02-09-2019

Doc :No: RICS-SBE/XX/XX/S006/R02

Revised on: 24-05-2019

Economics for Built Environment

MBA CPM, MBA QS & MBA REUI

Nihar Nanyam, Arun Ahuja & Brijesh Bhat

References

1. Construction Economics – Danny Myers 4th Edition, Routledge

2. The Economics of the Modern Construction Sector – Graham J Ive and Stephen L
Gruneberg, 2000, Macmillan Press
3. The Economics for the Modern Built Environment – Leslie Ruddock, 2009, Taylor and
Francis
4. Economics - a foundation course for the built environment – J L Manser, 2005, Taylor and
Francis Group
5. Urban Economics and Real Estate Markets – Denise DiPasquale, William C Wheaton,
1996, Pearson Education
6. Economic Analysis for Property and Business, Marcus Warren, Routledge, 2011
7. Stiglitz, J.E. and Walsh, C.E. (2006) [SW]. Economics, W.W. Norton and Co.
8. Pyndick and Rubinfield (2008) [PR]. Microeconomics, Wiley India
9. Dornbusch and Fischer (2007) [DF]. Macroeconomics, McGraw Hill India
10. Deepashree, Principles of Micro Economics, Ane Books Pvt Ltd, New Delhi
11. Deepashree, Vanita Agarwal, “Macro Economics”, Ane Books Pvt Ltd, New Delhi

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Lecture 3
Theory of Demand and Supply

Key Terms

• Market: a set of arrangements by which buyers and sellers are in contact to

exchange goods or services
• Price is the number of dollars/rs that must be given up in exchange for an item this is
referred to as the money price. The ratio of one price to another is referred to as the
relative price.
• Demand: the quantity of a PRODUCT, buyers wish to purchase at each conceivable
price
• Supply: the quantity of a good sellers wish to sell at each conceivable price
• Equilibrium price: price at which quantity supplied = quantity demanded
• “Price falling” means the price falls relative to the average price of other goods and
services.

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Demand & Supply

• A supply and demand graph enables the relationship between price and quantity to be explored from
the consumers’ (demand) perspective and the producers’ (supply) perspective.

Demand & Supply

Per period of time

• This is to highlight that supply or demand is a flow that takes place during a certain
time period
• Ideally, the time period should be specified as a month, year, week, or whatever.
Without a time dimension, the statements relating to quantity become meaningless.

Ceteris Paribus
• Latin phrase ceteris paribus, which means other things being equal or constant.
This is an important assumption to make when dealing with a graph showing two
variables. The ceteris paribus assumption approximates to the scientific method of a
controlled experiment

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Demand & Supply

• Demand and supply curves: When using supply and demand curves to illustrate our
analysis, they will frequently be drawn as straight lines. Although this is irritating from
a linguistic point of view, it is easier for the artist constructing the illustrations and
acceptable to economists, since the ‘curves’ very rarely refer to the plotting of
empirical data.
• Price is right: there is a point at which the two curves must cross. This point
represents the market price. The market price in Figure is P0 and this reflects the
point where the quantity supplied and demanded is equal, namely point Q. At price P
the market clears. There is no excess supply; there is no excess demand.
Consumers and producers are both happy. Price P is called the equilibrium price:
the price at which the quantity demanded and the quantity supplied are equal.

Concept of Equilibrium

Equilibrium in any market may be defined as: “ a situation in which the plans of buyers
and the plans of sellers exactly Mesh”.
• Stable Equilibrium : If the price drifts away from this equilibrium point—for whatever
reason—forces come into play to find a new equilibrium price. If these forces tend to
re-establish prices at the original equilibrium point, we say the situation is one of
stable equilibrium.
• Unstable Equilibrium : An unstable equilibrium is one in which if there is a
movement away from the equilibrium, there are forces that push price and/or quantity
even further away from this equilibrium (or at least do not push price and quantity
back towards the original equilibrium level).
Shock to the system:
• The shock can be shown either by a shift in the supply curve, or a shift in the
demand curve, or a shift in both curves. Any shock to the system will produce a new
set of supply and demand relationships and a new price-quantity equilibrium.

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Law of demand

• The shape of the demand curve for most goods or service is not surprising when one considers the
basic law of demand. This may be stated formally as: “at higher prices, a lower quantity will be
demanded than at lower prices (and vice versa), other things being equal”
• Demand curve has a negative slope. It moves downward from left to right.

The law of demand, therefore, tells us that

Demand the quantity demanded of a product is
Curve for ‘n’
inversely related to that product’s price,
other things being equal.
Reasons for the Law of Demand
• Substitution Effect
• Income Effect
Quantity demanded of ‘n’/month

Law of Demand

1. Substitution effect:
When the price of a good rises, other things remaining the same, its relative price –
opportunity cost –rises. When the price of a good rises people buy less of that
good and more of its substitutes.

2. Income effect:
When the price of a good rises, other things remaining the same, the price changes
relative to peoples incomes. So, people can not afford to buy all the things they
previously bought.

