The housing market is in these woes for the simple reason that supply exceeds demand. Like any market, the laws of supply and demand apply to houses. The demand side of the housing market is particularly dependent on income levels.
According to the law of demand, as the price of a good falls, the quantity demand rises. With the large drop we have seen in housing prices these past couple of years, you would think more houses would be bought and sold. But many other determinants of demand — the total amount consumers want to buy at any price level — must be considered. Two important factors beyond the price of a good are income levels and expectations. Both current income levels and expectations for future growth are way down.
Economists use a measure called income elasticity to predict the rise or fall in the demand for a product for any given change in income levels. The income elasticity of demand for housing tells us how much the quantity demanded for home purchases responds to changes in consumers’ income. Compared with many other goods, housing is highly income elastic. In a 2006 study from the Joint Center for Housing Studies at Harvard University, income elasticity for housing in Western cities and suburbs was measured at 2.00.
In effort to spur residential housing demand, two U.S. senators announced this week new legislation that would extended the $8,000 federal tax credit for first-time home buyers passed earlier this year along with other economic stimulus plans. The new legislation would also raise the income limit to qualify from the current $150,000 for a married couple to $300,000. It’s hard to think of many households earning $300,000 a year that don’t already own a home, but regardless, high unemployment and an economy in recession mean demand for homes just isn’t there. Tax incentives for first-time buyers do little to affect the income factor of demand.
The research shows that new home sales are income elastic. What does this mean? Economically justify why new home sales might be income elastic. Why do you think the $8,000 subsidy "for first-time buyers [will] do little to affect the income factor of demand"?
