Mark Breakdown:
Knowledge - 3 marks
Application - 3 marks
Analysis - 3 marks
Evaluation - 6 marks
Structure:
Para 1. Definition of economic concept + application
Para 2. Analysis + diagram + application
Para 3. Eval + knowledge
Para 4. Analysis + application
Para 5. Eval + knowledge
Para 6. Short conclusion
Governments intervene to correct market failure, the inefficient allocation of resources by the free market. The market failure in the housing market occurs due to shortages in housing; there is excess demand. For instance, the UK suffers from a shortage of housing. The UK government has a target of building at least 300,000 new homes per year.
One way the government could intervene in the housing market is by introducing a subsidy to construction firms. A subsidy is a grant given to firms by the government to lower firms’ costs of production, which would translate into a lower price for the consumer. As shown on the diagram below, a fall in the cost of production leads to an outward shift of supply. As such, the price of housing would fall from P1 to P2, and the quantity produced and demanded increases from Q1 to Q2. Furthermore, consumer and producer surplus would also increase; this is the difference between what the consumer/producer is willing to pay/sell and what they pay/sell. As the extract shows, the government introduced a subsidy program subsiding the mortgage needed to buy a property.
However, to evaluate, supply may not increase because it’s price inelastic, meaning that supply won’t be particularly responsive to changes in price. This is because it takes a long time to build homes, there is limited availability of land, and high levels of regulation which make it difficult to construct new homes. Additionally, demand may not increase, because even with the subsidy it is still very expensive for consumers to buy a property. For example, in the UK it can still take ‘up to three years’ to save up for a deposit to secure a mortgage to buy a property.
Alternatively, another way the government could intervene is through direct provision of housing, such as in the case of social housing. In this way, the government funds and directs the building and allocation of housing at the price point they choose, so that supply and demand meet at the socially optimal equilibrium. This would help eliminate the shortages through an extension in. By building social housing, this would increase employment of construction workers and therefore incomes may rise. Additionally, construction firms’ profits would also increase and therefore they would have more to investment. As incomes and profits rise, government tax revenue may also rise, helping reduce the government’s budget deficit.
However, to evaluate, there is a significant opportunity cost. This is defined as the next best alternative foregone. In this case, the government expenditure on housing could be spent on providing education. Furthermore, the government’s provision of housing could lead to a form of government failure in that they are providing poor quality housing. Society might be more benefited by new infrastructure in the form of roads than housing.
To conclude, government intervention in the housing market is beneficial as there is an immense number of people willing to buy houses but unable to. Government intervention in the form of subsidies may, however, be more beneficial than in the form of direct provision, as they won’t suffer government failure from providing the wrong combination of goods.
