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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.
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.
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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.
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 next Federal Open Market Committee (FOMC) meeting in late January will bring stable monetary policy decisions from the Fed policymakers.
In addition, the fiscal policy affects the housing industry as well. Governments adjust interest rates according to the economy and how much the government is spending and-slash-or borrowing. Recent weeks have brought a slight increase in mortgage interest rates as the housing economy is beginning to stabilize (Seiders, 2007b). However, this contraction follows an unusually large increase in sales and construction both of which had impeccable results for the economy. As a result, employment rates are sliding slightly as new construction is subsiding. New construction starts in November we almost 30% below their peak during January of 2006. There is some uncertainty as to exactly what triggered this downfall; however, it should be noted that during this period long-term interest rates were on the rise.
The housing industry is influenced both positively and negatively by varying factors of the overall economy. On the up side, the housing economy has witnessed exceptional success in recent years. Since 2001 mortgage rates, influenced by the Federal Reserve's decisions and adjustments in regard to fiscal policy, have been relatively cheap. This period of low mortgage interest rates brought on a frenzy of new homes demanded which in turn increased the selling prices of home. As the demand for new homes increased, unemployment rates dropped due to the rise in employment demand in the residential construction industry.
Monetary policy also has a major impact on the housing industry. The Federal Open Market Committee (FOMC) strives to meet the established target of the federal funds rate. In doing so, changes in the interest rates the Federal Reserve charge financial institutions for borrowing has an impact the short-term interest rates and money supply available by banks. Hence, the lower the federal funds rate, the lower short-term interest rates and money available for lending to homebuilders.
In addition to supply, demand, and interest rate, the housing industry has been impacted by our aging population. As the baby boomers are approaching retirement age, there has been overwhelming increase in the number of funds spent on vacation homes and-slash-or retirement dwellings.
The housing economy impacts the economy of various other industries as well. As the spillover effects of the successfulness of the housing economy have been witnessed, we also have seen increases in other economies such as those which supply lumber, brick, steel, appliances and landscaping products.
Nevertheless, just as the housing industry can be positively affected by changes in the economy, negative effects of changes in the economy is a result as well. When the Federal Open Market Committee (FOMC) increases the federal funds rate, banks tend to charge higher interest rates and decrease the amount of money available in the economy. Builders are less likely to take loans at these higher rates resulting in a decrease in the supply of homes available and an increase in the selling price of those which are available for sale.
Increases in fiscal policy affect mortgage interest rates in a negative way. As mortgage interest rates increase, mortgage loans become less desirable and sometimes difficult for individuals to obtain. As interest rates increase, bidding wars for homes decrease thus increasing the inventory of homes available for sales.
The housing industry is a major portion of the economy. Demand is high during favorable economic times, such as those recently witnessed. Unfortunately, as has been witnessed in the housing industry high demand times can result in the production of goods outweighing the supply needed leaving higher volumes of inventory when shifts in the economy arise. Nevertheless, a healthy job market, continuation of higher education which result in higher individual and family incomes, favorable interest rates, and sufficient money supply will most definitely help in ensuring the success of the industry as well as the future of the United States' economy.
Frantantoni, M. (2005, September 6). Housing and mortgage markets an analysis. Retrieved November 28, 2006, from Mortgage Bankers Association Web site: http://www.mortgagebankers.org/files/News/InternalResource/29899_HousingandMortgageMarkets-AnAnalysis.pdf
Glaeser, E.L., & Shapiro, J.M. (2002, October). The benefits of the home mortgage interest deduction. Retrieved December 17, 2006, from Harvard Institute of Economic Research Web site: http://post.economics.harvard.edu/hier/2002papers/HIER1979.pdf
Glaser, E.L., Gyourko, J., & Saks, R. (2003, November). Why is manhattan so expense: Regulation and the rise in house prices. Retrieved December 17, 2006, from Harvard Institute of Economic Research Web site: http://econweb.fas.harvard.edu/hier/2003papers/HIER2020.pdf
Mankiw, G. (2004). Elasticity and Its Application. In Principles of Economics (3rd ed., p. 90). Chicago, Illinois: Thompson South Western.
Nutting, R. (2006). Top minds answer key 2007 questions. Retrieved January 6, 2007, from MarketWatch Web site: http://biz.yahoo.com/weekend/economyquestion_1.html
Seiders, D. (2007, January 24). The interest rate structure remains historically low. Retrieved January 24, 2007, from National Association of Home Builders Web site: http://www.nahbmonday.com/eyeonecon/issues/2007-01-24.html
Seiders, D. (2007, January 15). Eye on the economy: Home sales may be firming up. Retrieved January 26, 2007, from National Association of Home Builders Web site: http://www.nahb.org/news_details.aspx?newsID=3910
Wage and Salary Accruals Per Full-Time Equivalent Employee by Industry. (2006, August 2). Retrieved February 2, 2007, from U.S. Department of Commerce Web site: http://www.bea.gov/bea/dn/nipaweb/TableView.asp?SelectedTable=190&FirstYear=2004&LastYear=2005&Freq=Year