Demand In The Construction Industry

Published Date: 02 Nov 2017

By:

MAHIMA SINGH

ADT- 1ST YEAR (FULL TIME)

2012-2013

@00343537

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TASK 1

DEMAND:

Demand refers to how much quantity of a commodity is or service is desired by a buyer to buy it at a given price over a period of time. The relationship between price and quantity demanded is known as the demand relationship. But when Economists speak of demand they mean Effective demand which is money backed desire. It is distinct from need. Demand depends on the ability and willingness to buy a good. In other words, Demand is the relationship between the price of good and the quantity demanded in a given period of time.

The demand curve for most goods and services slopes down from left to right as higher the price the lower the level of demand (other things being equal).

(Myers, 2008)

LAW OF DEMAND

‘At higher prices, a lower quantity will be demanded than at lower prices (and vice versa), other things being equal.’

(Myers, 2008)

In other words more goods will be demanded at a lower price than at higher price if other things remain constant. The law of demand therefore tells us, that the quantity demanded of a product is inversely related to that product’s price. Higher prices demand decreases the quantity demanded for two reasons:

Substitution Effect- Higher relative prices raise the opportunity cost of buying a good and so people buy less of it as they can get other alternative goods (substitutes) at cheaper prices.

Income Effect- Higher relative price reduces the amount of goods people can buy. This effect reduces the amount people buy after an increase in price. In other words; when the price of commodity falls, the real income (the income measured in terms of how much it can buy) of a consumer increases as they spend less to buy the same quantity.

DEMAND IN THE CONSTRUCTION INDUSTRY

The determination of demand for goods and services produced by the construction industry is a complicated process due to longevity, cost, size and investment nature of the products and partly due to what constitutes construction industry. The UK housing sector is broadly divided into four sectors:

The owner occupied sector- i.e. accommodation owned outright or bought with a mortgage.

The private rented sector- property lent to tenants and landlords at a ‘fair’ market price.

The local authority rented sector- housing made available by the local authority at a subsided rate from public funds.

The registered social landlord sector- comprises of non-profit organisations that manage properties provided through public and private funds to rent to those in need.

DEMAND FOR OWNER OCCUPIED HOUSING

Most households in UK and much of Europe demand homes to own and occupy. This form of ownership is generally supported by government initiatives that encourage demand by making the process of buying home as transparent, fast and as consumer friendly as possible. The main factors affecting demand are mentioned below:

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 benefit

Demographic factors such as the number of households

Price of associated goods and services, such as maintenance, furniture, council tax, insurance, etc.

(Myers, 2008)

DEMAND SIDE FACTORS:

Other than price there are other factors which determine the demand. Changes in any of the factor affecting demand other than the price cause the entire demand curve to shift.

Income- When there is an increase in income the standard of living improves causing more people to buy their own houses which leads to an increase in the total demand of house. But even the vice versa is true when there is decrease in the income, more people will shift towards rented housing i.e. the ability of customers to buy goods is based directly on their income.

Price of other goods- As mentioned above, when the income decreases or the price of house increases more will people will shift towards rented housing. Here the rented houses are the substitutes for the owner occupied ones and as they are available at cheaper price more people will shift towards it and the demand for owner occupied housing will decrease. But since here the owner occupied housing is new their market price is going to be lower than other owner occupied house so more people can buy them easily at a feasible price.

Expected future price- If in future the price for the housing will increase as expected more people would be inclined to buy it today due to which demand will increase for short run. On the other side if future price is expected to decline people will wait to buy it in future and demand decreases (i.e. the demand curve shifts leftward).

Tastes and preferences- The market demand is also affected by buyer’s willingness to purchase different goods. The tastes and preferences which affect this willingness vary over time.

Jobs- Job is an important factor to consider while determining demand of housing. Unemployment can trigger low housing demand as fewer jobs will lead to low average incomes which will in turn lead to a decrease in housing demand.

Number of buyers- Individual demands of every buyer in the market are composed together to form market demand. If the number of buyer increases, the market demand shifts rightward and a decrease will make it shift leftward.

Shift in Demand Curve:

http://tknomics-com.webs.com/beanie.gif

(Rahman, 2012)

SUPPLY

Supply refers to the quantity of goods suppliers are willing and able to offer for sale in the market.

(Manser, 2005)

In other words, the quantity of a commodity that seller is willing and able to sell at a given price over a period of time.

LAW OF SUPPLY

The basic law of supply can be stated formally as:

‘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.’

(Myers, 2008)

In other words, less of a good will is supplied at a lower price than at higher price, if other things remain constant. A positive relationship exists between the price of a commodity and the quantity that sellers are willing and able to supply in a given period of time if other factors are held constant.

