economics case 1

8/13/2019 Economics Case 1

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THE DEM ND FOR RENTAL HOUSINGA REVIEW OF THEORY AND EMPIRICAL EVIDENCE

prepared forOntario Regional Office

Canada Mortgage and Housing Corporationby

John R MironCentre for Urban and Community Studies

University of TorontoToronto

Principal Consultant John R MironCentre for Urban and Community StudiesUniversity of Toronto455 Spadina AvenueToronto Ontario M S G

MH Project Manager Dallard Runge

Centre for Urban and Community StudiesUniversitv of Toronto


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STR CT

Residential rents , especia l ly those for newly const ruc ted dwell ings , haver isen quickly in recent years. Housing analysts , planners , and builders al ikeface a common question. How sensi t ive i s the demand for renta l housing to theprice being charged? This report reviews the empirical evidence avai lable. tbegins with a review o f methodological questions. How do we measure demandHow do we empirically define a consumer ? How do we separate quali ty fromprice changes? How do we measure a consumer s w il li ngne ss to pay or abi l i tyto afford ? What form does a demand function take? The report examines thedata sets on which most Canadian and u.S. studies are based. Subsequently, i tpresents a review of empirical estimates of the price sens i t iv i ty of ren ta lhousing demand. se t of conclusions are drawn which emphasize the need forbet ter data and a more thorough and systematic analysis of housing demand inCanada.


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This study was conducted by John R Miron of the Centre for Urban and ommunityStudies University of Toronto for Canada Mortgage and Housing Corporation underPart V of t he Nat io na l Housing Act The analys is in terpret t ions andrecommendations are those of the consultant and do not necessarily ref lec t theviews of Canada Mor tgage and Housing Corporation or those divisions of theCorporation that ssisted in the study and i t s publication


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L i s t of ContentsThe Demand fo r Rental Housing:A Review of Theory an d Empirical Evidence

1. Introduction2 Fundamental concepts

2.1 Measuring a consumer s demand f o r housing2. 1. 1 The expenditures approach2 .1 .2 The p r i c e di scount i ng approach2 .1 .3 The measured q u a l i t y approach2 .1 .4 The d i s c r e t e choice approach2 .1 .5 The simultaneous demand approach2.2 Defining the r e l e v a n t consuming u n i t2 .3 E qu il ib ri um an d d i s e q u i l i b r i u m in the housing market2.3.1 hy disequilibrium?2 .3 .2 Modelling d i s e q u i l i b r i u m2 .3 .3 Movers versus n on mo ve rs a nd d i s e q u i l i b r i u m2 .3 .4 Short an d long-run demand e l s t i i t i es an d d i s e q u i l i b r i u m2.4 A bility to afford an d w i l l i n g n e s s to pa y2.5 Sources of d a t a2 .5 .1 Data sources in Canada2 .5 .2 Data s our c e s in the United S t a t e s2.6 P r i c e q u a l i t y an d demand2. 6. 1 hy do p r i c e s vary?2 .6 .2 o r o l e f o r p r i c e or q u al it y v a ri at io n s2.6.3 Standardizing fo r q u a li ty d i ff e re n ce s2 .6 .4 A l te rn a ti ve methods of computing p r i c e2.7 Income and demand2 .7 . Income measures based on c u r r e n t income2 .7 .2 Income measureS based on augmented c u r r e n t income2 .7 .3 Income m ea su re s b as ed on permanent income2 .7 .4 Wealth an d housing demand

3. F or mu la ti on o f demand function3.1 S t r u c t u r a l form3.1.1 Linear an d l o g - l i n e a r models3. 1. 2 Logit p r o b i t an d ot her nonlinear models3. 1. 3 L in ea r e xp e nd it ur e systems3.2 Relevant d emo g rap hic g ro u ps

2 .5 .1 Data sources in Canada2 .5 .2 Data s our c e s in the United S t a t e s

12334778991011 213

141517192022 3232 427829293 2334343 53 637

19? O


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3.3 Demographic gr oups . residenti l mobili ty. and housing demand3.4 Economic factors other than price and income4. Empirica l evidence on price and income e l s t i c i t i es

4.1 Muth 19604.2 19684.3 Leeuw 19714.4 Straszheim 19754.5 Struyk 19765. Conclusions

NotesReferences

4 04143434 3444546475054


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Pr efac e

Within the pas t decade housin g demand r esearch in Canada has en te r e d a newl e ve l of soph i s t i c a t i on . This work has be en mad e poss ib le by th e pub l i c r e l eas eof l a rge micro-data f i l e s . I in clude he r e th e 1971 and 1976 Census Publ i c Us eSample s the b ienn ia l Hous ehold In come Fac i l i t i e s a nd Equ ipment samp le sth e 1974 Surve y of Housing Units sample th e 1977 Incom e s As s e ts a n d Deb t ssample and the 1978 Famil y Expend i tu r e Surve y sample. In most c as e s th esesamples were co l l ec ted by S t a t i s t i c s Canada and were in t ended to s erv e a numbe ro f d i f f e ren t use s . The sample s a r e usefu l fo r housing demand res earch becaus ee a c h con ta ins some d a ta about h ou seho ld composi t ion income and dwe l l i n gcha r ac t e r i s t i c s . Becaus e th es e samples prov id e data about a l a rg e numb er ofindividu a l households t i s now poss ib le fo r r es ear che rs t o ana l yz e hous in gdemand a t a ver y de ta i led l eve l . In th e pas t t h i s was not poss ib l e . Hou s ingr esea rcher s s impl y did not hav e th e f inanc i a l r e sources to g ene r a t e such l a r gesamples .

Almost a l l of th e em pir ic al s tu d i es des cr ibed in th i s r epor t h ave mad e us eo f m ic ro -d ata f i l e s . Aft e r read in g th i s r epor t th e r i chnes s and va l ue o f thes ef i l e s should be evid ent . Without th em housin g demand r es ear ch i n Canada wouldhave been severe ly l im i t ed.

At th e s ame t ime we hav e come t o r e cogn iz e th e l im i t a t ion s o f t he s e da t asource s . Being omnibus sample s they o f te n do not co n t a i n enoughhousin g- r e la ted da ta t o su i t our v r g r o w da t a n e eds . We hav e le arned muchfrom these s ampl e s but a r e f as t r each ing th e s ta ge whe r e we n e ed mor e. Apar t i cu l a r shortcoming of these sample s i s tha t th e y a r e a l l cros s - se c t i ona l :i . e . once-on ly s amp l e s of a s e t of hous ehold s a t a g i ven po in t in t ime . Asargued in th i s pap e r th e r e a r e many empir i ca l i ssu es in housin g demand r es e a r chfo r which long i tud in a l samples would b e inv a l uable . A long i t ud ina l or pane ls tud y fo l lows a given se t of household s ove r t ime pe r i o d i c a l l y r e - i n t e rv i ewingthem . From su ch a s amp l e i t i s po ss i b l e t o l o ok a t how c han 8e s i n in coQe orhousing pr ic e s or hous ehold composi t ion t r ans l a t e ove r tim e in t o changes indwel l in g occupancy. From a c ro ss - s ec t i o na l sample on e ca n onl y gu es s a t su chimpac t s . Some pane l s tud y da t a ar e ava i l ab l e fo r th e Un i t e d Sta t e s but none fo rCanada . This pap e r conclude s with an a ppe a l fo r th e dev elopmen t o f n ew pane ls tud y sample s fo r Canad a. Such s ampl es would open u p a n ew and r ic h a r ea o fexplo r a t ion i n hou s in g demand r e sea rch.

In c l o s i ng I would k e to thank Canad a Mor tg a ge and Hou s in g Corpora t ionfo r i t s co n t i nue d suppo r t and in t e re s t . Wth in MH th e r e hav e ov e r th eyea r s been go od numbe r s of peopl e who r e cogniz ed th e impor t an c e an d va lu e o fhousing d emand r es e a r ch. Without th em much r e cent work in Canada mi ght n ev e rhave be en done .

argued in th i s pape r th e r e a r e many empir i ca l i ssu e s in housing demand r es e a r chfo r which long i tud in a l sampl e s would b e inv a l uable . A long i t ud ina l or pan e ls tud y fo l lows a given s e t of household s ove r t ime pe r iod ica l l y r e - in t e rv i ewing


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Summary

w sensi t ive i s the demand for rental housing to the price being charged ?As cons truc tion cost s r i se , this question must be of some concern to theres iden t ia l building industry. Higher rents presumab ly imply lowe r demands fora rental unit of a given set of character i s t ics and location. For thedeveloper, a lower demand manifests i t se l f in a longer ren t -up period or apers is ten t high vacancy ra te . Anecdotal evidence abounds of par t icu larbuildings which were slow to re nt-u p o r have a high vacancy ra te . However, wasth is due primarily to price sens i t iv i ty or to some bad character i s t ic such asinfer ior building qual i ty, inappropriate design , or i nacces sib le locat ion?

