relationship between microeconomic theory and essential components of microeconomics

 relationship between microeconomic theory and essential components of microeconomics

Introduction

Economics is the inquiry into the activities which revolve around extraction, distribution, and consumption of goods and services. It can be classified into two distinct disciplines of study, which are macroeconomics and microeconomics (Eastin & Arbogast, 2011). Macroeconomics digs into the broader scope of the economic aggregates like national income statistics and total output within a country. On the contrary, microeconomics sheds light on markets and the decision making processes of specific economic structures such as businesses and market consumers.

This paper aims at establishing a relationship between microeconomic theory and essential components of microeconomics; supply and demand in the U.S housing industry. Analysis of demand and supply is the study of the interchange between sellers and buyers to arrive at favorable prices and quantities. As the paper unfolds, it will highlight how both the home buyers and sellers respectively associate value and cost to the prices of houses. Supply and demand analysis surrounds the most fundamental tools of microeconomics in the markets for private entities.

The analysis into supply and demand was carried out thorough research into existing literature concerning the contemporary U.S housing market economies. Moreover, classical economics research papers were also employed as a framework for understanding essential economic theories.

The U.S housing sales declined by 1.3 percent in January when compared to the registered sales in the previous month. However, the rise in sales before the backdrop was attested to the affordable mortgage (Shiff, 2020). It contributed to an estimated 9.6 percent increase in sales. In the coming months, sales may be suppressed by the crisis of few homes listed in the real estate market. As of January, 1.42 million houses were available at the moment, which is perceived to be a fall from the past one year. Therefore, this crisis has subjected buyers to confined options, and the cost of housing is shooting faster than the increase in wage.

Literature Review

Microeconomics delves into the nitty-gritty of financial resolutions, individual activities, and the activities of businesses. In the constraints of its wide scope, there exist various theories that highlight some expectations and presumptions of economic behaviors (Pettinger, Prachi, Makgoka, Acharya, & Nita, 2020). The essential theory is the neo-classical theory, which stresses on the precept that individuals are reasonable and seeks to reap maximum benefits and also the concept of free markets. Nevertheless, some counter-arguments of the neo-classical model have come up and stipulates that the concept of economics is so complicated with matters such as illogical behaviors and decline in markets. Following immediately after are the descriptions of the theories which have been employed in interpreting events surrounding economic markets.

Pre-Classical Microeconomic Theory

The concept of economics never had a theoretical framework to be applied in the interpretation of the different concepts in economics before the days of Adam Smith. The philosophers of the time based their proclamations on economic issues like the division of labor (Pettinger, Prachi, Makgoka, Acharya, & Nita, 2020). Moreover, the dominating ideologies of the pre-classical economics found their roots in mercantilism theories, the notion that countries should concentrate on the accumulation of Gold.

Classical Microeconomic Theory

It was established by Adam Smith from his work, Wealth of Nations (1776), and later expounded by the economist David Ricardo. The important aspect of this theory comprises of:

1. Determination of market price and output

Figure. 1

Illustration of invincible hand of market by Adam Smith

Adam Smith introduced the invincible hand of the market. He insinuated that if people act on the basis of self-interest, markets will incline towards availing goods and services demanded by consumers (Pettinger, Prachi, Makgoka, Acharya, & Nita, 2020). It implies that the shift in demand and supply influences the market forces. For instance, the shortage of houses increases their prices, which eventually leads to the downfall of demand.

Smith also highlighted the significance of cost to consumers and businesses. Moreover, he elaborated on the concepts of specialization, economies of scale, and division of labor.

Utility maximization

The concept of utility maximization was advanced by classical economists, John Stuart Mill and Jeremy Bentham. They believed that the ability to obtain maximum benefits from a commodity had a major influence on the purchasing habits of consumers. The theory supposes that consumers are in a position to make informed decisions.

Neo-Classical theory.

It is considered to be a contemporary break down of the classical economics which brought into the picture by the nineteenth century. It laid emphasis on the markets and came about with new concepts, which are related to rational choice theory and utility (Pettinger, Prachi, Makgoka, Acharya, & Nita, 2020). This theory comprises of elements like the notion that people act on the basis of self-interest, therefore builds on existing information. Additionally, it claims that individuals harbor specific preferences and make logical choices that are aimed at reaping maximum benefits; wages, profit, investment, and consumption.

The Economic theories lay the framework from which the analysis of the housing situation in the U.S was constructed. This year, an estimate of about 5 million millennials are crossing into their third decade (Shiff, 2020). This implies that there is an increase in the demand for houses as the ones listed in the market are slowly reducing. That number of millennials translates to half of the total purchases taking place across the nation.

The recent growth in demand for homes can be attributed to the stable economy and affordable loans extended by financial institutions. Furthermore, workers are assured of the existence of their jobs since the unemployment rate index have been dropped to lows of 3.6 percent.

Main Body

Effects of Demand and Supply in the Housing Market.

The Real estate industry is also predisposed to the circumstances surrounding demand and supply. Just like bonds and stocks, the cost of houses is highly influenced by the laws of demand and supply.

