Supply is the quantity of goods that a supplier wishes to sell at each possible price whereas demand is the quantity of goods that a buyer wishes to buy at each possible price. Price is determined by equilibrium in demand and supply.
For housing, supply market depends upon various factors such as:
Availability of land - easy and profitable land availability enhances the supply.
Government policies - strict policies discourage suppliers.
Cost of building material - higher cost of material lowers the incentives for suppliers, unless house prices rise proportionally.
Opportunity cost for builders - more the opportunity cost, less favorable to deal in supply of houses.
However, demand market depends upon following:
Economic growth or real income of people - more income people have, more they can spend on luxury goods.
Interest rate - low interest rate helps to borrow money for mortgage making repayments easy.
Availability of mortgage finance - easy mortgage finance encourages people to buy houses.
Unemployment rate - low unemployment means rise in income and spending hence high standard of living.
Consumer confidence - with high confidence, people can be willing to take risky mortgages to buy house.
Substitute of buying houses, renting - lower the substitute price; lower the demand for buying house.
Demographic factors - as there is more number of single people due to rise in divorces, increase in immigration, and enhancement in life expectancy, demand is ought to rise.
Inherent wealth - as people also have other source of money apart from income, buying decision becomes more flexible and favorable.
In UK market, supply of houses has always been low due to shortage of residential land sanctioned by planning department, strict government policies such as sustainability policies, and building regulations (Ball, 2010), increase in the cost of building materials, and low demand of existing houses, creating gap between demand and supply.
Furthermore, as houses take a variable amount of time to build, quantity of houses at a particular time is fixed; hence supply is inelastic at short run. Due to this, price becomes highly depended on demand; increase in demand will lead to high increase in price.
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Price trend from January 2006:
There have been vast change in prices of houses and apartments in UK since 2006 which can be noted in graph given below.
There was increase in price in 2006 to 2007 third quarter reaching price peak. Then there was a rapid fall of price in the following year (2008 - 2009). Thereafter, price started to shoot again in 2009 -2010 though didn't go that high as previously. Finally from 2010 till now it's more or less constant with slight fluctuation. Changes in price can be determined due to factors affecting the demand.
Firstly, in 2006 to 2007 3rd quarter with high economic growth and high income, people could spend more on house. During that period there was low unemployment and high consumer confidence. There was three times loan to income ratio making easy for people to take larger mortgage. Furthermore, banks were trying to increase their mortgage market share, hence implemented easy lending criteria, enabling people to get more finance. Due to increasing price of houses, a new market, buy to let, was developed leading to speculation. Moreover, this also made renting, main substitute of buying, expensive. They increased demand, shifting the demand curve to right and hence increase in price.
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Secondly, in 2007 4th quarter to 2009, there was a downfall in price of housing. This was mainly due to financial crisis and credit crunch which shaken the complete market. There was low trust between banks which lead to decrease in interbank lending and tightening of lending criterions. Mortgage rates became expensive. There was increase in unemployment rate which decreased real income and consumer confidence. Furthermore, speculation had increased the prices so much that it became difficult for first time buyer to bear that cost. These factors shifted demand curve to left lowering the demand, therefore drop in price.
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Thirdly, in 2009 to 2010, there was again rise in prices, even though unemployment rate was rising and inflation was low. This happened because banks lowered interest rate which boosted consumer confidence and ability to buy, hence raising the demand. Low supply and increase in demand again triggered rise in price.
Finally, from 2010 till now 2012, there has been constant price with slight ups and downs. This is due to factors being stable. There hasn't been much difference in interest (0.5%), mortgage and lending rate. Though there were slight fluctuations in 2012, unemployment, income and spending power are almost constant.
Summary of changes in various factors of demand leading to change in price:
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Graphs depicting changes in different factors that influence demand and price of housing:
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Different elasticity of demand:
First, price elasticity of demand is a dimensionless measurement of quantity demanded with respect to change in its price, keeping all other factors constant. In 2006-2008, with small rise in demand there was high raise in price, whereas, in 2008-2009, small fall in demand lowered the price largely. Hence demand is inelastic to price. In addition, demand is more sensitive to price over a long period. For housing, price has varied frequently with peak prices in 2007 to lowest prices in 2009. Furthermore, price elasticity tends to be low with fewer substitutions, as is the case for housing. However, high price did make buying difficult for new buyers with limited budget which lead to fall in demand, but demand was largely rising and falling due to other factors.
PED<1
Second, income elasticity measures change in demand respect to change in income. As large portion of income is spend on housing, it is normal luxury goods. 1% increase in income increases the quantity demanded by more than 1% as spending power of people increases. This can be note in 2006-2008 when there was economic growth and real income with people, they were able to spend large amount on housing and demand was shooting. However, demand dropped as consumers' income decreased after the financial crisis, and rise of unemployment rate, which restricted their spending power.
YED>1
Third, cross elasticity measures the sensitivity of demand to change in price of related product. Renting, substitute of housing showed positive cross elasticity. As renting became expensive, demand for buying increased. However, interest rate and mortgage rate showed negative cross elasticity of demand of housing. In 2009-2010, dip in interest rate and mortgage rate again boosted people's interest in buying houses, leading to rise in demand and hence price.
CEDR,H>0
CEDIR,H<0
Finally, other factors that influence the demand are bank lending criteria and availability of credits. In 2006-2008 when banks had easy lending criteria with high availability of credits, people showed high demand for houses. On the other hand, 2008-2009 witnessed credit crunch leading to fall in credits, which dropped the demand. Another factor affecting is consumer confidence; with high confidence, consumer can take high risk. Similarly, high spending power of consumer adds to his ability to buy normal luxury goods.