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Changing Market Conditions

Clearly there are many non-price determinants of demand, such as the cost of financing
(interest rates), technological developments, demographic make-up, the season of the
year, fashion, and so on. We shall the consider the following four generalized
categories
• income,
• price of other goods,
• Expectations, population, preferences and
• Government
taking each in turn and assuming ceteris paribus in each case.
• An increase in demand causes the demand curve to shift rightward.
• A decrease in demand causes the demand curve to shift leftward.

Changing Market Conditions

Price of Related Goods

• Demand curves are always plotted on the assumption that the prices of all other
commodities are held constant
• A substitute is a good that can be used in place of another good. For example, coke
is a substitute for Pepsi., CD is a substitute for tape, and bus is a substitute for train.
If the price of a substitute for tape goes up people buys less of the substitute and
more tapes. The demand for tapes increases. A price change in the substitute good
will cause an inverse change in the pattern of demand for the other alternative.
• A complement is a good that is used in conjunction with another good. Hamburgers
and fries, tapes and Walkmans are complements. If the price of walkman falls the
demand for tapes increases. A fall in the price of one product may cause an increase
in the demand for both products, and a rise in the price of one product may cause a
fall in the demand for both.

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Changing Market Conditions

Expected Future Prices

• If the price of a good is expected to rise in the future, people buy more of the goods now.
• If the price of a good is expected to fall in the future, people buy less of the good now.

Population & Preferences

• Demand also depends on the size and the age structure of the population. The larger the
population the greater the demand for all goods and services and vs. Also the age
distribution of the population affect the demand for goods consumed by each group.

• Demand also depends on preferences. Preferences are an individual’s taste and choice.
Attitudes toward goods and services

Changing Market Conditions - Income

When income increases consumers buy more of most goods, and when income
decreases, they buy less of most goods. Increase in income does not increase
demand for all goods. It increases demand for normal goods and it decreases
demand for inferior goods. Eg. air travel vs bus trips.
• A NORMAL GOOD has a positive income elasticity of demand
an increase in income leads to an increase in the quantity demanded e.g., dairy
produce
• An INFERIOR GOOD has a negative income elasticity of demand
an increase in income leads to a fall in quantity demanded e.g., coal, demand for
private rented houses falls as people would buy their own.
• A LUXURY GOOD has an income elasticity of demand greater than 1
• e.g., wine

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Income and the demand curve

For an increase in income:

NORMAL GOOD INFERIOR GOOD

D0 D1 D1 D0

Quantity Quantity
Demand curve Demand curve
moves to the right moves to the left

Changing Market Conditions - Government

• Legislation can affect the demand for a commodity in a variety of ways. For example,
changes in building regulations may increase the demand for double glazed window
units, regardless of their present price and demand curve will shift to right.
• Demand curve for all the code compliant products will shift to right and implying that
greater quantities are demanded at each and every price. It will take time for
suppliers to adjust, so prices might at first rise and then decrease with the technology
catch-up.
• The government can also influence the level of demand by changing taxes or
creating a subsidy

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Revisiting Ceteris Paribus

• When we first introduced the idea of holding other things constant, it may have
appeared that these ‘other things’ were unimportant.
• Indeed the ceteris paribus assumption enables economists to emphasise the fact
that price and a host of other factors determine demand.
• Whenever you analyse the level of demand for any construction product there will
always be a need to consider both the price and many other related factors.
• To clarify this important distinction between the price determinant and the non-price
determinants, economists are careful to distinguish between them when they discuss
changes in demand.

Generalised Demand Equation

This is formally referred to as a demand function. It may look complicated

but it is only a form of shorthand notation
Qnd=f(Pn, Pn-1,Y, G, …..)
• It states that Qnd the quantity demanded of good ‘n’ is f a function of all
the things listed inside the bracket: Pn the price of the good itself, Pn-1
the price of other goods, Y income, G government policy, and…a host of
other things.
• These equations may be adapted and extended as necessary to support
the analysis of a specific sector

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Change in Demand

Original demand schedule New demand schedule

Walkman $200 Walkman $50

Price Quantity Price Quantity

(dollars (millions of tapes (dollars (millions of tapes
per tape) per week) per tape) per week)

a 1 9
Assume the original price of
b 2 6 Walkmans is $200. The
demand schedule shows
the Price-Quantity
c 3 4 relationship for tapes.

d 4 3
e 5 2

Change in Demand

Original demand schedule New demand schedule

Walkman $200 Walkman $50

Price Quantity Price Quantity

(dollars (millions of tapes (dollars (millions of tapes
per tape) per week) per tape) per week)

a 1 9 a' 1 13
b 2 6 b' 2 10
c 3 4 c' 3 8
d 4 3 d' 4 7
e 5 2 e' 5 6

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Demand

Price (dollar per tape)

5 Demand for
e e' tapes
(Walkman $50)
4
d d'
3
c c'
2
b b'
Demand for
1 tapes
(Walkman $200) a a'

0 2 4 6 8 10 12 14
Quantity (millions of tapes per week)

The Demand for Tapes

The Law of Demand

The quantity of tapes demanded
Decreases if:

The price of a tape rises.

