Market Bubbles

Between 2000 and 2019 in China the average price of a house increase from 4000 yuan Per
square meter (m^2) 260,000 yuan per m^2. The ratio of average house prices to average
incomes increase from 5.6 to 7.6, showing their houses were becoming less affordable.

Evaluate the impact of Market bubbles in the housing market. (20)

Answer: Market bubbles occurs when rising demand drives prices beyond the level that
might normally be expected. 
        Market bubbles are an example of market failure.Market failure occurs when the free
market fails to allocate resources to the best interest of society, so there is an inefficient
allocation of scare resources. Economic and social welfare is not maximized when there is a
market failure.

 Market bubbles occur because of speculation. Speculation is when an economic agent

buys or sells something in the expectation of a future price change in the hope of generating
a profit. Speculation mainly happens in the financial market such as housing, equities,
stocks, shares and currencies. In China there was a market bubble in the housing market.
This is because in China the price per meter^2 has increased from 4000 yuan to 60,000 yuan
between 2000 to 2019. This was a 1400% increase in price over 20 years (4000-
60000/4000*100).
 Speculation occurred in the housing market because investors started buying
properties in the hope of getting rich in the future, this increased the normal demand for
housing. The supply of houses are limited in the short run and so the supply tends to increase
more slowly than demand and so prices rise further. So as property prices rise, more buyers
join in to purchase and therefore the value of houses increase and the market bubble takes
off. 
 Houses became less affordable in China because of the high prices. The high prices
lead to low/middle income families finding it difficult to purchase a house. House price to
income ratio has increased from 5.6 to 7.6 showing that house prices have gone from being
5.6× to 7.6x the persons income. Therefore, these low/ middle income families will borrow
money from banks to make purchases for houses. This will lead to banks lending more
money and generating more profits and revenue. 
 A rise in the prices of the housing market means consumer confidence is being
created. This will lead to a greater consumption of other goods and services since people are
now more willing to consume more. After consumers purchase a house they need to buy
other goods and services to maintain the house, this increases the consumption of other
goods and services. Leading to overall aggregate demand in the economy.
 Moreover, The construction sector will benefit from increased demand to build more
houses. This increased demand for houses will lead to more profit in the construction sector. 

However, this is a bubble and just like real bubble state can suddenly collapse. When the
market bubble burst the price will return to a value that reflects the fundamental value of the
property. The market bubble may burst because someone may decide to sell the properties,
so the price rise stops and may even drop. 
  The housing markets have a risk of bubbles because when it is easy to get a mortgage
or when interest rates are low many people buy houses and so the price rises. But later if the.
economy faces problems or if interest rate goes up, many house owners will be forced to sell
their houses and therefore the bubble bursts.
 If the bubble bursts the construction sector will suffer significantly with
unemployment (unemployment occurs when individuals are without a job but are actively
seeking work) because then less labour will be needed as less houses will be made to meet
the market equilibrium. Market equilibrium is where market supply and demand balance
each other and as a result price becomes stable. This occurs after the bubble burst.
 Moreover, if the bubble burst then the falling prices of houses will see a fall in
consumer confidence as their will be less consumption of other goods and services.
If a investor buys the house in return for higher rent then they will not see an increase in rent.
This is because rise in house prices increases the wealth of the property owners and not the
value of the property. 

 A rise in the house prices because of the demand means that the economy is growing. It
is likely that with rapid economic growth throughout 20 years will reflect to the
economies excellent performance. For example, there might have been high levels of
employment, improved balance of payment, increase in aggregate demand and supply,
increased investment and consumption in the economy. High economic growth for much
of this period of the economy means that the rise in price of houses is a convenient
increase in the value of housing. Therefore affordability for low/middle income families
may not be an issue as wages will also increase because of the high level of economy
growth. 

In conclusion, it may be difficult to measure how much of the price change reflects to the
actual value of housing and how much it links to the speculative investment in housing.