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Housing Demand and Supply
Demand
• Related to:
– Price
– Income
– Demographics
Hhsize = 2
• HH Size
• “Life Cycle”
Hhsize = 6
High income
Low income
Housing, h
Income Elasticities
• If our income increases by $500, do we
move? Why?
• Economists feel that the appropriate
measure to use is “permanent income,”
related to wealth.
• Permanent income elasticities are probably
somewhere between 0.5 and 1.0. Best
guess may be 0.5 to 0.7. Discuss.
Price Elasticities
• Think back. How did we get price of
housing?
• Is a $100,000 house half as expensive (per
unit housing) as a $200,000 house?
• Presumably price of housing decreases as
you move further out. Why?
• Most estimates of price elasticity of demand
are less elastic than -1.0 (between 0 and -1.0)
Price Elasticity and Expenditures
• Price elasticity is probably around -0.7 in absolute
value.
• Suppose you own a house worth $100,000, and
value is a straight multiple of rents (housing
prices).
• As you move further out, price of housing falls by
20%, and that price elasticity is -0.7. What
happens to expenditures?
• E = (% D Q)/ (% D P).
Price Elasticity and Expenditures
• E = (% D Q)/ (% D P).
• -0.7 = (% D Q) / (-0.2) -- Why?
• 0.14 = (% D Q)
So, we’re buying 14% more housing, at 80% of the
previous price.
New house will cost:
V* = 100 * (1.14) * (0.8)
V* = 91.2.  Our expenditures .
Moving Costs
• Changing housing consumption is costly.
Why?
• You have to MOVE.
– Search costs
– “Adventure in moving”
• O’Sullivan gives one graph. I’m going to
give you a different one.
Suppose
• You just got
married.
• You want 2 kids.
• You expect your
income to go up a
little bit each year.
• Moving is a pain.
• What do you do?
Adjustment w/o
Moving costs
Late y
Early y
Housing, h
BUT
• If you move it
costs you … and
you KNOW it
Adjustment w/
Moving costs
Late y
Early y
• INSTEAD, you
buy a little more,
early …
• And a little less,
late.
Housing, h
What happens?
• You avoid the moving costs.
• Point here, is that households don’t move
every time their incomes change …
• Or every time the housing price changes.
• We want a story that is realistic.
Supply
• Think, for now, of housing as entirely rental stock.
• What do we know?
– It is durable. Dwellings can last for 100 years
or more.
– Most of our housing supply comes from “used”
stock, rather than new stock.
– Supply of services is pretty inelastic. Only 2 to
3% of the housing on the market in any year is
new.
Housing Services and Housing Supply
$ of rent
• Assume owner has
bought the house
new.
• Rents it at $1
per/unit of
services.
• Provides Q*.
Why? Excel - OS_CH14
Revenue
Maximum Profits
Cost
Q*
Quantity of services, Q
Housing Services and Housing Supply
$ of rent
• What happens as
house gets older?
• A> more expensive
to maintain
Revenue
Maximum Profits
Cost
• We provide less of it.
Q**
Q*
Quantity of services, Q
Marginal Analysis
• House ages,
provide less
MC
$
MR
• Price (MR) rises,
provide more
Quantity
Q*