Increases if:

The price of a tape falls.

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Changes In Demand

The demand for tapes

Decreases if:

The price of a substitute falls.

The price of a complement rises.
Income falls
The population decreases.
The price of a tape is expected to fall in the
future.

Changes In Demand

Changes In Demand
The demand for tapes
Increases if:
The price of a substitute rises.
The price of a complement falls.
Income rises (a tape is a normal good).
The population increases.
The price of a tape is expected to rise in the future.

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A Change in the Quantity Demanded

Versus a Change in Demand
A movement along a

Price
demand curve, which Decrease in
results from a change in quantity
demanded
price, shows a change in
the quantity demanded. Increase in
Decrease in
If some other
deman
influence on buyers’ d deman Increase
d in
plans changes, holding quantity
price constant, there is a demand D1
ed D0
change in demand. D2

Quantity

Understanding changes in Demand

• Non –Price determinants can cause the

demand schedule to shift which are
referred as increases or decreases of
demand.
• Consider an example of representing an
increase in the quantity demanded of
naturally ventilated commercial buildings
(at all prices)
• The demand curve for naturally ventilated
buildings would shift to the right,
representing an increase in the demand
at each and every price.

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Understanding changes in Demand

• If a non-price determinant of demand

changes, we can show its effect by
moving the entire curve from D to D1.
We assumed in our example that the
move was prompted by some research
in favour of naturally ventilated
buildings.
• Therefore, at each and every price, a
larger quantity would be demanded than
before. For example, at price P the
quantity of naturally ventilated buildings
demanded increases from Q to Q1.

Understanding changes in Demand

• By contrast, the price determinant causes a

movement along the demand curve.
• Changes to the quantity of demand due to price
alone are often referred to as an extension or
contraction of demand. This involves a move
along the demand curve.
• When more is demanded at a lower price, this
may be regarded as an extension from one
coordinate on the demand curve to another.
• When less is demanded due to a rise in price,
demand contracts.

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Understanding changes in Demand

• If the price is P1, then the quantity

demanded would be Q1; we will be at
coordinate A. If the price falls to P2, and
all other factors in this market remain
constant, then there will be an
extension of demand to Q2— from
coordinate A to coordinate B

Construction Market

Buyers Sellers Commodity

Construction The service required to design and erect, alter,
Clients
enterprises repair or maintain a particular physical facility

Users Construction clients Newly completed building or part of a building

The legal interest in an existing property or part

Users
of a property

All these three types of markets are interrelated

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Elasticity of Demand

News Paper Snippets

• Micro Findings In our micro-study of the determinants of housing Demand, we profiled the borrowers
in terms of Location, Gender, Age, Income, House Size etc based on large sample data obtained from
HFCs and Banks. Some Key findings are listed below:
• A typical borrower would most likely to be a male in the age group of 40 to 50 having an average
monthly income of Rs.10000 who prefers to buy a house of the size of 100 square meters. • Though
most of the borrowers are in the age group of 40-50, a significant 25% are below 35 years of age. It is
also found that there is a falling trend in average age profile of the housing demand. It is found that
income and price elasticity of demand is less than unity. An increase in house price by 10%,
ceteris paribus, results in a 4.6% decrease in housing demand as affordability comes down.

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An extract from The Hindu

Elasticity of Demand

• It is measurement of degree of responsiveness of demand to a change in market conditions

or external variable is termed as elasticity.

It is defined as:
% change in quantity demanded
% change in price

• For example we may wish to know that change in price of petrol will cause the quantity of
demand for petrol to change, other things held constant. Petrol prices rise by 10% and this
leads to reduction in demand by 1%. Then elasticity would be = -1%/10% = - 0.1.
• The theory of demand states that quantity demanded is inversely related to the relative price,
consequently price elasticity is always a negative number – if price rises, which is a positive
percentage change, the quantity demanded falls, which is a negative percentage change

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Elasticity of Demand

• Demand is ELASTIC when the price The price elasticity varies

elasticity (ignoring the negative sign) is along the length of a
straight-line demand
greater than 1. i.e., when the % change in
curve.
quantity demanded exceeds the change in
price Elastic
Unit elasticity
• Demand is INELASTIC when the price
elasticity lies between 1 and 0 i.e., when the
% change in quantity demanded is smaller
than the change in price Inelastic
• Demand is UNIT ELASTIC when the price
elasticity is exactly -1 i.e., when the %
change in quantity demanded is equal to the Quantity
change in price

What determines the price elasticity?

• The ease with which consumers can substitute another good.

• EXAMPLE:
• Consumers can readily substitute one brand of detergent for another if the price
rises,
• so we expect demand to be elastic,
• but if all detergent prices rise, the consumer cannot switch,
• so we expect demand to be inelastic.

In general, the more narrowly we define a commodity, the easier it is to

find a substitute, so the larger will be the price elasticity.

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Elasticity is higher in the

long run
• In the short run, consumers may not be able (or ready) to adjust their pattern of
expenditure.

• If price changes persist, consumers are more likely to adjust.

• Demand thus tends to be more elastic in the long run but relatively inelastic in the
short run.

