Supply and demand: The MANY DIMENSIONS of housing (Part II)

Supply and demand of what? That is a question we always need to ask to make sure we are coherent in our economic analysis

In Part I of this Supply and Demand Series, we looked at the concept of economic equilibrium and how supply and demand reasoning helps us understand this process.

Supply and Demand: They MUST apply to housing (Part I)

We learnt some core economic insights that enhance our understanding of markets and trade, including the following:

1. Supply and demand are tools to help explain the economic idea of equilibrium.

2. Supply means the benefit from not trading the thing that can be traded by the person owning it, while demand is the benefit to someone who doesn’t own the thing yet.

3. A trial-and-error process of finding mutually-beneficial trading partners pushes markets towards an equilibrium.

4. Barriers to trade can separate markets and prevent the trades that would lead to a single equilibrium price from forming.

Here we dig deeper into the important fact that economic trades take place across many potential trading choices in time and space. Doing so helps us avoid errors of economic reasoning that are all too common, especially in housing policy debates.

Correctly defining trade possibilities

Throughout our checkout queue example in Part I, we assumed these two things:

1. The dimension across which trades are made—in this case, queues.

2. The source of the benefit to each side of the trade—in this case, queue position.

The dimension and source of benefit are two ingredients necessary to understand any market equilibrium process, and therefore to use supply and demand reasoning about that process.

In most economic analyses, these two ingredients are assumed without any interrogation of their appropriateness and then hidden away behind layers of further assumptions.

It matters because the dimension of trade and the source of benefit are the units of measurement of a market. To clarify any supply and demand analysis, this question can be useful: “Across what dimension are you assuming trades take place, and what is the source of benefit for sellers and buyers?” See if that helps the conversation.

An engineer couldn’t get away with inconsistent units—calling area volume, or speed acceleration—but in economics, we all too often brush over these questions of dimensions without ensuring that what we call supply and demand are even related.

We need to know which dimension is being traded and which dimensions are held fixed in our analysis.

Getting dimensions right

In our supermarket checkout example, the dimensions were the two queues—we assumed that trades happen across the queue choice dimension.

In reality, it is tricky to understand across which dimension trades are being made. For example, shoppers can swap queues, but they can also swap their shopping times to shop to avoid long queues. They can swap shops too. Across the shopping time dimension, there will also be an equilibrium as a result of trading off benefits from each alternative shopping time choice. Across shops, there will be a shop choice dimension. In any supply and demand analysis, we hold fixed such potential trades in other dimensions.

In the economic lingo, we look at a partial equilibrium market adjustment holding fixed shopping time and shop choice trade dimensions. Another way we describe a similar assumption in economics is by the phrase short run, which assumes that capital investments are unchanged; in this case, the number of checkouts is held fixed regardless of queue length.

This is subtle but important.

It is common in housing economics, for example, to confuse the dimension of density, or the number of homes per site, with the dimension of the rate of production of homes, or the number of homes built per period across all projects at all sites.

In the density dimension, a property owner’s trading choices, holding the time of development fixed (a different dimension), involve swapping between more or less dense project designs. Is the benefit gained (demand) for more density greater than the benefit forgone (supply) to build it?

Let’s see how that works.