Is it all “Sup­ply & Demand”?

Flattr this!

As we head towards the fed­eral elec­tion, the term ‘hous­ing short­age’ will be trot­ted out again and again by politi­cians. Their rhetoric will rely on the deeply ingrained received wis­dom that Aus­tralia has a ‘hous­ing short­age’, and no politi­cian will want to do the hard work of dif­fer­en­ti­at­ing between a gen­uine short­age in hous­ing stock (which we don’t have) and a short­age of ‘afford­able hous­ing’ which we do have. 

And why won’t they acknowl­edge this dis­tinc­tion? Sim­ply, because admit­ting that it is only the prices of houses that are dys­func­tional, and not sim­ply the sup­ply, would be too much even for their loyal vot­ers.

Once group­think has infected politi­cians and media com­men­ta­tors, rea­son goes out the door. That’s why I find it infu­ri­at­ing to hear con­stant ref­er­ence to Australia’s soar­ing prices being sim­ply a prod­uct of a ‘sup­ply and demand’ imbal­ance.

The sup­ply-demand argu­ment is easy to sell. The rea­son­ing goes that there are too few houses being built, and the hous­ing mar­ket is just like any ordi­nary com­mod­ity mar­ket, so the price rises. 

This pric­ing model is super­fi­cially appeal­ing at the level of every­day con­sumer items – cork­flakes, for instance (though even here it’s a flawed logic, as I explain in these two [1] [2] rather tech­ni­cal papers). But the model breaks down com­pletely in asset mar­kets. If the price of cork­flakes rises due to sup­ply con­straints, con­sumers switch to com­ple­men­tary goods. They don’t rush to the super­mar­ket to buy more corn­flakes at the higher price. 

But in asset mar­kets, con­sumer behav­iour is turned on its head. Instead of being more reluc­tant to buy an asset that is ris­ing in price, buy­ers rea­son that they’d bet­ter get in quick and buy while the asset is still within their reach. So higher prices actu­ally stim­u­late demand, and this behav­ior often reaches a fever pitch a short time before an asset bub­ble deflates. 

In other words, prices have a per­verse impact upon asset mar­kets, and it is sim­plis­tic to inter­pret how asset prices behave sim­ply on the basis of “sup­ply and demand” analy­sis.

It’s also rather hard to sus­tain the “sup­ply and demand” argu­ment on the basis of the data alone—because it if were true, house prices should have been falling (rel­a­tive to the price of other goods) for most of the last thirty years. 

Firstly it’s obvi­ous that real house prices have been ris­ing in real terms. The next chart deflates the ABS’s index for estab­lished houses (ABS 641601 and 641603) by the CPI. Houses are now two and a half times as expensive—relative to other goods—as they were in 1986. 

And yet for most of that period, we’ve been build­ing accom­mo­da­tion at a faster rate than pop­u­la­tion has been growing—so on “sup­ply and demand” logic, house prices should have been falling for all but the last cou­ple of years. 

Have a look at the chart below. The aver­age num­ber of peo­ple liv­ing in each dwelling in Aus­tralia in the year 2007 was around 2.6 (the black line)—and it was higher in ear­lier years. To keep the ratio of peo­ple to dwellings con­stant, we would need to build a new dwelling for every 2.6 new peo­ple. In fact, on aver­age between 1986 and 2009, we’ve been build­ing a new dwelling for every 1.8 new Aus­tralian res­i­dents. Only in the last cou­ple of years—after the GFC hit—has pop­u­la­tion grown more rapidly than we’ve added accom­mo­da­tion.

This is where neo-clas­si­cal econ­o­mists’ ‘sup­ply-demand’ argu­ments fail the com­mon-sense test. If we’ve con­sis­tently built more new dwellings than required by the num­ber of new peo­ple in Aus­tralia, and if “sup­ply and demand” explained every­thing, then real prices should have been falling for all but the last cou­ple of years (in the past two years a new dwelling has been built for approx­i­mately every 3 new peo­ple – see chart). 

News last week that Syd­ney has just recorded a six-year high in build­ing approvals ( will be wel­comed by politi­cians and com­men­ta­tors want­ing to argue that the ‘short­age’ is being addressed. 