The cross price elasticity of demand

•The cross price elasticity of demand for good i with respect to the price
of good j is:

% change in quantity demanded of good i

% change in the price of good j

•This may be positive or negative

•The cross price elasticity tends to be positive
• if two goods are substitutes: e.g., tea and coffee
•The cross price elasticity tends to be negative
• if two goods are complements e.g., tea and milk
•Goods are independent if it is equal to zero

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The income elasticity of demand

The income elasticity of demand measures the sensitivity of quantity

demanded to a Change in income:

% change in quantity demanded of a good

% change in consumer income

The income
elasticity may be
positive or
negative.

How Do We Interpret the Price Elasticity of

Demand?
• A good economist is not just interested in calculating numbers. The number is a
means to an end; in the case of price elasticity of demand it is used to see how
sensitive the demand for a good is to a price change. The higher the price elasticity,
the more sensitive consumers are to price changes
• A very high price elasticity suggests that when the price of a good goes up,
consumers will buy a great deal less of it and when the price of that good goes down,
consumers will buy a great deal more
• A very low price elasticity implies just the opposite, that changes in price have little
influence on demand.
• PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes)
• If PEoD = 1 then Demand is Unit Elastic
• If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price
changes)

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How Do We Interpret the Cross-Price Elasticity of

Demand?
• The cross-price elasticity of demand is used to see how sensitive the demand for a
good is to a price change of another good. A high positive cross-price elasticity tells
us that if the price of one good goes up, the demand for the other good goes up as
well. A negative tells us just the opposite, that an increase in the price of one good
causes a drop in the demand for the other good. A small value (either negative or
positive) tells us that there is little relation between the two goods.
• If CPEoD > 0 then the two goods are substitutes
• If CPEoD =0 then the two goods are independent (no relationship between the two
goods
• If CPEoD < 0 then the two goods are complements

How Do We Interpret the Income Elasticity of

Demand?
• Income elasticity of demand is used to see how sensitive the demand for a good is to
an income change. The higher the income elasticity, the more sensitive demand for a
good is to income changes. A very high income elasticity suggests that when a
consumer's income goes up, consumers will buy a great deal more of that good. A
very low price elasticity implies just the opposite, that changes in a consumer's
income has little influence on demand.
• If IEoD > 1 then the good is a Luxury Good and Income Elastic
• If IEoD < 1 and IEOD > 0 then the good is a Normal Good, necessity and Income
Inelastic
• If IEoD =1, good is normal and a comfort
• If IEoD < 0 then the good is an Inferior Good and Negative Income Inelastic

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ELASTICITIES OF DEMAND

Linear Demand Curve ● linear demand curve Demand curve that is a straight line.

Linear Demand Curve

The price elasticity of demand
depends not only on the slope of the
demand curve but also on the price
and quantity.
The elasticity, therefore, varies along
the curve as price and quantity
change. Slope is constant for this
linear demand curve.
Near the top, because price is high
and quantity is small, the elasticity is
large in magnitude.
The elasticity becomes smaller as we
move down the curve.

ELASTICITIES OF DEMAND

Linear Demand Curve

(a) Infinitely Elastic Demand

For a horizontal demand curve, ΔQ/ΔP

is infinite. Because a tiny change in
price leads to an enormous change in
demand, the elasticity of demand is
infinite.

● infinitely elastic demand Principle that consumers will buy as much of a good as
they can get at a single price, but for any higher price the quantity demanded drops
to zero, while for any lower price the quantity demanded increases without limit.

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ELASTICITIES OF DEMAND

Linear Demand Curve

(b) Completely Inelastic Demand

For a vertical demand curve,
ΔQ/ΔP is zero. Because the
quantity demanded is the same
no matter what the price, the
elasticity of demand is zero.

● completely inelastic demand Principle that consumers will buy a

fixed quantity of a good regardless of its price.

Theory of Supply

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Arc & Point Elasticity

Arc & Point Elasticity

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Law of Supply

“The higher the price the greater the quantity offered for sale, the lower the price,
the smaller the quantity offered for sale, all other things being held constant”
• The law of supply, therefore, tells us that the quantity supplied of a product is
positively (directly) related to that product’s price, other things being equal.
• The supply curve slopes upwards from left to right, demonstrating that as price rises
the quantity supplied rises and, conversely, as price falls, the quantity supplied falls

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Market Supply Schedule

• The market supply of a product is given by the sum of the amounts that individual
firms will supply at various prices.
• We see from the data that as price increases suppliers are willing to produce greater
quantities. At the other extreme, low prices may actually discourage some firms from
operating in the market. By combining the supply from each firm within the industry,
we can identify the total market supply at each price; we do this in the final column.

Market Supply Schedule

• At low prices, producers B and C offer nothing at all for sale; most probably because
high production costs constrain them
• At higher prices, the law of increasing opportunity costs imposes constraints. By
adding up each individual firm’s output, at each specific price, we can discover the
total supply that firms would be willing and able to bring to the market.

Plotting these total

amounts against their
related prices enables one
to construct a market
supply curve.

