(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 155

130 PART 2 • Producers, Consumers, and Competitive Markets

TABLE 4.4

PRICE AND INCOME ELASTICITIES OF THE DEMAND FOR ROOMS

GROUP

PRICE ELASTICITY

INCOME ELASTICITY

Single individuals

−0.10

0.21

Married, head of household age less than 30, 1 child

−0.25

0.06

Married, head age 30–39, 2 or more children

−0.15

0.12

Married, head age 50 or older, 1 child

−0.08

0.19

land.) Table 4.4 lists price and income elasticities for
different demographic groups.
There are significant differences among subgroups
of the population. For example, families with young
household heads have a price elasticity of −0.25,
which is more price elastic than the demands of families with older household heads. Presumably, families
buying houses are more price sensitive when parents
and their children are younger and there may be plans
for more children. Among married households, the
income elasticity of demand for rooms also increases
with age, which tells us that older households buy
larger houses than younger households.
For poor families, the fraction of income spent on
housing is large. For instance, renters with an income
in the bottom 20 percent of the income distribution
spend roughly 55 percent of their income on housing,
as compared to 2.8 percent of income for households
overall.4 Many government programs, such as subsidies, rent controls, and land-use regulations, have
been proposed to shape the housing market in ways
that might ease the housing burden on the poor.
How effective are income subsidies? If the subsidy increases the demand for housing substantially,
then we can presume that the subsidy will lead to
improved housing for the poor.5 On the other hand,
if the extra money were spent on items other than
housing, the subsidy will have failed to address policy concerns related to housing.

The evidence indicates that for poor households (with incomes in the bottom tenth percentile
of all households), the income elasticity of housing is only about 0.09, which implies that income
subsidies would be spent primarily on items other

than housing. By comparison, the income elasticity
for housing among the wealthiest households (the
top 10 percent) is about 0.54.
This discussion assumes that consumers choose
their expenditures on housing and other goods to
maximize their overall satisfaction, where the benefits of housing (and thus the demand for housing)
arise from the amount of living space, the safety of
the neighborhood, the quality of schools, etc. In
recent years, however, the demand for housing has
been partly driven by speculative demand: People
bought homes under the assumption that they can
re-sell the homes in the future at a much higher
price. Speculative demand—demand driven not
by the direct benefits one obtains from owning a
home but instead by an expectation that the price
will increase—has caused housing prices in many
parts of the United States to increase sharply, far
more than could be justified by demographics.
Speculative demand can lead to a bubble—an
increase in price based not on the fundamentals of
demand, but instead on a belief that the price will
keep going up. Eventually, bubbles burst—the price
stops rising as new buyers stop coming into the market, owners of the good become alarmed and start to
sell, the price drops, more people sell, and the price
drops further. As we will see in Chapter 5, bubbles
are problematic because they can distort the functioning of a market and lead to financial dislocations

when they burst. That is what happened to the U.S.
housing market, which experienced a housing price
bubble that finally burst in 2008, leading to mortgage defaults and contributing to the financial crisis
that hit the U.S. and the global economy in late 2008.

4
This is the starting point of the “affordable” housing debate. For an overview, see John Quigley
and Steven Raphael, “Is Housing Unaffordable? Why Isn’t It More Affordable,” Journal of Economic
Perspectives 18 (2004): 191–214.
5

Julia L. Hansen, John P. Formby, and W. James Smith, “Estimating the Income Elasticity of Demand
for Housing: A Comparison of Traditional and Lorenz-Concentration Curve Methodologies,” Journal
of Housing Economics 7 (1998): 328–42.