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Gee, Ya Think? Supply Influences Price?

This article is more than 9 years old.

I think we might want to keep this little story for when someone starts the "bad newspaper stories about economics" competition. The contention is that British house prices are high because there aren't that many British houses available for people to purchase. Which seems rather likely to be true if we're to be fair about it, but quite why this should make an interesting newspaper story is a bit harder to fathom. Because that's how we generally think that markets work. There's supply of whatever it is, there's demand for that thing, and then prices move around so as to increase or decrease one and the other so that the market actually clears. Thus a lower supply relative to demand should indeed bid prices up. This isn't some mystery, some unfathomable trick being played on us by the universe, this is just how it all works. So much so that we can look at prices, observe that if they're rising then we think that there's a bit of shortage of supply relative to demand.

But here is that story:

Property prices are being forced up because there are not enough homes to satisfy demand.

As I say, we would conclude that there's a shortage of supply simply from observing the rising prices. But it's sufficient of a story to get more airplay:

However, according Rightmove's latest statistics, the end is not nigh for soaring UK house prices.

The listings website, one of the largest in Britain, blamed a "decades of inadequate provision of homes to satisfy demand" for the latest boost in asking prices across the country.

This really does work both ways. Why are prices going up? A shortage of supply. How do we know there's a shortage of supply? Prices are going up.

Sadly they've also missed the important economic story here, which is that British house prices haven't really changed. They are, just as they pretty much always have been, at around and about replacement cost. Anyone can check this by looking at the house insurance policy. Someone might have paid £1 million for that three bed house in London but that's not what they would get if it burned down. They'd get perhaps £200,000, the cost of rebuilding that house. The other £800,000 is the value of the planning permission to build a house on that specific piece of land. So, what is rising is the value of that planning permission. And that's because fewer planning permissions are being issued than the number which would meet demand. Issue more planning permissions and prices would start to fall.

It really is, I'm afraid, that simple.

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