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Supply in the Construction Industry

• Many firms contribute to the supply of construction products, including large national
contractors, material manufacturers, plant hirers and local site labourers. So while it
may be theoretically possible to estimate construction supply by summing what the
firms in the market are willing to supply at various prices, the huge range of private
contractors involved in construction complicates the process of simply aggregating
individual supply curves.
• Industry is not clearly one simple market and there are separate markets
• It should be pointed out that the labour, capital and management resources
employed on any one construction project could transfer to another.
• Firms move from one site to another upon completion and some stay for the whole
duration of project. There is an overlapping effect.
• It is this overlapping nature of the sectors comprising construction that give rise to
some common reference points for factor rewards across the industry. In other
words, rates of profit, wages and material prices tend towards some kind of
equilibrium.

Supply and The Price Determinant

• As the law of supply states: more goods are supplied at higher prices, other things
being held constant. This is because at higher prices there is greater scope for firms
to earn a profit.
• Firms already in the market have an incentive to expand output, while higher prices
may also enable those firms on the fringes of the market to enter the industry.
• At higher prices, therefore, the increased quantity supplied is made up by existing
firms expanding output and a number of new firms entering the market.
• As shown in previous table, higher prices enticed other firms into the market and total
supply increased

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Supply and Non-price Determinants

• Till now, we have discussed supply curve based on the assumption that only price
changes other things being constant (ceteris paribus qualification).
Some of these ‘other things’ assumed constant are
• the costs of production,
• technology,
• government policy,
• weather,
• the price of related goods,
• expectations,
• the goals of producers

Changes in Supply – Cost of production

• Any change in production costs will affect the quantity supplied.

• If unit production costs increase by Rs1, and this additional cost cannot be passed
on by suppliers, then they will supply less to the market at each price. These
changed conditions will cause the market to shrink so that,
• The supply curve has shifted to the left: less is now supplied at each and every price.
The opposite would occur if one or more of the inputs became cheaper.
• This might be the case if, say, technology improves, but such opportunities seem
slow to emerge in a construction industry that is both labour intensive and culturally
inclined to invest little in research, development and training

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Changes in Supply – Supply chain management

• It would be a very rare for a contracting firm to be able to complete any construction
activity entirely alone
• Most construction activity normally involves integrating and managing a whole host
of activities and processes to reach the final product, including subcontracting skilled
work and purchasing materials.
• The larger firms, especially the huge conglomerates, ensure their clients are
provided with prompt and reliable services by diversifying into other businesses to
extend their range of operations.
• This emphasizes that construction firms not only produce different products but they
also operate outside their immediate business and, to understand the supply
implications, we find ourselves considering changes in many related markets as well
as the conditions in the construction industry

Changes in Supply – Expectations

• A change in the expectations about future prices or prospects of the economy can
also affect a producer’s current willingness to supply.
• For example, builders may withhold from the market part of their recently built or
refurbished stock if they anticipate higher prices in the future.
• In this case, the current quantity supplied at each and every price would decrease,
the related supply curve would shift to the left.

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Changes in Supply – Government

• Taxes and subsidies also affect costs and thus supply.

• A more complicated issue is the impact of general taxation, as much of the
construction industry’s demand is derived and depends on how others forecast their
requirements. The most direct impact that the government has on construction
markets is through legislation.
Summary
• If the prices of productive resources goes up supply decreases. Eg. A rise in the
minimum wage decreased the supply of hamburgers.
• If the price of a good expected to increase the current supply decreases.
• Supply also depends on the number of suppliers. The larger the number of firms that
produce a good the greater the supply of the good.
• New technologies lower the cost of producing products, therefore they increase
supply of products.

UNDERSTANDING CHANGES IN SUPPLY

• A change in the price of a good itself will

cause a movement along the supply
curve, and be referred to as an
extension or contraction of supply.
• A change in any non-price determinant,
however, will shift the curve itself and be
referred to as an increase or decrease in
supply.
• If price changes, we move along a given
curve. However if the costs of production
fall, the supply curve shifts to the right
from S to S1 representing an increase in
the quantity supplied at each and every
price

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UNDERSTANDING CHANGES IN SUPPLY

• If a new computer-assisted design package

(CAD), that incorporates cost estimating,
reduces fees relating to new builds, then
design and build contractors will be able to
supply more new buildings at all prices
because their costs have fallen.
• we can see that this rightward movement
represents an increase in the quantity
supplied at each and every price.
• For example, at price P, the quantity
supplied increases from Q to Q1. Note that
if, on the other hand, the costs of production
rise, the quantity supplied would decrease at
each and every price and the related supply
curve would shift to left.

