Demand and Supply for Residential Housing in Urban China

Micro Economics Paper

Demand and Supply for Residential Housing in Urban China

Gregory C Chow

Ever since residential housing in urban China became commercialized in the late 1980s the price of houses has increased rapidly from 408.18 yuan per square meter in 1987 to 3119.25 in 2006, or at an annual growth rate of 11.3 percent. (See data in Table 1 of this paper.) Such price increase has been a great concern to the Chinese government and the Chinese people. At times the government attempted to regulate the housing market because it believed that the rise in price was due to speculation. For example, purchasers of new houses were not allowed to resale them within two years without paying a penalty of 5% in the form of a business tax on the total transaction price; 40% down-payment is required for second mortgages. A main purpose of this paper is to show that the price of urban housing in China is determined mainly by the basic economic forces of demand and supply. If the price increase is partly due to the upward shift in demand resulting from the rapid increase in disposable income, and partly due to the upward shift in the supply curve resulting from the rapid increase in construction cost, any government interference of the market price will lead to inefficient allocation of resources in the housing market. (Although construction cost as measured by the Building Materials Industry Price Index did not increase after 1992, average land purchasing price as a major component of construction cost has increased at an annual rate of 11.8% from 1997 to 2007.) Furthermore government regulation is unlikely to be effective in controlling the price of housing because the basic forces of demand and supply, namely changes in disposable income and construction prices, are more powerful than government action.

We start with the basic premise that the standard theory of demand for and supply of consumer durable goods is applicable to urban housing in China after the market for housing was established in the late 1980s and provide estimates of income and price elasticities of demand for urban residential housing. Although previous studies, e.g. Hu, Su, Jin and Jiang (2006) and Zhang, Weng and Zhou (2007), have examined the determination of housing prices in China, none has estimated the demand and supply equations for urban housing in a simultaneous equations framework and provided estimates of price and income elasticities of demand and price elasticity of supply.

Beginning with the study of Chow (1957) economists have accepted the proposition that the demand for total stock of a consumer durable good such as automobiles and housing can be treated in the same way as the demand for non-durables and services. To explain the change in the stock of a durable good Chow (1957) introduced and found evidence to support the partial adjustment hypothesis, namely, that the actual change in the stock in one year is a fraction b of the difference between the "desired stock" and the stock of the preceding period, where the "desired stock" is determined by a demand equation for the services generated from the stock with income and price as the most important explanatory variables. Conclusions

Summary

In this paper we have applied the standard theory of consumer demand supplemented by a partial adjustment mechanism to explain the demand for and supply of urban residential housing in China. The demand for housing is explained by real income and relative price. The supply of housing is explained by relative price and the cost of construction. The interaction of demand and supply can explain the annual price of urban housing at the aggregate level in China very well. This result helps dispel the notion that urban housing prices in China are mainly the result of speculation.

In the introduction we pointed out that in applying the standard theory of consumer demand to the demand for durable goods we have adopted two simplifying assumptions. First the rent of housing is approximately proportional to the price variable for housing that we use. Second the movement of the rate of interest which affects monthly mortgage payment is small and infrequent relative to the movement of prices. While these two assumptions may introduce errors in the price variable in our model, the fact that the simple model of demand and supply employed in this paper has succeeded in providing elasticity estimates of correct signs and reasonable orders of magnitude is reassuring. Our estimates of income elasticity are similar to those found in other countries and in China in the early 1930s. This study is an example of the applicability of standard economic analysis to the Chinese economy.

MACROECONOMICS

Why does money have value? (Mike Moffatt)

Money doesn't have any inherent value. It is simply pieces of paper or numbers in a ledger. A car has value because it can help you get where you need to go. Water has a value because it has a use; if you don't drink enough of it you will die. Unless you enjoy looking at pictures of deceased national heroes, money has no more use than any other piece of paper.

It didn't always work this way. In the past money was in the form of coins, generally