Rent levels can not be considered in i sola t ion. They must be related tochanges in consumer income. The price sens i t iv i ty of renta l housing demand inpart also depends on the avai labi l i ty of subs t i tu tes . Consumers mightsubst i tute ano th er k in d e .g. s ize , type, tenure) o f dwel lin g that is almost asdesirable, or subst i tute some housing f or ot he r good s a l t oge t he r , or may choos ean al te rna t ive l iv in g arrangement a s i n doub l i ng up ). An as ses smen t of th pprice sens i t iv i ty of demand should c on sid er th e f eas ib i l i ty of suchsubst i tut ions. The abi l i ty to subst i tute wil l dif fer among households;therefore , the i r price sensi t iv i t ies wil l vary as well.

Any examination of the price sens i t iv i ty of rental housing demand mustconsi de r th re e basic questions. 1) w does one conceptually measure thedemand for housing? 2) w do prices and incomes shape th is demand and howare these related to the abi l i ty to subst i tute? 3) w and why does the demandfor housing vary among di f ferent demographic groups?In this paper, the approaches of previous empirical studies to the abovethree questions are reviewed. Section 2 discusses some fundamental concepts in

housing demand an aly sis ; section 3 considers t he formulat ion of a demandfunction; and sect ion 4 reviews the empirical evidence on the sens i t iv i ty ofhousing demand to income and price changes. In the f inal section, someconclus ions a re presented.

The principal conclusions of this review are as follows: i ) There i s a paucity of Canadian research on renta l housing demand.

i i ) In part , th is is because of the lack of any l ong it ud in al d at a setsby which housing demand can be analyzed a t a micro l evel . i i i ) Any considerat ion of the demand for rental housing must simu l taneously

look at the demand for owner-occupancy because of the extent of subst i tu t ion possible between these two demand forms .iv ) Currently-available housing demand models vary greatly in the i rspeci f ica t ion, thus l imit ing comparisons amon g them.v) Nearly a l l demand studies estimate the housing choices of exis t ing

households. The impact of a change in price on the decision of anindividual or family to form a new household is i gnored.

_ _ ...._ t t . .. . , - ~ t t ... ...,.....- .... _ _ _ _LUot .............. _ ... .... _ ... .......- _three questions are reviewed. Section 2 discusses some fundamental concepts inhousing demand analys is ; section 3 considers t he formulat ion of a demand


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v i ) The abi l i ty to neasure p r i c e sens i t iv i ty depends cr i t ica l ly on th eabi l i ty to fa c to r r e n t s i n t o q u a l i t y an d price components. Severalmethods o f measuring housing q u a lity have been proposed: none of whichare entirely sat i s factory .

v i i Most demand s t u d i e s assume t h a t the housing market i s in economicequi l i br i um. However, th i s assumption has been widely contested. do not know however, how a v a i l a b l e price sens i t iv i ty es t i mat es wouldchange i f th is assumption were dropped.

v i i i There are s e ve r al e st im a te s a v a ila b le of p ric e sens i t iv i ty . However,t hes e estimates are based on s e v e r a l d i f f e r e n t measures o f demand.Care must be taken not to i n c o r r e c t l y compare t hes e different kinds ofprice sensi t iv i t ies .

ix ) There is a cons i der abl e d iv er sity in the measurement o f income inhousing demand s t u d i e s . Although a n a l y s t s agree on th e need to measurepermanent income , th is ca n be defined in di f feren t ways. This l i m i t scomparisons o f income e las t ic i t i es an d pr i ce sens i t iv i t i e s .

x) There are s u b s t a n t i a l differences in price sens i t iv i ty among co h o rts ofhouseholds. In terms of thei r tenure choi ces , an d o th er a sp ec ts o fthe i r demand fo r housing, young husband-wife families appear to be themost price sensi t ive .


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THE DEM ND FOR RENT L HOUSINGREVIEW OF THEORY ND EMPIRIC L EVIDENCE

INTRODUCTION

How sensi t ive is the demand for rental housing to the price being charged? s cons truct ion cost s r i se , th is question must be of some concern to theres iden t ia l bu ilding indus try . Higher rents presumably imply lower demands fora rental unit of a given se t of character i s t ics and location. For thedeveloper, a lower demand manifests i t se l f in a longer rent -up period or apers i s tent high vacancy ra te . Anecdotal evidence abounds of part icularbuildings which were slow to ren t-u p o r have a high vacancy ra te . However, wasth is due primarily to price sens i t iv i ty or to some bad character i s t ic such asinfer ior building qual i ty, inappropriate design, or inaccessible location?

Rents, of course, have not increased in i so la t ion . Incomes have also beenr is ing. rent that was thought to be unaffordable a decade ago might now beconsidered modest. Therefore, we must examine rent levels in relat ion toincomes. Indeed, i t has been argued that one way of forecasting the demand forrental housing a t a given rent i s by project ing the incomes of renter householdsand then calcula t ing what, for them, might be an affordable rent . In th ispaper, such approaches are evaluated.

The price sens i t iv i ty of housing demand in part depends on the avai labi l i tyof subst i tu tes . If the price of a certain kind of housing increases, consumerswil l attempt to subst i tute a less expensive al ternat ive . What might thatal ternat ive be? I t could take several forms. Fi r s t , the consumer maysubst i tute another kind e .g . s ize , type, tenure) of dwelling that is almost asdesirable. Second, the consumer may subti tute some housing for other goodsaltogether: for example, giving up a la rger house to l ive in a smaller one buttaking more-frequent vacations. Third, the consumer i . e . the person or personsmaking up the consuming uni t ) may ei ther disband or no t form. For example, ayoung woman might want her own apartment but instead choose subst i tute toremain in her parents home i f rents are too high. n assessment of the pricesens i t iv i ty of demand should consider the feas ibi l i ty of such subst i tut ions.Note that the abi l i ty to subst i tute di f fers among households; thei r price

rental housing a t a given rent i s by project ing the incomes of renter households


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sens i t iv i t i e s wi l l t h e r e f o r e , vary as w e l l .Any examination of the p r i c e sens i t iv i ty of rental housing demand must

consi der t hree basi c q u e s t i o n s . 1) How does on e c onc e ptua lly measure th edemand fo r housing? 2) How do p r i c e s and inc omes shape th is demand an d howare th e se r e l a t e d to the abi l i ty to s u b s t i t u t e ? 3) How and why does the demandf o r h ou si ng v ar y among different demographic groups?

In t h i s paper, the approaches o f pr e vious em pi ri cal s t u d i e s to the abovet hree q ue st io ns a re reviewed. Section 2 di scusses some fundamental concepts i nhousing demand a n a l y s i s ; s e c t i o n 3 consi ders the formulation of a demandfunct i on; an d s e c t i o n 4 reviews the em pi ri cal evidence on the sens i t iv i ty ofhousing demand to inc ome a nd p r i c e changes. In th e f ina l s e c t i o n , someconclusions are present ed.

2. FUND MENT L ON EPTSThere a re numerous economic s t u d i e s of markets. In a simple v e r s i o n , we

c an i ma gi ne a demand curve which re la tes th e q u a n t i t y demanded to the p r i c epai d. can al so imagine this demand curve shif t ing with changes in the incomeof a consumer. A supply curve showing th e q u a n t i t y of the commodity suppl i ed a tdifferent p r i c e s can be superimposed on th e demand curve. A market equi l i bri umi s defined where the s e two curves in tersect . Changes in the equi l i bri um p r i c ean d q u a n t i t y tr a de d ca n then be t raced to f a c t o r s t h a t cause shif ts in th edemand o r supply curves.

In principle th is paradigm ca n be used to di scuss housing as much as an yot her commodity. However, s e v e r a l quest i ons must be faced in applying th isparadigm. 1) How does on e measure the demand fo r housing by a consumer? 2)How does on e d e fine the r e l e v a n t consuming uni t : i . e . the i n d i v i d u a l o r group ofi n d i v i d u a l s whose demand i s being measured? 3) How r e l e v a n t is the assumptionof market equilibrium in th e market fo r housing an d what are the i m pl i cat i ons ofassuming di sequi l i bri um ? 4) How does on e measure or est i m at e th e h ou se ho ld sabi l i ty to afford or w i l l i ngness to pa y f o r a gi ve n dwelling? 5) What sourcesof dat a ca n be used in the a n a l y s i s of housing demand and what a re thei rl i m i t a t i o n s ? 6) How does on e measure the p r i c e of r e n t a l housing in a waywhich c o n t r o l s fo r q u a l i t y i . e . amount demanded). 7) How do changes in incomeaffect th e conconsumer s demand curve?

pai d. can al so imagine this demand curve shif t ing with cha nge s in the incomeof a consumer. A supply curve showing th e q u a n t i t y of the commodity suppl i ed a t


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In the conventional economic par adigm price p) i s the amount pa id p er u n i tconsumed. I f q u n i t s a re consumed, then expenditure i s the product p q . In aconventional demand model, q i s the dependent variable an d p i s an e x p la n a to r yvariable in a demand model. This mode o f a n a l y s i s i s not f e a s i b l e in housingmarket r es ear ch because gener al l y only on e u n i t o f housing i s consumed perhousehold. However, i t i s not c le a r t h a t pq ca n be s u b s t i t u t e d as the dependentvariable i n a demand model in the ab sen ce o f q .

