2013 Essay Question 2

Question

The Urban Redevelopment Authority (URA) announced that prices of private residential properties in Singapore rose by 1.3% in the third quarter of 2011, but the rise in the prices has been slowing for eight consecutive quarters. At the same time it reported that the total supply of new private residential properties nearing completion was at a record high.

Source: http://www.ura.gov.sg/pr/text/2011/pr11-135.html, accessed 28 October 2011

Discuss the different supply and demand factors and their likely importance in determining the reported changes in the prices of private residential properties in Singapore. [25]

Answer

There are two parts to the question: what would lead to a rise in the prices of private residential properties in Singapore and what would lead to a slower rise in the prices.

There are two possible factors that may lead to a rise in the prices of private residential properties in Singapore: an increase in the demand and a decrease in the supply.

Increase in the demand
The prices of private residential properties in Singapore may rise due to an increase in the demand. As the income elasticity of demand for private residential properties is positive, which means that they are a normal good, an increase in income will lead to a rise in the demand. The national income of Singapore has generally been increasing which has led to an increase in the demand for private residential properties. This is largely due to globalisation and the export-driven growth strategy that the government has been pursuing. The number of immigrants in Singapore and hence the population has been increasing which has led to an increase in the demand for private residential properties. A main reason for this is the relaxation of the immigration policy to increase the size of the labour force. The number of foreign buyers of private residential properties in Singapore has been increasing which has led to an increase in the demand. A main reason for this is the rising affluence in some Asian countries such as China. The rising prices of private residential properties in Singapore have induced many buyers to expect the prices to rise further. Expectations of a further rise in the prices have induced many of them to bring forward the purchase to avoid paying a higher price in the future and this has led to an increase in the demand. As private residential properties can be resold, many people have also bought private residential properties to sell them at a higher price later and this also led to an increase in the demand. An increase in the demand will lead to a rise in the prices.

Decrease in the supply
The prices of private residential properties in Singapore may rise due to a decrease in the supply. The Singapore government has recently increased foreign worker levies and decreased foreign worker quotas in an attempt to boost labour productivity growth, among other objectives. As a large majority of construction workers in Singapore are foreign workers, this has led to an increase in the cost of production resulting in a decrease in the supply. The cost of production in the construction sector in Singapore has also increased due to a rise in the prices of construction materials such as ready-mixed concrete and an increase in the cost of land as the demand has continually outstripped the supply. The rising prices of private residential properties in Singapore have induced many sellers to expect the prices to rise further. Expectations of a further rise in the prices have induced many of them to put off their sales to increase their capital gains and this has led to a decrease in the supply of private residential properties. A decrease in the supply will lead to a rise in the prices.

There are four possible factors that may lead to a slower rise in the prices of private residential properties in Singapore: a slower rise in the demand, a slower fall in the supply, a higher price elasticity of demand and a higher price elasticity of supply.

Slower rise in the demand
The slower rise in the prices of private residential properties in Singapore in recent years may be due to a slower rise in the demand. The Singapore government has implemented some measures to cool down the residential property market in recent years. The additional buyer’s stamp duty was introduced in 2011 and revised in 2013. Under the new rule, the Singapore government imposes an additional buyer’s stamp duty of 15 per cent on foreign buyers of private residential properties in Singapore. For permanent residents, they have to pay an additional buyer’s stamp duty of 5 per cent, and 10 per cent if they already own one or more private residential properties. For citizens, they have to pay an additional buyer’s stamp duty of 7 per cent if they already own one residential property and 10 per cent if they already own two or more private residential properties. This measure has reduced the effective return on investment for speculative buyers of private residential properties resulting in a slower rise in the demand and hence a slower rise in the prices. The total debt servicing ratio of 60 per cent was introduced in 2013. Under the new rule, the monthly total debt obligations of an individual are not allowed to exceed 60 per cent of their gross monthly income. This measure has made it more difficult for prospective buyers of private residential properties to obtain mortgages resulting in a slower rise in the demand and hence a slower rise in the prices. After a long period of rising prices of private residential properties, many buyers expect less room for appreciation. Indeed, some buyers have formed the expectation that a period of depreciation will begin in the near future. These expectations have also slowed down the rising demand for private residential properties resulting in a slower rise in the prices.

Slower fall in the supply
The slower rise in the prices of private residential properties in Singapore in recent years may be due to a slower fall in the supply. Due to the rising prices of private residential properties and hence the rising profitability in the construction industry, there has been an increase in the number of firms and an expansion of the production capacities of the existing firms. Therefore, the production capacity in the construction industry has increased resulting in a slower fall in the supply of private residential properties and hence a slower rise in the prices. Indeed, the supply of private residential properties may have even increased. After a long period of rising prices of private residential properties, many sellers expect less room for appreciation. Indeed, some sellers have formed the expectation that a period of depreciation will begin in the near future. These expectations have also led to a slower fall in the supply of private residential properties resulting in a slower rise in the prices.

Higher price elasticity of demand
The slower rise in the prices of private residential properties in Singapore in recent years may be due to a higher price elasticity of demand. The price elasticity of demand for a good is a measure of the degree of responsiveness of the quantity demanded to a change in the price, ceteris paribus. The demand for private residential properties is price inelastic due to the high degree of necessity and lack of close substitutes. As the prices of private residential properties rise, the proportion of income spent on the good will increase, assuming consumers’ income does not rise by the same or larger proportion. When this happens, the price elasticity of demand will rise. With a less price inelastic demand, the same decrease in the supply will lead to a smaller rise in the prices.

Higher price elasticity of supply
The slower rise in the prices of private residential properties in Singapore in recent years may be due to a higher price elasticity of supply. The price elasticity of supply of a good is a measure of the degree of responsiveness of the quantity supplied to a change in the price, ceteris paribus. The supply of private residential properties is price inelastic as the production time is long due to the long construction time of buildings. The production time of private residential properties may have decreased due to technological advancements in the construction industry. If this happens, the price elasticity of supply will rise. With a less price inelastic supply, the same increase in the demand will lead to a smaller rise in the prices.

Evaluation

Point 1: The rise in the prices of private residential properties in Singapore started slowing down shortly after the introduction of the cooling measure of additional buyer’s stamp duty and the slowdown picked up pace shortly after the introduction of the cooling measure of the total debt servicing ratio. A closer examination of these cooling measures will reveal that they target mainly the speculative demand for private residential properties. For example, the additional buyer’s stamp duty only applies to citizens when they purchase the second residential property onwards. Therefore, the slowdown in the rise in the prices of private residential properties in Singapore in recent years is likely to be mainly due to a decrease or smaller increase in the speculative demand.

Point 2: There may have been some technological advancements in the construction industry in recent years. However, technological advancements generally do not occur substantially over a short period of time. Furthermore, given the nature of the machinery used in the construction industry, such as hydraulic excavators and wheel loaders, any technological advancements are unlikely to be major. Therefore, although potential technological advancements in the construction industry in recent years may have shortened the production time of private residential properties, this is unlikely to have a significant effect on the slowdown in the prices.

A more elaborate answer to 2013 Essay Question 2 will be provided in the economics tuition class.

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