ECON1011 Economics for Business Lecture 3: Housing Crisis PDF

ECON1011 Economics for Business Lecture 3: Housing Crisis, Part 2 Announcements RiPPLE Round 1 has started! Goes until Friday 23 August 3pm. Topic: Housing Crisis or Cost of Living You need to create one (1), moderate five (5) and answer ten (10) resources in each round As long as you su...

ECON1011 Economics for Business Lecture 3: Housing Crisis, Part 2 Announcements RiPPLE Round 1 has started! Goes until Friday 23 August 3pm. Topic: Housing Crisis or Cost of Living You need to create one (1), moderate five (5) and answer ten (10) resources in each round As long as you submit an effective resource before the deadline – even if it is not moderated before the deadline – it will still count towards your creation. However, if it was later deemed as ineffective, you won’t get the mark for creation. So please start early. 2 Useful Reference HGLO Chapter 5 Ignore the bits about consumer and producer surplus. We’ll get to that in a future lecture. 3 Housing Crisis in Australia – The Human Toll Why do we care? Explaining is not ignoring Just because we can explain why there is a housing crisis in Australia doesn’t mean we justify it The purpose of explaining the problem is to find good solutions Economics is important in public policy debate because good intentions alone do not make good policies 5 Should the Government Intervene? Don’t economists love laissez-faire? Generally speaking Economists care about efficiency because it’s a basic requirement – if we can achieve the same outcome at a lower cost, then the resources saved can be used towards other desirable social goals. There may be other requirements that we care about (equality, fairness etc.) But even if we just talk economic efficiency Housing unaffordability is economically costly and inefficient to society 6 What is Homelessness? Source: Homelessness Australia 7 What is Homelessness? Source: Homelessness Australia 8 Source: Homelessness Australia 9 Trends in homelessness Source: Australian Homelessness Monitor 2022 “SHS” refers to Specialist Homelessness Service Number of SHS users is a proxy of homeless population 10 Correlation with housing unaffordability Source: Australian Homelessness Monitor 2022 11 Homelessness is costly “Beyond the human tragedy, what most passers-by fail to see is the cost of homelessness to us all. It includes the bills for police and ambulance call-outs, prison nights, visits to emergency departments, hospital stays and mental health and drying out clinics.” If we realised the true cost of homelessness, we’d fix it overnight, The Conversation, September 22, 2020 12 Accounting for the cost of homelessness In 2021, the NSW government commissioned Taylor Fry, an actuarial firm, to identify risk factors and costs of homelessness in NSW between 2011 to 2017 From the executive summary: “The average cost to government over six years for people accessing homelessness services is $186k, nearly 4 times higher than the NSW population. Only 9% of costs relate to the homelessness and housing sector. “Within this group of people accessing homelessness services, the 5% with the highest cost represent 1,500 people. The average cost to government across six years is $706k per person, with 84% of these costs attributable to the NSW Government, mostly in the health and justice sectors.” See Pathways to homelessness 13 Opportunity cost is high too Loss in economic output due to reduced employment Loss in human capital – People with insecure housing have lower life expectancy – Less likely to have access to training and education – More likely to have health problems (e.g., substance misuse, mental health issues) Loss in participation in the community See Adam Steen, ‘The many costs of homelessness’, The Medical Journal of Australia, 2018 14 Why care about