The formulation of demand models is d is c u s s e d a t le n g th i n Section 3.Here, l e t us simply n o t e t h a t a common form i s

1 q f p , y , x , Z )

where y i s income, x i s a vect or of prices of o t h e r commodities, an d Z i s avect or o f p r e fe r en c e p a ra m et e rs . [Usually on e price i s taken as n um eraire an dy , p, an d x a re in r a t i o to t h i s . ] In housing market r e s e a r c h whereexpenditures a r e the dependent v a r i a b l e , the following model i s t y p i c a l :

2) pq f y , x , z ) .

However, t h i s l a t t e r model assumes t h a t e xp en di tu re s a re a function only of theconsumer s c h a r a c t e r i s t i c s y an d z) an d o th er p ric es x ). The fa c t th a t aconsumer s wi l l i ngnes s to spend i s also a f u n c tio n of the d e s i r a b i l i t y of thedwelling i s ignored. A developer would be very unwise to c on si de r u si ng a modelsuch as 2 ) to p r e d i c t t he r en t- pa yi ng a b i l i t y of p r o s p e c tiv e t enant s withoutsimultaneously cons i der i ng th e c h a r a c t e r i s t i c s of t h e i r dwelling choi ces .

2 . 1 . 2 THE PRICE DIS OUNTING PPRO HA second approach d is co un ts the r e n t expenditure of a household by some

pr i ce index v a lu e . Discounted expenditure i s in te nd ed to be a measure of theq u a l i t y of t he d we lli ng o c c u p i e d . Proponents t y p i c a l l y argue t h a t each r e n t a lu n i t ca n be assigned a q u a l i t y l e v e l , Q. Often, r e n t a l u n i t s providing ana v e r a g e bundle of services a re assigned a Q = 1 while those providing b e t t e r

o r w o r s e bundles have Q s which a r e l a r g e r o r s m a lle r than uni t y r e s p e c t i v e l y .Suppose f u r t h e r t h a t each r e n t a l u n i t commands a r ent which i s pr opor t i onal to

2 ) pq f y , x , z ) .


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i t s leve l of Q. In other words, the p r ice of each unit of quali ty is somefixed amount, say P. I f the rent expenditure for a par t icular unit is r dol larsper month, and i t s bundle of services provided is Q then r = PQ. If P werethe same for each dwelling, then rent expenditure would be proportional toquali ty and the expenditures approach described above could be used. However,the rent for a unit bundle of housing services wil l not necessari ly be the samefor a l l dwell ings. I t might well vary geographi ca ll y o r with the type ofdwelling being constructed. I f we knew for example that a dwelling of the samecharacterist ics rented for 400 per month in Oshawa but 360 per month inBarrie, we could def la te rents paid in Oshawa by 10 and assume that anyremaining var ia t ion in rents ei ther within Oshawa or between i t and Barrieref lec ts quali ty differences. This is the price discounting approach.

Three different methods of price discounting have been used: metro-wided is coun ting , cos t function discounting, and hedonic price discounting.

1) e t r o ~ w i e Dis counti ng . Sev er al analysts have used metro-widediscounting in cases Where the dataset includes households from a number ofdifferent metropoli tan areas. l n average rent expenditure i s calculatedfor each metropoli tan area. Then, the rent expenditure of each sampledhousehold in tha t metropol it an a rea is divided by that average ren t; th is rat iobecomes the quali ty measure. For example, i f a consumer spends 300 per monthon rent when the average for that metro area is 240, i t is assumed that 300/240= 1.25 qua li ty un it s are consumed. The problem with th is method is tha t i tassumes i ) that the only price variat ions are between ci t ies and i i ) thataverage-priced units are comparable in quali ty in each ci ty .

2) Cost Function Discounting. Cost f un ct i on discounting ha s not beenused to date in rental housing demand s tudies . Polinsky and Ellwood 1979) haveused a cos t f unction approach to measure the quali ty of owner-occupied housing,however. In this approach, a production function is assumed for housingPolinsky and Ellwood use a C S funct ion) . By assuming competitive markets andprofit-maximizing landlords, one can derive a cost function showing the marginalcost per unit quali ty as a function of input prices and technical parameters.By further assuming a competitive market for housing in equilibrium, themarginal cost must be the same as th e price per unit qual i ty . Dividing th isunit price into the sel l ing price yie lds the qua lit y le ve l of the dwel l ing. AU L L LC Lt UL W L LUlJU L J L l l l C l L t d ~ n .u t V O : : J t ~ O : : J.O::l lL O::A P O::l lU .J. L U J. e u L:t1.J .L:U.J. t1LO::U

for each metropoli tan area. Then, the rent expenditure of each sampled


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s imi lar approach could be used for rental housing. The advantage of th isapproach is that i t permits a measurement of the impact of v ar ia tio ns inbuilding t echnology, zoning , and the costs of land, construction mater ials , andlabour on the price of housing within and between metro areas. I t s disadvantagei s the necessity of assuming a housing market which is competit ive and inequilibrium.

3 Hedonic Price D iscoun tin g. S ev eral analysts have used a hedonic pricediscounting method. 2 Consider, as an examp le , de Leeuw and Struyk 1975 .They est imate a hedonic price equation in which rent expenditures are related todwelling character i s t ics , using a metro-wide sample. Then, the metro area isdivided into geographic zones and the hedonic price equation i s applied to these t of mean dwelling character i s t ics for ea ch zon e. This yields a hedonicestimate r1 of the average rent fo r a dwelling, which is then compared to theactual average rent r2 in tha t zone. The rent expenditure r of eachhousehold in a given zone i s multiplied by the ra t io of r1 to r2 . The deLeeuw-Struyk method eliminates spa t i a l v aria tio n in rents by making thediscounted rents r r1 / r2 comparable from one zone to the next. w wellthe method works depends par t ly on how well the hedonic price function i sspecif ied: i . e . whether the dwelling character i s t ics tha t affect rents have beenadequately and correct ly specif ied. I t also depends on the purpose of thehedonic price function. The de Leeuw-Struyk method can be cr i t ic ized because i teliminates spat ia l v ar ia tio ns in rents when these might be ar is ing because oflocat ional considerations and therefore ref lec t qual i ty differences as definedhere rather than price differences.

All of the above methods have some potent ia l and some problems. Thefundamental dif f icul ty is that the construction of a quali ty measure i sessen t ia l ly an indexing problem. There are many dif fe ren t at t r ibu tes of abundle of housing services which have to be combined via weights into a singlevalue the index . What weights are to be used? w much does extrafloorspace, bet ter quali ty of construct ion, or a bet te r locat ion each contributeto th is index of quality? Are there constant marginal contr ibut ions or does thequali ty level change nonlinearly with any of these? Are there jo in t e ff ec ts ; inother words, does the marginal contribution of extra floorspace depend onlo ca tio n f or example?

discounted rents r r1 / r2 comparable from one zone to the next. w well _ L J 1 _ __ J _ 1 L \ \ 1 4 ;; _


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The weighting scheme to be used must ref lec t consumer preferences.Presumably these weights are im plic it in the rents consumers are will ing to payfor d if fe re nt u n it s However, these weights may also vary among consumers. Theyoung large family may put a large weight on outdoor play space whereas theolder empty nester couple may not . If weights do di f fer among groups ofconsumers, how i s quali ty measure to be derived?

2.1.3 THE ME SURED QU LITY PPRO HI t is p ossible to measure some aspects of housing quali ty di rect ly These

include flo or area, number of rooms and lo t size for dwe ll ings w ith private ,ground-level outdoor space . For example, Miron 1980 and 1982 and Wilkinson1973 measure the income elast ic i ty of the demand for rooms and for flo or a re a.Kain and Quigl ey 1975 : pp 231-255 estimate demand functions for the number ofrooms, the number of baths, the f i r s t f loor area, the parcel area , and newnessyears since construct ion . Straszheim 1975 estimates demand functions fo rnumber of rooms and lo t s ize Provided that the quali ty aspect of in teres t canbe measured in th is way and provided that other quali ty at t r ibu tes are notimportant, this approach is valuable.