A Change in the Quantity Supplied Versus a

Change in Supply

Increase in
S2 S0
Price

quantity S1
supplied

Decrease in Increase in

supply supply

Decrease in
quantity
supplied

Quantity

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Elasticity

• Elasticity is defined as a measurement of the degree of responsiveness of demand

or supply to a change in price.
• The measurement of price responsiveness is termed price elasticity

There are three types of measure:

1 Price-inelastic supply
2. Price-elastic supply
3. Unit-elastic supply

Elasticity

Price – Inelastic supply :

• When the numerical coefficient of the price elasticity of supply calculation is less than 1, supply is said
to be ‘inelastic’.
• This will always occur when the percentage figure for the change in supply is smaller than the
percentage figure for the change in price. A PES coefficient of anything between 0 and 1 represents a
situation of inelastic supply.
• In most cases where firms are supplying into the construction industry the price elasticity of supply, in
the short term at least, will be inelastic.
Price-elastic supply
• When the numerical value of the price elasticity of supply calculation is greater than 1, supply is said
to be ‘elastic’.
• This will always be the case when we the percentage change in supply is larger than the percentage
change in price.
• This would be unusual occurrence in the markets for construction or property—but not impossible.

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Elasticity

Unit-elastic supply
• This is the most hypothetical case, as it describes a situation in which a percentage change in price
leads to an identical percentage change in supply.
• This will always produce a coefficient value of 1, since the same figure appears on both the top and
bottom lines of the price elasticity of supply formula
The estimates taken from different time periods suggested that PES of housing is always less than 1. It
ranges from 0.3 to 0.8.

Price Elasticity of supply (PES)

• Es approaches infinity, supply is perfectly elastic. Producers are very sensitive to

price change.
• Es > 1, supply is elastic. Producers are relatively responsive to price changes.
• Es = 1, supply is unit elastic. Producers’ response and price change are in same
proportion.
• Es < 1, supply is inelastic. Producers are relatively unresponsive to price changes.
• Es approaches 0, supply is perfectly inelastic. Producers are very insensitive to price
change.
It is impossible to judge elasticity of a supply curve by its flatness or steepness. Along a
linear supply curve, its elasticity changes.

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Determinants of PES

• Time lag: How soon the cost of increasing production rises and the time elapsed
since the price change influence the Es. The more rapidly the production cost rises
and the less time elapses since a price change, the more inelastic the supply. The
longer the time elapses, more adjustments can be made to the production process,
the more elastic the supply.
• Storage possibilities: Products that cannot be stored will have a less elastic supply.
For example, produces usually have inelastic supply due to the limited shelf life of
the vegetables and fruits.

Price Elasticity of supply

• In the short run, rental values and house prices are

demand determined because adjustments cannot quickly Perfectly inelastic supply
be made to the supply of property. The markets for
construction in the short term are price inelastic in supply.
• In fact, it is the inelastic supply relative to demand that
causes property markets to be unstable and characterised
by fluctuating prices. In the extreme short run, the supply
of buildings or infrastructure is fixed and the supply curve
is a vertical straight line.
• If a change in the quantity supplied is zero, then the
numerator is zero, and anything divided into zero results in
an answer of zero. This is defined by economists as
perfect inelasticity
• The supply curve is vertical at the quantity of 100,000
units per year, as the price elasticity of supply is zero.
Producers supply 100,000 units no matter what the price.

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Price Elasticity of supply & Time lags

• Time tends to be the main determinant of the

elasticity of supply. In the immediate time period Perfectly inelastic supply
supply is fixed, and inelastic to the value of zero; but
given time for adjustments, supply increases can be
organised and responses become elastic.
• This feature of supply inelasticity is particularly
notable within property markets.
• Land is characterized by being perfectly inelastic;
that is, as house and property prices increase the
quantity supplied does not alter.
• Undeveloped areas can be developed and existing
areas of land can change use; but both these
possibilities take time

Elasticity

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Equilibrium price
6
The equilibrium price D S Surplus at 2
is the price at which

Price
5 units
the quantity
demanded equals 4 • •
the quantity
supplied. The
3 • Equilibrium

equilibrium quantity 2 • •
is the quantity
1 Shortage at 3
bought and sold at
units
the equilibrium
price. 0 2 4 6 8 10
Quantity

Market Equilibrium

Quantity Quantity Shortage(–)

Price demanded supplied or surplus(+)
(dollars
per tape) (millions of tapes per week)

1 9 0
2 6 3
3 4 4
4 3 5
5 2 6

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Market Equilibrium

Quantity Quantity Shortage(–)

Price demanded supplied or surplus(+)
(dollars
per tape) (millions of tapes per week)

1 9 0 -9
2 6 3 -3
3 4 4 0
4 3 5 2
5 2 6 4

Market Equilibrium

Price as a Regulator

If the price is too low, quantity demanded exceeds quantity
supplied.

If the price is too high, quantity supplied exceeds quantity
demanded.

Price Adjustments

A shortage forces the price up.

A surplus forces the price down.

Such price changes are mutually beneficial to both buyers and

sellers.