Supply and Demand

The law of supply and demand is an essential concept of economics, which elaborates on the nature of the relationship which exists between the quantity demanded and quantities supplied of a commodity (Hall, 2020). It also highlights how interconnection has a bearing on the resultant cost of the good or service. An increase in the demand for a commodity will increase its price while a vast supply of a commodity will consequently reduce its cost when there is inadequate demand. The two concepts work contrary to each until an equilibrium cost is attained.

Demand and supply for housing

Demand refers to the willingness and ability of a consumer to buy a specified amount of product or service at a specific cost (Eastin & Arbogast, 2011). Consumer behavior is analyzed in the demand function or demand curve where at the highest prices, the consumer still has the willingness to acquire goods or services. The consumer’s willingness and ability to purchase a certain quantity of goods or service relies on variables. From the law of demand, economists argue that a rise in the price of a commodity influences the consumer’s decision to buy less of it, and as the price falls, consumers buy large quantities of the commodity. Even though the price of a commodity influences the decision of a consumer in buying a product, there are other variables to this effect. They include an income of the consumer, consumer tastes and preferences, price of the substitute product, and many more. All these variables are captured in relation to buying a product by the economists and are referred to as the demand function. On the other hand, supply is the willingness of the seller to sell a certain good or service at a specified cost.

The relationship between price and the measure is of balance between supply and demand in the housing sector (Hall, 2020). Generally, measurement of demand and supply is usually not easy though it has been done from the available data. Why is the measure of supply and demand for housing quite difficult? The duration of time that is taken in construction or the duration of time taken in fixing old buildings and bringing them back to the market takes a significant amount of time.

Additionally, houses as a product cannot be regularly sold like the other market goods; it takes longer durations to sell a house.

There are various factors that influence the supply and demand for housing, for example, low-interest rates. Low-interest rate spurs borrowing, as the loans are affordable and less strenuous in the repayment plan (Hall, 2020). When many people get loans and flood the market in a bid to acquire homes, the demand for housing shoots and the supply for housing is small. This will automatically influence the price; the people with low-interest loans will have the purchasing power to acquire more as their repayment plan is less burdensome.

Figure. 2

Demand and Supply Curves in the Real Estate Industry

The graphical representation assists in understanding the interconnection between demand and supply in the housing sector. The horizontal axis represents the number of households listed in the market. In contrast, the vertical axis represents the costs of the respective prices of homes with the amount available in the market.

Changes in the factors that influence the homeowners and buyers will cause a significant move along the curves. For example, an increase in earnings will consequently raise the demand for homes. This can be reflected when the movement along the demand goes up, resulting in an increase in the equilibrium prices. However, a decline in the cost of building and repairing old houses will increase the number of houses listed in the Real estate markets. The circumstances will also lead to a downward movement along the supply curve, which will change the resulting equilibrium price. The concepts of supply and demand are fundamental in foretelling the expected changes within the home markets in the future.

As of July 2019, the number of home sales that could be retrieved from the statistics of the National Association Realtors home sales are as highlighted below.

Table. 1

Home sales

SALES (JUNE)

MEDIAN PRICE

HOUSING STARTS

(JUNE)**

NEW HOME SALES

(MAY)**

5.27 million units*

$285,700

$1,253,000*

626,000*

Note. *Periodically revised annual rate

The real estate has experienced a quite unusual percentage point fluctuations. There are significant changes in the market every month, which takes different angles (Worstall, 2019).

In the same manner, the available housing stocks after major sales are made is an important indication in the real estate market (Jang, Lee, Kim, & Kim, 2010). It directly links to profit maximization from the home construction business, and it comes up from the dynamics between supply and demand for houses in the United States.

Conclusion

In general, supply and demand as concepts of microeconomics are essential in the consistent existence and thriving in the U.S real estate industry. Therefore, a study on the market needs and consumer behavior will assist in aligning with the expected trends and the constantly changing needs of the home buyers. For instance, the unprecedented increase in demand for houses in the market calls for immediate countermeasures before the situation springs out of control. The cost of putting up new houses ought to be manageable to excite an increased venture of potential home sellers into the business.

1. Determination of market price and output

Figure. 1

Illustration of the invincible hand of market by Adam Smith

Adam Smith introduced the invincible hand of the market. He insinuated that if people act on the basis of self-interest, markets will incline towards availing goods and services demanded by consumers (Pettinger, Prachi, Makgoka, Acharya, & Nita, 2020). It implies that the shift in demand and supply influences the market forces. For instance, the shortage of houses increases their prices, which eventually leads to the downfall of demand.

Smith also highlighted the significance of cost to consumers and businesses. Moreover, he elaborated on the concepts of specialization, economies of scale, and division of labor.

Utility maximization

The concept of utility maximization was advanced by classical economists, John Stuart Mill and Jeremy Bentham. They believed that the ability to obtain maximum benefits from a commodity had a significant influence on the purchasing habits of consumers. The theory supposes that consumers are in a position to make informed decisions.

Neo-Classical theory.