2.1.4 TrlE DIS RETE HOI E PPRO Hthe l a s t approach i s to t rea t the demand for housing as a problem in

discrete choice. A consumer might be seen to choose between two al ternat ives :e g owning vs rent ing, detached dwel l ing vs some other , la rge vs smalldwelling, or central vS suburban locat ion. Several housing demand studies havelooked a t such binary choice problems. 3 In addit ion, i t i s possible to looka t multiple choice problems: e g choosing among several different sizes ofdwellin g o r choosing a part icular dwelling type and tenure combination. 4Logit , probi t , and other s t a t i s t i ca l models can be us ed to re la te the choice ofdwelling to incomes, prices , and consumer preferences. Such models can then beused to predict the p robab il it y t ha t a consumer wil l choose any al ternat ive overthe res t When aggregated over the entire population of consumers theseprobabi l i t ies indicate the demand for part icular categories of housing.

The discrete cho ice app roach, unlike price discounting, appears to avoidthe quali ty index problem. This is tru e in the sens e that the discrete choice

important, this approach is valuable.


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methods do not require r ent expe nd i t u r e discounting. However, these methodsmodel demand only for those qual i ty at t r ibutes tha t are detailed by the choicea l t e r na t i ve s In discre te models of te nu re cho ic e, for example, othera t t r i but e s of a dwelling such as qual i ty of construct ion, design, or loc at iona r e ignored. 5

2.1.5 TKE SIMULT NEOUS DEM ND PPRO HIn recent years, a simultaneous demand app roach has been developed which

combi ne s the discrete choice approach with one of the ear l i e r three. Typically,these s tudies model i tenure choice and i i housing expenditu re s o r quali ty .Proponent s a rgue that housing at t r ibutes are not available in whatevercombinations the consumer wants. If the consumer wants a dwelling of a cer ta ins ize and qual i ty in a speci f ic locat ion, he or she may find tha t the uni tsavailable are a l l owner-occupier or a l l re nta l u ni ts . The consumer may preferone tenure but choose the other in i t s absence.

The empirical evidence on demand simultaneity is scat tered and confl ict ing.Struyk 1976: pp 143-149 is among th e ear l ies t to attempt a jo in t est imation.He looks at the tenure and housing expenditure choices o f households usingtwo-stage least -squares . He finds that the effect of income on tenure choice isconsiderably reduced once the housing expenditure decision is taken in toaccount. An al ternat ive s t a t i s t i ca l approach using two-stage maximuml ikel ihood has been developed by Lee and Trost 1978 . They do not find theincome ef fec t noted by Struyk. They find only weak evidence of a simultanei tybetween tenure and housing expenditure choices. Rosen 1979a and Boehm andMcKenzie 1982 also use the Lee-Trost procedure, but on d if fe re nt d a ta s et s.They again find only weak evidence of simultanei ty between tenure and price-discounted expenditure. King 1980 uses a di f fe rent estimation methodalso based on maximum l ikel ihood and finds that simultaneity has a s igni f i ca ntef fec t .

I t s t i l l remains to be seen whether a simultaneous approach t o demandestimation i s superior to the t rad i t ional approach. There i s , ar guably, somesimultaneity present but i t is unclear whether th i s is numerically extensiveenough to be important .

The empirical evidence on demand simultaneity is scat tered and confl ict ing.


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2.2 DEFINING THE RELEV NT CONSUMING UNITA household i s defined i n the Census of Canada to be th e c o l l e c t i o n of

i n d i v i d u a l s occupying a dwelling u n i t . I t i s not uncommon to begin an a n a l y s i sby assuming t h a t each household i s a consumer. The housing a n a l y s t might beginby p u t t i n g each household i n t o a economic-demographic group an d then examiningthe housing demands of each group. This i s the preval ent approach to demanda n a l y s i s an d f o r e c a s t i n g today.

However, the exi st ence of a household i s i t s e l f condi t i onal upon th e p r i c eof housing. C o nsid er, fo r example, a young bachelor s t a r t i n g h is f i r s t j o b .Depending on v a ri o us c ir cu m st an c es , t h i s person may 1 ) co ntinu e l i v i n g in h isp a r e n t s home 2) l i v e as a lodger i n someone e l s e s dwelling, 3 ) rent adwelling on his own 4) share a rented d we ll in g w it h on e or more p a r t n e r s , or 5 ) purchase a dwelling an d perhaps r e n t out space i n i t to lodgers or p a r t n e r s .This p e r s o n s choice w i l l depend on the p r i c e s of each form of accommodation asw e ll as on s e v e r a l ot her c o n s i d e r a t i o n s : e . g . h is income, p r ef er en c es , f u tu r ehousing r e quir e m e nts , proximity of dwelling to j o b s i t e expectations aboutfut ure house p r i c e s , an d wealth. I f he chooses a l t e r n a t i v e 1 ) , no newhousehold i s formed. However, i f the p r i c e of some othe r form o f accommodationi s lo w enough, he may f ind i t d e s i r a b l e to change h is l iving arrangement an dthus cont ri but e to an i ncreased demand for t h a t form of accommodation.

The problem here i s t h a t the household i s an e l a s t i c measure i n housingdemand s t u d i e s . One cannot measure pri ce s e n s i t i v i t y of r e n t a l demand bylooking simply a t how a given s e t o f households change t h e i r te nur e an d dwellingc hoic e s . One must al so look a t how the number an d c om po si ti on o f h ou se ho ld s area f f e c t e d by p r i c e changes. However, t here has no t been an y em pi ri cal work todate on such p r i c e impacts. In the work of St eel e 1979), Miron 1980), andMiron 1982), income i s shown to have s u b s t a n t i a l impacts on the number an dc om po si ti on o f households. To the e xtent t h a t a f f o r d a b i l i t y r e f l e c t s a t r a d e o f fbetween incomes an d p r i c e s , t h i s l a t t e r evidence may well imply t h a t p ric eimpacts are s u b s t a n t i a l .

2.3 EQUILI RIUM NO DISEQUILIBRIUM I N THE HOUSING M RKETMuch of the l i t e r a t u r e presumes t h a t the housing market is i n a s t a t e o f

s h o r t ru n economic equi l i bri um . 6 In ot her words, the r e nt b ei ng c ha rg ed fo r

i s lo w enough, he may f ind i t d e s i r a b l e to change h is l iving arrangement an dthus c on tr ib ute to an i ncreased demand for t h a t form of accommodation.


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an y kind o f occupied dwel l i ng i s j us t enough to make th e demand equal to th es uppl y. t enant has an i n c e n t i v e to change dwellings an d no landlord has anin c e n tiv e to withdraw a dwelling from the market to ad d a new one o r to seek anew t e n a n t . Let us refer to such r e n t s as the equilibrium rents

2.3.1 Y DISEQUILIBRIUMAt an y poi nt in time however the housing market l ikely wil l not be in

e q u i l i b r i u m . In o t h e r words market r e n t s di ver ge from equilibrium ren ts Thedurabi l i ty of the housing s to c k the absence o f p e r f e c t information among marketpar t ic ipan ts the c o s t s of moving an d exogenous changes in market conditionsover time are often c it e d i n s ugges t i ng t h a t equilibrium may never be e x a c tlyat ta ined fhis does not mean t h a t th e housing market bear s no resemblance to anequilibrium. In broad te r m s market an d equilibrium r e n t s may be s i m i l a r .However disequilibrium could be expected to in tro du ce at leas t smalld i f f e r e n c e s between t hes e two.

The notion of s h o r t - r u n economic equilibrium is in h e re n tly s t a t i c I f th emarket were fo r an ins tan t in such an e q u i l i b r i u m t h e r e would be no movement o fhouseholds because there would be no in c e n tiv e fo r a ra t ional household to move.Any renta l unit which was vacant would remain so an d no occupied dwel l i ng wouldbe vacat ed. The not i ons o f rent-up per i ods an d vacancy r a t e s would bemeaningless.

I t i s s pe ci fi ca ll y because o f disequilibrium t h a t the not i ons of rent-upperiod an d vac anc y ra tes become meaningful. A d ev elo pe r p uts up a building inth e bel ief th a t there w i l l be a demand fo r i t ei ther among newly-formingh ou se ho ld s o r among a l r e a d y - e x i s t i n g households who a re dissa t is f ied w ith the i rc u rre n t accommodation. The d ev el op er a sk s a cer ta in re n t fo r each uni t Thisasking r e n t is t y p i c a l l y s e t w ith o u t p e r f e c t knowledge of the equilibrium ren tIf th e asking re n t is e q u a l to th e equ ilbriu m re n t an d i f th e ho usin g market isot her wi s e almost in e q u i l i b r i u m the u n i t should r e n t up quickly an d have a lo wvacancy ra te Even h e re though the landlord cannot expect zero rent-upperiods an d zero vacancy ra tes as i t takes time fo r in fo rm atio n to d is se m in atein the market an d fo r th e r i g h t tenant to appear. However i f th e asking rentis substant ial ly above the market ren t th e re w i l l be a l a r g e r rent-up periodan d hi gher vacancy ra te I t wil l t ake l onger to fin d a t enant to f i l l the u n i t

The notion of s h o r t - r u n economic equilibrium is in h e re n tly s t a t i c I f th e


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and, once t h e r e , the tenant i s more l i k e l y to continue s ea rc hin g fo r a lessexpensive u n i t o r on e of bet ter q u a l i t y . The problem fo r the l andl or d is tof i nd a p r o f it- m a x im iz in g re n t level ; a l e v e l which trades o ff r e n t s receivedwhile rented against the l i k e l i h o o d of vacancy.

