ASRJC 2022 A Level H1 econs CSQ1 answers

© ASRJC Economics Department 1 H1 GCE A Level Examinations 2022 Question 1: The Housing market – Global perspectives Suggested Answers (a) With reference to Figure 1, compare the trend in the real house price index for Singapore with that of Germany and Turkey over the period shown. [3] The real house price index for both Singapore and Germany generally increased over the period shown [1], while that of Turkey fell over the period shown [1]. The increase in real house price index for Singapore is larger than for Germany[1]. (b) With reference to Extract 1, explain how well-functioning housing markets where the ‘consumer is sovereign' can affect the supply of houses. [4] In a well -functioning housing market, the price mechanism performs the signaling and incentive functions and thus solves the problem of resource allocation. In a market, there is consumers’ sovereignty. This means that consumers would determine how resources are to be allocated based on their willingness and ability to pay and this in turn would affect the supply of housing. Thus, housebuilding firms would respond to changes in housing prices brought about by changes in demand. Cities are growing at unprecedented rates coupled with a growth in their population sizes. This leads to an increase in demand for housing. The increase in demand results in a shortage of housing. Consumers will compete for the limited quantities available and offer higher prices. The higher price signals to firms that there is a shortage of housing. It also provides a "financial incentive" for firms to increase quantity supplied of hous es as they become more profitable. Price continues to increase until a new market equilibrium is attained. We can thus see that where consumer is sovereign, the quantity of hous es supplied would increase with an increase in demand. (c) Using price elasticity of demand, explain how 'an increase in stamp duty' (Extract 2) is likely to affect total expenditure on private housing. [5] The increase in stamp dut y would cause an increase in the cost of production for housebuilding firms, as it is a tax they must pay on the sale of a house. As cost of production rises and hence fall in profitability , the supply of private housing will fall. This is represented by a leftward shift of the supply curve from SS0 to SS1 in fig. 1. This fall in supply resulted in shortage and an increase in equilibrium price (P0 to P1) and a decrease in equilibrium quantity (Q0 to Q1).

© ASRJC Economics Department 2 The demand for private housing tends to be more price inelastic, as a 12% increase in prices has led to a less than proportionate decrease in the quantity demanded (Ext 2). The increase in consumers’ expenditure due to rise in price (illustrated by area X) is more than the fall in consumers’ expenditure due to the less than proportionate fall in quantity demanded ( as shown by area Y). Thus, total expenditure on private housing would increase. (d) 'The benefits to society of residential homeownership are greater than the private benefits perceived by the homeowner' (Extract 3). With the use of a diagram, explain how this situation would cause the housing market to fail. [6] Assuming a perfectly competitive market, the demand curve reflects the marginal private benefits (MPB) of consuming an additional unit of residential housing such as having a safe place to live while the supply curve reflects the marginal private costs (MP C) of producing an additional unit of residential housing such as the cost of labour and capital. In the free market, consumers and producers being rational and pursuing self-interest will seek to maximise their utility and profits. They consider only their private costs and benefits when deciding how much to consume/produce. This means that the free market equilibrium, where demand meets supply or when MPB = MPC is at Qe. Price SS0 SS1 Quantity of private housing P1 P0 Q1 Q0 fig. 1: Market for Private housing DD0 X Y

© ASRJC Economics Department 3 However, the benefits to society of residential home ownership are greater than the private benefits to the homeowners. This is because the consumption of residential home also generates positive externalities, i.e. marginal external benefits (MEB) to third parties . A higher rate of homeownership creates a safe neighbourhood and community as the residents feel that they have a greater sense of ownership and belonging to the estate and the community . This leads to fewer neighbourhood crime s and higher youth academic achievement which can help to increase their productivity and income s. Employers can also earn higher profit s from the increased productivity due to a more educated workforce and lower crimes . In this case, t he firms are the third parties as they do not pay for the benefits. The MEB results in divergence between MSB and MPB. Hence, the marginal social benefit (MSB) curve is above the MPB curve and MSB=MPB+MEB. However, the socially optimal level of consumption of residential housing is at Qs where MSC=MSB. As Qe<Qs, there is under -consumption of residential housing. QsQe represents an under -consumption of residential housing, that is, the price mechanism under -allocates resources to the market for residential housing. From Qe to Qs, the MSB is greater than the MSC, indicating that the additional benefit to society is more than the cost to society of producing these units. By summing the excess of the marginal social benefit over the marginal social cost for QeQs, we arrive at a monetary measure of total deadweight loss to society equal to the area ABE. Thus, society welfare is not maximised when society under -consumed residential housing. MEB A E B Quantity of residential housing Cost/Benefit MPB (Demand) MSB MPC=MSC (Supply) Qe Qs

© ASRJC Economics Department 4 (e) Comment on the extent to which the information in RESIDENTIAL HOUSING SUPPLY (Extract 1) supports the view that the short -run price elasticity of supply of housing is likely to be inelastic. [6] Price elasticity of supply measures the degree of responsiveness of quantity supplied of a good to a change in its price, ceteris paribus. The supply of residential housing in the short -run is price inelastic. The main reason for this is the time it takes to build a new ho use. The construction of a house can take years, from the planning process to the project's completion. As shown in Table 1, the planning process alone takes an average of 196 days in Latin America and 201 days in Asia. Hence, the short-run supply of housing in likely to be price inelastic. This means that even with the shortage, an increase in price will only cause a less than proportionate increase in the quantity supplied of housing due to housebuilding being a lengthy process. Comment However the information provided in Table 1 is only for the planning stage. After the planning stage comes the other stages such as land purchase, clearance and construction, but information on the number of days involved in these stages is not provided. Thus more information is needed. Nonetheless, Table 1 shows that just the planning process alone takes more than six months. Thus when we factor in all the other stages, including land clearance and construction which are expected to take a longer time, the information is fairly sufficien t to support the view tha t the short-run price elasticity of supply of housing is likely to be inelastic. [Other possible Comment] The information provided in the case is insufficient to support the view that supply of housing in the short run is price inelastic. There are other factors that also determine elasticity of supply such as the stoc