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Factors That Determine House Prices in a Free Market Essay

First, we note the inter-relational and inter-dependent nature of supply, demand, and the public sector. The classification we offer in this paper is for the organisation of ideas into manageable chunks for ease of explanation only. We will not offer these characteristics as distinctive to demand or supply factors, since we recognize that certain characteristics can be classified in both. Second, we present the factors that determine house prices in a free market and emphasize that an understanding of the inter-relationship of several items is necessary and serves as evidence to the nature of money, and hence, house prices.

We assert that money circulates and the greater that circulation is; the greater is the positive impact on house prices. We hereby list demand factors, as follows: (a) Population growth; (b) Productive age; (c) Income; (d) Psychology; and (d) Global competition in trade or services. Population Growth. Land in Great Britain is scarce. A rapid growth in population leads to greater population densities in economically attractive living areas like London.

When land supply is fixed and the population, either through birth or foreign migration, grows constantly, the tendency of housing structures is to go vertical. Vertical expansion means higher volumes, and thus cost,

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of construction materials such as steel and cement. This leads to higher house prices, not only for high-rise or medium-rise structures, but also for low-rise houses due to the greater attractions and benefits of a low-rise house. Moreover, high-rise or medium-rise residential structures are costlier to maintain than low-rise homes.

In addition to this, negative externalities are many in high-rise or medium-rise housing developments such as: greater volumes of solid wastes, greater demand for the supply of water, higher crime rates, higher traffic congestions, etc. Naturally, local governments find ways to compensate for these social costs in the form of higher property or business taxes. Thus, we assert that all of these inter-related circumstances put an upward pressure in the cost of housing in economically-attractive living areas. Productive Age.

As a young population matures, it becomes more productive and reproductive. These lead to higher disposable incomes due to more efficient, economically-productive, skill sets as a result of age. A mature population also tends to become reproductive, which increases demand for housing. In addition to this, the European culture of independence and forcing it on our children, who have became adults and must leave our homes (ODPM 2005, p. 3), also leads to an increased demand in housing, naturally pushing house prices up.

Income. Houses are usually purchased through a mortgage and an essential requirement to qualify for a mortgage is a potential house buyer’s ability to pay (Dorfman 1992, p. 28). Naturally, after considering a mortgage’s monthly amortization, a bank lender that finds a potential buyer’s income as insufficient to sustain a living will reject the housing loan applicant. The volume of loans, whether these are rejected or approved, affects demand and thus, house prices. In support to this, Cameron, Muellbauer, & Murphy (2006 p.

6) also note that: “House prices are positively related to real per capita incomes… ” Pyschology. Farlow (2004) offers psychology as an explanation to, and major attribute of, currently rising UK house prices. He mentions the bandwagon effect in the unprecedented rise of UK house prices and considerably attributes this bandwagon as a media creation. Farlow explains that the media has been constantly reinforcing the dominant perception that house prices will continue to rise and create profits for house buyers, thereby compounding the demand for more houses.

Farlow also cites the works of Loomes & Sugden (1982), Bell (1982), Josephs, Larrick, Steele, & Nisbett (1996), and Ritov (1996) in an attempt to explain irrational consumer behaviour and herd mentality which creates a potentially destabilizing imbalance in the cost of homes. English and Cardiff (1979) also suggest that the growth assumptions (expectations) of house buyers compound increases in the cost of homes as growth assumptions pile up on top of the other. Global Competition in Trade or Services. International demand for British exports affects the UK Labour Market.

Any decrease in demand due to global competition will contract production and thus, employment opportunities in the UK. The opposite holds true in cases of increased demands. As already elaborated in the previous paragraphs, the circulation of money in the British economy affects house prices. We hereby list supply factors, as follows: (a) housing stock producers; (b) housing stock suppliers and materials; (c) technology; (d) geographic location; (e) financial services; and (f) global competition in supplies. Housing Stock Producers. Cameron (2003 p.

5) recognizes a constricted housing supply in the UK recession of the early 1990s. He notes that the recession led to a “major shakeout in the insurance and estate agency sectors” and suggests that a similar situation occurred in the house building industry. This implies lesser housing stock producers due to concentration and appears to be one of the reasons why UK house prices are currently rising. Moreover, Cameron also notes a weak supply response due to higher concentrations of (lesser) house builders. Housing Stock Suppliers and Materials.

