Question:
Housing is an exceptionally durable asset, often enduring for decades. Let’s delve into the housing market of Cleveland.
As we project into 2026:
- Cleveland boasts 250,000 existing homes, all constructed prior to 2000.
- Homes do not depreciate over time.
- No new homes have been built in Cleveland in the past 26 years.
- The marginal cost for constructing a new home in Cleveland stands at $200,000, with the construction industry operating under constant returns to scale.
(a) Utilizing a standard supply and demand graph, depict Cleveland’s aggregate housing supply curve for 2026. Clearly label any significant prices and quantities.
(b) If the demand for housing in Cleveland rises, use your diagram to illustrate how this influences the equilibrium price and quantity of housing.
(c) Conversely, if demand for housing in Cleveland decreases, use your diagram to demonstrate how this affects the equilibrium price and quantity of housing.
(d) Are the effects of increasing and decreasing housing demand symmetrical in terms of housing prices and quantities in Cleveland? Provide an explanation using your supply curve.
Solution:
The Cleveland housing market is defined by two critical features. First, there exists a fixed stock of 250,000 homes built before 2000, which do not depreciate. Second, the cost of constructing new homes is a constant $200,000. These characteristics—durability and a steady construction cost—shape the supply curve and dictate the market’s reaction to shifts in demand.
Let’s start with supply.
Given that homes retain their value, the existing stock of 250,000 homes is immutable. Any price below $200,000 fails to incentivize new construction, as builders would operate at a loss. Thus, the total housing supply remains fixed at 250,000 units, represented by a vertical supply curve at that quantity for any price under $200,000.
Now, consider the scenario at $200,000. At this price point, builders are willing to enter the market to construct new homes. Because the construction sector enjoys constant returns to scale, the marginal cost of building additional homes remains at $200,000, irrespective of the number of homes built. This means that once the price reaches $200,000, builders will supply any quantity of housing at that price. Graphically, this results in a kinked supply curve: vertical at 250,000 homes up to a price of $200,000 and horizontal at $200,000 for quantities exceeding that threshold.
With the supply curve established, let’s examine how the market reacts to demand fluctuations.
Imagine demand surges. Initially, the equilibrium is situated on the vertical segment of the supply curve. With the quantity of housing fixed at 250,000 homes, an increase in demand drives up housing prices without altering the quantity. As buyers compete for the limited stock, prices escalate.
As demand continues to climb, the price eventually hits $200,000. At this juncture, new construction becomes economically viable. Builders then enter the market, supplying additional homes. Further demand increases no longer elevate the price beyond $200,000; instead, they enhance the housing quantity through new builds. Consequently, the price stabilizes at $200,000 while the quantity expands.
This mechanism also alters the supply curve over time. When new homes are constructed, the total housing stock increases. What was once a vertical supply curve at 250,000 homes can shift rightward, perhaps to 260,000 or even 275,000 homes, reflecting a larger existing housing stock. Thus, previous demand increases leave a lasting mark on the market by augmenting the housing inventory. The vertical portion of the supply curve isn’t static; it adjusts outward as new homes are incorporated.
Now, let’s turn our attention to a demand decrease.
When demand contracts, the equilibrium remains on the vertical section of the supply curve. The existing stock of homes—potentially larger due to earlier construction—remains unchanged. There is no mechanism to reduce housing quantity in response to waning demand; homes don’t vanish, and no one can “unbuild” them. Therefore, all adjustments must occur through prices. A drop in demand results in a lower equilibrium price while the quantity of housing stays fixed at the existing stock.
This highlights a critical asymmetry. Increases in demand elevate prices and ultimately trigger new construction, which enlarges the housing stock and shifts the supply curve outward. Conversely, decreases in demand do not reverse this trend. The housing inventory remains constant, necessitating that prices fall to equilibrate the market.
This asymmetry holds significant implications in the real world. In cities facing prolonged demand declines—due to population decreases, deindustrialization, or evolving economic landscapes—the housing inventory persists even as demand diminishes. This leads to a chronic oversupply at prevailing prices, manifesting as declining property values, increasing vacancy rates, and underutilized housing. In extreme situations, this can culminate in urban decay as properties are neglected or abandoned due to market values sinking below maintenance costs.
The primary constraint is straightforward: while housing can be added, it cannot be easily taken away. When demand surges, prices eventually catalyze construction, thereby expanding the housing stock and shifting supply outward. When demand wanes, however, that adjustment capacity evaporates—the quantity is bounded by the existing stock, thus leaving prices to absorb the shock. The outcome is an inherent asymmetry: upward demand shocks translate into both increased prices and greater housing availability, while downward shocks mainly result in lower prices. This phenomenon is not exclusive to housing; in any durable goods market, historical production choices limit current adjustments, influencing how prices and quantities respond.
