Worksheet on the Housing Market (Tutor Version)
This worksheet looks at the factors affecting supply and demand in the housing market and goes on to examine the way in which prices have changed in recent years. It should be possible for students who have grasped the basic principles of supply and demand to complete the whole worksheet; there is no use of elasticity.
Step 1 - Supplying the demand and demanding the supply?
The main determinants of demand and supply are:
| Determinants of demand | Determinants of supply |
|---|---|
| Price of the good / service | Price of the good / service |
| Income | Costs of producing the good / service |
| Price of substitutes / complements | Objectives of the firm |
| Tastes | Profitability of alternative products |
| Expectations of future price changes | Shocks |
With the buying and selling of houses there may also be additional factors that affect people's supplying or demanding decisions. The main determinants of the demand and supply of houses may include: (there could be a wide variety of answers here - students may also pick up on the differences between new and second-hand houses)
| Determinants of demand for houses | Determinants of supply of houses |
|---|---|
| Price | Price |
| Income / level of economic activity | The price of land |
| The level of rents | The cost of building materials |
| Interest rates | |
| Expectations of future price increases | |
| The ratio of income to house prices |
Step 2 - When are houses in equilibrium?
The events will have the following effects on the level of demand, supply and price.
| Event | Effect on demand?? | Effect on supply?? | Effect on price?? |
|---|---|---|---|
| Increase / decrease / stay same? | Increase / decrease / stay same? | Increase / decrease / stay same? | |
| 1. There is a shortage of skilled bricklayers | Stay same | Decrease | Increase |
| 2. There is an increase in the rate of economic growth | Increase | Stay same | Increase |
| 3. Rent levels increase significantly | Increase | Stay same | Increase |
| 4. New environmental regulations reduce the amount of building land available | Stay same | Decrease | Increase |
| 5. People's tastes change and they prefer to rent houses instead of buying them | Decrease | Stay same | Decrease |
Use the above examples and try to identify on the diagram below, the point that the market will end up at following each change. The initial equilibrium is at X.
| Event | New equilibrium point |
|---|---|
| 1. There is a shortage of skilled bricklayers | C |
| 2. There is an increase in the rate of economic growth | A |
| 3. Rent levels increase significantly | A |
| 4. New environmental regulations reduce the amount of building land available | C |
| 5. People's tastes change and they prefer to rent houses instead of buying them | B |
Step 3 - How do you pay?
Buying a house takes far more money than most people usually have available, and so they often have to borrow. The internet site Houseweb (http://www.houseweb.co.uk/house/index.html) gives some background on the ways in which this can be done. Browse the site to find the answers to the following questions:
What is a mortgage?
A loan from a bank, building society or other financial institution for the purchase of a house. The loan is usually "secured" against the property; meaning that if the borrower fails to meet the loan payments the lender can repossess the property to recover their money.
What is the difference between a fixed rate and variable rate mortgage?
A fixed rate mortgage is one where the interest rate is kept the same for a certain period of time. This means that the payments are fixed for that time. This may be good for borrowers who want to know that their payments will stay the same for a while to help them budget for the mortgage. A variable rate means that the interest rate is changed to reflect the financial conditions prevailing in the economy.
One of the key determinants of demand for houses is the interest rate. Why is this the case?
Because most people finance the purchase of a house by borrowing. A high interest rate means high loan repayments and will therefore suppress the demand for houses.
Step 5 - Is your rate interesting?
INTEREST RATE - The cost of a mortgage is set by the rate of interest that is charged on it. This may be set for a certain number of years, but will normally vary. To find out how interest rates have changed, go to the Office for National Statistics (ONS) data on Biz/ed (http://www.bized.co.uk/dataserv/ons/data/data.htm). N.B. Look under the monthly data for the interest rate.
From this data identify periods over the last decade where you might have expected demand to be high, and where demand might have been low.
| High demand? | Low demand? |
| In periods of low interest rates (and high economic growth) | In periods of high interest rates (and low economic growth) |
INCOME - Of course the interest rate is not the only determinant of demand for houses. Another important one will be the level of income that people have. The faster the level of income people earn is growing the more money they have to invest in their houses. The overall level of income in the whole economy is known as GDP (Gross Domestic Product) and so if we look at the behaviour of that we can see how the level of income on average has grown.
