Strategic & Innovative Marketing
STRATEGIC AND INNOVATIVE MARKETING
Question
Examine the factors that determine the price of houses in a free market. How and to what
extent could government policies affect house prices?
Your research is to be mainly concentrated on UK housing market. However, you can also
include references based on different countries.
ASSIGNMENT 01
Full Name: Manohareswarasarma Sanjeevkumar
ID No: B0629KDKD0410
School of Business and Law
MBA 1
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Strategic & Innovative Marketing
1. Introduction
The housing is an important sector of any country or economy regardless of their size.
The prices of house in the UK continue to be fallen down despite the many attempts
to control the price fall. There is a limited mortgage available to the people to buy a
house. Renting a house is considered to be an alternative way to buy a house, but it
also affected by various reasons. Though the fall in house prices have adversely
affected the UK economy suggested that majority of UK citizens welcome falling
house prices. Falling in prices of house has some negative wealth effect as it causes
decline in household wealth. This leads to lower consumer confidence and led to
significantly lower growth. Thus falling house price can be a trigger that could hurry a
recession in the UK. Some may say falling house prices will make first time buyers
better off and therefore they can spend more. However, this group represents a small
% of the economy.78% of homes are already owed.
This assignment analyses the factors that affect the housing prices in the UK market
including demand and supply side factors, government interventions in housing
market to prevent the crashes in the prices of house and the conclusion
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2. Factors that affect house prices in UK
Figure: Changes in house price
The prices of houses in UK are determined by both demand side and supply side. The factors
affect the house prices on the demand side are discussed briefly below.
Economic Growth/Real income
A rise income is given opportunity for the people to spend more on buying a house. There is
a mortgage ratio of three times on a person’s salary. If a person earns £ 10,000 the building
society would lead to £ 30,000. Therefore a rise income will lead to the increase in price of a
house. But due to the recession, the ratio of house prices to incomes has increased
remarkably. Therefore the demand for buying houses has been fallen significantly
The following graph clearly depicts the changes in price of house. There is a shift towards
left side. Though there is a rise income, the demand for price will be reduced because of the
economic recession.
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D2
Price of house
D1 S
1
P1
P2
D2
D1
Q2 Q1 Quantity
Interest Rates
Interest rates affect the cost of paying for a mortgage. Interest rates are a vitally important
factor as mortgage repayments are usually the biggest part of the housing owner’s monthly
spending. The majority of house owners have a variable repayment patterns for mortgage
which means an increase in rates will cause the cost of mortgage to rise which prevents
people to buy a house. The bank of England usually set the base rates and in some cases they
reduce the interest rate but the customers of other banks are not able to receive interest cut.
The cost of mortgages has been increasing for last five years. The following graph depicts the
changes in the interest rate. Lambert (2010) cited that with the spending cut from
government, potential rise in interest rates, and limited mortgage availability would hold the
market back. The mortgage lenders’ house price index is currently recording a mini-boom
with prices up 10.5% in the year to April,2010, but this has been skewed by the low level of
property transactions’ and Nationwide said rapid house price inflation will be occurred.
D1
D1 S
Price of house 1
P1
P2
D1
D1
Q2 Q1 Quantity
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Consumer Confidence
If people have a high confidence, they are more willing to take risky mortgages to be able to
buy a new house. During the period between 2001-2007, there were 100% mortgages and
interest only mortgages were entertained by the people. In year 2000, the people UK were
more optimistic about the housing market and so took out more mortgages with a higher debt
income ratio. Buy of new house has been reduced extensively for last five years.
As the spending cut imposed by the recent government will definitely have a great impact on
the confidence of consumers. Obviously they have a low confidence in relation to the
availability of mortgage and possible cut in the interest rate.
Availability of mortgage finance
There was time in which most of the people UK experienced a rise in the number of
mortgage products such as interest only house, self certification mortgage and mortgages up
to 06 six times income have allowed people to buy more houses .According to Nationwide,
the availability of mortgage is very much limited, so the people’s ability buy a new house is
also restricted. It will further reduce the price of house as the demand for house is reduced.
Due to the credit crunch in 2008, the number of mortgage products on offer fell due to a
shortage of finance in the money markets.
The restriction on the mortgage availability reduces the people’s ability to purchase a house
and it will therefore reduce the demand for house.
D1
Price of house
D2 S
1
P1
P2
D1
D2 1
Q2 Q1 Quantity
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Demographic factors
The numbers of households in the UK have been increased. The number of households can
increase faster than the population if the average family size decline and therefore are more
single people living alone. The demand for housing in the UK has been increasing for various
reasons such as an increase in divorce rates, an increased in net immigration from Eastern
Europe. UK, increasing in life expectancy and more old single people, children leave home
early and less marriage
Due to the above factors the demand for house is increased. The following graph depicts the
changes. In this case, there will be a shift towards right side of the demand curve.
D2
Price of house
D1 S
P1
P2
D2
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Q2 Q1 Quantity
Speculation
An increasing number of property investors in order to make capital gain buy houses and
renting out them to get additional income. This buy to let investor is typically more unstable;
they will buy when there is a increase in the house price and sell when the market appears to
turn. This makes the price of house more unstable because speculators will buy in a boom
and sell in a bust. The number of buy to let investors has been increased for the last ten years
in UK.
The price of rented accommodation
House prices in UK have increased than inflation but the people used to rent house a
substitute for buying house however the renting has also become expensive in recent years.
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If the rent a house becomes cheaper the people tend to use rented houses than buying a new
house in this house, the demand for house will be reduced which is shown in the below
graph.
