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- [Alex] Why is this house selling
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 --
the elasticity of supply.

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Sounds complex, 
but it's actually quite simple.

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In the United States
around the world,

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many industries and jobs

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have been concentrating
in a few dynamic cities,

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like tech in Silicon Valley, 
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
in these dynamic cities,

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and that increases
the demand for housing.

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And remember, what happens
with an increase in demand?

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The demand curve
shifts to the right,

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

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This leads to a new equilibrium,

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with a higher quantity
sold at a higher price.

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But which increase
will be larger --

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the quantity change
or the price change?

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That depends upon

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whether the supply
is elastic or inelastic.

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If the supply is elastic,

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meaning the producers
can easily produce more housing,

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then the quantity supplied
will increase a lot,

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and the price
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
to produce more housing,

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and our supply curve
looks more like this.

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In this case,

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the quantity supplied
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
their production

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in response to the higher price.

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Now, unfortunately, many cities
have inelastic housing supplies.

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

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with little increase
in the quantity of housing.

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Why?

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Well, first, there are
natural problems.

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Many of the in-demand cities --

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they're surrounded
by beautiful water.

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Nice, but that means
a limited supply of land.

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But we compound natural problems
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
from creating more housing.

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Take San Francisco, for example.

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

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

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There's plenty of land in the sky.

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San Francisco's 
zoning laws, however,

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have made it impossible
or very expensive

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to build taller buildings
in many parts of the city.

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Even changing single-family homes
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
a plot of land to use.

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Well, next, they need
a building permit.

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And the process for filing
for building permits --

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it could be hard to understand.

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City officials can leave applicants
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
for a new house.

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

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

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Many people can still veto
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
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
is inelastic,

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let's revisit our supply
and demand graph

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and illustrate what happens
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
in that city increases.

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The demand curve
shifts to the right.

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To keep it simple,

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say that ten people
want to move into the city.

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Builders see
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
supply of housing.

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

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increasing the quantity supplied a
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
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
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
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
of housing jacking up the price.

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It's the buyers who must bid
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
values for existing residents.

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

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And that's one reason
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
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
be able to live near good jobs at all.

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And notice that the people who
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
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
allow upzoning in much of the city.

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

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The rest of New Zealand
is now following suit.

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

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

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Okay. There you have it.

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If you want to understand why
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
in many parts of the world inelastic.

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Now, you can test your
understanding of elasticity

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by checking out our practice questions.

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

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