Go once again to the ONS data on Biz/ed (http://www.bized.co.uk/dataserv/ons/data/data.htm) to fill in the table below for the level of economic growth over the last decade. (You will need to calculate this as the percentage change in GDP, but use GDP at constant prices to remove the effect of inflation).
In the third column identify how you would describe the performance of the economy in that year from the four words given, and in the fourth column put what effect you would expect that level of growth to have on the demand for houses.
| YEAR | ECONOMIC GROWTH | Boom / Recovery / Recession / Slowdown ?? | Effect on demand for houses ?? Increase / Decrease / Stay same ?? |
|---|---|---|---|
| 1987-1989 | High | Boom ("Lawson Boom") | Increase |
| 1990-1992 | Low | Recession | Decrease |
| 1992-1995 ish | Moderate | Recovery | Increase - but only very slightly due to high level of negative equity |
| 1995- | High | Sustained growth | Increase - reduced negative equity leading to recovery in the housing market |
Step 6 - Priceless properties?
This step considers how prices have changed in practice, and what factors may have influenced these changes. One of the best sources of information about house prices on the Internet is the Halifax House Price Index. This gives information on how house prices vary from area to area and how they have changed over time.
Use the Halifax House Price Index (http://www.halifax.co.uk/) to try to find out the following:
| Current index value | |
| Index base year (when value was 100) | |
| Most recent monthly change | |
| Annual % change | |
| Price of an average house |
How much have average house prices gone up since the base year of the index?
This should be calculated by taking the change in the value of the index from the base year in 1983 (1983=100), to the present value.
There is a worksheet on index numbers (http://www.bized.co.uk/learn/economics/macro/indnos/student.htm) that looks at what they mean and how to calculate them available on Biz/ed.
Use the Halifax House Price Index (http://www.halifax.co.uk/) once again to try to find out the following:
| Average house price in: | Terraced house | Detached house |
|---|---|---|
| North | ||
| Greater London | ||
| West Midlands | ||
| Your home area |
How do the prices in your home area compare with the other areas?
Students may want to look at the prices in their home area in more depth. The Halifax Index classifies houses according to age as well as according to area and so they may be able to examine those trends as well.
What factors may have caused these differences? What differences are there in demand and supply between your area and the other areas?
Students should aim to look here at why their area may be cheaper / more expensive than others. They should aim to consider issues like:
- The level of employment in the area
- The pattern of industry
- Land prices and the intensity of land use
- Planning restrictions (Green Belt / Conservation etc.)
- The "feel" / "desirability" of the area
- Regional income levels
- Cost of living in that area
Use the annual price increase section of the Halifax House Price Index (http://www.halifax.co.uk/) to try to find out the price changes of the average level of property prices in your area between the following years:
| Years | House price | % Price change |
|---|---|---|
| 1989 | £50,000 | ******** |
| 1994 | ******** | |
| % change from 1989 - 1994 | ******** | |
| 1999 | ******** | |
| % change from 1994 - 1999 | ******** | |
| House price now | ******** | |
| % change from 1999 - now | ******** |
They should hopefully discover a fall in house prices for 1989-1994 and slow recovery of prices from 1992 until 1999. After 1999 and particularly from 2001 onwards they should find a considerably more rapid perios of growth - particularly in 2002. However, the exact results will clearly vary according to the area they have chosen and so the results may need a little interpretation. Altering the years of the area may yield results that are clearer.
Show on the diagrams below the changes that you think have been taking place during these years, and write a short description below the diagram.
1989 - 1994
Higher inflation led to increases in interest rates forcing many repossessions from over-borrowing. Recession and increases in unemployment also led to rapidly decreasing demand. High levels of "negative equity" by the early 1990s.
1994 - 1999
Slow and gradual recovery in housing market. Level of negative equity reducing and lower interest rates help to give small increases in demand. Economic growth gradually increasing.
1999 - now
Sustained economic growth, low inflation and resultant low interest rates start to increase mortgage demand and put pressure on house prices. A low price to income ratio in the earl peiod helps to drive this. By 2002 house prices are again increasing at record levels - as fast as in the 1988 boom.