One of the arguments for a permanent increase in housing prices inside the Beltway is the lack of available space. “There’s no place to build any more houses, so prices can’t possibly go down,” is what people say. I’m sure the same reasoning has also been applied to many other metropolitan areas.
It’s nice that people at least understand the economic principle that, if supply is fixed but demand increases, then there is an inevitable increase in prices. (But if they understand this principle, why aren’t they asking politicians to allow more residential construction? Probably the 70% who own homes don’t want prices to go down. But whenever Democrats whine about how the middle class worker can’t afford the cost of housing, but then don’t follow up with the only logical solution to the problem which is to build more houses, they just demonstrate their failure to understand basic economics.)
However, supply of houses isn’t truly fixed, even in an area like inside the Beltway northern Virginia. Michael Higgins writes in his blog today about how old run down homes are being torn down and replaced with new luxury homes, thus increasing the supply of luxury homes.
The second way that demand is satisfied is through the creation of substitute goods. “In economics, one kind of good (or service) is said to be a substitute good for another kind insofar as the two kinds of goods can be consumed or used in place of one another in at least some of their possible uses. Classic examples of substitute goods include margarine and butter…”
The obvious example of a substitue for a house is an apartment or condo. A high rise building occupying the land of just a few houses can contain hundreds of apartments. In the long run, the potential supply of condos and apartments is nearly infinite, even in a “fully developed” area like inside the Beltway northern Virginia. In fact, when I look out my window in Arlington, I see the skyline littered with construction cranes. High rise residential buildings are going up all over Arlington.
Of course people will always pay a premium to have their own parcel of land in a desirable neighborhood. And the bigger the parcel the higher the premium. But there is a definite limit to the premium people are willing to pay. An increasing supply of high rise residential buildings puts downward pressure on the price of houses.
So we see, it’s a fallacy that housing prices can never go down in a “fully developed” area.
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