1. Introduction 3
2. The evolution of house price in the UK and the factors affecting 3
supply and demand
3. The price and income elasticity of housing demand 9
4. Literature 11
The aim of this study is to explain the changes in the prices of houses by shedding light on factors affecting the demand and supply of houses in the UK. Firstly, we will look at the evolution of house prices in the UK since 2006 and examine relations between house prices and output, employment and mortgage interest rate. Also, supply of houses will be discussed by ...view middle of the document...
” However, Barker (2004) additionally suggested that housing supply is commonly assumed fixed in the short term unlike demand. Therefore, the UK home prices initially are affected by demand and expressed as a function of the physical housing stock, real income and other demand shifters such as interest rate, the GDP, unemployment (Kuenzel & Bjornbak, 2008).
According to the emprical studies, the GDP and interest rates are the most important house prices drivers (Egert & Mihaljek, 2007). The interest rates are divided into the real long-term interest rate and the short-run nominal interest rate. The nominal interest rate influences the decisions of individuals on whether to buy a house in the short-run (Barrell, et al., 2011). Namely, an increase in the interest rates makes home loans more costly and this leads to cut both housing demand and prices (Apergis, 2003). According to the second graph, house prices have experienced initially a bust in 2008 and then boom in 2010. The main driver of the sharp fall in prices is the low level of interest rate in 2008 since the house demand is responsive to sudden changes in interest rates. Moreover, the housing boom occurred as a period of rapid output and gross domestic product growth (GDP) (Farlow, 2005).
GDP growth rate
GDP growth rate
According to the third and first graph, a significant impact of GDP changes on housing prices can be seen. In 2008, house prices fell due to the global financial meltdown and the economic recession since GDP and house prices have a direct relation between current economic conditions (Adair, et al., 2009). Hence, any decline in GDP has an impact on housing demand through households’ confidence and their spending. In terms of unemployment, there is an inverse correlation between unemployment and home prices (Prakash, 2012). Income level tends to be lower in case of high unemployment and this directly limits the number of people who are able to afford properties (Riley, 2012). Looking closely at the fourth and first charts, one can see that the effect of unemployment level is very clear in 2009. Because of a decrease in demand, house prices fell and unemployment rose at the same time.
Furthermore, there are some factors apart from interest rate, GDP and unemployment that could explain sharply rising house prices. For instance, in case of immigration, increased divorce rates, demographic changes, expectations of future income and changes in the supply of mortgages, house prices may increase in response to demand pressures (Levin & Pryce, 2009).
House price changes in the UK will be explained by illustrating the demand and supply curve. A real GDP growth, decrease in interest rate, decrease in unemployment lead to increase in income and confidence and an increase the demand for UK houses, hence house prices temporarily increase in the short...