The availability or unavailability of certain house building components that are being produced by British manufacturers can also lead to stable or higher house prices. The affordability of raw materials also plays a significant role in price determination as well as the economic value added and the cost of producing these house building components. Petroleum-based products like paints, adhesives, and other important chemicals needed in the manufacture of house building components are directly affected by the affordability and availability of petroleum. Technology.

The invention of the elevator has paved the way for the rapid development of the skyscraper. Due to this, high rise commercial buildings in concentrated locations have led to huge population densities during the working day. This has also established the necessity for commuting as land prices in prime areas have skyrocketed and workers have settled in areas where land values are cheaper as it radiates away from the economic centers of activity of urban areas. This is a structural representation of the ripple effect as to house valuations and density of low-rise, medium-rise, or high-rise house constructions.

Other inventions or new technologies are expected directly impact house prices in the area of wealth creation as described by US Economist, Douglas A. Ruby (2002): “Economic growth is …the sum of the rate of growth in technology in addition to a weighted average of the rate of population growth and the rate in which capital accumulates. ” He explains further that in order to maintain or improve living standards, capital must be accumulated or technology should progress. Geographic Location.

Alan Greenspan (2002) notes that: “Unlike stocks, where you have a single market, low transaction costs and an ability of people to pile on nationally and cumulatively, residential housing markets are all local. ” Moreover, Cameron, Muellbauer, & Murphy (2006 p. 9) also note that: “Greater London is considerably more expensive than the other regions. ” Financial Services. The eagerness of the financial sector to provide greater accessibility to mortgage also affects house prices.

Interest rates may be lowered, acceptable debt-to-income ratios increased, and other bank offerings can lead to increased demand due to the greater affordability and availability of credit. Farlow (2006) notes the findings of Groupe Caisse des Depots (2002) as to the housing market in Spain and France in which lower interest rates have led to higher house prices. Global Competition in Supplies. Unless regulated by government, the inflow of cheaper housing supplies from other countries could affect the cost of houses in the UK. The logic to this is self-evident and deserves no further explanation. Conclusion

We greatly attribute the behaviour of house prices to the public sector. Most government policies affect the entire nation in economic and psychological terms. Likewise, different markets, and also situations, affect one another either in a negative or positive way through the principle of cause and effect. To this extent, we accept that the housing market is mainly local, yet we also strongly assert that changes in national policies impact the housing market to much great effect, top-down or bottom-up. Careful analysis indicates that the root cause of housing price movements can always be pointed back to the public sector.

The other causes are either secondary or nth generational branches from the root cause.


BELL DE 1982, ‘Regret in Decision Making Under Uncertainty’, Operations Research, 30: 961-81, in Farlow 2004. BEYER, GH 1978, `Housing’, The World Book Encyclopedia, Vol. 9, World Book—Childcraft International, Inc. , USA. , p. 359. CAMERON G Aug. 21, 2003, The Barker Review of Housing Supply, Some Analytical Comments, Department of Economics, University of Oxford, Oxford, UK, p. 3. CAMERON G, MUELLBAUER J, & MURPHY A Mar. 5, 2006, ‘Was There A British House Price Bubble?

Evidence from a Regional Panel’, Department of Economics, University of Oxford, Oxford, UK, pp. 17, 18. CECCHETTI S, GENBERG H, LIPSKY J, & WADHANI S 2000, Asset Prices and Central Bank Policy: Geneva Reports on the World Economy 2, London, UK, CEPR, in Cameron, Muellbauer, & Murphy 2006. DORFMAN, JR 1992, The Mortgage Book, Consumers Union of the United States, Inc. , Yonkers, New York, USA. ENGLISH, JW & CARDIFF, GE 1979, The Coming Real Estate Crash, Arlington House Publishers, New Rochelle, New York, USA, pp. 56-58. FARLOW A Jan. 2004, Part Two The UK Housing Market: Bubbles and Buyers, Credit Suisse First Boston.

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