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The Effects of a Change in Demand

S
• When demand
increases, both 5

Price
the price and the 4

quantity increase
3 •
• When demand
2
decreases, both
the price and the 1 D0 D1
quantity
decreases 0 2 4 6 8 10 12 14
Quantity

Changes in Supply

6 S0 S1
1. When supply increases,
Price

the quantity increases 5

and the price falls.
4
Excess
2. When supply decreases,
the quantity decreases
3 • • Supply
and the price rises. 2 •
1
D

0 2 4 6 8 10
Quantity

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The Effects of an Increase in Both Demand

and Supply
• When both demand and S0
6 S1
supply increases the

Price
quantity increases and the 5

price increases, decreases,

4
or remains constant.
3 • •
• When both demand and
2
supply decrease, the
quantity decreases and the 1 D D
1
price increases, decreases, 0
or remains constant. 0 2 4 6 8 10 Quantity

The Effects of a Decrease in Demand and an

Increase in Supply
When demand decreases
6 S0 S1
and supply increases, the
price falls and the quantity
•
Price

5
increases, decreases, or
4
remains constant.

When demand increases

3 •
and supply decreases, the 2 •
price rises and the quantity D
1
increases decreases, or D 0
1
remains constant.
0 2 4 6 8 10 Quantity

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Case

The demand for housing is often described as being highly cyclical and very sensitive to
housing prices and interest rates. Given these characteristics, describe the effect of
each of the following in terms of whether it would increase or decrease the quantity
demanded or the demand for housing. Moreover, when price is expressed as a function
of quantity, indicate whether the effect of each of the following is an upward or
downward movement along a given demand curve or involves an outward or inward
shift in the relevant demand curve for housing. Explain your answers for the below.
• A. An increase in housing prices
• B. A fall in interest rates
• C. A rise in interest rates
• D. A severe economic recession
• E. A robust economic expansion

Case solution

A. An increase in housing prices will decrease the quantity demanded and involve an
upward movement along the housing demand curve.
B. A fall in interest rates will increase the demand for housing and cause an outward
shift of the housing demand curve.
C. A rise in interest rates will decrease the demand for housing and cause an inward
shift of the housing demand curve.
D. A severe economic recession (fall in income) will decrease the demand for housing
and result in an inward shift of the housing demand curve.
E. A robust economic expansion (rise in income) will increase the demand for housing
and result in an outward shift of the housing demand curve.

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Problem 1

• Qd = 8 - P
• Qs = - 4 + P^2
• Calculate the market equilibrium.
• Sketch this market.
Qd = Qs
8 - P = - 4 + P^2
- P^2 - P + 12 = 0
- (P^2 + P - 12) = 0
- (P + 4)(P - 3) = 0
[P1 = - 4] [no solution because P < 0]
P2 = 3 [because if P = 3 ® (3 - 3) = 0]
Qd = 8 - P = 8 - 3 = 5 ® Q = 5

Sketch and calculate the equilibrium

Demand: P = 32 - 8Qd
Supply: P = 12 + 2Qs

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Problem 2

• Situation on a 'no tax'-market:

Demand: P = 32 - 8Qd
Supply: P = 12 + 2Qs
Calculate the market equilibrium.
• Now a tax is introduced. The seller has to pay a tax of 2 out of the price received.
New supply: (P* - 2) = 12 + 2Qs [P* = Gross receipt (new price)]
Calculate the market equilibrium with tax.
• Who bears how much of the new tax (tax incidence)?
• Calculate total tax receipt.
• Graph the market without tax and with tax in the same diagram.

Solution 2

• Market equilibrium on a 'no tax'-market:

32 - 8Q = 12 + 2Q ---> - 10Q = - 20
Q = 2; P = 32 - 8Q = 32 - 16 = 16
• Demand: P = 32 - 8Qd , Supply: (P* - 2) = 12 +
2Qs ----> P* = 14 + 2Qs
Market equilibrium with tax:
14 + 2Q = 32 - 8Q ---> 10Q = 18
Q = 1.8; P = 32 - 8Q = 32 - 14.4 = 17.6
• Buyer bears 1.6 (old price 16, new price 17.6),
seller bears 0.4 (old receipt = 16, new net
receipt = 15.6). Q is reduced for both.
• Total tax receipt = 1.8 * 2 = 3.6

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Problem 3

'No tax'-situation :
Demand: P = 32 - 8Qd
Supply: P = 12 + 2Qs
Now a 10%-tax is introduced. It has to be paid by the seller out of the gross
receipt P* (= 100 %).
• Formulate the new supply function (P* = ...).
• Calculate the market equilibrium with tax.
• Who bears how much of the new tax (tax incidence)?
• Calculate total tax receipt.

Solution 3

Market equilibrium (no tax)

Q = 2; P = 16
Market equilibrium (with tax)
Q = 1.83; P = 17.39
Buyer bears 1.39 (17.39 - 16),
seller 0.35 (16 - [0.9*17.39]).

Total tax receipt: Q*0.1*P* = 1.83*0.1*17.39 = 3.18

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Combining Supply & Demand

Below are Supply and demand shocks and identify the new equilibrium in each case.

Price

Combining Supply & Demand

• The three hypothetical markets and the

changes described in Table are plotted. In
market A we assume an increase in
demand causing quantity and price to
increase.
• In market B we assume an increase in
supply causing quantity to increase and
price to decrease.
• In market C we assume an increase in
demand and a long-run decrease in supply
causing a higher equilibrium price but no
significant short-run change to quantity.

