Question

Think about a housing market where demand for housing is downward sloping and supply of housing is vertical. Draw a graph and show the equilibrium. What is the elasticity of supply of new housing? Now suppose if the government wants people to buy more houses, it announces a tax credit policy for new home buyers. Which curve will shift? Will it lead to an increase in houses purchased?

Answer 1

The original equilibrium is at e* where equilibrium quantity and price of housing are Q* and P* respectively.

Elasticity of supply of new housing is inelastic because houses cannot be built quickly in response to a sudden increase in demand, construction of new houses takes time. It is also constrained by the limited availability of land and labour.

If govt announces tax credit for new home buyers, the demand for housing will increase which will shift the demand curve to the right to dd'. Since supply of housing is fixed in the short run, an increase in demand will increase the equilibrium price of houses. New equilibrium is at e' where equilibrium quantity and price of housing are Q* and P' respectively.