The standard supply curve for most goods and services slopes upward from left to right. The higher the price, the higher the quantity supplied (other things being equal).

(Myers, 2008)

Supply Curve:

http://www.netmba.com/images/econ/micro/supply/curve/supplycurve.gif

(The supply curve)

SUPPLY IN THE CONSTRUCTION INDUSTRY

A number of firms contribute to the supply of construction products, including large national contractors, material manufacturers, plant hirers and local site laborers. So it is 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.

SUPPLY SIDE FACTORS

According to the law of supply more goods are supplied at higher price if other things are held constant. This is due to the fact that at higher prices there is greater scope for firms to earn profit. So if the product is in demand in the market, the firm increases the price of that good and people are still willing to pay for it the supply of that particular good will increase. The other factors which were constant until now can be altered to see their effect on supply. These factors are known as supply side factors and some of them are mentioned below:

Cost of production- The producers in the market are seeking for profit. Therefore, any change in the cost of production will, ceteris paribus, will affect the quantity supplied. For example: If unit product cost increases by 1£, and this additional cost cannot be passed on by suppliers then they will supply less to the market at each price. These change conditions will cause the market to shrink i.e. only 300 units per day will be supplied at a price of 6£ per unit. In technical terms, the supply curve shifts towards left: less is now supplied at each and every price.

Government- Taxes and subsidies also affect the costs and thus supply in a similar way. For example, a landfill tax has increased construction costs and reduced supply at each price. A subsidy would do the opposite and increase supply at each price since every producer would be paid a proportion of the cost of each unit produced by the government. Through legislation there is a more direct impact on construction markets along with planning, building, health and safety.

Technology- Technology determines the alternative methods of combining labor, capital, and land in the production of output. Technological improvement will reduce costs and increase the profit margin on each unit sold which will in turn increase the supply.

Supply chain management- It is very rare for a construction firm to complete any construction activity entirely alone. Most construction activity involves integrating and hosting a whole host of activities to reach the final product, including subcontracting skilled work and purchasing materials. One medium sized contractor with an annual turnover of £240 million (made up of contracts averaging £7 million each) claimed that 75% of its total work was subcontracted, 8% was spent on materials and 4% was used to hire plant. (Jessop 2002:7)

Expectations- A change in the expectation of future prices or prospects of the economy can also affect a producer’s current willingness to supply. For example: builders can withhold themselves from selling their recently built or refurbished stock in the market if they think prices will go up in the future. In this case, the current quantity supplied at each and every price would decrease and the supply curve will shift to the left.

Number of sellers in the market- The market supply is composed of the supply of the individual sellers in the market. If more sellers enter the market, the market supply curve shifts rightward.

Other factors affecting supply include weather conditions, methods of production, transport facilities, labor disputes, political changes, transport facilities etc.

Supply curve shift when the above mentioned factors are changed:

http://www.netmba.com/images/econ/micro/supply/curve/supplyshift.gif

(The supply curve)

SUPPLY AND DEMAND RELATIONSHIP

The demand and supply relationship between buyer and seller with respect to offered and agreed prices. Demand and supply factors help in determining the market value of properties. House buying and market selling depends on two factors: The seller is willing and agreed on the property price with the buyer and the buyer is willing and is able to pay the actual price.

Sellers and Buyer’s market- If the demand of houses in a particular area is high and the availability of good houses is low then the market balance shifts to the seller because of the higher demand for good property. On the other side if the demand for housing is low and a large supply of property is available in the market then the balance shifts towards buyers.

http://www.tutor2u.net/economics/content/diagrams/housing9.gif

(Demand and supply for housing)

Elasticity- Price affects the quantity traded. If increased demand pushes up prices sellers strive to supply more goods. If a cut in supplies forces the price up, consumers will buy less. The effect on sales may be less or substantial. Elasticity measures the degree of response to price changes. The more prices sensitive a person is as a consumer/supplier, the greater the elasticity of demand or supply. For example- if there is an increase in the population or in the economy of people then the demand for housing will increase and vice versa.

MARKET EQUILIBRIUM

Equilibrium in any market can be defined as a situation in which the plans of buyer and the plans of seller exactly match. House prices affect both demand and supply and the equilibrium price will come at the point when the price for current supply and demand matches. The point at which the quantity demanded equals the quantity supplied is the equilibrium point.

http://i.investopedia.com/inv/tutorials/site/economics/economics5.gif

(Heakal)

When either the demand or supply changes so that one of the demand or supply curves shifts, the effect on both the price (P) and quantity (Q) can be determined:

An increase in demand (a rightward shift in the demand curve) raises P and increases Q.