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Tutorials

Lecture 2 – Demand and Supply

Task – Group Activity

Each group has to identify the non price determinant factors that would affect the
demand for
A. The owner occupied sector
B. The private rented sector
C. Social Housing
D. Industrial Buildings
E. infrastructure and public sector construction
F. Repair and maintenance

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Demand for Owner occupied housing

Factors affecting demand for owner occupied housing:

• The current price of housing
• The price of other forms of housing
• Income and expectations of change
• Cost of borrowing money and expectations of change
• Government incentives such as tax benefits
• Demographic factors such as the number of households
• Price of associated goods and services, such as maintenance, furniture,
insurance, etc.

Demand for privately rented housing

Factors affecting demand for privately rented housing

• Current rent levels and expectations of change
• Income distribution—which determines affordability
• The cost of borrowing and expectations of change
• The law on rents and security of tenure
• Demographic factors, such as household formation
• The price of owner occupation

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Demand for Social housing

Factors affecting demand for social housing

• The current price (rent) of social housing
• The price level of other forms of tenure
• Assessment of need
• Availability of finance, such as income support and mortgages
• Levels of government subsidy

Demand for Industrial & Commercial Buildings

Factors affecting demand for industrial and commercial buildings:

• Technological developments
• Changes in taste or fashion
• Expected levels of cost, including interest rates
• The state of the economy and government policy
• Business confidence
• The age and condition of existing premises

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Demand for infrastructure and public sector

construction

Factors affecting demand for infrastructure and public sector construction:

• Assessment of need-present and future
• Availability of finance and levels of government subsidy
• Government policy
• The age and condition of the existing stock

Demand for repair and maintenance

Factors affecting demand for repair and maintenance

• The current cost of repair and maintenance
• The cost of new building
• Level of current income
• Government policy associated with heritage and conservation, etc.
• The age and condition of existing stock (and its state of disrepair)
• The ownership pattern, since owner-occupied property tends to be better
maintained

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Problem 1

Suppose the total demand for wheat and the total supply of wheat per month in the Kansas City
grain market are as follows:

a. What is the equilibrium price? What is the equilibrium quantity? Fill in the surplus-shortage
column and use it to explain why your answers are correct.
b. Graph the demand for wheat and the supply of wheat. Be sure to label the axes of your
graph correctly. Label equilibrium price P and the equilibrium quantity Q.
c. Why will $3.40 not be the equilibrium price in this market? Why not $4.90? “Surpluses drive
prices up; shortages drive them down.” Do you agree?

Solution 1

• Shortage/Surplus = -13; -7; 0; +7; +14; and

+21.
• A. Pe = $4.00; Qe = 75,000. Equilibrium
occurs where there is neither a shortage
nor surplus of wheat. At the immediately
lower price of $3.70, there is a shortage of
7,000 bushels. At the immediately higher
price of $4.30, there is a surplus of 7,000
bushels
• C. Because at $3.40 there will be a 13,000
bushel shortage which will drive price up.
Because at $4.90 there will be a 21,000
bushel surplus which will drive the price
down. Quotation is incorrect; just the
opposite is true.

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Problem 2

• Graph this market and calculate the market equilibrium:

• To protect consumers, the government sets a maximum price (ceiling) of 9. Add the
maximum price to the graph .
• Calculate the excess demand.

Solution 2

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Problem 3

All variables refer to the supplier of good X, except PY (= Price other goods).

Demand: Q = 200 - 5P - 2PY + 0.2I

when P = 10, PY = 12, I = 1000

• Calculate Price elasticity of demand (e), cross-price elasticity of demand (Ce) and
income elasticity of demand (Ie)
• Characterize the good

Solution 3

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Problem Solution

• Explain Income Elasticity of Demand and characterize the below goods. À Good X: +
0.5, Á Good Y: + 2.6, Â Good Z: - 0.4. Cross Price Elasticity of P and Q is +1.9,
Characterize P&Q
Sol:
• Income Elasticity is % change in quantity demanded w.r.t % change in Income.
• X – Normal & necessity, Y- Normal & Luxury, Z- Inferior, P&Q are Substitutes

Problem

• A new sales tax (for example $ 1 per piece) is introduced.

1. Who bears the tax increase in the cases 1 to 3?
2. Describe the relationship between price elasticity of demand and tax incidence.

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Problem

• Determine the Price Elasticity in above cases

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Solution

• E=0, Completely Inelastic.

• E=INFINITY, Perfectly Elastic
• E=0.25 IN-Elastic

References

• Myers, Danny (2013) Construction Economics – a new approach, third edition, Routledge, London
and New York.
• Ball, M Fraschi, M and Grilli, (2000), Competition and the Persistence of Profits in the UK Construction
Industry, Construction Management and Economics, 18: 733-45.
• Bon, R. and Crosswaithe, D. (2000) the Future of International Construction, Thomas Telford: London.
• De Valence, (ed) (2001) Modern Construction Economics: Theory and application. Spon Press:
London and New York.
• Salvatore. D., “Managerial Economics”, Tata McGraw Hill.
• Google and Wikipedia sites

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Thank You

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