2 . 3 . 2 MO ELLING DISEQUILIBRIUMFew empi r i cal s tu d ie s of housing markets specif ical ly allow fo r

disequilibrium. mong those t h a t do, two categories of s tu d ie s may beiden t i f ied In on e cat egor y, disequilibrium i s pr es ent because a household isunable fo r some reason to choose the dwelling i t wants ev en th ou gh i s w i l l i n gto pa y the p r i c e charged. K ing s 1980) study of the U.K. housing marketexempl i f i es th is cat egor y. In th e second cat egor y, disequilibrium a r i s e sbecause a household i s slow to respond to an u n s a t i s f a c t o r y housing assignmentev en th ou gh more sat i s factory housing i s a v a i l a b l e . Le t us consider ea ch oft hes e in t u r n .

King 1980) argues t h a t the U.K. housing market can be d iv id e d i n t o threes e c t o r s : subsidized renta l unsubsidized renta l an d owner-occupied. He arguesf u r t h e r t h a t households a re not free to e n t e r the subsidized r e n t a l s e c t o rbecause access there i s controlled by l o c a l housing author i t ies Access to theo w n er - oc cu p ie d m ar ke t i s a l s o res t r ic ted he ar gues , by the avai labi l i ty ofcredi t A model i s cons t r uct ed in which each household makes aut i l i t y- maxi mi zi ng choice among the three s ec to rs s ub je ct to the c on st ra in t t ha taccess to a given s e c t o r may be r a t i o n e d , forcing th e consumer i n t o a l e s sdesired form of accommodation. King uses a s o p h is tic a te d maximum l i k e l i h o o dtechnique to e stim ate a housing demand function on th is b a s i s .

H an us he k a nd Quigley 1979 an d 1980), Rosen an d Rosen 19 80 ), an d Friedmanan d Weinberg 1981) are examples of s tu d ie s wherein the consumer is assumed toa d ju s t slowly to changes in i t s equi l i br i um demand fo r housing. Suppose thep r i c e of a c e r t a i n kind of housing we re to r ise suddenly. These s t u d i e s arguet h a t the response of t enant s would not n e c e s s a r i l y be immediate. Somehouseholds might move q uic kly to a more preferred uni t Fo r o t h e r s , however,the costs of giving up an old neighbourhood, searching for in f o r m a tio n about newren ta l uni ts or moving migh t be too grea t They would not move immediately butmight choose to move la te r on, ei ther as the dif f icul ty of maintaining the i r

f u r t h e r t h a t households a re not free to e n t e r the subsidized r e n t a l s e c t o rbecause access the re i s controlled b lo c al housin a u t h o r i t ie s . Access to the


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w i l l take th a t in to account in choosing t h e i r housing now. Second, i t i s a r guedt h a t moves of r e n t e r s i nt o owner-occupied u n i t s a re r e l a t e d to the a v a i l a b i l i t yof c r e d i t th e t ra n sa c ti on s c os ts of moving, an d the consumer s expectedd u r a t i o n of residency. When such a household moves an d what kind or s i z e ofdwelling i t occupies are conditioned by t h e s e f act or s as well as by p r e f e r e n c e s ,p r i c e s , an d income. ut also d i s c u s s e s how the depreciation of housing overtime w i l l lead a r a t i o n a l consumer to i n i t i a l l y overconsume housing. Inl1uth s view, l oo kin g o nly a t movers tends to over st at e th e demand f o r housingan d i t s s e n s i t i v i t y to income because of t h i s . These t h r e e a n a l y s t s concludet h a t i t i s not apparent a p r i o r i whether r e c e n t movers are any c l o s e r to t h e i rc u r r e n t equilibrium demand than are nonmovers. Straszheim 1975: p 8) concludest h a t w hi l e mover an d nonmover cr oss- sect i on samples lead to d i f f e r e n t r e s u l t si t i s not c l e a r t hat a sample based only on recent moves provides morein fo rm atio n o r i s th e preferred s p e c i f i c a t io n .

2. 3. 4 SHOKT AND LONG RUN OEM N ELASTICITIES N DISEQUILIBRIUMInherent in the notion of disequilibrium i s a p e r i o d of adjustme n t . The

period of adjustment i s the time re qu ire d fo r a housing market to r e tu rn to ane q u i l i b r i u m a f t e r being d i s e q u i l i b r a t e d . I t i s commonly argued t h a t housingmarkets a re slow to e q u i l i b r a t e although there i s only scant y e m p i r i c a l evidenceon t h i s . The following exemplifies t h i s .

Hanushek an d Quigley 1980) c o n s t r u c t a p a r t i a l adjustment model of housingdemand t h a t d i s t i n g u i s h e s between a d e s i r e d housing consumption l e v e l an d ana c t u a l l e v e l . The d e s i r e d l e v e l i s supposed to r e f l e c t t he p re fe re nc es of theconsumer as well as income c o n s t r a i n t s ; i t i s the l e v e l of housing consumptiontoward which a consumer with those preferences and income w i l l tend r e g a r d l e s sof c u r r e n t consumption. Hanushek an d Quigley 1980: p 451) find t h a t among lo wincome r e n t e r s i n c l u d i n g movers an d nonmovers) i n P i t t s b u rgh an d Phoenix, only20 to 35 of th e ga p between d e s i r e d an d a c t u a l consumption is closed in on ey e a r . Friedman a nd W ei nb er g 1981: pp 322-3 26 ta ke except i on to Hanushek andQ ui gl ey s a n a l y s i s . They argue t hat th e way i n which Hanushek an d Quigleymeasure the d e s i r e d housing consumption l e v e l does not take i nt o accounti n d i v i d u a l v a r i a t i o n s . The gap thus appears to close more slowly than i t does.Using s im ila r d ata , but r e s t r i c t i ng themselves to movers and allowing crudely

period of adjustment i s the time re qu ire d fo r a housing market to r e t u r n to an


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fo r i nd iv id ua l v a r i a t i o n s in d e s i r e d housing consumption l e v e l s , Friedman an dWeinberg f i n d t h a t 1 of th e ga p is closed each y e a r .

I f the housing m arket does not immediately a d j u s t back to e q u i l i b r i u m , themeasured demand e las t i c i ty depends on th e time span over which the measurementis made. Suppose fo r example t h a t i ) a consumer s income e la st i ci ty is 0 .8 i i ) th e consumer c l o s e s 25 of the ga p i n on e y e a r , i i i ) the consumer is

in i t i a l ly in e q u i l i b r i u m , an d i v ) the consumer s income suddenly r ises to al e v e l 2 higher than b e f o r e . The des i red consumption l e v e l thus r i ses by0 . 8 x 2 = 16 . The a c t u a l consumption le v e l in each year i s as follow s standardized to equal 1.00 a t i n i t i a l e q u i l i b r i u m ) .

Years Elapsed 0 1 2 3 4 5 6Actual Consumption 1.00 1.04 1.07 1.09 1.11 1.12 1.13 1. 16

In this c a s e , the consumer is only about 3/4 of the way to i t s d e s i r e dconsumption le v e l f iv e yea r s l a te r . If we were measuring the income elast ic i tyof demand by using observed changes in housing consumption over a f i v e - y e a r timep e r i o d , We would thus miss 1/4 of the i n co m e- in d uc e d c h a ng e . I f only a two-yearperiod ha d been used, l e s s than o n e - h a l f of th e change would be d e t e c t e d .

The a bo ve e xa mp le is merely intended to be i l lus t ra t ive . The r at e ofadjustment may be hi gher o r lower than the 0.25 value used h e r e . The importantp o i n t here i s that , un le ss th e market a d j u s t s very qu ickly to a given change,measured sens i t iv i t i e s w i l l depend on the time span over which the measurementsa r e t aken.

