Elasticity of Supply: Why Housing is Unaffordable

- [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.