- [Alex] Why is this house selling for more than $2.5 million?
Or this apartment,
renting for almost $3,000 a month?
Is it greed? Conspiracy?
No.
Just a powerful economic concept -- the elasticity of supply.
Sounds complex, but it's actually quite simple.
In the United States around the world,
many industries and jobs
have been concentrating in a few dynamic cities,
like tech in Silicon Valley, entertainment in LA,
and pharmaceuticals in Boston.
So more and more people --
they want to live in these dynamic cities,
and that increases the demand for housing.
And remember, what happens with an increase in demand?
The demand curve shifts to the right,
and buyers are willing to buy more at any given price.
This leads to a new equilibrium,
with a higher quantity sold at a higher price.
But which increase will be larger --
the quantity change or the price change?
That depends upon
whether the supply is elastic or inelastic.
If the supply is elastic,
meaning the producers can easily produce more housing,
then the quantity supplied will increase a lot,
and the price will only increase a little.
But if the supply is inelastic,
that means it's not easy to produce more housing,
and our supply curve looks more like this.
In this case,
the quantity supplied only increases a little,
but the price goes up a lot.
That happens when housing suppliers
can't easily expand their production
in response to the higher price.
Now, unfortunately, many cities have inelastic housing supplies.
So as people flock to these cities, we see higher and higher prices,
with little increase in the quantity of housing.
Why?
Well, first, there are natural problems.
Many of the in-demand cities --
they're surrounded by beautiful water.
Nice, but that means a limited supply of land.
But we compound natural problems with unnatural ones.
In many cities,
zoning laws and other regulations
prevent builders from creating more housing.
Take San Francisco, for example.
It's surrounded by water, so there's limited land.
But if you can't build out, how about building up?
There's plenty of land in the sky.
San Francisco's zoning laws, however,
have made it impossible or very expensive
to build taller buildings in many parts of the city.
Even changing single-family homes to duplexes or fourplexes
has typically been prohibited.
And that's not all.
Suppose a builder does find a plot of land to use.
Well, next, they need a building permit.
And the process for filing for building permits --
it could be hard to understand.
City officials can leave applicants hanging for years.
In San Francisco,
it takes an average of 627 days
to receive a building permit for a new house.
And that delay adds a lot to the costs for builders.
And if a builder does get a building permit, it's not over.
Many people can still veto the project:
environmental agencies,
planning commissions,
historic preservation societies,
and groups of existing residents.
They can slow things down with lawsuits, protests,
and bureaucratic objections.
So now that we better understand
why the supply of housing is inelastic,
let's revisit our supply and demand graph
and illustrate what happens in the housing market
with an increase in demand.
Suppose a city is thriving,
and the demand to live in that city increases.
The demand curve shifts to the right.
To keep it simple,
say that ten people want to move into the city.
Builders see the increase in demand,
and they try to build more,
but they're stopped
by water, height restrictions,
zoning laws, bureaucracy, lawsuits.
That's our inelastic supply of housing.
So imagine, somehow a builder finds a way to construct one home,
increasing the quantity supplied a little. But 10 people want to move in.
So who gets the new home?
Well, the potential new residents,
they compete to get the new home by bidding up the price.
The price for the new home goes up.
First, one person drops out, and then the price goes up Some more,
and another person drops out.
The price keeps going higher
and higher and higher until just one person is left,
and the high bidder wins the new home.
Notice that it's not the owners of housing jacking up the price.
It's the buyers who must bid higher to out-compete one another,
given the limited supply.
And inelastic supply of housing,
it does mean higher property values for existing residents.
So existing property owners, they have an incentive to block new construction.
And that's one reason why reform is difficult.
And who's harmed?
Well, lots of people,
but most especially the potential residents who are bid out of the market.
They'll have to live further away,
with longer commutes, or they may not even be able to live near good jobs at all.
And notice that the people who are harmed, they don't get a vote.
By definition,
the potential residents,
they don't live in the city that priced them out of a home.
It's not all bad news, however. Slowly,
some cities are starting to change.
In 2016, Auckland, New Zealand,
they liberalized their laws to allow upzoning in much of the city.
And the number of new houses skyrocketed and housing prices moderated.
The rest of New Zealand is now following suit.
Even San Francisco is starting to allow new duplexes and fourplexes.
So let's hear it for a more elastic supply of housing.
Okay. There you have it.
If you want to understand why housing prices are rising,
you must first understand the elasticity
of supply and what makes housing supply in many parts of the world inelastic.
Now, you can test your understanding of elasticity
by checking out our practice questions.
We also have test banks and lesson plans for economics teachers.
Or, if you're ready for more microeconomics, click for the next video.