2. 4 ABILITY TO AFFORD N WILLINGNESS TO PAYHow much might a gi v e n household be w i l l i n g or able to pa y to r e n t a

p a r t i c u l a r dwelling? In a s e n se , th er e are two dis t inc t questions h e r e . Howmuch a household is able to pa y is a normative q u e s t i o n ; how much a householdis w i l l i n g to pay is behavioural. In a s s e s s i n g the p r i c e sens i t iv i ty of r e n t a lhousing demand we are presumably more in te re st ed i n the behavi oural q u e s t i o n .However, answering th e normative quest i on under cer ta in assumptions ca n give anupper l i m i t on an answer to the behavioural q u e s t i o n .

There are two dis t inc t e m p i r i c a l approaches to th e question of what a

p e r i o d , We would thus miss 1/4 of the income-induced change. I f only a two-year


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household can af f or d to pa y fo r housing. One is a minimum budget approach.In t a b a s i c bundle of n ec es sitie s e .g . food. c l o t h i n g . health c a r e )excluding housing is costed taking in to account th e household s sizecomposition. an d geographic l o c a t i o n . The d i f f e r e n c e between th e household sincome an d i t s costed b a s i c bundle is i t s abi l i ty to af f or d housing. 8Inherent in th is approach a re value j ud ge me nt s a bo ut ne cess i t ie s versus n o n - n e c e s s i t i e s an d about the minimum l e v e l of well-being t h a t everyone insoci et y should be ab le to at ta in

The second approach uses r e n t - t o - i n c o m e ra t ios Commonly. spending up to5 of a househol d s income on r e n t is thought to be affordable although o t h e rthreshold percentages have al so b ee n e mp lo ye d. 9 U su ally. th e same thresholdpercentage i s used fo r a l l h ou se ho ld s e ve n though th e minimum budget approachmight suggest different t h r e s h o l d s depending on th e h ou se ho ld s character is t icsThe choice of t h r e s h o l d is arbitrary an d presumably ref lec ts a value judgementabout the expenditure on housing t h a t i s reasonable fo r a household re la t ive toi t s income.

What a household is Willing to pa y fo r a given u n i t of housing i s anot herquestion a l t o g e t h e r . In p r i n c i p l e . the household would p r e f e r to spend asl i t t l e as p os sib le fo r an y given r e n t a l uni t Given i t s income and a p a r t i c u l a rconfiguration of r e n t s fo r d if fe re n t un it s the household may be wi l l i ng to pa ymore. However. there i s presumably a r e n t beyond which th e household wouldpr ef er some o th er d w el li ng . This r en t r ep re se nts the househol d s w illingness topay. I t is determined p a r t l y by th e q u a l i t y of th e d we llin g uni t i ts designa t t r ibu tes an d i t s l o c a t i o n ; p a r t l y by th e househol d s i ncome and preferences;

an d p a r t l y by th e avai labi l i ty an d spat ia l c o n f i g u r a t i o n of a l t e r n a t i v edwellings

2.5 SOURCES OF DATAWhat kinds of data are needed or avai l abl e fo r the estim ation of a consumer

demand function? The form ul at i on of a demand function is discussed in de ta i l inSection 3. To summarize here. th e demand function should show how th e quantitydemanded i s r e l a t e d to the price being asked. I t should also show how theconsumer s income and housing preferences an d the pr i ces of o t h e r goods alsoaffect th e demand f o r housing. Typically. a demand function is never e x a c t l y

question a l t o g e t h e r . In p r i n c i p l e . the household would p r e f e r to spend as


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o b se r v e d . What we do observe a r e th e housing c h o ic es o f consumers thei rincomes household compos i t i on s an d housing expendi t ur es. Can a demandf unct i on be derived from th ese data?

Most analysts would answer a f f i r m a t i v e l y provided t h a t the housing marketis in equi l i br i um as d e s c r ib e d in Section 2 .3 above. If th e housing market isnot in equi l i br i um then a consumer i s occupying on e u n i t a t a cer ta in goingpr i ce whereas he o r she would p re fe r to occupy some o t h e r u n i t at i t s goingprice The housing choices of such consumers would n o t t h e r e f o r e r e p r e s e n tpoi nt s on thei r demand c u r v e s .

The t y p i c a l source of dat a fo r a housing demand study i s a set o f householdinterview s. Questions are asked o f each household of t en in reg ard to i t sdemographic c o m p o si t i o n income e x p e n d i t u r e s l o c a t i o n an d te n u r e an d o t h e rcharacter i s t ics o f th e d w e lling o c c u p i e d . Most o f th e s e surveys are s t r ic t lycr oss sec t iona l c ov eri ng o nly some c u r r e n t p e r i o d . Others a re cr oss s e c t i o n a lbut include q u e s tio n s about th e previous h i s t o r y of the household or about i t sn e a r - f u t u r e p l a n s . St i l l ot her s are l o n g i t u d i n a l surveys which followh ou se ho ld s o ve r a number of years r ei nt er vi ew i ng them from time to time tomeasure how thei r condi t i ons have been changing.

These t y p i c a l dat a sources are however of t en i n a d e q u a t e in a t leas t t hr eemajor r e s p e c t s . As d is c u s s e d in Section 2.2 above a study of housing demandmust look a t more than j u s t exis t ing h o u se h o l d s. I t must also examine th ep r o p e n s ity fo r new households to form an d th e r e l a t i o n s h i p s between householdformation an d p r i c e s an d incomes. This n e c e s s i t a t e s dat a f or i nd iv id u al s whomight form households as w e ll as fo r e x i s t i n g households. D a ta s e ts whichcont ai n both i n d i v i d u a l an d household information a re uncommon

The second inadequacy is t h a t d a ta ar e almost never c o l l e c t e d on thehousing a l te rna t ives t h a t were not chosen by a consumer. O rdinarily onlyinformation about th e c u rr en t r es id en c e i e the chosen al ternat ive isrecorded. To be fa i r i t is no t l ike ly that households would be a b le to recal la c c u r a t e l y what th e c o s t s an d th e at t r ibu tes were of th e o t h e r al ternat ivesHowever th e consumer s demand for a par t icu la r dwelling wil l depend on thep r i c e s of th e al ternat ives In prac t ice housing a n a l y s t s ei ther igno re thep r i c e s o f alternatives a l t o g e t h e r o r e l s e assume t h a t th e s e prices can besomehow e s tim a te d from the ch oice d ata fo r o th e r h ou se ho lds. N eith e r approachmay be very sat i s factoryh ou se ho ld s o ve r a number of years r ei nt er vi ew i ng them from time to time tomeasure how thei r condi t i ons have been changing.


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The t h i r d inadequacy i s t hat most of these a re cross s e c t i o n a l , not panelst udy d a t a . In a cross s e c t i o n a l s t u d y , th e household is interviewed on l y once.In a housing demand s t u d y , the househol d s choice of dw elling is then comparedwith th e choices of peers facing d i f f e r e n t p r i c e s o r having d i f f e r e n t income s .The assumption made i s t hat i f th e household ha d the same income o r faced thesame prices as i t s peers then i t s choice would a l s o be s i m i l a r . However, t h i sassumes t h a t we can i d e n t i f y a househol d s p e e r s . In a panel s t u d y , the samehousehold i s reinterviewed on s e v e r a l occasions. Changes in th e h ou se ho ld sincome, changes in the housing p r i c e s facin g it an d change s in the household scomposition an d housing preferences ca n also be measured. These can then ber e l a t e d to an y a c t u a l change in housing consumption. This i s s t r o n g e r . With apanel s t u d y , we ca n say, f o r example, t hat a c on su me r c ha ng ed dwelling inconjunction with a change in income. With a cross sect i onal st ud y, we ca nm er el y c on cl ud e t h a t , i f Smith s income r i s e s to the l e v e l of J o n e s , i t i sreasonable to expect t h a t Smith w il l l iv e in a s i m i l a r dwelling because Smithan d Jones a re o th er wis e s i m i l a r i . e . p e e r s ) . U nfort unat el y, th e re are very fewpanel s tu d ie s a v ai la b le of use to hous ing demand r e s e a r c h .

Let us now review some of the p r i n c i p a l d a t a sources for housing demands tu d i es in Canada an d the United S t a t e s . Some American d a t a sources a re muchb e t t e r than a nything c u rr en tl y a v ai la b le in Canada an d the purpose in reviewingthem i s to i l l u s t r a t e how Canadian d a t a might be impr oved.

2.5.1 D T SOURCES IN C N DIn Canada, only t h r e e d a t a s e t s have been w idely us ed t o d a t e . These are

S t a t i s t i c s Canada s Census Public Use Sample PUS) f i l e s c ur re n tl y a v ai la b lef o r 1971 an d 1976), S t a t i s t i c s Canada s Househo ld F a c i l i t i e s , In come , an dEquipment HIFE) f i l e s c u r re n tl y a v ai la b le every o t h e r year from 1972 to 1980 ) ,and CMHC s Survey of Housing Units SHU) f i l e conducted in 1974). A ll a recross s e c t i o n a l samples.

