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MAE101 Economic Principles of Housing Market

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Questions:

Question 1 – Article Analysis
i. Read the following articles and write a summary of each article that highlights the main economic issue(s) being discussed.
“RBA governor Philip Lowe only sees one way to solve Australia's housing affordability problem” at https://www.businessinsider.com.au/lowe-housing-affordability-2017-4 “Sydney squeeze: Is rent control the answer to the housing affordability crisis?” athttp://www.abc.net.au/news/2017-03-21/sydney-squeeze-affordable-housing-rent-controloptions/8370364
ii. Discuss three (3) of the factors that have contributed to the unaffordability of housing in Australia and three (3) approaches that policy makers have put forth to address the issue of housing affordability.
iii. Using a demand and supply diagram for the housing or rental market in Australia, illustrate the effect of one of the factors that have contributed to the rise in housing or rental prices in Australia. Briefly explain your diagram and state which side of the market is being affected and why and the effects to equilibrium price and quantity.
Question 2 – Rental Market Analysis
i. Using a demand and supply diagram for the market for rental properties, illustrate and explain the effect of a (binding) rent ceiling.
Your analysis should discuss the welfare effects on this market and the changes to quantity demand and supplied.
ii. List and briefly discuss 2 alternative mechanisms that may help to ration the rental stock when the free-market price is prevented from achieving a market-clearing equilibrium.
iii. Discuss how the quality of the rental stock may be affected by the implementation of a rent ceiling.


Answers:

Answer 1

Supply And Demand of Houses

The price of homes in Australia has increased significantly making it difficult for many individuals to acquire homes. The provision of houses has not kept up with the rising demand caused by population increase in the main cities of Australia. Thus, the excess demand has made the prices of homes to hike. Low costs of borrowing and speculative demand among the investors have also contributed to higher prices. Improving infrastructure, restraining tax concessions and minimizing immigration levels can help to improve housing affordability.

Rent Regulation

The direct involvement of the government in rental prices will be vital in cushioning the renters from price hikes determined by the private landlords. Solving housing affordability should not only focus on affordable purchasing but also affordable renting. There is a need for regulation to offer protection to low and mid-income families.

Unaffordability of Housing in Australia

Large urban centers in Australia have witnessed an increase in population. Moreover, the average incomes, as well as household wealth, have been growing in the past one decade (Gurran & Phibbs 2013, p. 382). Higher numbers of people and increase in the earnings have increased the demand for houses and hence pushing the prices up.

Undersupply of Housing

Insufficient infrastructure and high costs of constructing houses have significantly reduced the supply of housing. For example, the costs of land comprise a considerable fraction of the cost of establishing housing (BROWN et al. 2011, p. 560). Therefore, inadequate supply of houses has increased the prices and hence unaffordability.

Lower Interest Rates

In the past decade, Australia has encountered a decline in the home loan interest rates. This situation has increased the amount borrowed by household to acquire houses and hence raising the demand and ultimately the prices. In addition to reduced interest rates, it has become easier for individuals to obtain loans (McLaren, Yeo & Sweet 2016, p. 40).

Both local and national governments should collaborate to provide appropriate and sufficient infrastructure to serviceable land. Studies show that the cost of core infrastructures like sewerage, roads, and water are often passed to the purchasers of new houses and hence higher prices (Rowley, Ong & Haffner 2015, p. 480). Therefore, if the government improves infrastructure, the prices of homes will reduce.

The government should come up with favorable funding policies that can facilitate and support the delivering of new houses. The funds for putting up housing units should be made accessible and more affordable to encourage the establishment of new houses. As a result, more persons will be motivated to secure finances for the development of more homes to increase the supply.

Answer 2

Enhance the Operation of Housing Market

There are plentiful steps the government can take to improve the functioning of accommodation market. For example, the state should ensure timely and adequate supply of properly situated residential land. Moreover, the government should develop tax policies that are favorable to housing and create structures to sustain institutional venture in housing.

Population influx has increased the demand for housing units. On the graph below, this situation is displayed by the shift of the demand curve, that is, from D1 to D2. Consequently, the prices have increased, from P1 to P2. While the demand has been increasing, the supply of housing units has remained relatively constant and hence a shortage.

Consumer surplus and producer surplus decline significantly and hence dead weight loss. Before the implementation of the rent cap, the producer surplus is represented by the triangle MNP1. After the imposition of the ceiling, the producer surplus shrinks, that is, triangle marked P. On the other hand, triangle P1NK denotes the consumer surplus before rent regulation. This surplus reduces after the introduction of rent ceiling by the government, that is, triangle marked C. As a result, dead weight loss, area marked D. The welfare of both the landlords and renters is reduced.

The government should increase investments in construction of new houses to increase the supply. For example, the state can work with Non-Governmental Institutions and private sectors to deliver housing units especially in areas encountering severe shortage. The establishment of additional houses will make the supply curve to shift and hence attainment of the market equilibrium.

The tax concessions are known to encourage speculation and play a significant role in increasing the investor demand for houses and hence increase in the prices (Mankiw & Cosgrove 2014, p. 53). Therefore, these incentives should be reduced, and others scrapped to reduce the competition for the limited housing units. With low demand, the prices will normalize to the equilibrium point.  

Rent cap by the government deteriorates the quality of rental stock. The quality of rental stocks heavily depends on the profits of the producers receive from the leases. Cap reduces the gains, and thus the suppliers become demotivated. Usually, the rent ceiling prevents the prices from rising to cater for the maintenance costs. Therefore, the landlords undertake minimal renovation and maintenance of the structures.

Bibliography

BROWN, R, BROWN, R, O'CONNOR, I, SCHWANN, G & SCOTT, C 2011, 'The Other Side of Housing Affordability: The User Cost of Housing in Australia', Economic Record, vol 87, no. 279, pp. 558-574.

Gurran, N & Phibbs, P 2013, 'Housing supply and urban planning reform: the recent Australian experience, 2003–2012', International Journal of Housing Policy, vol 13, no. 4, pp. 381-407.

Mankiw, NG & Cosgrove, S 2014, Principles of microeconomics, Cengage Learning, Stamford, CT.

McLaren, J, Yeo, A & Sweet, M 2016, 'Australia is Facing a Housing Affordability Crisis: Is the Solution to this Problem the Singapore Model of Housing? ', Australasian Accounting Business & Finance Journal, vol 10, no. 4, pp. 38-57.

Rowley, S, Ong, R & Haffner, M 2015, 'Bridging the Gap between Housing Stress and Financial Stress: The Case of Australia', Housing Studies, vol 30, no. 3, pp. 473-490.

Scutt, D 2017, RBA governor Philip Lowe only sees one way to solve Australia's housing affordability problem, viewed 18th April 2017, <https://www.businessinsider.com.au/lowe-housing-affordability-2017-4>.

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