Monday, 6 March 2017

Housing Crisis : Supply vs Demand In Colour

In the top graph we have a snapshot of the UK housing market, with 27 million dwellings being supplied at an average of £220K each.  At £100K this represents the capital only constituent of that average home. 

The bottom graph shows the results of two different ways to bring down average house prices (and rental incomes). 

The most popular option is to increase the supply of housing. Demand 1 stays the same, while supply is shifted to the right to position 2. The pink area shows the added costs resulting from this. 

The unpopular option is to reduce demand by a recurring tax on the rental value of land(location). Supply 1 stays the same, while demand is shifted to the left to position 2. The blue area shows the reduced costs resulting from this. 

Of course in my graphs I've made all sorts of assumptions/guesses about supply/demand elasticity which gives the following results.

The difference in the number of houses is 12 million x average capital cost £100K = £1.2trn

The numbers don't really matter, but the principle does. Given economic policy should be about reducing costs, why on earth do so many economists recommend policies that increase them?


Mark Wadsworth said...

I';ll have to think about that.

I think it's better to assume 27m homes as our starting point with zero cost.

If the Faux Libs are correct* and increasing supply causes prices to fall uniformly, then maybe increasing supply to 33 million would cause price to fall to £100k. Demand is price insensitive so a small increase in supply = large fall in clearing price.

So that's a 6 million x £100,000 cost = £600 billion, let's just focus on the area to the right of the current equilibrium.

* They are wrong, as the Spanish and Irish experience shows, most of the extra 6 million new homes would stand empty, be sold for firesale prices etc, the downward impact on prices in places where people want to live would be barely affected and might increase in some places.

Ben Jamin' said...

@ MW

I think I've heard it quoted that there is about a 1% reduction in selling prices for every 100,000 extra homes built.

To get down to £100K average, would necessitate plenty of empty stock driving land values negative in large areas of the UK.

On the demand side, obvs the number of dwellings couldn't realistically drop below the number of households (say 26 million), but the equivalent number of bedrooms could be reduced to 2.2 per dwelling from 3 for owner occupiers.

Ok that wouldn't save £600bn in costs, but it would save something.

Dinero said...

I dont think these type of charts are correct.

They show quantity demanded at different prices but they dont include and allow for the effect of buyer demand on the price. And so on these charts, shifting supply to the right reduces price , but in reality buyers bid up small amounts of extra supply to the previous price level, and so more supply results in no price change.

Bayard said...

BJ, you also have to factor in the effect of decades of rising prices. Much of the demand is driven by the fact that land has been a good investment. Once land starts going down in value for more than a very short crash, which the public consciousness can ignore, this demand will dry up, leaving only the demand for land as somewhere to live, which is likely to be considerably less, if history is any guide.

Even if the Faux Libs model of supply and demand was accurate, you would still need the housebuilders to build more houses than they could sell in order to get the price down and no-one is going to be the one that does that and makes a loss. If you apply this idea of reducing prices by overproduction to any other industry, you can see how laughable it is and how everyone strives to avoid precisely that situation.