D1
Price of house
D2 S
1
P1
P2
D1
D2 1
Q2 Q1 Quantity
Inherited wealth
It is common in UK that the parents used to lend children the inherited wealth to buy their
first house as a support. This created the rising ratios of house price to incomes. It is also
becoming more common for parents to lend their children a deposit to help get their first
house. In this case, rise in price of a house will not prevent them to buy a house. This caused
the increase in the demand for a house.
D2
D1 S
P1
P2
D2
D1 1
Q2 Q1
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The factors that affect the supply side of the price of house are discussed below.
Supply of housing in the short run is fixed as it takes time to build houses. In the short run the
demand for house has a impact on the housing price than supply. In this situation, the supply
of housing is inelastic. According to Mankiw (2008), in most markets including housing
markets a key determinant of the price elasticity of supply is the time period being
considered. The supply is usually more elastic in the long-run than in the short run. Therefore
in the short run, the quantity of supplied is not so responsive to the price. In the case of house
market the homeowner can build new houses over longer periods.
1. In the long run the price of house is affected by many factors which are discussed
below,
2. Availability of planning permission. This is somewhat difficult to get in rural areas to
build the house
3. Opportunity cost for house builders are there any other investment opportunities to
utilize their capital investment
4. Existing houses may be knocked down because they are supposed to be unfit to live in
5. An increase in the cost of building of new houses will shift supply to the left (decrease
in supply)
6. It is argued in the UK that there is a remarkable shortage of housing is this explains
why house prices are increased much faster than inflation and earnings.
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3. Government interventions in housing market to prevent the crashes
in the prices of house
There has been a continuous rise in the house prices in the UK market and it is ever
increasing. As per the predictions of economist, there is a possibility of price fall in the
future. If this were to emerge what would be the economic implications and should the
government do anything about it. There are arguments for and against the government
interventions to control or prevent the fall in house prices.
Arguments that support to the government interventions are as follows,
House prices seemed to be unstable; this is because of supply and demand inelastic.
Also the housing market is subject to speculation, people may buy houses during
house price increase to try and profit, hence if house prices fall these speculators will
be inclined to sell, causing a bigger crash in house prices. So any fall in house prices
could have significant consequences for the whole economy
The whole economy can be affected due to the adverse effect in house prices. For
example If house prices increase quickly then it can cause inflationary effects to build
up leading to a boom and bust economic cycle. If there is a house price crash this will
leave many house owners with the negative equity. Therefore this will notably reduce
the consumer confidence and therefore a reduction in consumer spending leading to
lower growth and possibly a full blown recession.
The housing market has a significant impact on the economy, because over 75% of
households are homeowners and mortgage repayments are a significant part of
people’s income. Housing is the biggest asset and therefore the negative impact
should not be underestimated.
The fall in prices of house could also lead to negative multiplier effect, where the final
fall in Gross Domestic Product is bigger than the initial because of the bandwagon
effect.
Government intervention’s to prevent house price crash will allow people to repossess
their homes and this is because with negative equity and high interest payments
people would be unable to pay off their debts.
There are some arguments against the government intervention to prevent the housing price
crash which are discussed as follows,
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It is somewhat difficult to predict the future inflation on house price. For a long time,
people have argued that house prices are overvalued but houses prices continue to
rise. Therefore it is hard to judge whether change in house prices are due to pure
speculation or having good fundamental reasons
As the house is a private good, there are some alternatives such as renting a house
If house prices are overestimate then there are benefits of letting their prices fall
because it will help first time buyers be able to afford to buy a house, at the moment
many key public sector workers are unable to buy . Cheaper house prices would
increase efficiency of the economy and increase the restriction in the geographical
mobility.
A fall in prices of houses would reduce house price speculation therefore the house
prices will be more stable in the future.
It is difficult for the government to intervene in the housing market. Interest rates
could be reduced. But if the MPC cut interest rates it may conflict with other
objectives like the government’s inflation target.
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4. Conclusion
The housing prices in the UK market is continue to fall despite the various efforts taken by
government to control this issue. There has been a drastic change in the UK housing market
that caused mainly due to the economic recession. The continuous fall in the housing prices is
not only affected the homeowners but also the letting companies as well. The recent survey
suggested the fall in the price of houses not only a problem but also it provides some benefits
as well. The benefits due to the fall in prices include increase of affordability: many first time
buyers have been out of the market by prices rising faster than not just inflation but also
average incomes. This will help to reduce inequality between young people and older
generations, who have benefitted from rising prices, the correction in prices is inevitable
given the present unaffordability of housing. However long term forecasts for house prices
suggest that actual prices may continue to rise faster than incomes in the future that increased
flexibility of labour market. This assignment has discussed the factors that affect the house
prices in the UK market, the government interventions to prevent the continuous fall in the
prices of houses and it ended up with the conclusion.
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5. List of references
Books
1. Mankiw,G.N.(2008)Principles of Economics,4th Edition, Cengage Learning, USA
2. Harris,N.(2001)Business Economics, 1st Edition,Butter Worth-Heinemann, Oxford
3. Griffiths,A.(2001)Business Economics,1st Edition, Heinemann Educational
Publishers, Oxford
4. Baumol,J.W.(2009) Macro Economics- Principles and Policy, 11th Edition, Cengage
Learning, USA
Internet
1. [Link]
in_article_id=505257&in_page_id=57&position=moretopstories: Accessed[ 21 June
10] time: 19.23pm
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3. [Link] Accessed[25 May 2010]:time 11.50am
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May 2010]:time 12.10pm
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6. [Link] : Accessed[26 May 2010]:time
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