A decrease in demand (a leftward shift in the demand curve) lowers P and decreases Q.

An increase in supply (a rightward shift in the supply curve) lowers P and increases Q.

A decrease in supply (a leftward shift in the supply curve) raises P and decreases Q.

(Demand and Supply)

Markets are not always in equilibrium. After reaching equilibrium, if changes in factors other than price can cause a shift in demand and supply curves.

An increase in demand: demand curve shifts to the right higher equilibrium price and higher equilibrium quantity

An increase in supply: supply curve shifts to the right lower equilibrium price and higher equilibrium quantity.

The leftward shift of the demand curve indicates that consumers are now willing and able to buy fewer properties in every price range due to the increase in mortgage rates. The excess supply of properties on the market at old price causes a new equilibrium to be found at lower price at which the quantity demanded and supplied are again found to be equal.

(Myers, 2008)

Over time, demand for housing in UK has risen rapidly while the supply is stable. UK house buildings in recent years have been one of the lowest in Europe, and this has contributed to the rising level of average prices.

http://www.economicsonline.co.uk/How%20markets%20work%20graphs/Housing-equilibrium.png

(The housing market)

TASK 2

ECONOMIES AND DISECONOMIES OF SCALE

ECONOMIES:

These refer to gains in productivity from scaling up production.

Lower input costs: When a company buys inputs in bulk - for example, potatoes used to make French fries at a fast food chain - it can take advantage of volume discounts. (In turn, the farmer who sold the potatoes could also be achieving ES if the farm has lowered its average input costs through, for example, buying fertilizer in bulk at a volume discount.)

Costly inputs: Some inputs, such as research and development, advertising, managerial expertise and skilled labour are expensive, but because of the possibility of increased efficiency with such inputs, they can lead to a decrease in the average cost of production and selling. If a company is able to spread the cost of such inputs over an increase in its production units, ES can be realized. Thus, if the fast food chain chooses to spend more money on technology to eventually increase efficiency by lowering the average cost of hamburger assembly, it would also have to increase the number of hamburgers it produces a year in order to cover the increased technology expenditure.

Specialized inputs: As the scale of production of a company increases, a company can employ the use of specialized labour and machinery resulting in greater efficiency. This is because workers would be better qualified for a specific job - for example, someone who only makes French fries - and would no longer be spending extra time learning to do work not within their specialization (making hamburgers or taking a customer's order). Machinery, such as a dedicated French fry maker, would also have a longer life as it would not have to be over and/or improperly used.

Learning inputs- Similar to improved organization and technique, with time, the learning processes related to production, selling and distribution can result in improved efficiency - practice makes perfect.

(Marshall, 2009)

According to the diagram below:

Scale economies allow a supplier to move from SRAC1 to SRAC2

A profit maximizing producer will produce at a higher output (Q2) and charge a lower price (P2) as a result – but the total profit is also much higher (compare the two shaded regions)

Both consumer and producer surplus has increased – there has been an improvement in economic welfare and efficiency – the key is whether cost savings are passed onto consumers!

http://www.tutor2u.net/economics/revision-notes/a2micro-economiesofscale2.jpg

(Riley, 2012)

DISECONOMIES OF SCALE

Diseconomies are the result of decreasing returns to scale and lead to a rise in average cost

Diseconomies of scale a business may experience relate to:

Control – monitoring the productivity and the quality of output from thousands of employees in big corporations is imperfect and expensive – this links to the concept of the principal-agent problem i.e. the difficulties of shareholders monitoring the performance of managers.

Co-ordination - it can be difficult to co-ordinate complicated production processes across several plants in different locations and countries. Achieving efficient flows of information in large businesses is expensive as is the cost of managing supply contracts with hundreds of suppliers at different points of an industry’s supply chain.

Co-operation - workers in large firms may develop a sense of alienation and loss of morale. If they do not consider themselves to be an integral part of the business, their productivity may fall leading to wastage of factor inputs and higher costs. Traditionally this has been seen as a problem experienced by the larger state sector businesses, examples being the Royal Mail and the Fire fighters, the result being a poor and costly industrial relations performance. However, the problem is not concentrated solely in such industries. A good recent example of a bitter industrial relations dispute was between Gate Gourmet and its workers.

Economic theory predicts that a firm may become less efficient if it becomes too large. The additional costs of becoming too large are called diseconomies of scale. Diseconomies of scale result in rising long run average costs which are experienced when a firm expands beyond its optimum scale, at Q.

Economies and diseconomies of scale

(Diseconomies of scale)