Homelessness? Persons experiencing Homelessness suffer negative health, social and developmental consequences. Lack of Secure Housing exposes the homeless to violence and victimisation. Lack of a fixed address: – Reduces a person’s ability to secure employment – Hampers affected children’s ability to access education (ABC article) – Often prevent people from securing bail or parole Health Consequences of homelessness – Poor nutrition – Poor access to healthcare – Depression and other mental health issues The University of Queensland 15  Source: ABC News The University of Queensland 16 Perry and Craig (2015) The University of Queensland 17 Potential solutions What can we do? There are quite some debates Source: ABC News 19 Overview of potential solutions Measures directed to renters who stay in the rental market Rent control or rent freeze Rental subsidy Measures attempting to move renters out of the rental market Help-to-buy Measure targeting supply Increasing housing supply Negative gearing 20  Rent control What if we prohibit price increase? Price controls Price controls are legally binding restrictions on prices that can be charged for goods and services Two types of price controls: 1. Price ceilings: A maximum price that can be legally charged for a good or service. – Example: Rent control 2. Price floors: A minimum price that can be charged – Example: Minimum wage 22 Price Floors A Price Floor is a legally mandated minimum market price. Obvious example: Minimum wage (currently AUD24.10/hour in Australia) Price Floor in the Australian labour market is 𝑃𝑃𝐹𝐹 = $24.10 Employers (buyers of labor) cannot legally offer less than $24.10 for each hour of work If the Equilibrium Market Price is Above the Price Floor 𝑃𝑃∗ ≥ 𝑃𝑃𝐹𝐹 The Price Floor will not affect the resulting market price. In this case, we say that that Price Floor is non-binding. If the Equilibrium Market Price is Below the Price Floor 𝑃𝑃∗ < 𝑃𝑃𝐹𝐹 The market price will be forced UP to the Price Floor. In this case, we say that the Price Floor is binding. Non-Binding Price Floor P Supply The Price Floor is below the Equilibrium Price. Sellers are allowed to charge the equilibrium price 𝑃𝑃∗ , so the 𝑃𝑃∗ imposition of the Price Floor does not change the market outcome. 𝑃𝑃𝐹𝐹 Even after the Price Floor is introduced, Market Price and Quantity will remain at 𝑃𝑃∗ and 𝑄𝑄∗ Demand respectively. Q 𝑄𝑄 ∗ Binding Price Floor The Price Floor is above the Equilibrium Price. P Illegal for sellers to charge 𝑃𝑃∗. Supply The market price is forced UP to the Price Floor 𝑃𝑃𝐹𝐹. Excess Supply B An Excess Supply arises as Quantity 𝑃𝑃𝐹𝐹 Supplied (𝑄𝑄2 ) exceeds Quantity Demanded (𝑄𝑄1 ) at the Price Floor. 𝑃𝑃∗ A We can’t force Buyers to buy more than what they wish to buy (𝑄𝑄1 ) at the Price Floor. Market Quantity decreases from 𝑄𝑄 ∗ to 𝑄𝑄1. Demand The Market Outcome shifts from Q 𝑃𝑃𝑃𝑃 𝐴𝐴 to 𝑃𝑃𝑃𝑃 𝐵𝐵 𝑄𝑄𝐷𝐷𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 = 𝑄𝑄1 𝑄𝑄 ∗ 𝑄𝑄𝑆𝑆𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 = 𝑄𝑄2 Economic Consequences of Price Floors Non-binding price floors have no economic impact. Binding Price Floors – Lowers market price to the Floor Price – Create excess supply in the market – Lowers market quantity available – compared to the competitive market equilibrium Impact on Sellers (who might be expected to lobby for Price Floors) – Higher prices (good!) – Lower quantity sold (bad!) – overall ambiguous impact Impact on Buyers – Overall bad – forced to pay a higher price and faced with lower quantity available. The University of Queensland 26 Price Ceilings A Price Ceiling is a legally mandated maximum market price. For Example, if the Price Ceiling is the market for Apples is 𝑃𝑃𝐶𝐶 = $4, That means that sellers can charge any price 𝑃𝑃 ≤ $4, But they are not allowed to charge any price above $4. If the Equilibrium Market Price is Below the Price Ceiling 𝑃𝑃∗ ≤ 𝑃𝑃𝐶𝐶 The Price Ceiling will not affect the resulting market price, since sellers are charging a price below the legal maximum. Say that that Price Ceiling is non-binding. If the Equilibrium Market Price is Above the Price Ceiling (𝑃𝑃∗ > 𝑃𝑃𝐶𝐶 ) The Sellers will be forced to lower prices to the Price Ceiling. Say that the Price Ceiling is binding (since it constrains the pricing decisions of sellers) Non-Binding Price Ceiling P Supply The Price Ceiling is above the Equilibrium Price. 