Ec2066 Microeconomics - Economic Analysis Assessment Answers

You are asked to draw on news stories (news articles) related to microeconomic issues and to select one from which to develop a case analysis. Using the microeconomic concepts/theories you have learned during the course, you will analysis the situation described in the news story. The analysis then moves on to describing how the issues raised impact on an organization/industry that the story raises and to providing recommendations on how to address those issues. The recommendations must be grounded in economic thinking.

Introduction:

Demand and supply are two chief concepts of microeconomics that are used to determine the equilibrium market price and the corresponding amount of output for a product. The concept of demand is supported by consumer’s income, which represents the amount of output that the person desires to buy. On the other side, supply means the amount of output that a market offers to customers. In a free market, these two concepts set the price of a product automatically (Boland, 2014). Hence applying these economic tools, the report intends to describe the reason for increasing rents in the United Kingdom for coming five years. After discussing the demand and supply concepts briefly, this report tries to analyse the housing market based on these.

Economic analysis:

The demand law represents an inverse relationship between price and quantity demanded, where demand for a product can decrease after increasing of its own price. The opposite situation also happens when price of the product decreases (Amir, Erickson & Jin, 2017). However, in this situation, other demand influencing factors like income along with taste and preference of consumers and prices of related commodities remain stable.

                              Figure 1: Inverse relationship between price and demand

                                                                    Source: (created by author)

The above figure has represented the inverse relationship between price and quantity demanded for a product, where price increases by P0P1 unit and consequently demand for this product decreases by Q0Q1 unit. As other factors are considered as constant, the price moves along the demand curve and consequently change in quantity demanded happen. However, the entire demand curve can shift towards left or right if other demand influencing factors change (Varian, 2014). For instance, an increase in income of consumer can lead the demand for a product to increase further at given price level. In this situation, change in demand occurs.

                                                       Figure 2: Change in demand

                                                                        Source: (created by author)

The above figure signifies a change in demand through shifting the demand curve either rightward or leftward direction. In the above figure, initial demand curve is represented by D0. If demand for the product declines at P0 price level due to change in any demand influencing factor, then the entire demand curve shifts towards left from D0 to D1.

The concept of supply represents a positive relationship between price and amount of output. Producers intend to increase the supply of a product along with its price increase for earning more amount of revenue. In this context, it can be mentioned that supply is a factor of time, as producers cannot increase the supply of a product immediately after the increasing the demand for this product in market (Azevedo & Leshno, 2016). Some other factors that can influence the supply of a product are production cost, natural condition, transport cost and technology. In addition to this, other factors like prices of inputs, government’s policies and price of related goods can also influence the supply of a product, where entire supply can decrease or increase at a given price. The following figure represents a positive relationship price and quantity supplied of a product.

                             Figure 3: Positive relationship between price and demand

                                                                      Source: (created by author)

In the above figure, a supplier wants to supply Q0 amount of product at I0 price. If the price increases from I0 to I1, the supplier increases its quantity supplied by Q0 Q1 amount. In this situation, price moves along the supply curve, where other supply influencing factors are considered as constant (Stoneman, Bartoloni & Baussola, 2018). However, the entire supply curve can shift towards left or right if these supply increasing factors change accordingly.

                                                             Figure 4: Change in supply

                                                                          Source: (created by author)

According to figure 4, the initial supply curve is S0. Changing of one factor can lead the producer to increase the production accordingly and this further can shift the entire curve to the right. In above figure, the curve shifts from S0 to S2 and this in turn increases the amount of output supplied from Q0 to Q1 at P0 price level. For the opposite situation, the entire curve can shift towards to the left and this in turn can reduce the amount of quantity supplied from Q0 to Q1.

The equilibrium regarding price and output in product market can occur when demand and supply curve intersect with each other, representing that the amount of quantity demanded for a product equates with the amount of quantity supplied in market (Kirschen & Strbac, 2018). According to the following figure, the amount of equilibrium price and output for the product is P* and Q*, respectively.

