In this essay, I will examine the factors that determine the price of houses in UK housing market. Firstly we will have a look the past and the recent history of UK housing market. The UK housing market has been booming in the past few years, with prices rising much faster than household incomes. After its dramatic crash in the early 1990s, the UK housing market has staged a remarkable recovery.1 In the early 1980s widespread financial deregulation raised the availability of mortgage finance and stimulated the demand for housing. Real house prices rose by over 4½ percent per annum on average during the decade, with nominal house price inflation peaking at 28 per cent in 1988. Monetary policy was subsequently tightened in the late 1980s as inflationary pressures began to emerge in the wider economy, with mortgage interest rates rising to over 15 per cent in 1990. This helped to push the economy into recession, and the housing market weakened considerably. Nominal house prices fell by around 7½ percent between 1990 and 1992, the first such decline for nearly forty years. The recent downturn is notable not only for the depth of the decline in real house prices, but also for its relative longevity, with real prices falling by an average 6¼ per cent per annum from 1989 to 1994 and by a further 2½ per cent in 1995.2 In equilibrium the price paid by consumers for the flow of services from the housing stock, the real rental price of housing services, should equal the real user cost, which is the opportunity cost of investing in those services. Under the dual assumptions that both the quality and quantity of the housing stock are fixed in the short-term, real house prices must adjust to ensure equilibrium.2 The market value of some people's houses fell below the amount of their mortgage. When home owners cannot repay their mortgages by selling their properties, they fall into what is known as 'negative equity'. Unable to meet monthly mortgage payments, or to sell and move to a cheaper house, many people defaulted on their loans and repossessions soared.1
The tightening of government building regulations will act to change the supply conditions within the housing market.The tighter regulations will cause the market supply curve to shift to the left. This is because the tighter regulations are likely to either increase the costs of building homes, or reduce the availability of space for homes. In either case the profit maximising producer will seek higher returns in other markets. Therefore, fewer homes will be built.The magnitude of the change in price and quantity will depend on the price elasticity of demand and price elasticity of supply. The reduction in economic output of other sectors and the reduction in the cost of land will influence the supply curve.The relationship between economic output of other sectors and the supply of housing is that they are in composite demand. For instance, the fall in output of other sectors means that there is more available land for housing, hence, the supply curve will shift to the right.The lower costs of land will also increase the market supply of housing. The lower cost represents lower costs of production, this will increase profitability, so attracting more producers into the market. The outcome is that market supply curve shifts to the right.The lower interest rate will reduce the cost of borrowing money to buy a house. The current situation is where people have to borrow money to purchase a house, then a mortgage and a house are complementary goods. Therefore, if the demand for mortgages increase then there will be a corresponding increase in the demand for housing.3
Figure 1 : Real House Prices in UK, 1984 - 2007
Demand and Supply for Housing Market
We are seeing the interaction between buyer and seller with prices being offered and agreed before a final transaction is made. In this section we focus on the demand and supply side factors that determine the...