only that they can afford home ownership today but that they will be able to afford ownership in the future as well. If there is a risk that one of the family members will lose his or her job, that will add risk to the purchase decision. The riskier the purchase decision, the lower the price will need to be in order to compensate for that. Another factor here is the expected change in housing prices or interest rates. Buyers are inclined to enter the market if they believe that the cost of home ownership will be higher next year, but they may delay purchases if they believe that costs will be lower next year.
With last summer, the dip could be in part due to worries about a double-dip recession. The summer was characterized by an inane fight over the debt ceiling, something that shattered confidence of many in the political system, and some of the key actors within that system. A fractured political system is one that is less likely to spur economic growth, so there was cause for pessimism, and that pessimism could well have driven people out of the housing market. The threat of further rounds of layoffs in corporate America, and the realization that interest rates are not going to increase any time soon could easily suppress demand.
Other Potential Factors.
In addition, if the conditions of economic recovery are tenuous but housing prices increase significantly in a short period of time, that could also impact negatively on purchase decisions. The reason for this would be that the utility of home ownership may have increased only slightly in comparison with the cost of home ownership, the result being a decline in demand. Additionally, if concerns about the state of the economy or political discourse increase the wariness of banks, they might tighten their credit policies. There might not be any decline in endogenous demand for new housing; the decline might be in the availability of financing, which is a complementary product, but one that is essential to almost all new housing purchases.
In addition, there is a substitute for new housing, and that is the secondary market for housing. Changes in the conditions of that market can impact on the conditions in the new housing market. Older housing stock might be considered to be better value by those who are a home. Consumers are going to choose the good with the highest utility, and if that is older housing stock, then new housing demand is going to fall as a result.
Works Cited:
Hauser, C. (2011, Aug 24). Sales of new homes fell again in july. , pp. B.6-B.6. http://search.proquest.com/docview/884825381?accountid=35812