The HIFE f i l e s are samples of households drawn from across Canada. From1972 to 1976, t h e r e are about 15,000 households per survey in the f i l e . In 1978and 1980, there a re about 30,000. The d a t a c o l l e c t e d f o r e ac h h ou se ho ld v a r i e ss l i g h t l y from on e year to th e n e x t , but i nc lu d e i nf o rm a ti on on a household sdemographic composition, income, an d except in 1978) rent paid i f an y ) . Early

Let us now review some of the p r i n c i p a l d a t a sources for housing demand_ . . . . ,... ..J _ I T_ _ l ... _ ... _ .. .. . C A . l ..... . . _ l-


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~ I F f i les also d e t a i l e d th e e xp ec te d se l l ing price an d presence of mortgage fo rowner-occupiers but such d ata a re no l onger included in the f i l e .

The ~ I F f i les cont ai n no information about past changes or expected futurechanges i n the household or i t s composition. They also cont ai n vir tual ly noinformation about i nd iv id u al s o th er than th e head of a household or spouse i fany)

The PUS f i les are produced in t hr ee v er si on s: i n d i v i d u a l , f am i l y, an dhousehold. Each i s a 1 in 1 sample fo r n in e p ro vi nc es Prince Edward I sl andan d the two northern te r r i tor ies are not r epr esent ed in these samples). The PUShousehold f i les are somewhat l a r g e r than HIFE In 1976, they included about 71thousand households. The PUS household f i les an d th e HIFE f i les include s e v e r a lv a r i a b l e s t h a t are iden t ical ly or s i m i l a r l y defined an d th is makes i t possibleto do some em pi r i cal c om p ar is on s b et we en them. The PUS f i l es , h ow ev er , h av e twos u b s t a n t i a l a dv an ta ge s o ve r ~ I F Fi rs t , i t is possible to look a t the l i v i n garrangements of i n d i v i d u a l s and f a m i l i e s , regardless of whether they aremaintaining a household or n o t . Thus, i t is possible to c o n tra st the incomes,fo r example, of persons who l iv e i n c e r t a i n kinds of households with the incomesof those who choose other al ternat ives . Second, the 1971 PUS does includeinformation about the duration of r esi dence and previous tenure. This i svaluable in the cont ext of the discussion on movers versus nonmovers an ddisequilibrium see Section 2 . 3 ) . Unfortunately, there are no other deta i ls ofthe househol d s p re vi ou s c om p os it io n, income, or housing choi ces. The 1976 PUSf i le does not cont ai n an y information of t h i s t ype.

C an ad a M or tg ag e an d ~ o u s i n g Corporation s 1974 Survey of Housing Units isperhaps th e most d e t a i l e d study of households and the i r housing i n Canada. I ti s a sample of about 63 thousand households. I t is drawn from only the 23l a r g e s t urban centres in Canada. Not being a n a tio n a l sample re s t r i c t s i t scomparability with PUS and ~ I F f i l es . with ~ I F SHU is a sample ofhouseholds only. However, the SHU f i l e i ncl udes d e t a i l e d information on thedemographic an d income character i s t ics of every i n d i v i d u a l in a sampledhousehold. This perm its the construction of an i n d i v i d u a l f i l e fo r SHU t h a tcan be used to examine housing demand a r i s i n g from household form ation . Ina d d i t i o n , the SHU f i le is unique i n t h a t i t cont ai ns very d e t a i l e d informationon the p re vi ou s d w el li ng an d household for r ecent movers. S ~ U providesinformation on th e pr ev iou s dw el l i ng, the com position of the household l i v i n g

JI .> .J . . U . t ~ - t -- A _ - ...

of those who choose other al ternat ives . Second, th e 1971 PUS does include


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t h e r e , an d s el ec te d f in a nc ia l aspects such as r ent and mortgage payments.

2.5.2 DATA SOURCES IN THE UNITED STATESMuch of th e U.S. research on housing demand has r e l i e d on cross s e c t i o n a l

d a t a . In h is pioneering work, David 1962) used the Survey of ConsumerFinances. De Leeuw an d Struyk 1975) and Struyk 1976) r e l i e d on the 197Census Public Use Sample. Straszheim 1973 and 1975), Kain and Quigley 1975),Quigley 1976) used cross s e c t i o n a l samples from San Francisco, S ain t L ouis, an dPi t t sbur gh re sp ec tiv ely . F olla in 1979 an d 1982) used the Annual Housing Surveyf o r 1975. Hossons 1978) employed the Federal Reserve Board s Survey ofFi nanci al C h a r a c t e r i s t i c s o f Consumers from 1963. In ad d itio n , s e v e r a l s t u d i e swere based on mortgage a p p l i c a t i o n data Maisel e t a l 1971), Smith andCampbell 1978), Polinsky and Ellwo od 1979), and Rosen 1979b) w hic h w er ec r o s s s e c t i o n a l , although nonrandom, samples. In addi t i on to being crosss e c t i o n a l , the basi c o b se rv at io n al u n it appears to be th e h ou se ho ld . 1 Thus,these dat a sources preclude an anal ysi s of th e responsiveness of householdformation to changes in income or pr i ces as discussed above in Section 2.2.

The most widely-applied panel dat aset in U.S. housing demand s t u d i e s is theP a n e l Study of Income Dynamics PSID) by th e Survey Research Center of theU niversity of Michigan. This i s a unique study which has fo llo wed a sample off am il ie s s in ce 1968. I t is possi bl e in this stu dy to examine how income an df am il y c om po si ti on changes over th e years have been associ at ed with changes i ndwelling charac ter i s t ics Among th e users of the PSID have been Car l i ner 1973), Lee an d Kong 1977), Roistacher 1977), Lee an d Trost 1978), Rosen 1979a), I h l a n f e l d t 1980 an d 1981), Boehm 1981), and Boehm and McKenzie 1982).

A sm aller group of st udi es have employed reinterview data from th e HousingAllowance Demand Experiment HADE conducted by th e U.S. Department of Housingan d Urban Development in Pi t t sbur gh and Phoenix. Under HADE, a s o c i a lexperiment was conducted in which a sample of low income households was dividedi n t o two groups. One group received direc t housing subsi di es of from 2 to 6percent of the i r r e n t payments for a period of tim e; th e ot her group receivedno subsidy. Households were r ei n te r vi ew e d a n n ua l ly . The HADE data provide are la t ive ly unique source of information on housing demand at l e a s t on lo w


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income households. These data have been used by Hanushek an d Quigley 1979 an d1980), Friedman an d Weinberg 1981), Mayo 1981), and Cronin 1982).F i n a l l y , Lee 1 968) used reinterview dat a from the Survey of ConsumerFinances from 1960 to 1962 i n a housing demand st udy. This appears to have beenthe only use of the Survey of Consumer Finances on a l o n g i t u d i n a l b a s i s .

These t hr ee panel d a t a s e t s are unlike anything a v a ila b le fo r Canada. Theygive a n a ly sts th e abi l i ty to examine changes in dwelling character i s t icsassociated with changes i n household character is t ics incomes, an d p ric e s for agiven household. Because Canadian s t u d i e s must r e l y on cr oss s e c t i o n a l d a t a , i s no t possible to st udy such l in k a g e s. We have to assume, perhaps incorrect lyt h a t i f a househol ds s character i s t ics or income changes, i t w i l l change i t sdwelling to be l ike those of other households who al r eady have th a t income an dthose character is t ics . There is a need fo r a panel study in Canada to provideth is kind o f valuable d a t a .

2.6 PRICE QU LITY N DEM NDIn t he c on ve nt io na l economic paradigm, a consumer s demand is a function of

p ri c e . P ric e , in th is case, means the d o l l a r value attached to on e u n i t of thecommodity of a c e r t a i n fixed q u a li t y . I f q u a l i t y were permitted to vary fromon e u n i t of the commodity to the n ext, th ere would n o t be a simple r e l a t i o n s h i pbetween demand an d p r i c e . However, th is i s exactly the problem in housingdemand. Quality does vary among u n its of housing. Comparing th e r e n t s of twou n i t s of d i f f e r e n t q u a l i t y l e v e l s is meaningless in the absence of q u a l i t yi nf or m at i on.

