How supply & demand affects housing prices

Written by christopher faille
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How supply & demand affects housing prices
An owner-occupant is both an investor in and a consumer of the same asset. (urban housing image by stoffies from

The basic concepts of supply and demand apply to real estate much like they apply to other goods or services. In any case, the equilibrium price is the price at which the quantity demanded is equal to the quantity that sellers are willing to supply.

There are, though, a couple of intriguing complexities in the case of real estate. First, many families see their home as their nest egg -- the depositary of their savings. There is a great unwillingness to sell at all when market prices would require that one take a loss in order to do so.

Another complicating factor is the treatment of mortgage interest in the tax code.

The Basics

An increase in the number of houses that owners are willing to sell will tend to drive the price down. This might come about if, for example, construction methods become more efficient or the prices of components, such as lumber, bricks, or wiring, should fall.

On the other hand, an increase in the number of buyers in the market for a house will tend to drive the price up. This might happen if tax laws change in ways favourable to home ownership or if the adult population of a country or region increases.

If these respects, housing prices work the same way that the prices of crude oil or car-detailing services work: prices move with changes in demand, and inverse to changes in supply.

Price Stickiness

One of the features distinctive to the housing markets is that would-be sellers can easily "hold out." They can decide the market price is too low, and withdraw their home from the market. This makes the price "sticky." It can be very slow to fall, because buyers don't need to accept the loss of the value of their home. Indeed, given the enormous investment that many homeowners have put into their property, it is a wrenching decision to accept a price that acknowledges the loss of its value, so it is unsurprising that many homeowners put off that decision.

Mortgage Interest

Another feature of the housing market is that, since houses are extremely expensive, they are almost always purchased with borrowed money. The market, then, is sensitive to public policy decisions with regard to both the housing transaction itself and the loan.

In the United States, mortgage interest is the only interest expense that consumers may deduct in full from their gross income in the calculation of their taxable income.

As the national debt has increased and the U.S. government looks to broaden its revenue sources, this deduction has become very controversial. Should there be a change, though, it will no doubt have an impact on housing prices.


Because much of the value of a home is typically borrowed, and this loan is secured by the asset itself, the title to a home can change when the buyer cannot make the payments. This creates another unique element in the supply-and-demand picture: much housing, in coming on to the market, arrives there after a passage through the courts and the foreclosure passage.

In the U.S. in 2010, the foreclosure process was stalled in many states due to concerns about inproper paperwork by the lending institutions. One of many consequeces has been a delay in the process by which housing prices might otherwise have found a supply/demand equilibrium.

Real-estate investor John Downs has written that, because in part of the sloppiness or worse on the part of banks that has presented for defaulting homeowners with a "once-in-a-lifetime opportunity," he does not believe that the real estate market in the U.S. will soon improve. The lawyers can delay bankruptcy-auction sales indefinitely, the houses that are destined to come on to the market eventually will do so only slowly. This means they will continue to exert pressure on the market for a long time to come, there will be no hitting of bottom for purposes of a rebound.

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