𝑃𝑃𝐶𝐶 Sellers are allowed to charge 𝑃𝑃∗ , so the imposition of the Price Ceiling 𝑃𝑃∗ does not change the market outcome. Even after the Price Ceiling is introduced, Market Price and Quantity will remain at 𝑃𝑃∗ and 𝑄𝑄∗ Demand respectively. Q 𝑄𝑄 ∗ Rent Controls Rent Controls can take the form of: Rent Caps: Govt. Imposes a Maximum Rent that can be charged for a property Rent Freeze: Rents not allowed to increase over time We’ll analyse Rent Control as a Rent Ceiling (or Cap) – Landlords can charge a rent that is less than or equal the Rent Ceiling 𝑷𝑷𝑪𝑪 – But cannot legally charge a rent > 𝑃𝑃𝐶𝐶 What if the government imposes a Binding Rent Ceiling? – Pointless to impose a non-binding rent ceiling… 29 Binding Rent Ceiling The Rent Ceiling is below the Equilibrium Price. P Illegal for sellers to charge 𝑃𝑃∗. Supply The market rent is forced down to the Rent Ceiling 𝑃𝑃𝐶𝐶. A shortage arises as: Quantity Demanded (𝑄𝑄2 ) exceeds Quantity Supplied (𝑄𝑄1 ) at the Price Ceiling. 𝑃𝑃∗ A We can’t force Sellers to supply a greater B quantity that what they are willing to sell 𝑃𝑃𝐶𝐶 (𝑄𝑄1 ) at the price ceiling. Excess Demand The Market Outcome shifts from a.k.a Shortage 𝑃𝑃𝑃𝑃 𝐴𝐴 to 𝑃𝑃𝑃𝑃 𝐵𝐵 Demand Q Market Quantity decreases from 𝑄𝑄∗ to 𝑄𝑄1. 𝑄𝑄𝑆𝑆𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶. = 𝑄𝑄1 𝑄𝑄 ∗ 𝑄𝑄𝐷𝐷𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶. = 𝑄𝑄2 Economic Consequences of Rent Ceilings Non-binding rent ceilings have no economic impact. Binding Rent Ceilings Market Price falls to the Ceiling Rent (𝑷𝑷𝑪𝑪 ) Create rental shortages (excess demand) in the property market Lowers market quantity available (i.e. available rental properties) – compared to the competitive market equilibrium Impact on Renter (those who might be expected to lobby for Price Ceilings): Those lucky enough to rent are able to enjoy lower rents But many Renters are left homeless Impact on Landlords Unambiguously bad – forced to rent lower quantity for lower returns The University of Queensland 31 Unintended consequences The road to hell is paved with good intentions The rental shortage (excess demand) caused by rent control leads to more intense competition among renters: Price competition Black-market renting – Renters enter informal rental agreements lack protection – (Illegal) rent-bidding: advertise properties with no fixed rent, encouraging interested parties to put in “best offer” Non-price competition – Landlords (or their agents) select “desirable” renters (e.g. no students or young people, no pets, no children, no immigrants) These responses harm vulnerable renters the most! If you are interested, see this Conversation article 32 Unintended consequences The road to hell is paved with good intentions The rental shortage (excess demand) also have impact on Supply Impact on Quality of Housing – Rent controls reduces returns on rental properties – Landlords cut back on maintenance – lowering quality of rental properties Impact on Rental Supply in the Long Run – Lower rents reduces returns on investment in residential properties – Many landlords might leave the rental market – i.e. sell off their investment properties to pursue higher returns in other asset classes. – Many potential landlords deterred from investing into residential rentals. – Lowering Supply of Residential properties