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Essay requirements:

  1. Use the concepts of demand, supply, price elasticity of demand, income elasticity of demand and price elasticity of supply to explain the sharp rise in the prices of residential properties in Singapore.
  2. Examples are crucial in this type of question to illustrate understanding of the relevant economic concepts.
  3. Explain the demand-and-supply mechanism (price adjustment) due to the nature of the question and mark allocation.

 

Introduction

The concepts of demand, supply, price elasticity of demand, income elasticity of demand and price elasticity of supply may all be used to explain the sharp rise in the prices of residential properties in Singapore in recent years.

 

Point: Large increase in demand → Large increase in prices of residential properties in recent years

  • The demand for a good is the quantity of the good that consumers are able and willing to buy, known as the quantity demanded, at each price over a period of time, ceteris paribus.
  • The demand for residential properties may have increased substantially in recent years due to several reasons
  • Sub point: Income elasticity of demand
    • Income elasticity of demand for a good is a measure of the degree of responsiveness of the quantity demanded to a change in income, ceteris paribus.
      • Residential properties are a normal good → Income elasticity of demand for residential properties is positive → Increase in income will lead to a rise in demand.
      • National income of Singapore has increased substantially → Large increase in the demand for residential properties.
      • (Example) The national income of Singapore grew by 14.8 per cent in 2010, which recorded the highest growth in the world
    • Sub point: Increase in foreign buyers
      • Rising affluence in some Asian countries such as China → Large increase in foreign buyers of local residential property → Large increase in demand
        • (Example) 17% of private residential properties sold in Singapore in 2011 were purchased by foreigners, excluding permanent residents, an increase from 12% in 2010
      • Sub point: Increase in immigrants in Singapore
        • Relaxation of immigration policy in Singapore to increase labor force → More immigrants in Singapore → More demand for housing
          • (Example) Increase in non-residents by 7.20% in 2012, much higher than average of 0.05% around the world
  • Sub point: Lower interest rates
    • Sub prime mortgage crisis in 2008 → Large economies around world lower interest rates to boost aggregate demand
    • Singapore small and open economy, therefore fall in interest rates in large economies led to fall in interest rates in Singapore
    • Cheaper loans (Cost of mortgage decrease) → More people able to afford homes → Increase in demand
      • (Example) Interest rates hit all time lows in 2012

        • Sub point: Speculative demand (Creation of bubble)
          • Increase in real demand for residential properties → Increase in prices of residential properties → People expect prices to rise further → People purchase more property
          • Increase in speculative demand → Increase in demand for property
            • (Example) Many people in Singapore own more than one residential property for speculative purpose
          • General conclusion to why increase in demand causes increase in price
            • Increase in demand (D) from D0 to D1 leads to a sharp rise in the price (P) from P0 to P1.
            • When demand increase from D0 to D1, although the quantity demanded will rise at the same price (P0), the quantity supplied will remain at Q0 and this will result in shortage.
            • When firms do not produce enough to sell, they can raise price without losing sales, thereby increasing their profits
            • As the price rises, the quantity demanded falls and the quantity supplied can begin to increase as firms begin to meet the increased demand
            • Process will continue until price rises to P1 where quantity demanded and quantity supplied are equal at Q1

 

Point: Inelastic supply → Large increase in prices of residential properties in recent years

  • The price elasticity of supply of a good is a measure of the degree of responsiveness of the quantity supplied to a change in the price, ceteris paribus
  • Long construction time of buildings → Supply of residential properties is price inelastic → Increase in demand for residential properties leads to more than proportionate increase in prices
    • As supply of residential properties in Singapore is price inelastic, firms are not responsive to an increase in prices
    • Therefore, when demand increases, which leads to a shortage at the initial prices, a large increase in the prices is needed to induce firms to increase production to the level that eliminates shortage
  • Due to inelastic supply, which gives rise to steep supply curve, an increase in demand (D) from D0 to D1 leads to a larger than proportionate increase in price (P) from P0 to P1.

Point: Fall in supply → Large increase in prices of residential properties in recent years

  • Supply of a good is the quantity of the good that firms are able and willing to sell, known as the quantity supplied, at each price over a period of time, ceteris paribus.
  • Sub point: Rise in prices of construction materials
    • Limited financial resources + Price of inputs increase → Reduction in supply
  • Sub point: Speculative demand
    • Speculative demand induce many people to expect prices to rise further → Sellers hold back sales as they expect to profit more in future → Reduction in supply
  • General conclusion to why decrease in supply causes increase in price
    • A large decrease in the supply (S) from S0 to S1 leads to a sharp rise in the price (P) from P0 to P1.
    • Given the demand (D0) and supply (S0), the price and quantity are P0 and Q0.
    • When the supply decreases from S0 to S1, although the quantity supplied will fall at the same price (P0), the quantity demanded will remain at Q0 and this will result in shortage.
    • When firms do not produce enough to sell, they can raise prices without losing sales to increase profits
    • As the price rises, the quantity demanded will fall and the quantity supplied will rise. This process will continue until the price rises to P1 where the quantity demanded and quantity supplied are equal at Q1.

 

Point: Inelastic demand → Large increase in prices of residential properties in recent years

  • Price elasticity of demand for a good is a measure of the degree of responsiveness of the quantity demanded to a change in price, ceteris paribus.
  • High degree of necessity and no close substitutes → Demand for residential properties price inelastic → Decrease in supply of residential properties leads to more than proportionate increase in prices
  • When demand is price inelastic, consumers are not responsive to increase in prices
    • When supply decreases → Shortage at initial prices → Large increase in prices to decrease consumer consumption to eliminate the shortage
  • Due to the inelastic demand, which gives rise to the steep demand curve (D0), a decrease in the supply (S) from S0 to S1 leads to a sharp rise in the price (P) from P0 to P1.

 

 

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