A Brief Overview Of The Housing Economy

A Brief Economic Overview of the Housing Industry

The housing industry has definitely been on the downswing since the summer of 2006. Home sales as well as house prices are down. Inventories of unoccupied homes have increased and there has been a recent decline in the employment levels of the housing industry. Many economists are of the opinion that we have not seen the bottom of the decline in the 'Housing Market', which is one of the most important factors of the American economy. Recent statistics indicate that there is an increase in mortgage applications; however, at the same time there is a decrease in permits and new-home startups that could affect the economy for several years to come. In addition, another disturbing trend is the increase in home building cancellations during the last 3 - 4 months.

Elasticity of Supply and Demand

Most Americans consider housing a necessity. "Necessities tend to have inelastic demands, whereas luxuries have elastic demands" (Mankiw, 2004, p. 90). Due to the slight change in price if the quantity demanded increases or decreases, the price elasticity of demand in the home building industry is inelastic. Likewise, the price elasticity of supply in the home building industry is also inelastic due to the fact that changes in price only slightly change the quantity supplies.

Substitutes exist in the home building industry. Like automobiles, there are several homes to choose from ranging significantly in price. In an attempt to protect oneself from the elements as well as protect their personal belongings, people generally invest a significant portion of their earnings by renting or owning a home.

"Market prices depend on supply and demand, particularly the elasticity of supply" (Frantantoni, 2005). When prices for homes increase, if builders would increase the number of homes built - hence available for sale - prices would eventually taper off and possibly fall as the supply surpasses the demand.

Externalities

There are several positive and negative externalities related to the home building industry. Positive externalities include: aesthetic amenities, barrier in mobility, tighter communities, increased political and educational involvement as well as benefits for children and their families. Negative externalities include; overcrowding, view destruction, envy, and jealousy.

According to Edward L. Glaeser and Jesse M. Shapiro (2002) "The economics literature points to three reasons why homeownership might create externalities." First, homeowners have an invested interest in the property they own and the surrounding area; thus, homeowners have more interest in the attractiveness of the community. Participating in community activism and higher contributions to public goods are means by which homeowners can ensure the value of their property remains high and-slash-or possibly increases over time.

Secondly, there are not as many economic assets that involve such high costs related to sales as that of selling a home. Hence, homeowners are more likely to spend a longer amount of time living in a community than renters. There are more incentives to connecting with others in a community by participating in social activities and community gatherings for homeowners than for short-term renters.

The third externality created by homeowners is through gardening, landscaping, and home maintenance. These activities increase the aesthetic view of the property as well as increase the economy in other markets.

Negative externalities are also a result of the home building industry. In urban areas, condominiums and townhouses are becoming more popular because it is cheaper to build up than it is to buy more property for developing. Taller buildings obstruct the views from other buildings. Research indicates that blocking the view of one home by another home can reduce the value of the home by as much as 25% (Glaser, Gyourko & Saks, 2003).

In addition to view destruction, congestion and overcrowding are popular problems in urban areas that have a considerable amount of property developed into condominiums and-slash-or townhouses. Often, during the process of planning and developing a community, home builders will provide an over abundant number of homes which causes the community to become congested. This excessive number of homes is typically the results of the home builders attempting to increase the economy as well as the profit of a project. Nevertheless, the result is congestion which leads to pollution and higher crime rates.

Wages

Economists forecast that 2007 will result in the lowest number of new home starts since 2001 (Nutting, 2006). A decrease in the demand for new homes will result in a decrease in the demand for new home builders. A downward shift, or as otherwise referred to a shift to the left, in demand decreases the equilibrium wage companies can afford to pay their employees as well as the number of employees necessary to complete the projects available.

In addition, a decrease in demand for new home builders will result in the supply of workers available increasing. Thus, the shift in labor supply available will increase altering the equilibrium in the home building market to a lower wage as the supply level shifts to the right.

As a result, the decline in demand for labor in the home building industry will most likely result in career changes for many employees. When a labor market endures a negative change to wage earned, a fluctuation in job markets is a possibility as well as a predictable and reliable forecasted outcome.

According to the Bureau of Economic Analysis (Wage and Salary Accruals Per Full-Time Equivalent Employee by Industry, 2006), in the housing economy it would appear wage inequality is virtually nonexistent. In 2005, full-time construction employees earned an average annual income of $43,575. Compared to the average annual income of $44,884, it would appear that construction employees had earnings relatively close to that of the national average of all full-time employees. However, what should be considered is the fact that construction employees work is seasonal as well as weather related.

Monetary and Fiscal Policies

The monetary policy, which is the process by which the policymakers at the central bank determines the country's money supply, affects the fluctuation of mortgage interest rates. NAHB has projected that a one percentage point increase in mortgage rates can have a negative effect on 4.7 million home buyers' ability to purchase a median-priced home because they are considered ineligible. According to David Seiders (2007a) it is expected that the