in the long-run (further reducing the quantity of rental properties offered) 33 Unintended Consequences Source: Forbes The University of Queensland 34  Unintended Consequences ⋮ Sidenote: Black Market in Rentals: “Under-the-table” rental ⋮ agreements in which desperate renters secure housing by agreeing to pay rents higher than rent ceiling. Source: The Conversation The University of Queensland 35 The verdict Source: Urban Institute 36 Subsidy How about handing money out? National Rental Affordability Scheme (NRAS) Rolled out in 2008, property investors accepted into the program are offered financial incentives each year (for up to 10 years) when they rent out their property at a minimum 20% below market rate to eligible residential tenants (mostly low-to- moderate income households) The rental charge should not exceed 30% of the tenant’s income Incentives include tax offsets and cash payments Investors must meet all the federal and state compliance rules throughout the course of their NRAS funding Set to end in 2026 38 Rental Subsidy A subsidy is a payment from the government to either suppliers or consumers to encourage consumption and/or production. 2 types of Subsidies: Ad-valorem Subsidy – Subsidies calculated as a percentage of price. E.g. Subsidy rate of 20% - If 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = $1000, then 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 = $1000 × 20% = $200 Unit Subsidy – A fixed subsidy payment for each unit transacted. E.g. If unit subsidy is $300, then the government pays $300 per unit transacted, regardless of the price of each unit. For simplicity, we’ll focus only in Unit Subsidies. 39 Arrangements of subsidy Subsidies can be: Paid to Seller (Landlord); or Paid to Buyer (Renter) But it actually doesn’t matter – the market impact will be the same. Email me ([email protected]) if you are interested – happy to provide references to demonstrate this. We’ll focus on Subsidies paid to Sellers Because Australia’s National Rental Affordability Scheme (NRAS) operates by paying subsidies to Landlords. (See Forbes’ explainer on the NRAS.) 40 Buyer’s Price, Seller’s Price and Market Price Buyers’ Price (𝑃𝑃𝐵𝐵 ): Price that Buyers pay out-of-pocket for a good or service Literally what the Buyers need to pay to acquire the good or service The price that Buyers actually care about Sellers’ Price 𝑃𝑃𝑆𝑆 : Price that Sellers receive Literally how much enters the seller’s pocket for each unit sold The price that Sellers care about Market Price 𝑃𝑃𝑀𝑀 : Sticker price How much the Buyer pays the Seller The University of Queensland 41 No Unit Subsidy Buyer: 𝑃𝑃𝑀𝑀 Seller: 𝑃𝑃𝐵𝐵 = 𝑃𝑃𝑀𝑀 𝑃𝑃𝑆𝑆 = 𝑃𝑃𝑀𝑀 The University of Queensland 42 Government Pays Unit Subsidy to Suppliers Buyer: 𝑃𝑃𝑀𝑀 Seller: 𝑃𝑃𝐵𝐵 = 𝑃𝑃𝑀𝑀 𝑃𝑃𝑆𝑆 = 𝑃𝑃𝑀𝑀 + 𝑆𝑆𝑆𝑆𝑆𝑆 𝑆𝑆𝑆𝑆𝑆𝑆 Government The University of Queensland 43 Market with Subsidy (paid to Sellers) Suppose a unit subsidy (𝑺𝑺𝑺𝑺𝑺𝑺 = $𝟏𝟏𝟏𝟏) is paid to suppliers: What impact would this have on market Supply? Recall that the Supply Curve is relationship between Market Price and Quantity Supplied Suppose that without a subsidy, a market price of 𝑃𝑃𝑀𝑀,0 = $100 is required to induce suppliers to provide 100 units. When the subsidy of 𝑆𝑆𝑆𝑆𝑆𝑆 = $10 introduced, what market price would suppliers accept for them to supply the same 100 units? 