Economics Questions Essay

1. Housing Prices 1.1 Fundamental and Non-fundamental Factors Pricing of a product depends on many factors such as demands for the product and how excessive the product exists in the market (supply). Housing price is influenced by `fundamental` and `non-fundamental` factors. The fundamental factor inn housing price is about supply and demand (Himmelberg, Christopher, and Sinai, 2005). 1.2 Market Bubbles and Fundamental Factors The question is whether market bubbles emerge from fundamental factors or what evidence that leads to a bubble in house prices. The fundamental factor inn housing price is about supply and demand (Himmelberg, Christopher, and Sinai, 2005). However, people know the theory of supply and demand are only the first steps towards understanding how setting up the market prices of a product. Furthermore, the theory also helps people to understand the way in which these prices help shape production and consumption decisions. It means that the law of supply and demand will explain any situation that might exist if the market price is too high and vice versa. At any given moment, where the market price is too high, we might expect that consumers will leave sellers since they are already have other options having the same characteristics, size, and the tastes with lower price. The supply-and-demand theory revolves around the proposition that a free, competitive market does in fact successfully generate a powerful tendency toward the market-clearing price. Without any conscious managing control, a market spontaneously generates a tendency toward the dovetailing of independently made decisions of buyers and sellers to ensure that each of their decisions fits with the decisions made by the other market participants. Were this tendency to be carried to the limit, no buyer (seller) would be misled that it wastes time attempting to buy (sell) at a price below (above) the market-clearing price (Kirzner, 2004) Since housing market attracts many investors to put their money for hope that it will raise significantly over times, the housing prices may reach a bubble period. The raise in house prices is influenced by fundamental factors, the supply and demand. This makes sense since the demand for having houses may be exploded when the bubble exist. By definition, bubble situation occurs when housing price is high because buyers/investors predict that the selling price of houses will rise dramatically in the future (Himmelberg, Christopher, and Sinai, 2005). 1.3 Current Housing Prices and the Bubble The housing prices continue to rising today. There are many underlying factor behind the uplifting housing prices. According to McCarthy and Peach (2004), one of the cause behind the rising housing price is because the existence of a speculative bubble in this asset market. This condition present potential threats as the asset market could experience a collapse that further harm the U.S. economy. Another reason of the uplifting housing prices is that the some home buyers Have the willingness and intention to buy the rising housing prices for hope that the houses will rise significantly in the future (McCarthy and Peach (2004). 2. Urban Land Theory Given the case that the town of Valley stream, Long Island is 20 miles by car from midtown Manhattan and in 2000, the median home value was $199,800. The town of Dix Hills, Long Island is 36 miles from Midtown Manhattan and the median home value in 2000 was $386,100. Explain why these facts do or do not disprove the standard `urban land theory` as formulated by economists such as Kain and Alonso. The case does not comply with the urban land theory since the price of housing does not merely relate to distance from a city center or any places of interests. Many factors or preferences have great impacts towards customers’ decision on buying housing that further influences the price as following: a) A Change in Buyers’ Incomes and Wealth According to Howard Community College, â€Å"the demand for most products will go up of buyers’ real incomes or real wealth, i.e., their purchasing power rises.† In the case of housing, if a buyers of the housing manage to earn $25,000 next year instead of $10,000 this year (and assuming there is no increase in the price level), it means that the costumer’s real income increases. This situation will affect the customer’s spending such as their preferences to buy houses that are more expensive. b) Buyers’ Tastes and Preferences Another factor that influences the demand for a product is buyers’ tastes and preferences. In case of housing, the existence of emotional benefits such as good neighborhood or areas where there are celebrities will raise the price of housing in the areas. In addition, the availability of transportation to distance location may increase the housing prices. Another theory says that fundamental factors, the supply and demand, may have influence towards the pricing of cities. Third, changes in underlying fundamentals can affect cities where in locations where housing supply is inelastic, prices tend to be higher relative to rents (McCarthy and Peach, 2004) c) The Prices of Related Products or Services In the housing case of Valley stream, Long Island and Dix Hills, Long Island, the difference of pricing may happen if in the areas there are many housing or other substitutes like apartment, condominiums, and townhouses. Therefore, it does not matter a housing is located hundreds miles away from the downtown, as long as there are value added that customers will obtain when purchasing the houses in the are, the price could be much higher than that near to a city center. The situation explains why Valley stream, Long Island that is 20 miles by car from midtown Manhattan and in 2000, the median home value was $199,800 is priced lower than town of Dix Hills, Long Island is 36 miles from Midtown Manhattan and the median home value in 2000 was $386,100. d) Buyers’ Expectation of the Product’s Future Price This factor will play a role when, for instance, Dix Hills, Long Island announces that the price of their houses will increase next month or year since there will be a shopping centers of any place of interests that located near to the housing. This situation will drive consumers to buy the houses in Dix Hills, Long Island quicker. Therefore, this kind of determinants will increase current demand for the housing in Dix Hills, Long Island and shift the demand curve to the right. 3. Feds and booms and busts in the housing market In the New York Times column of May 27, 2005 economist Paul Krugman wrote: After all, the Feds ability to manage the economy managing comes from its ability to create booms and busts in the housing market In 2004, inflation had picked up and had raised questions in the minds of some people about whether it might be on a rising trend that poses a risk to price stability. Total consumer price inflation as measured by the chain price index for personal consumption expenditures (PCE) has risen from 1.4 percent over the twelve months of last year to an annual rate of 3.0 percent over the first four months of 2004. Donald L. Kohn, a Governor of the Federal Reserve, says that price stability is Fed’s responsibility since it allow businesses and households to plan and operate without worrying about increases in the general price level over the long run is how we contribute best to fostering economic efficiency and rising standards of living (â€Å"Remarks†). Inflation has closed relationship with interest rates. In the situation where retail prices experience a significant increase, people might expect that interest rate will rise as well. The reason is that government try to control the amount of money exist in the market. According BBC News (2005), the increase of oil price and Katrina storm have caused investors in Wall Street to think of Federal Reserve that will likely to push up interest rates rapidly to control inflation. In the United States, the Treasury yield curve is the first indicator of all domestic interest rates and it influence global rates setting. Therefore, in the U.S., interest rates on all other domestic bond categories rise and fall with Treasuries yield. Below is the figure explaining the impact of inflation and interest rates on the Yield.