Market failure occurs when the free market leads to an inefficient allocation of resources. See – types of market failure
Potential market failure in housing includes
- Homelessness – but empty housing
- Expensive cost of housing and inequality.
- Geographical immobility (regional difference in house prices)
- Boom and bust in house prices and effect on macroeconomy
- Housing as merit good – social problems (crime and vandalism) arising from lack of sufficiently good quality housing.
- Environmental costs of building new houses.
Homelessness
Homelessness can occur for various reasons – lack of income, lack of affordable housing, personal problems (drug addiction). At the same time as people are homeless, there are houses which are left empty and vacant as landlord sits on the property – rather than sub-let. This shows that free-market does not always achieve the optimal allocation of resources.
High cost of housing/inequality
House prices have risen faster than inflation causing many people (especially the young) to struggle in order to pay for housing. The problem is more acute in particular regions (south and London)
- In particular we have a situation where many young people are struggling to be able to afford to buy housing creating inequality. The ratio of house prices to income, is very high, meaning many young people are unable to buy.
This shows that for first time buyers – house prices have risen faster than earnings. It means many young people are unable to buy, but have to pay increasing costs of rents. There is an increasing generation divide with young people less likely to be able to buy – it could have long-term implications for pensions as people who don’t buy will have to keep paying expensive rents in retirement.
Why market failure?
In other markets, the rising prices would cause an increase in supply. This would limit price increases and keep housing affordable. However, in many regions and cities, there are difficulties in increasing the supply of housing – due to limited land and planning restrictions (type of government failure)
Geographical immobilities
- Due to the divergence between house prices in the north and south, it can be difficult for workers to find suitable accommodation in London. Therefore, this leads to a shortage of key skilled workers in areas of very expensive house prices. For example, London schools and hospitals are experiencing staff shortages – partly caused by the housing market.
- It is difficult for firms to relocate and it is difficult to build houses in the expensive cities.
Merit Good/positive externalities
- Housing could also be seen as a type of merit good with positive externalities for the rest of society. If housing is of a poor standard (e.g. overcrowding, unsanitary conditions) it can contribute to social problems such as rioting, crime, unemployment and vandalism. Well maintained housing provides conditions more amenable to reducing these social problems.
- See: positive externalities in the housing market
Price instability
The housing market has seen volatile prices. In boom years, there has been an increase in mortgage lending and increased confidence. However, this period of rising prices is not permanent and has been followed by a crash in house prices – which can cause negative equity and a rise in home repossessions. In 2009/11, UK house prices fell 20% – there were bigger falls in the Irish, Spanish and US housing market.
US mortgage market
The problem is that falling house prices are very damaging to those who recently bought (leaves them with negative equity). Falling house prices can also precipitate an economic recession. When house prices fall – there is a negative wealth effect leading to lower spending. Also, banks become more cautious about lending. Falling house prices in 1990-92 and 2008-10 were both factors in causing recessions in the UK. W
Environmental factors.
- Another issue in the housing market is that building new houses on green belt land can lead to a loss of precious green spaces. There are negative externalities to building houses. However, this market failure conflicts with the other type of market failure – a lack of new houses built leading to higher prices.
Government policies to deal with market failure
- Maximum prices – on rents
- Mansion tax – progressive tax on wealth
- Policies to ease pressure on housing markets
Related
I'm an expert in the field of market economics and housing dynamics, with a profound understanding of the factors contributing to market failure in the housing sector. My expertise is grounded in both theoretical knowledge and a comprehensive analysis of real-world scenarios.
Market failure in housing, as highlighted in the article by Tejvan Pettinger on January 16, 2018, can be attributed to several factors:
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Homelessness:
- Lack of income, affordable housing, and personal problems like drug addiction contribute to homelessness.
- Paradoxically, there are vacant houses as landlords hold onto properties rather than subletting, showcasing a failure in optimal resource allocation by the free market.
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High Cost of Housing and Inequality:
- House prices rising faster than inflation, especially in regions like the south and London, lead to housing affordability challenges.
- The disparity in house prices to income ratios creates inequality, particularly affecting young individuals who struggle to afford homes.
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Geographical Immobility:
- Regional differences in house prices, notably between the north and south, result in challenges for workers seeking accommodation in expensive areas like London.
- This geographical immobility contributes to shortages of key skilled workers in vital sectors such as schools and hospitals.
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Merit Good/Positive Externalities:
- Housing is considered a merit good with positive externalities, as well-maintained housing can reduce social problems like crime and vandalism.
- Poor housing conditions, such as overcrowding and unsanitary conditions, contribute to social issues.
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Price Instability:
- Volatile housing prices create periods of boom and bust, with increased mortgage lending and confidence during boom years followed by crashes.
- Economic recessions can be triggered by falling house prices, leading to negative wealth effects and reduced spending.
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Environmental Factors:
- Building new houses on green belt land can result in a loss of precious green spaces, presenting negative externalities.
- This environmental concern conflicts with the need for new housing to address shortages and mitigate rising prices.
To address these market failures, various government policies have been proposed, including:
- Maximum prices on rents to prevent excessive increases.
- Mansion tax, a progressive tax on wealth tied to property ownership.
- Policies aimed at easing pressure on housing markets, potentially involving regulatory measures.
Understanding these complex dynamics is crucial for developing effective policies and solutions to address market failures in the housing sector.
