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ECONOMICS FOR MANAGERS

MPE 781/MPE 981

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1 Summary and main messages of the Article, “Australian Housing Market Review,” by Arnhem Investment Management, November 2012

Housing is a very significant asset for individuals across the globe, and it also plays a crucial part in the development of a particular economy as well. This article throws light on various economic variables such as demand, supply and credit availability that affects the housing market. Although, examples of major economies (like US, UK, China) have been included in the article, the major focus of discussion relies upon the Australian Housing Market throughout the article. The article has been well supported with the use of graphs, figures and statistics to make the reading intuitive and informative for the reader.

Demand Side

The first part of the article relates the demographics of a particular economy to the Housing Markets. The main findings of the analysis include the relevance of the age group band between 20-44 years which is considered to be primary for basing the decision of purchasing a home. This figure is expected to lower down as per the economic experts by the year 2020 relative to the current trend which is prevailing in the economy.

The article also relates the immigration trends in Australia which has considerable effect on the demand side of the Housing Market in the Australian economy as depicted in the figure above. As shown in the figure, the green bars reveal the net migration, and it is relatively higher given that Australia is a popular education destination for working officials and also for international students who aspire to settle in Australia after the completion of their respective education. Another key factor highlighted is the change in the people per dwelling that has been consistently reducing in Australia as size of the families become smaller. This also impacts directly other related industries such as theconstruction business, mortgage, electricity and other micro industries thus affecting the economy as a whole.

Supply Side

Although the population of Australia has been on the lower side relative to other counter parts and major economies in the world, Australian economy has been supplying over 140,000 units annually. Die to an increase in the immigrants, focus of the supply side has shifted to building up apartments rather than independent houses. The social trends also favour people living in apartments that are in close proximities to the commercial areas and the CBD in major cities of Australia.

The other major points highlighted in this article include the impact of taking credit for buying a house. Certain finance companies offer credit in order to increase their business and this aggressive lending which leads to high rates of returns that are paid back to these financial institutions. This leads to lack of liquidity in the economy and creates a stage for thefinancial crisis.

The gist of the article reveals that the housing market from an economic perspective is contingent upon several factors that affect several layers of the economy.The major factors that are discussed in this article leads to the argument whether Australian economy will face the issue of the property bubble that is essentially caused by supplying more housing units which a country might need or more than the demand of the economy. This situation can result into several consequences including that of global financial crisis. However, it is ascertained that the Australian economy is not going to face this situation as the higher supply is backed up by increasing population trends and the affordability of the people to buy homes(Arnhem Investment Management, 2014).

2. Why Melbourne Housing Pricing are overvalued

The housing market within Melbourne is 20%to 30%overvalued. This has made Australiato be highly vulnerable to a huge global economic shock. The fiscal policy settings are to blame for the overvaluing of the housing prices. In addition, the low rates of interest have significantly pushedthe prices of the housesout-of-proportion with fundamentals. The prices of the houses are 26%beyond their peaks prior to the financial crisis.

Distortionsin valuation havebeen plummeted by the easy monetary policy as well as the reluctance of the regulators to make use of the macro-prudential techniques to slow the growth in the housing prices. Additionally, the general financial situations have been very loose hence undermining the long term financial stability (Allen, 2013).

Numerous reports have also pointed out that the housing sector in Australia ranks number five among the most overheated market. This is after Belgium, Canada, Norway, as well as New Zealand. This analysis was done based on the average of two major ratios: the prices of the homes in comparison to the income, as well as the prices of homes in comparison to the rent in relation to the historical averages. The report further points out that the housing market in Australia's is 40% overvalued on the basis of an estimate that the prices of the homes to the rent are 52% beyond the historical averages and again, the prices of the home to income are about 28% above average (Allen, 2013).

Source (Schelesinger,2013).

Real House Price Index of Australia and USA

3 Effects of the buyer’s tax on the equilibrium housing prices, consumer surplus, producer surplus and total surplus

According to Giles & Tedds (2002), governments always increase the taxes in order to increase revenues that they employ in relocating wealth besides increasing social welfare. The figure below illustrates the impacts of imposition of thetax on the houses.The price before the imposition of thetax was P0 while the price that is paid by the consumers ispD. The price received by real estate developers, on the other hand, is pS. Surplus of the consumer is reduced byE and B while the producer surplus generally decreases byF and C. the government increases the revenue from point zero up to C andB. products, in this case the real estate developers and the consumers lose E+ B+C+F. Revenue from the tax isC+B which generally influences deadweight loss, total surplus reduction:E+F. Deadweight loss is dependent on the elasticity of demand curves and the supply curves. As Giles & Tedds (2002) posit, when elasticity is very high in absolute terms, thedeadweight loss becomes very large.

