2013 A level H2 Economics Review: Microeconomics Qn 2

The Urban Redevelopment Authority (URA) announced that prices of private residential properties in Singapore rose by 1.3% in the third quarter of 2011, but the rise in prices has been slowing for eight consecutive quarters. At the same time it reported that the total supply of new private residential properties nearing completion was at a record high.

Discuss the different demand and supply factors and their likely importance in determining the reported changes in the prices of private residential property in Singapore. [25]

The long-winded(well-played) preamble basically feeds us with these two pieces of information:

1. Price has been increasing at a decreasing rate since the 3rd quarter of 2009 (8 quarters ago).

PoverT

Prices of Private Residential Properties in Singapore is increasing at a decreasing rate.

2. Supply in the next period is likely to be at an all time high.

Notice that number 2 says nothing about the state of supply in this period and supply in all previous periods, so be very careful what sort of inferences you want to make here. Moreover, bear in mind that supply and demand are flow concepts, so they only make sense when measured over a period of time.

Now, we are going to skip the basics and assume you have already identified a list of supply and demand factors, how do you distinguish which is more important in explaining the price changes?

The answer is, you need to tell a convincing story.

One possible story could be that in 2009, there was a sudden rise in demand that persisted for quite some time, which seems highly plausible at least to me because Singapore and most of the world were just coming out of the recession in 2008. Moreover, interest rates were at all time low so mortgages would have been very attractive. Prices would have spiked in the short run because supply is price inelastic.

Demand

The diagram shows changes in demand from each period to the next.
Demand is increasing more than supply throughout but at a slowing rate.

 

Now let’s finish the story by looking at the supply side.
Supply

When we perform the analysis, we will make the rather natural assumption that there is a lag time between the decision to increase supply and the actual impact of the increase in supply. (simply because construction projects take time)

The graph shows the change of supply in each period relative to the previous. If it’s below the zero line it means supply this period is lower than the previous period; if it is above it means supply this period is higher than the previous period. Naturally, it can have many discontinuities because supply in one period is not necessarily related to the next.

At point A, it is before/during the recession/financial crisis in 2008. Producers at this point cut down on construction projects, which will affect supply in 2009.

At B, the impact of the crisis hits and supply starts falling. Also at this point, the recession is over and producers begin resuming their normal operations/ production cycles.

Somewhere between B and C, the spike in prices happen. Clearly we can see that this is because the shortage in supply coincides with the demand spike.

At C, the impact of the previous period decisions take place and supply begins increasing every period.

Point D is pivotal. This is where prices are increasing very quickly, so producers increase the number of new construction projects and new firms will also enter the industry because of the increasing profit opportunities.

At E, some of the completed projects hit the market and supply increases at very high rates (but still less than the increase in demand as prices rose last quarter).

F is where we are at now, where there is a record number of about to be completed residential projects.

In conclusion, if you believe my story…

Looking at both supply and demand together:

For demand, income factor (YED) and perhaps a rise in speculative demand (low interest rates and expectations of future) are the most significant factors throughout. Population growth and foreign investment in domestic property could also be significant latent demand factors.

For supply, the key factor that accounts for this particular sequence of price movements will be the price elasticity of supply. Low PES arises from the fact that construction projects have a long lag time. During the crisis, limited access to funding leading to a higher cost of production could also be an important factor that explains the supply shortages in 2009.

As mentioned previously, take note that the above is merely a partial answer to this question (because I have skipped the boring bits at the front). For the full answer you’ll have to list the possible supply and demand factors and explain each of them, especially the significant ones, in detail using economic theory.

Till next time, dream economics.

The above was jointly written by Kenneth and Hanfei.