                                                     Figure 5: Equilibrium condition

                                                                  Source: (created by author)

Article Analysis:

In the U.K, rents in the housing market will increase for the next five years by 15% due to insufficient supply of rental houses and increasing demand from tenants. For the next 12 months, housing rents can increase by 2% all over the U.K. As people in this country cannot afford to purchase their own homes, the demand for house rents has increased significantly (Kollewe, 2018). The southeast part of England and East Anglia can experience a sharp increase in rents over the year. The chief reason behind shortage of rent accommodation has occurred due to changing structures in recent and ongoing taxes (Poggio & Whitehead, 2017). The market for residential property sales remains low except Northern Ireland, Scotland, the Midlands and Wales, where transactions have done at higher prices.

Hence, the reason behind increasing rents can be described with the help of demand and supply concepts. The following diagram has represented this situation.

                                                      Figure 6: Increasing demand

                                                                      Source: (created by author)

According to figure 6, demand for rental accommodation increases from D0 to D1 while supply of it remains at S. As a result, the amount of rent increases from R0 to R1.  As supply depends on time, it is not possible for a producer to build a house instantly after increasing of its demand (Blanco-Romero, Blázquez-Salom & Cànoves, 2018). For this, the supply curve in above figure is drawn as comparatively steeper. This inelastic nature of supply curve represents that a small increase in demand can increase the rent by large amount.

Recommendation:

The problem of increasing rents in the U.K can be reduced further and this in turn can decrease the rents of houses in future. To do this, the government can increase the rental accommodation within the country by constructing more houses in some extended of cities. Moreover, the tax structure can be reformed to influence the owner of houses for let their houses to tenants (Hoolachan, McKee, Moore & Soaita, 2017). In addition to this, the government can implement suitable monetary and fiscal policies to reduce interest rates for purchasing a house so that people can afford new houses. As, rents are increasing in some well-known cities of the U.K, the government can provide subsidies to influence people for taking rent in some other cities, which are situated nearby but do not have so much economic importance.

Conclusion:

Thus, the entire report has discussed about two chief microeconomic tools, which are, demand and supply and their impacts on economy. For this, the problem of increasing rents in the U.K has been considered, where shortage of rental accommodation and increasing demand from tenants has led the rents to increase further. The chief reason behind this shortage of housing supply is reformation of tax structure. On the contrary, demand for rent has increased because people cannot purchase new houses.

References:

Amir, R., Erickson, P., & Jin, J. (2017). On the microeconomic foundations of linear demand for differentiated products. Journal of Economic Theory, 169, 641-665.

Azevedo, E. M., & Leshno, J. D. (2016). A supply and demand framework for two-sided matching markets. Journal of Political Economy, 124(5), 1235-1268.

Blanco-Romero, A., Blázquez-Salom, M., & Cànoves, G. (2018). Barcelona, Housing Rent Bubble in a Tourist City. Social Responses and Local Policies. Sustainability, 10(6), 1-18.

Boland, L. A. (2014). Methodology for a New Microeconomics (Routledge Revivals): The Critical Foundations. Routledge.

Hoolachan, J., McKee, K., Moore, T., & Soaita, A. M. (2017). ‘Generation rent’and the ability to ‘settle down’: economic and geographical variation in young people’s housing transitions. Journal of Youth Studies, 20(1), 63-78.

Kirschen, D. S., & Strbac, G. (2018). Fundamentals of power system economics. John Wiley & Sons.

Kollewe, J. (2018). Rents in UK will rise for next five years, experts predict. the Guardian. Retrieved 14 August 2018, from https://www.theguardian.com/business/2018/aug/09/rents-in-uk-will-rise-for-next-five-years-experts-predict

Poggio, T., & Whitehead, C. (2017). Social housing in Europe: legacies, new trends and the crisis. Critical Housing Analysis, 4(1), 1-10.

Stoneman, P., Bartoloni, E., & Baussola, M. (2018). The Microeconomics of Product Innovation. Oxford University Press.

Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.