Tuesday, September 19, 2006

Supply and Demand in Housing (Part II)

Today saw the release of new housing starts and permits (permits are the written permission to construct a new home). You can read the article that summarizes the data here. But this paragraph in particular is helpful:

"Housing starts have been beating a hasty retreat since January as home builders have quickly responded to slowing sales and ballooning inventories of unsold new homes,"

Translation: Slowing demand (sales) has caused an increase in inventories (supply and demand are not in equilibrium). This in turn has caused suppliers to cut back dramatically on the construction of new homes and purchases of permits to build new homes (quantity supply is declining). The question you may have is what about price. Well, the housing market is peculiar in that the overall price level for homes has never fallen. The reasoning behind this is that the housing market is "illiquid" in that it does not adjust fast. But while the sticker price you see at the real estate agency may not fall, inflation ends up eating away the REAL price of a home and thus the price either falls or stops going up in real terms.

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