Managerial Economics Essay Example | Topics and Well Written Essays - 1000 words - 2

Managerial Economics - Essay Example There are several factors that contribute to the pricing of houses in a free market. The Basic Principle of demand and supply This basic principle of demand and supply would chiefly govern the housing market, i.e. when the demand for housing increases the prices will tend to go up in order to reach equilibrium at the present level of supply. This is a typical example of demand and supply. The equilibrium is determined when the price at which the buyer would like to make purchase coincides with the price at which the seller would like to make the trade. Now the value of the housing properties is determined by both the supply side and the demand side factors which include the price at which the seller would like to go for the transaction with a prospective buyer and the actual price which the buyer would like to pay (Ngai and Tenreyro, 2009, p.7). Now when the demand for residence in a particular locality is high then the dearth of supply would cause the market power to shift from the buyers to the sellers and hence prices would be determined by the seller. Thus, when there is excess demand in the housing market the sellers may hoard the residential unit in order to create a price differential and make more profits. On the other hand when the demand for housing is low the sellers might compromise on the prices and it would be a buyer’s market where the buyer would have a lot of control over the settlement of the prices. The demand for housing at a particular area may increase due to demographic reasons as well. Suppose a new industry is set up in a place where previously there was no human establishment, then labour migration will take place in that particular area and those people would need residential investments. Again as the number of divorces is increasing people these days need more residential units separately and hence the demand for housing increases. In the above figure we see that the initial demand for housing in a particular area id D1 and th e initial supply is S1. The vertical axis would represent the prices of the housing units and the horizontal axis would represent the quantity of houses traded in the market of that particular area. The initial equilibrium price and quantity is at P1 and Q1 respectively. Now due to population inflow, the demand for housing units increases to D2. The supply remaining constant at S1, the new equilibrium would be at the point P2Q2. A point to be noted in this context is that due to an increase in demand the quantity supplied is increasing but at the lesser rate than that of the prices, i.e., P1P2 would be greater than Q1Q2. It should be noted that the supply here is relatively inelastic. The reason behind this is that there is a lag in time in between the price change and the augmentation of supply in housing in that area. When the supply of housing becomes more elastic as in the above figure, the supply curve would move in the rightward direction indicated by the arrow. The new supply curve will be S2. Now if we assume that the demand is unchanged then the prices would tend to go down to P3 which is a price that is higher than P1 but lower than P2. On the other, the equilibrium quantity would further move upwards to Q3 which is higher than both Q1 and Q2.