The housing market is a critical sector of the economy, with supply elasticities shaping how communities expand and grow. Whether you are considering buying your first home, investing in rental properties, or are simply interested in understanding the economics of housing, it’s important to explore the differences between owner-occupied housing and rental housing. In this post, we’ll examine the long-run supply of housing for both sectors, highlighting key economic principles that drive these markets.
What is the Long-Run Supply of Housing?
In economic terms, the long-run supply refers to the ability of suppliers (in this case, builders, developers, and landlords) to respond to changes in demand by increasing the quantity of services provided. In the housing market, this means how well builders and developers can meet the demand for housing by constructing new properties or improving existing ones.
People buy or rent housing to obtain services such as shelter, comfort, security, and a place to call home. If the price of these services rises in a particular area, we would expect suppliers to respond by increasing the quantity of housing available. However, the way this happens—and how effectively the supply increases—varies greatly between owner-occupied and rental housing markets.
Owner-Occupied Housing: A Nearly Horizontal Supply Curve
Let’s first consider the supply of owner-occupied housing. In areas where land is plentiful, such as rural or suburban regions, the supply of housing can be quite elastic in the long run. This means that as demand for housing increases, developers can relatively easily build more houses without a significant rise in costs.
Why Is the Long-Run Supply of Owner-Occupied Housing So Elastic?
In these areas, the price of land does not tend to increase substantially as the quantity of housing supplied goes up. For instance, suburban developments often have ample space for new housing projects, and there is less competition for land compared to urban areas. Additionally, construction costs are unlikely to soar because materials such as lumber and concrete are sourced from national markets, which keeps prices relatively stable.
Economists describe this as a constant-cost industry, where the cost of inputs remains steady regardless of the scale of production. As a result, the long-run elasticity of supply for owner-occupied housing tends to be very large, meaning that an increase in housing prices will result in a substantial increase in the number of houses built.
In fact, many studies show that the long-run supply curve for owner-occupied housing is nearly horizontal. In simpler terms, small changes in price can lead to large increases in supply, as long as there is available land and stable construction costs. This elasticity helps explain why suburban sprawl is a common phenomenon in many countries, as developers can easily meet rising demand by building more homes on the outskirts of cities.
Rental Housing: Zoning Laws and High Costs Restrict Supply
Now let’s turn to rental housing, where the dynamics of supply are quite different. The supply of rental housing is often much less elastic than owner-occupied housing, particularly in urban areas where land is scarce and valuable.
The Impact of Zoning Laws and Urban Land
Urban rental housing is typically restricted by zoning laws—rules put in place by local governments that regulate how land can be used. In many communities, zoning laws either limit or completely outlaw the construction of new rental properties, particularly in residential neighborhoods that are primarily owner-occupied. Even when new rental units are allowed, they are often limited to certain areas, making the available land for rental housing both scarce and expensive.
Since urban land is so valuable, developers face higher input costs when building rental properties. This, combined with the restrictions imposed by zoning laws, means that the long-run supply of rental housing is far less elastic than that of owner-occupied housing. When the demand for rental housing rises, it’s much harder to increase the supply without a corresponding increase in the cost of land and construction.
High-Rise Buildings and the Rising Costs of Construction
Another factor that limits the elasticity of rental housing supply is the cost of building high-rise apartment buildings, which are common in urban areas. As demand for rental housing increases, developers may respond by constructing taller buildings to maximize the use of valuable land. However, taller buildings come with increased construction costs, as the infrastructure and materials required for high-rise buildings are more expensive than for single-family homes or low-rise buildings.
As urban land becomes more valuable due to housing density, the cost of construction continues to soar. This is known as an increasing-cost industry, where the cost of producing additional units increases with each new project. In other words, the more rental units that are built, the more expensive it becomes to build the next set of units. This dynamic further reduces the elasticity of rental housing supply, as developers face higher costs as they try to meet demand.
Comparing Elasticities: Why Rental Housing is Less Responsive
To illustrate the difference in supply elasticity, let’s look at a study referenced in the example above. In this study, the long-run elasticity of rental housing supply was found to be 0.36, which means that a 1% increase in rental prices would result in only a 0.36% increase in the quantity of rental housing supplied. This is a much lower elasticity than what we would expect to find in the owner-occupied housing market, where the supply curve is nearly horizontal.
Conclusion: Why Understanding Supply Elasticity Matters
Understanding the long-run supply of housing is crucial for policymakers, investors, and consumers alike. For policymakers, knowing that rental housing has a low supply elasticity can inform decisions about zoning laws and urban planning. If the goal is to increase the availability of affordable rental housing, for example, easing zoning restrictions or providing incentives for developers to build more rental units could help increase supply and stabilize prices.
For investors, understanding these dynamics can help identify opportunities in the housing market. Investing in rental properties in urban areas, where supply is restricted and prices are likely to rise, may offer higher returns. However, these investments also come with higher risks due to the increasing costs of construction and land.
For consumers, knowing the difference between owner-occupied and rental housing supply elasticities can help in making informed decisions about where to live and whether to buy or rent. In suburban or rural areas, where the supply of owner-occupied housing is highly elastic, buying a home might be more affordable in the long run. On the other hand, in urban areas with limited rental supply, renting could become increasingly expensive unless new policies or innovations make it easier to build rental units.
In summary, while the long-run supply of owner-occupied housing can expand quickly in response to rising prices, the supply of rental housing faces significant barriers, leading to slower growth and higher costs. Understanding these economic principles is essential for anyone interested in the housing market, whether as a buyer, renter, investor, or policymaker.