Based on the quantity of the tax, tax revenue might be smaller, or it might be bigger.

Relationship between the buyer’s tax and social welfare

According to Torgler & Schneider (2005), economic welfare can be defined as the total benefit that is available to the society from the economic situations or transactions. Economic welfare can also be referred to as a community surplus. In the diagram below, welfare can be illustrated by area ABE,which has consumer surplus that is ABP together with the region for the producer surplus which is PBE.

Tax brings about a decrease in welfare, even considering that the government gets revenues from the taxes. Welfare decrease is always called deadweight loss because of the taxes. Deadweight loss because of the excise tax is a kind of inefficiency in the economy. It is a reduction in the consumer surplus and also in the producer surplus. Excise taxes always distort resource allocation. Through taxes, minimal amounts of the resources of the society are devoted to good. However, this does not have the implication that ought not to impose taxes in a bid to raise their revenues. In numerous instances, individuals will agree to bear the consequences of deadweight loss brought about by taxes when the government is capable of providing services, which the market might fail to offer. The services might entail things like income redistribution, defence, as well as legal protection and education, among other things (Torgler & Schneider, 2005).

Effect of the increase in the buyer’s tax on the revenues for the city government

The impact of change in the level of taxation on the revenues is always dependent on the type of the goods and also on the price elasticity of demand. If a given item has a very low elasticity of demand, (price inelastic), when there is an increase in duty or tax, decrease in demand will be very small, sometimes it may not be enough to balance the high tax that is got from every unit. Therefore, there will be a rise in the total tax revenue. On the converse, for the goods that are price elastic, when there is an increase in the rate of taxes, the revenue always falls (Alm, Martinez-Vazquez & Schneider, 2004).

Because of theinelasticity of demand, an increase in buyer’s tax will have minimal effects on the demand; it might not have the capacity to balance with a high tax that will be gained in terms of the revenues. Therefore, increase in buyers’ tax will play a role in raising revenues for the city government.

4.(a) If the city government’s objective is to maximize profits, what would be the housing price set in this new area?

The city government is a monopolist. In amonopoly, there are no very close competitors and,therefore, it canignore the possible reactions of the other companies in choosing the output, as well as the price.

Profit maximizationrefers to theshort runand the long runprocess through which firms establishes theprice, as well as theoutputlevel which brings the highestprofit. Numerous approaches can be applied. The first oneis the total revenue–total cost approach which is based on the notion that profit is to revenue less costs. It mainly focuses on the minimization of the difference. The other approach is marginal revenue–marginal costand is generally founded on the notion that total profit generally reaches the maximum point in which marginal revenue is equal to the marginal cost. For the maximization of profits, the city government should sett marginal cost to be equal to their marginal revenue (Alm, Martinez-Vazquez & Schneider, 2004).

Welfare maximizing price and output

Welfare can be defined as the sum of the consumer surplus, as well as the producer surplus.

In most cases, welfare is very low in monopoly in comparison to thecompetition because competition plays a major role in maximizing welfare since price is equal to the marginal cost. Through the setting of theprice to be beyond the marginal cost, monopolies make the consumers to purchase less than competitive levels and hence theoccurrence of deadweight loss within the society. Welfareis always maximized when the price is equal to the marginal cost. When the price is equal to the marginal cost, this is called allocative efficiency. It makes the consumer surplus to be at its greatest point. Hence, when the city government charges a price that equals the marginal cost, welfare will be maximized.When the city government sets the housing prices beyond the marginal cost, there will be the creation of deadweight loss(Martin, Paul,& Georg& Frank& Joel,2011).

Revenue Maximizing Price

A single way of indicating the distinction in output that may be from distinct business objectives is employing the total revenue, as well as the total cost curves. When firms face demand curves that are sloping downward, total revenue curve always rise at a rate that is highly decreasing until the point where the marginal revenue becomes zero. The total cost curve’s shape is dependent on the things that happen to its marginal cost, when it is assumed that the diminishing returns take place within a short run, the total cost eventually commences to go up at a rate that is increasing. Profit maximising output takes place at the largest vertical distance that exists between the Total Revenue and the Total Cost curves. On the contrary, revenue maximization takes place at an output level that is higher(Martin, Paul,& Georg& Frank& Joel,2011).

