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- [Alex] Why is this house selling[br]for more than $2.5 million?

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Or this apartment,

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renting for almost $3,000 a month?

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Is it greed? Conspiracy?

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No.

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Just a powerful economic concept --[br]the elasticity of supply.

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Sounds complex, [br]but it's actually quite simple.

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In the United States[br]around the world,

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many industries and jobs

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have been concentrating[br]in a few dynamic cities,

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like tech in Silicon Valley, [br]entertainment in LA,

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and pharmaceuticals in Boston.

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So more and more people --

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they want to live[br]in these dynamic cities,

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and that increases[br]the demand for housing.

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And remember, what happens[br]with an increase in demand?

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The demand curve[br]shifts to the right,

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and buyers are willing to buy more[br]at any given price.

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This leads to a new equilibrium,

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with a higher quantity[br]sold at a higher price.

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But which increase[br]will be larger --

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the quantity change[br]or the price change?

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That depends upon

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whether the supply[br]is elastic or inelastic.

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If the supply is elastic,

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meaning the producers[br]can easily produce more housing,

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then the quantity supplied[br]will increase a lot,

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and the price[br]will only increase a little.

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But if the supply is inelastic,

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that means it's not easy[br]to produce more housing,

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and our supply curve[br]looks more like this.

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In this case,

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the quantity supplied[br]only increases a little,

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but the price goes up a lot.

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That happens when housing suppliers

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can't easily expand[br]their production

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in response to the higher price.

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Now, unfortunately, many cities[br]have inelastic housing supplies.

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So as people flock to these cities,[br]we see higher and higher prices,

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with little increase[br]in the quantity of housing.

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Why?

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Well, first, there are[br]natural problems.

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Many of the in-demand cities --

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they're surrounded[br]by beautiful water.

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Nice, but that means[br]a limited supply of land.

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But we compound natural problems[br]with unnatural ones.

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In many cities,

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zoning laws and other regulations

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prevent builders[br]from creating more housing.

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Take San Francisco, for example.

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It's surrounded by water, [br]so there's limited land.

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But if you can't build out, [br]how about building up?

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There's plenty of land in the sky.

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San Francisco's [br]zoning laws, however,

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have made it impossible[br]or very expensive

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to build taller buildings[br]in many parts of the city.

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Even changing single-family homes[br]to duplexes or fourplexes

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has typically been prohibited.

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And that's not all.

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Suppose a builder does find[br]a plot of land to use.

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Well, next, they need[br]a building permit.

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And the process for filing[br]for building permits --

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it could be hard to understand.

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City officials can leave applicants[br]hanging for years.

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In San Francisco,

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it takes an average of 627 days

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to receive a building permit[br]for a new house.

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And that delay adds a lot[br]to the costs for builders.

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And if a builder does get[br]a building permit, it's not over.

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Many people can still veto[br]the project:

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environmental agencies,

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planning commissions,

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historic preservation societies,

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and groups of existing residents.

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They can slow things down[br]with lawsuits, protests,

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and bureaucratic objections.

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So now that we better understand

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why the supply of housing[br]is inelastic,

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let's revisit our supply[br]and demand graph

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and illustrate what happens[br]in the housing market

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with an increase in demand.

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Suppose a city is thriving,

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and the demand to live[br]in that city increases.

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The demand curve[br]shifts to the right.

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To keep it simple,

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say that ten people[br]want to move into the city.

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Builders see[br]the increase in demand,

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and they try to build more,

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but they're stopped

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by water, height restrictions,

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zoning laws, bureaucracy, lawsuits.

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That's our inelastic[br]supply of housing.

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So imagine, somehow a builder[br]finds a way to construct one home,

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increasing the quantity supplied a[br]little. But 10 people want to move in.

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So who gets the new home?

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Well, the potential new residents,

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they compete to get the new[br]home by bidding up the price.

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The price for the new home goes up.

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First, one person drops out, and[br]then the price goes up Some more,

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and another person drops out.

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The price keeps going higher

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and higher and higher until[br]just one person is left,

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and the high bidder wins the new home.

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Notice that it's not the owners[br]of housing jacking up the price.

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It's the buyers who must bid[br]higher to out-compete one another,

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given the limited supply.

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And inelastic supply of housing,

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it does mean higher property[br]values for existing residents.

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So existing property owners, they have[br]an incentive to block new construction.

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And that's one reason[br]why reform is difficult.

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And who's harmed?

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Well, lots of people,

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but most especially the potential[br]residents who are bid out of the market.

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They'll have to live further away,

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with longer commutes, or they may not even[br]be able to live near good jobs at all.

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And notice that the people who[br]are harmed, they don't get a vote.

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By definition,

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the potential residents,

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they don't live in the city[br]that priced them out of a home.

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It's not all bad news, however. Slowly,

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some cities are starting to change.

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In 2016, Auckland, New Zealand,

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they liberalized their laws to[br]allow upzoning in much of the city.

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And the number of new houses skyrocketed[br]and housing prices moderated.

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The rest of New Zealand[br]is now following suit.

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Even San Francisco is starting to[br]allow new duplexes and fourplexes.

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So let's hear it for a more[br]elastic supply of housing.

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Okay. There you have it.

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If you want to understand why[br]housing prices are rising,

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you must first understand the elasticity

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of supply and what makes housing supply[br]in many parts of the world inelastic.

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Now, you can test your[br]understanding of elasticity

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by checking out our practice questions.

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We also have test banks and lesson[br]plans for economics teachers.

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Or, if you're ready for more[br]microeconomics, click for the next video.