Housing demand is elastic
Whenever you are sifting new stories about housing prices and supply/ demand imbalance, just remember this:
Housing demand is elastic
How many square feet is this?
In economic terms, demand is elastic when consumption rises as prices fall, and vice versa.
As prices rise, demand falls — as prices fall, demand rises. Market price is the price at which a market clears — goods trade between willing buyer and willing seller. It’s the equilibrium where supply is just meeting demand.
Markets move fast. Widgets, you see, can made quickly, wear out quickly, and are easily transportable. Even cars, most people’s second-biggest expenditure, are by definition auto-mobile. While research and development may have a long lead time, once a prototype widget is made, pumping out more of them is pretty simple –
“I hear the price of widgets is rising, Clem.”
– so it’s usually fairly easy to increase supply. Widgets also wear out, bear, or become functionally obsolescent. To all these things, the market adapts rapidly.
So far, so Economics 101. But it gets much more interesting in housing.
Housing supply is highly inelastic. Housing takes a long time to build — even longer because localities throw up road blocks like building permits, zoning, and development moratoria (or water/ sewer, which accomplishes the same thing less overtly). Each individual housing widget is expensive. Once placed, you can’t move it (except mobile homes, and even they normally become sessile).
If you build it wrong, they won’t come.
Meanwhile, although supply is inelastic, demand is very elastic. Not because of population change (excepting immigration, that takes longer to change than homebuilding), but because of changing household size. What constitutes a ‘household’ is constantly mutating:
- When housing is cheap, households expand (fewer people per household). Young adults leave home. Roommates pack fewer to a suite. Homeowners trade up and get a family room, a media room, or a home office. Some buy second (or even third!) homes.
Some day I won’t have to share my toothbrush with the other blokes.
- When housing is costly, households shrink. Young adults move back with their parents. Starving artists consume less space. Parents put two children per bedroom instead of one. People who were using an extra bedroom as a study move into a smaller apartment and work from the kitchen table.
Supply, demand, supply, demand, in, out, in, out …
The flexibility mismatch between supply (inflexible) and demand (rapidly mutable) leads to several critical implications:
- Because consumers have a much faster market OODA loop than producers, rents can suddenly fall, and quite quickly. (Home prices fall much more slowly than rents because the people who move in to a smaller house are usually moving out of a bigger house that they have to sell.)
- Declining household size is a good indicator that housing is costing a smaller share of income and thus that real housing costs are declining.
- Housing demand studies that focus on slow-movement changes like general household formation and employment growth miss the point. Housing demand is all about availability at a price point.