44 Market Supply with Subsidy (paid to Sellers) Suppose a unit subsidy (𝑺𝑺𝑺𝑺𝑺𝑺 = $𝟏𝟏𝟏𝟏) is paid to suppliers: What impact would this have on market Supply? Without Subsidy: 𝑃𝑃𝑀𝑀 = 𝑃𝑃𝑆𝑆 – Sellers happy to provide 100 units when the seller’s price is 𝑃𝑃𝑆𝑆 = $100/𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢 – Takeaway: Sellers happy to supply 100 units if $100 per unit enters their pockets. With Subsidy: 𝑃𝑃𝑆𝑆 = 𝑃𝑃𝑀𝑀 + 𝑆𝑆𝑆𝑆𝑆𝑆 – Sellers still require 𝑃𝑃𝑆𝑆 = $100/𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢 to supply 100 units 𝑃𝑃𝑀𝑀 = 𝑃𝑃𝑆𝑆 − 𝑆𝑆𝑆𝑆𝑆𝑆 = $100 − $10 = $90 – When the government provides 𝑆𝑆𝑆𝑆𝑆𝑆 = $10 per unit sellers willing to accept a market price of 𝑃𝑃𝑀𝑀 = $90 since sellers still get 𝑃𝑃𝑆𝑆 = $100 for every unit sold. – Same applies for every combination of 𝑃𝑃𝑀𝑀 and 𝑄𝑄𝑆𝑆 along the original supply curve 45  Market Supply with Subsidy (paid to Sellers) Price Without Subsidy: ($/unit) Supply w/o subsidy – Market Price 𝑃𝑃𝑀𝑀,0 = $100 – Sellers’ Price 𝑃𝑃𝑆𝑆 = $100 Supply w/ subsidy – Sellers willing to supply 100 units since they receive 𝑃𝑃𝑆𝑆 = $100 per unit With Subsidy: 𝑃𝑃𝑀𝑀,0 = 𝑃𝑃𝑆𝑆 Sub=$10 – Sellers willing to supply 100 units so = $100 long as they receive 𝑃𝑃𝑆𝑆 = $100 per unit – 𝑃𝑃𝑀𝑀 = 𝑃𝑃𝑆𝑆 − 𝑆𝑆𝑆𝑆𝑆𝑆 – Sellers willing to supply the same 100 𝑃𝑃𝑀𝑀,1 = 𝑃𝑃𝑆𝑆 − 𝑆𝑆𝑆𝑆𝑆𝑆 Not to Scale! units if market price = $90 𝑃𝑃𝑀𝑀 = $100 − $10 = $90 – Relationship between market price and quantity supplied has changed – Supply Increased! Quantity Takeaway: Subsidies paid to suppliers increase Supply! 100 (unit/period) 46  Sale Subsidy Subsidy reduces the effective cost of providing the unit, shifting the supply curve down Price by the amount of subsidy. Landlords receive ($/unit) the price renters Supply w/o subsidy pay + subsidy Supply w/ subsidy 𝑃𝑃𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 = 𝑃𝑃𝑀𝑀𝑆𝑆𝑆𝑆𝑆𝑆 + 𝑆𝑆𝑆𝑆𝑆𝑆 Subsidy Landlord’s gain 𝑃𝑃∗ Renter’s gain 𝑃𝑃𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆 = 𝑃𝑃𝑀𝑀𝑆𝑆𝑆𝑆𝑆𝑆 New equilibrium quantity Renters pay the market determined by demand price at the intersection of and supply with subsidy. demand and supply with Demand subsidy. Quantity 𝑄𝑄∗ 𝑄𝑄𝑠𝑠 (unit/period) 47 Market Impact of Rental Subsidy Lower Buyer’s Price (Lower Rents!) Greater Quantity of Rental Properties available. Achieves the objective of Greater Affordability and Availability of Rental Housing Probably a better policy than Rent Controls Recall that Rent Controls reduce the availability of Rental Property. The University of Queensland 48 There is no free lunch Rental Subsidies come with opportunity costs Rental Subsidies are paid by the government and government spending has increased! Rental Subsidies divert funds from other socially beneficial government programs, some of which reduces homeless risks at the first place (e.g. public education, infrastructure, social security, public health, etc.) The opportunity cost of rental subsidies is the social benefits foregone due to reduced government spending on other social programs. The University of Queensland 49 Sidenote: Impact of Unit Taxes Unit taxes refer to taxes collected per unit of goods or services e.g. Australian Tobacco excise rates (link): $1.24 per cigarette Or $1842 per kg of tobacco Analytically, Unit Taxes are just negative subsidies Instead of government paying subsidies the government collect taxes from firms and consumers. Unit Taxes collected from Buyers Reduces Demand Increases price paid by Buyers 𝑃𝑃𝐵𝐵 ↑ Reduces price received by Sellers 𝑃𝑃𝑆𝑆 ↓ Creates excess supply – reducing market quantity – If interested (or if this is something that is relevant to your Video Critique) Please refer to Chapter 5 of HGLO textbook (Link) The University of Queensland 50 Increasing housing supply Back to the root cause Increase in Supply of Housing P 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑦𝑦0 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑦𝑦1 𝑃𝑃0∗ 𝑃𝑃1∗ Demand Q 𝑄𝑄0∗ 𝑄𝑄1∗ 52 Impact of Increase in Housing Supply As Houses become cheaper and more available to purchase: Owner-occupied housing market Lower property prices – easier to own a home Rental Market Increase in supply of rental units “Rich renters” move out of the rental market as they become home-owners – Decreasing demand for rentals The University of Queensland 53 Policies to increase Housing Supply Housing Australia Future Fund A $10bn fund aims to provide 30,000 new social and affordable rental homes in the fund’s first five years (Here is a Conversation article on the public economics of it) Inclusionary Zoning Requirements that property developers include a number of affordable housing units in new developments. (See AHURI explainer) Higher Density Zoning Rezoning suburbs to allow for mid to high rise apartment blocks (as opposed to single family dwellings with attached gardens 54 So why don’t we see more Housing Supply? The most obvious solutions are often the hardest to implement – Otherwise, we won’t have a housing crisis – if increasing supply is so easy. Australia has plenty of land – but everyone wants to live in the same places – I.e. close to urban centres – For access to amenities (e.g. schools & unis, public transport, entertainment, jobs) – So land that is attractive to home buyers/renters is limited. Issues: – NIMBYism (Not In My Back Yard) Many residents want to maintain the character of their suburbs I.e. single family houses with big backyards – reject proposals for higher density housing in their neighborhoods (e.g. mid-rise apartment blocks) Blocks higher density housing that might increase housing supply in desirable locations See Brisbane Zoning Map (Brisbane City Council) The University of Queensland 55 So why don’t we see more Housing Supply? Other Issues: – Shortage of Tradies – High Price of Building Materials – Issues discussed in the previous lecture Potential Solutions to these – Higher rates of skilled immigration (particularly for construction trades) But where will the new tradies live? – Lowering Construction Standards But what if buildings collapse due to poor construction standards? Example: London Grenfell Building Fire “Job creation isn’t always a good thing. Hobart’s new stadium can only make Tasmania’s housing crisis worse”, The Conversation, May 2023 We need to consider construction technology, not just “building houses” The University of Queensland 56 Conclusion What have we learnt? Recap Problem statement What policies may be helpful to alleviate the current housing crisis in Australia? Economic tools employed Interventions in competitive markets Findings Rent control backfires Rental subsidy increases quantity supplied Increasing supply addresses the fundamental supply issue – slowly Image: Adobe Stock 58 What we have left out – Applications Help to buy Can we move “rich” renters out of the rental market? This policy relies on the markets of substitutes – a decrease in price in the owner- occupied housing market will reduce demand for rental housing market Negative gearing Negative gearing refers to allowing landlords to deduct expenses on their rental properties from their taxable income In the rental market, negative gearing acts like a subsidy to landlords The complication is that it creates distortions in the real estate market – Creates demand in the Real Estate Market (where people buy properties) – Higher demand in Real Estate might result in higher house prices – Creating more demand for rentals (as people can’t afford to buy own homes) – Causing rents to be higher Impact of Negative Gearing on rents is controversial – argument can be made that removing negative gearing might actually make rentals more affordable. 59 What we have left out – Theory Sale Tax We discussed subsidy, but how about tax, the “opposite” of subsidy? This is left for Tutorial 3 Quota In the context of housing crisis, our hope is to increase quantity supplied However, the are cases when the goal of intervention is to restrict quantity (e.g., pollution) In those cases, a quota – a restriction on quantity supplied can be imposed. Analytically, it changes the supply curve to a vertical line at the restricted quantity 60 See you next week! Cost of Living next week CRICOS 00025B TEQSA PRV12080