But if ‘sup­ply and demand’ can­not explain the rise in house prices over the past quar­ter cen­tury, then this addi­tional supply—when it comes online—may have an equally per­verse impact: it might accel­er­ate a down­turn caused by the end of the great expan­sion in house­hold debt that has been the real force dri­ving house prices up. The new spike in approvals may actu­ally cre­ate an over­sup­ply after the great infla­tion caused by ris­ing debt has already ended. 

We need to bury the ‘hous­ing short­age’ myth, but to do so requires a shift in think­ing. Econ­o­mists fol­low a model of the econ­omy that is as real­is­tic as the view that the Earth is the cen­tre of the uni­verse, and the Sun, Moon and plan­ets revolve around it. It took the GFC to expose just how unre­al­is­tic this model is—a model that ignores credit and pre­tends that every­thing hap­pens in equi­lib­rium. We instead live in a credit-dri­ven world which is always in dis­e­qui­lib­rium. Until econ­o­mists and pol­icy mak­ers rec­og­nize this, we are likely to have poli­cies that address symp­toms but not causes, and ulti­mately make the prob­lem worse rather than bet­ter.

If we are to address the real causes of the GFC, then pol­icy mak­ers have to con­front the prob­lem of an out of con­trol credit sys­tem that drove mort­gage debt up by a fac­tor of five and turned the Aus­tralian hous­ing mar­ket into the world’s last sur­viv­ing Ponzi Scheme. 

Then again, it is most likely too late – the cur­rent frenzy of house buy­ing and house price growth is com­pletely decou­pled from any sense of scarcity in the mar­ket, and has all the signs of a bal­loon about to burst. 




About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
Bookmark the permalink.
  • MMitchell


    Sorry again. One more thing. If you are inter­ested in Socioc­racy a ref­er­ence is:

    Buck, J. and Villines, S. 2007. We The Peo­ple: Con­sent­ing to a Deeper Democ­racy, a Guide to Socio­cratic prin­ci­ples and Meth­ods., Wash­ing­ton D.C.

  • MMitchell

    Philip #124,

    There is an easy solu­tion to this prob­lem you raise. Sim­ply leg­is­late that all com­pa­nies above a cer­tain size need to be run using socio­cratic prin­ci­ples. This is one effec­tive way to limit the size of our cur­rent patho­log­i­cal cor­po­rate struc­ture and legal frame­work while still allow­ing for large projects.

  • Philip


    Yes, in the­ory that could work. Unfor­tu­nately, cap­i­tal­ists are greatly opposed to work­place democ­racy and decen­tral­iza­tion. For a coun­try such as Aus­tralia to call itself demo­c­ra­tic is a joke con­sid­er­ing that such democ­racy is lim­ited to select­ing rep­re­sen­ta­tives of one insti­tu­tion in our soci­ety while the work­place — where we spend half our wak­ing hours — is run under con­di­tions of author­i­tar­i­an­ism.

    If any such leg­is­la­tion were forced upon the state-cor­po­rate nexus, it would have to be on the backs of a strong pro­gres­sive work­ing class move­ment.

  • pb

    If Aus­tralia truly becomes a place where only the rich can afford hous­ing then we will truly start look­ing like the fol­low­ing coun­tries.

    Morocco 67.5
    Pak­istan 40.63
    Belarus 40.0
    Mon­tene­gro 30.0
    Rus­sia 28.58
    Roma­nia 24.28
    Lithua­nia 20.84
    Ser­bia 18.8
    Latvia 18.33
    Ukraine 17.37

    Surely then we can stop look­ing for Aus­tralia in those charts like “Top coun­tries to live” , “Top free coun­tries for Busi­ness”

  • MMitchell


    Unfor­tu­nately, cap­i­tal­ists are greatly opposed to work­place democ­racy and decen­tral­iza­tion.”

    Yes, well one could imag­ine that such a change would lead to a huge loss of wealth for many. How­ever, IMHO the cur­rent eco­nomic sys­tem will not sur­vive much longer any­way lead­ing to mas­sive wealth losses and much more. This way we still get a mas­sive wealth loss but also the oppor­tu­nity to take some­thing bad and make some­thing good of it rather than let­ting it all dete­ri­o­rate into chaos. Like you say though, Buckley’s Chances.