Maximizing the revenues that are obtained from sales is the alternative of maximization of the profits and as pointed, it takes place if the marginal revenue obtained from the selling of theadditional unit is zero.

For the city government to maximize revenues, there is a need for them to establish the housing units to a point in which Marginal Revenue becomes zero.At this level of output, PED is 1.

Maximization of sales takes place if the Citi government sells as much housing units as possible in the newer regions without making losses. Sales maximization entails attaining the highest attainable sales volume, devoid of making losses (Martin, Paul, & Georg& Frank& Joel, 2011).

5. Measures used by the United States to stabilize the housing market

Public housing within the US is generally administered by the state, federal, as well as the local agencies to offer subsidizedhelp for the households that are regarded to be low income earners. The Department of Housing and Urban Development is generally chargedwith the role of stabilizing the housing market besides offering security to the homeowners. In order to attain meet this objective within the market that is highly challenging, the Administration has put into place a broader approach of the implementation of the state, as well as the local housing agency measures, tax credits for the buyers of the homes, stabilization of the neighbourhood, as well as the implementation of a number of community development programs, mortgage modifications, as well as refinancing, continued engagement of the Federal Housing Administration, housing counselling, and increased protection of the consumers (Federal Reserve, 2012).

Additionally, the Treasury Mortgage-Backed Securities as well as the Federal Reserve purchase programs have played a major role in keeping the rates of mortgage interest to be very low for a number of years (Englund, P. (2003).

There are several other numerous housing market recovery efforts that commenced after the Obama administration took over in the year 2009. A number of the strategies have played a role in pointing out major indicators of the market health. For instance, the purchases of newer homes plummeted by about 18.6% in the month of May, 2014. Additionally, the sales of the previously owned homes grew in the month of May after the lackluster performance during the past two-quarters (Laurie, 2012).

The equity of the homeowners has generally continued to indicate stronger gains.

Generally, the Administration has generally taken a wide array of actions in a bid to effectively stabilize housing market besides helping the homeowners in American. In the recent years, there was stress within the financial systems, something which severely minimized mortgage credit supply, thereby limiting the capacity of the Americans to purchase homes and their capacity to refinance mortgages (Abramowitz, 2008).

The Homeowner Stability and Affordability Plan played a role in stabilizing the housing market. Several other measures have also been taken in order to stabilize the market. These include supporting Fannie Mae, as well as Freddie Mac in order to make sure that there is effective access by the Americans to mortgage credit that is affordable. At the same time, Federal Reserve, as well as the United States Treasury bought in excess of $1.4 trillion as agency mortgage sponsored securities via independent MBS purchase programs so as to help in keeping the rates of mortgage to be very low. It also launched the modification initiative in a bid to aid the homeowners in reducing mortgage payments to levels that are affordable and also to shun avoidable foreclosures. These have played major role in stabilizing the housing markets within the US (Roberto, Quercia, McCarthy, and Susan, 2009).

Measures used by the Canadian Government to stabilize the housing market

A number of strategies have been employed by the Canadian government in order to stabilize the housing market. The stabilization of the housing market by the Canadian government has been made to be a success through building of robust collaborative relations with partner agencies, stakeholders, as well as other governmental levels.

The government of Canada has also strived to make sure that there is responsive, balanced, as well as flexible regulatory systems which are aimed at making housing to be affordable for the Canadians. It has also strived to safeguard housing investments besides promoting the construction of healthy homes.

Measures used by the Government of UK to stabilize the housing market

Diverse strategies have been adopted by the UK in order to stabilize the housing market. Generally, the housing market within the United Kingdom is generally not impressive. However, some of the main strategies that have been adopted by the government include the provision of various forms of incentives in order to boost the players within the market. At the same time, there is a highly tight standard for mortgage affordability by various banks like the Bank of England. This is generally aimed at heading off various signs of overheating of the market.

References

Alm, J., Martinez-Vazquez, J. & Schneider, F.(2004).Sizing the Problem of the Hard-To-

Tax.Georgia State University: USA., Working Paper.

Arnhem Investment Management, (2014).Australian Housing Market Review. Market Drivers, Long Term Pricing Indicators and Investment Implications. Sydney: Arnhem Investment Management Pty Ltd, pp.2-15.

Abramowitz, D. (2008). “Green Affordable Housing: Within Our Reach”. Washington:

Centerfor American Progress. Retrieved from On September 5, 2014.