Why is Housing Different

1
Chapter 13

• Why is Housing Different?

2
Differences

• Heterogeneous dwellings differ in size, age,
  style, features, location
• Durable Deterioration rate depends on
  maintenance and repair decisions
• Costly Moving Households adjust their housing
  consumption when gap between ideal and actual
  housing consumption is large enough

3
Hedonic Pricing Approach

• A house as a bundle of attributes
• Houses differ in size, layout, neighborhood,
  quality of interior and exterior.
• The hedonic approach determines the price for
  each part of the housing bundle

4
Example of a hedonic study

• Base price for average dwelling 200,000
• Deviation from average carries a price
• Extra bedroom 30k
• Access -2k for additional mile from center
• Lower air quality -1k for each unit
• Better schools 2k for each unit increase in
  test score

5
Kain and Quigley (1970) Hedonic Study

• Using data from St Louis to estimate the housing
  values of different attributes

6
Durability, Deterioration, and Maintenance

• Quality Ladder
• With zero maintenance the dwelling deteriorates
  down the ladder
• Moderate expense keep dwelling at same
  level
• Large expense for remodel renovate
  to raise level

7
Quality Choice

• Cost of quality increases at an increasing rate,
  i.e. becomes more expensive to maintain a
  dwelling the higher its quality
• Total revenue increases with quality

How does the marginal revenue curve look like?
The marginal cost curve ?
8
Quality Choice

• Pick quality level that maximizes profit
• Upper panel Largest gap between revenue and cost
  curve
• Lower panel quality where marginal benefit
  marginal cost

9
Dwelling age and quality

• Older dwelling has higher cost of maintaining
  quality higher marginal cost of quality
• Eventually MC gt MR for all quality levels, and
  dwelling retired from housing stock

MC
MR
Q
QLOW
Q0
10
Possible retirement scenarios

• When the dwelling is retired from the housing
  market there are several possible scenarios
• Boarding up temporary removal from market if
  price expected to be higher in future and
  opportunity cost of funds low
• Conversion Profit from alternative gt Conversion
  cost
• Abandonment disown the dwelling if profit from
  alternative lt Conversion cost.

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Abandonment and Public Policy

• What causes individuals to abandon their
  properties?
• Inflexible tax structure
• White (1986) finds that high property taxes was
  responsible for property abandonment in New York
  city
• This contributes to budget deficit as
• Less properties are on the tax rolls
• City has to take over and demolish more properties

12
Abandonment and Public Policy

• Is government intervention needed?
• Negative Externalities imposed by abandoned
  property
• Affects values of nearby properties
• Self reinforcing process

13
Price of quality and quality

• Increase in price shifts the MR curve upward,
  increasing the profit-maximizing quality level

MC
MR
Q
Q High
14
Moving Costs and Consumer Disequilibrium

• A change in household income or the housing
  quality implies a change in the optimum amount of
  housing consumption.
• Due to the presence of moving costs (moving
  possessions and detachment from neighborhood),
  households may not readily change their housing
  consumption
• When the benefit from moving is high enough, a
  household will adjust its housing consumption.
  This adjustment will be large

15
Moving Costs and Consumer Disequilibrium

• Response to Increase in Income
• Initial utility maximization (q, A)
• Increase income shifts budget line to northeast
• In absence of moving cost, go to point k and
  reach U2
• High moving cost household will not adjust
  housing quality
• Move when gap between U1 and U2 large enough to
  justify moving cost

A0
All Other Goods
k
A2
A
U2
U1
U0
q
q2
Housing Quality
16
Implications

• Households dont respond instantly to change in
  circumstances
• When a household moves, the change is large

17
The Filtering Model of the Housing Market

• Filtering refers to the process whereby there is
  a
• Decrease in quality of the dwelling overtime
  physical deterioration, technology, fashion
• Decrease in its occupants income

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Filtering and the Housing Stepladder

• Simplifying assumptions
• Three different income levels high medium and
  low
• Demand for quality of a dwelling is proportional
  to income (H30, M20, L10)
• With regular maintenance, dwelling loses one unit
  of quality per year
• Each household adjusts its dwelling quality level
  once the gap between actual and ideal 10 units
• Assume upgrading is too costly

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Quality Deterioration

• Start of the decade points h (high income), m
  (medium), l (low)
• End of decade i (high income), n (medium), z
  (low)

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Quality Deterioration

• Options for high-income household to get back to
  point h
• Upgrade old dwelling is costly
• New house with new materials, technology, fashion
• Buy new house, sell old house which is at q 20

21
Quality Deterioration

• Options for middle-income household to get back
  to point m
• Costly upgrade
• Buy used house from high-income household
• Result Dwelling moves h to i (decrease in
  quality), then i to m (decrease in occupant
  income)

22
Quality Deterioration

• Same logic for low-income household
• Old middle-income dwelling point m to n
  (decrease in quality), then n to l (decrease in
  occupant income)
• Old low-income dwelling point l to z, then
  retired

23
Price Effects of Growth Controls

• Assumptions
• Three quality submarkets High medium and low
• A growth control that outlaws against building
  new houses

24
Effect on high-quality dwellings

• Owner of high-quality dwelling can either
• do nothing and quality drops
• spend money to prevent drop in quality
• Growth control (building ban) shifts supply to
  left by 45 units
• Supply shifts left by 45 (new houses not built)
• Shortage causes increase in quantity by 25
  (houses maintained, fewer units filter down to
  medium market)
• Price increases from 800 to 1,000 and quantity
  drops by 20

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Effect on medium-quality dwellings

• Supply shift by 25 Fewer units filter down to
  medium market
• Demand shift Increase in price of high increases
  demand for substitute good
• Price increases from 400 to 550

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General lessons

• Supply restriction in high-quality market causes
  higher prices in both markets
• Supply effects of building ban transmitted
  through reduction in filtering
• Demand effects contribute to higher prices in
  medium market
• Same logic applies to low-quality market

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Assignment

• Questions 1,2, 3
• Due on Dec 2
• Late assignments will not be accepted!