It is considered to be a contemporary break down of the classical economics which brought into the picture by the nineteenth century. It emphasized the markets and came about with new concepts, which are related to rational choice theory and utility (Pettinger, Prachi, Makgoka, Acharya, & Nita, 2020). This theory comprises of elements like the notion that people act based on self-interest, therefore, builds on existing information. Additionally, it claims that individuals harbor specific preferences and make logical choices that are aimed at reaping maximum benefits; wages, profit, investment, and consumption.

The Economic theories lay the framework from which the analysis of the housing situation in the U.S was constructed. This year, an estimate of about 5 million millennials are crossing into their third decade (Shiff, 2020). This implies that there is an increase in the demand for houses as the ones listed in the market are slowly reducing. That number of millennials translates to half of the total purchases taking place across the nation.

The recent growth in demand for homes can be attributed to the stable economy and affordable loans extended by financial institutions. Furthermore, workers are assured of the existence of their jobs since the unemployment rate index have been dropped to lows of 3.6 percent.

Main Body

Effects of Demand and Supply in the Housing Market.

The Real estate industry is also predisposed to the circumstances surrounding demand and supply. Just like bonds and stocks, the cost of houses is highly influenced by the laws of demand and supply.

Supply and Demand

The law of supply and demand is an essential concept of economics, which elaborates on the nature of the relationship which exists between the quantity demanded and quantities supplied of a commodity (Hall, 2020). It also highlights how interconnection has a bearing on the resultant cost of the good or service. An increase in the demand for a commodity will increase its price while a massive supply of a product will consequently reduce its cost when there is inadequate demand. The two concepts work contrary to each until an equilibrium cost is attained.

Demand and supply for housing

Demand refers to the willingness and ability of a consumer to buy a specified amount of product or service at a specific cost (Eastin & Arbogast, 2011). Consumer behavior is analyzed in the demand function or demand curve where at the highest prices, the consumer still has the willingness to acquire goods or services. The consumer’s willingness and ability to purchase a certain quantity of goods or service relies on variables. From the law of demand, economists argue that a rise in the price of a commodity influences the consumer’s decision to buy less of it. As the price falls, consumers buy large quantities of merchandise. Even though the price of a commodity influences the choice of a consumer in buying a product, there are other variables to this effect. They include the income of the consumer, tastes, and preferences, price of the substitute product, and many more. All these variables are captured in relation to buying a product by the economists and are referred to as the demand function. On the other hand, supply is the willingness of the seller to sell a particular good or service at a specified cost.

The relationship between price and the measure is of balance between supply and demand in the housing sector (Hall, 2020). Generally, measurement of demand and supply is usually not easy though it has been done from the available data. Why is the measure of supply and demand for housing quite difficult? The duration of time that is taken in construction or the duration of time taken in fixing old buildings and bringing them back to the market takes a significant amount of time.

Additionally, houses as a product cannot be regularly sold like the other market goods, and it takes longer durations to sell a house.

Various factors influence the supply and demand for housing, for example, low-interest rates. Low-interest rate spurs borrowing, as the loans are affordable and less strenuous in the repayment plan (Hall, 2020). When many people get loans and flood the market in a bid to acquire homes, the demand for housing shoots and the supply for housing is small. This will automatically influence the price; the people with low-interest loans will have the purchasing power to acquire more as their repayment plan is less burdensome.

Figure. 2

Demand and Supply Curves in the Real Estate Industry

The graphical representation assists in understanding the interconnection between demand and supply in the housing sector. The horizontal axis represents the number of households listed in the market. In contrast, the vertical axis represents the costs of the respective prices of homes with the amount available in the market.

Changes in the factors that influence the homeowners and buyers will cause a significant move along the curves. For example, an increase in earnings will consequently raise the demand for homes. This can be reflected when the movement along the demand goes up, resulting in an increase in the equilibrium prices. However, a decline in the cost of building and repairing old houses will increase the number of homes listed in the Real estate markets. The circumstances will also lead to a downward movement along the supply curve, which will change the resulting equilibrium price. The concepts of supply and demand are fundamental in foretelling the expected changes within the home markets in the future.

As of July 2019, the number of home sales that could be retrieved from the statistics of the National Association Realtors home sales as highlighted below.

Table. 1

Home sales

SALES (JUNE)

MEDIAN PRICE

HOUSING STARTS

(JUNE)**

NEW HOME SALES

(MAY)**

5.27 million units*

$285,700

$1,253,000*

626,000*

Note. *Periodically revised annual rate

The real estate has experienced a quite unusual percentage point fluctuations. There are significant changes in the market every month, which takes different angles (Worstall, 2019).

In the same manner, the available housing stocks after major sales are made is an important indication in the real estate market (Jang, Lee, Kim, & Kim, 2010). It directly links to profit maximization from the home construction business, and it comes up from the dynamics between supply and demand for houses in the United States.

Conclusion

In general, supply and demand as concepts of microeconomics are essential in the consistent existence and thriving in the U.S real estate industry. Therefore, a study on the market needs and consumer behavior will assist in aligning with the expected trends and the constantly changing needs of the home buyers. For instance, the unprecedented increase in demand for houses in the market calls for immediate countermeasures before the situation springs out of control. The cost of putting up new houses ought to be manageable to excite an increased venture of potential home sellers into the business.