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Housing Supply And Housing Bubbles Essay

1016 words - 5 pages

In this article the authors examine the nature of housing bubbles and how housing prices are affected by the elasticity of housing supply. They begin by citing from literature to show that price movements of assets, including markets, include an irrational exuberance element as well as their fundamental valuations; this leads to the difficulty in explaining the significant variations in housing prices between 1999 and 2005. As a result, instead of developing a test to detect the presence of a housing bubble, the authors propose to analyze the nature of this bubble; this is especially in light of the fact that housing supply and pricing influence construction activities as well as population ...view middle of the document...

An open city model is assumed, implying a uniform flow rate of new buyers into a city, with a purchase occurring if the buyer’s perceived utility in staying within a city combined with his expected resale value exceeds the price of the house. Based on these and some other assumptions, five propositions are outlines and proved. The propositions test various aspects of the model, such as: (i) for elastic supply and a finite number of buyers, equilibrium in the market does not exist – this analyzes irrational housing bubbles; (ii) change in housing price becomes slower as a bubble progresses, but stock supply increases – this analyzes the impact of a bubble on housing process, investment and supply; (iii) the effect of the bubble on housing stock supply – this analyzes price fall to levels lower than the pre-bubble values; (iv) the role of inelastic supply in sustaining the bubble; and (iv) the relationship between inelasticity and housing produced by a bubble. All the propositions are proved and examined logically, and the consequences are clearly defined. While the methodology seems adequate, the authors also point out that the model makes two empirical predictions, but is vague on a few other issues.
Empirical analysis and data presentation
In addition to the theoretical model, the authors also carry out an empirical survey and analysis of housing market data – once again, they examine the implications of the bubble, rather than testing its existence, in accordance with their stated objectives. Data for this study is obtained from the Office of Federal Housing Enterprise Oversight (OFHEO), and their indices for metropolitan area-level indices from 2000 onwards are used. A detailed analysis is performed to obtain the ratio of housing prices to their Minimum Profitable Production Cost (MPCC) for 79 metropolitan cities from 1982 to 2007; these mean ratios are then plotted graphically to illustrate the fact that prices increased dramatically above their MPCC levels during the housing boom post 2000. Similarly, another analysis is performed for the 1982-1996 cycle, and an extended...

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