How Supply & Demand Affects Housing Prices

by Naomi Smith

You may recall from economics class that the supply curve slopes upward for housing, so that when the price is higher, more owners want to sell. The demand curve slopes downward because when home prices rise fewer people are interested in buying. The two curves cross at what's known as the equilibrium point. There are a variety of factors that affect the supply and the demand, and they have different effects on housing prices.

Interest Rates

Changes in interest rates tend to affect the demand curve more than the supply curve. Since most consumers need a mortgage to buy a home, when interest rates are low, more people will want to buy. This causes an upward shift in the demand curve, and at every price point there will be more people interested in buying. This results in higher prices overall in the marketplace, until we hit a new equilibrium point.

Tax Policy

Some policies affect demand, such as the mortgage interest deduction. Owning a home costs less when you can deduct a portion of your payments from your taxable income. A tax break for new home purchases also provides lower taxable income. Both of these policies serve to increase demand for housing, and that can mean higher prices. Other policies affect the supply, such as reduced tax rates on capital gains. This causes more owners to want to sell, because they'll pay less tax on profits they have on the house. The supply curve moves out, pushing more homes onto the market, and unless demand changes, prices will fall. The demand curve may also shift as buyers are willing to pay more for homes, knowing they will pay less taxes later, making the net effect unclear.

Location

This factor is harder to quantify. You can't really move a house, but location has a huge effect on prices. Neighborhoods with good schools attract families, leading to higher demand and causing prices to rise. Demographic shifts can lead to lower demand if a recession forces a big local employer to close. Unemployed workers selling homes cause an increase in supply and lower prices, but a new factory opening will increase demand and local prices.

Oversupply

During the U.S. mortgage and financial market difficulties which began around 2007, banks foreclosed on homeowners who couldn't make mortgage payments, then tried to sell the homes to get their investments back. The glut of houses on the market pushed prices down dramatically. If financing is easy to get during an oversupply situation, the market should soon correct.

About the Author

Naomi Smith has been writing full-time since 2009, following a career in finance. Her fiction has been published by Loose Id and Dreamspinner Press, among others. She holds a Master of Science in financial economics from the London School of Economics and a Bachelor of Arts in political economy from the University of California, Berkeley.

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