Suppose a d i s c r e t e c ho ic e a pp ro ac h as di scussed in Section 2 . 1 . 3 above) i sbeing used. Suppose fo r the moment th a t the consumer is an already e x i s t i n ghousehold considering moving i nt o a rented detached house choice a) or a rentedapartment choice b ). Other things being equal, the household w i l l base i t schoice on the ren ts b ei ng a sk ed , r a an d r b, and th e q u a l i t y l evelsQa and Qb of the two choices r e s p e c t i v e l y . E ither choice gener at es aut i l i ty l e v e l fo r th e consumer. In both choi ces, there i s the ut i l i ty a r i s i n gfrom c on su mp ti on o f housing of th at q ua lity an d ut i l i ty which a r i s e s fromspending th e remaining income on nonhousi ng c om modit ie s . A rat ional householdchooses th e d wel lin g associated with the hi gher ut i l i ty l evel . I f choice a has

In t he c on ve nt io na l economic paradigm, a consumer s demand is a function of


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choices s t r i c t ly ref lects q u a li ty d i ff e re n c es . To have no di f feren t ia l ss e v e r a l c onditions would have to be met. For one, th e b uild in g i ndust ry wouldhave to be p e r f e c t l y competitive in a l l m ar ke ts ; e ve ry bui l der would be a ble topurchase inputs a t exact l y the same p r i c e s . There would have to be a f ixe dbuilding technology, u n i v e r s a l l y known, with c ons ta nt ret urns to s c a l e .F i n a l l y , the building i ndust ry would have to be i n long-run competitiveequi l i bri um . Muth 1971: pp 244-245) descri bes such a s c e n a r i o ; in i t thepri ce of housing i s dr ive n to th e minimum cost of pr oduc tion. With no excessprofi ts i n b uil di ng , p ric e d i f f e r e n c e s among dwellings ref lec t only thed i f f e r e n c e s i n the housing s e r v i c e s provided by each. 2

In th is t reat m ent , r e n t di f feren t ia l s s t i l l ar ise bec ause o f 10cationa1c o n s i d e r a t i o n s . Advantageous s i tes earn an e x t r a rent even in long runcompetitive equi l i bri um . However, in a competitive equi l i bri um , the s e10cationa1 r e n t di f feren t ia l s ge ne r a te a spat ia l equi l i bri um : the consumer beingi n d i f f e r e n t between a higher r e n t fo r a more accessi bl e si te an d a lower r e n t a ta less accessi bl e s i t e . ca n think of these rent di f feren t ia l s as th e p r i ceof access ib i l i ty in this s e ns e ; access ib i l i ty is jus t another at t r ibu te ofhousing q u a l i t y .

The obj ect i ve here i s not to a rg ue w he th er or not the re are pri ced i f f e r e n c e s , but r a t h e r to suggest how pri ce d i f f e r e n c e s might emerge in thereal world. The above discussion of a uniform pri ce world helps to clarifyth is . I f input p r i c e s th e c o sts of bui l di ng m a t e r i a l s , capital l abour, e t c )were not the same everywhere, i f b u i ld i n g t ec h no l og i es d i f f e r e d , i f zoning orbuilding bylaws d i f f e r e d , or i f th e market were not in long-run equi l i bri um ,then pri ce di f feren t ia l s could exis t . Also, i f on e did not accept the notion ofaccess ib i l i ty as an at tr ibute of housing q u a l i t y , r e n t di f feren t ia l s associ at edwith accessibil i ty would imply corresponding pri ce di f feren t ia l s .

should also remind ourselves here that when looking a t te nu re c ho ic e,the p r ice of owner-occupied housing wil l also depend on th e consumer s i n i t i a le q u i t y , the mortgage r a t e maintenance an d pr ope r ty ta x e xp en se s, e xp ec te dcapi ta l l o s s or gai n, an d th e c on su me r s m a rg in al personal income tax ra te .

l l U U t i l l ~ qua . J . l .Ly .The obj ect i ve here i s not to a rg ue w he th er or not the re are pri ce

d i f f e r e n c e s , but r a t h e r to suggest how p ri ce d if fe re nc es might emerge in the


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2.6.2 O ROLE FOR P R I ~ OR QU LITY V RI TIONSSeveral housing demand s t u d i e s ignore price dif ferent ia ls a l t o g e t h e r . This

has been e s p e c i a l l y t r ue in d i s c r e t e choice models of t e n u r e . Struyk 1976),Lee an d Kong 1977), Li 1977), Roistacher 1977), Bossons 1978), Smith andCampbell 1978), Steele 1979: pp 123-169), and I h l a n f e l d t 1980) are of th iskind. They assume t h a t t e n u r e choice i s a function of t he h ou se ho ld sc h ar ac te ri st ic s e .g . l i fe cycle character is t ics income, asse ts and households i z e ) but not of the c o s t s of owning versus r e n t i n g .

Prices are also o fte n ignored in t he e xp en di tu re s approach to housingdemand. Lee 1968), Lowry e t a l 1971: pp 228-237), Byatt e t al 1973). an dSteele 1979: pp 171-198) regress housing expenditures a g a i n s t s e t s of var i abl est h a t do n ot in clu de price terms. De Leeuw 1971). Maisel e t a l 1971). Car l i ner 1973). de Leeuw and S tru yk 1 97 5). Lee and T ros t 1978). Rosen 1 97 9b ). S te ve ns 1979). and I h l a n f e l d t 1981) a l l use pr i ce discounting as d e s c r i b e d i n Section2.1.2) to convert housing expenditures in to a qual i t y measure. H ow eve r. no ne ofthese st udi es includes a pr i ce term on the r i g h t hand side of the demandfunction to show th e sensi t iv i ty of demand fo r qual i t y to p r i c e .

2. 6. 3 ST N R IZING FOR QU LITY I F F E R E N ~ SOther st udi es do not include a price term but do dif ferent ia te among

housing u n i t s based on qual i t y levels Two approaches have been employed.One is to use dummy var i abl es to r ep re se nt q u ality on the r i g h t hand side

of a demand function. T his ap pr oa ch is pursued by Kain an d Q ui gl ey 1 97 5: pp154-189) and Hanushek and Quigley 1979). They use housing expenditures as th edependent var i abl e without any p r i c e d i s c o u n t i n g ) but include dummy var i abl esfo r the p res en ce o f such item s as landlord-supplied f u r n i t u r e . h e a t . a p p l i a n c e s .o r w ater. Presumably. the p re sence o f these items r a i s e s the r e n t s t h a t tenantsa re w i l l i n g to pay.

Another approach was employed by W ilkinson. In a study o f o w ne r- oc cu p ie rhousing demand. he used house value per room an d house value per u n it f l o o r areaas the dependent v a r i a b l e s . A si m i l ar approach is p o s s i b l e fo r r e n t e r s .Wilkinson claims t h a t t h i s crudely adj ust s expenditure fo r q u a l i t y . I t isuncl ear . however, in the subsequent anal ysi s whether value divided by dwellings i z e i s a measure of qual i t y b e t t e r qual i t y dwellings have a higher pr i ce per

r u n c ~ o n O snow Lne s e n S ~ V Y or aemana ro r qual1ty to pr1ce.


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room) o r p r i c e v a ri a ti o n i n p r i c e per room gre a t e r than could be expected fromq u al it y v a ri at io n a l o n e ) .

A problem with both approaches is t h a t they do not perm it an assessment o fth e impact of p r i c e change on demand. I t i s p o s s i b l e to c a l c u l a t e th e r e n tincrement associated w i t h , sa y, the provision of heat i n a dwelling or an ext r aroom. I t is not p o s s i b l e , however, to ca l c u l a t e how s e n s i t i v e the demand fo rhousing would be to an i n c r e a s e i n the p r i c e of heated or l a r g e r dw e lling uni t s .

2.6.4 L T ~ ~ T I V METHO S OF OMPUTING PRI EA no th er g ro up of s t u d i e s i ncl ude p r i c e terms as independent v aria b le s in

housing demand models. Seven di f feren t methods can be di scerned from th el i t e ra tu re , e ac h e mp ha si zi ng different sou rces of p r i c e v a r i a t i o n as di scussedin Section 2 .6 .1 .

i Metro-wide Price I n d i c e s . Se ve r a l r e s e a r c h e r s hav e worked with an a t i o n a l sample o f h ou se ho ld s drawn from s e v e r a l l a r g e c i t ies . 14 Fo r ea chc i ty , on e ca n g et r e n t e r an d owner-occupier shel ter p r i c e c o m p o n e ~ t s from theconsumer p r i c e i ndex. 15 A ll households in the s ame ci ty a r e i m p l i c i t l yassumed to face th e same p r ic e s f o r r e n tin g or owning. The only v a r i a t i o n s inp ric es a re assumed to be from on e ci ty to the n e x t . Presumably, p r i c ev a r i a t i o n s are seen to exis t only because of in ter -c i ty v a r i a t i o n s i n b u i l d i n gm a t e r i a l c o s t s , b u i l d i ng t e c h n o l o g i e s , or zoni ng/ bui l di ng bylaws. Polinsky 1977) shows t h a t demand models with metro-wide p ri ce i nd ic es tend to o v e r s t a t eth e effects of income an d p r i c e changes on housing demand b ec au se t he y a rem i s - s p e c i f i e d .

i i Hedonic P ric e I nd ic es . In Se ct i o n 2.1.2, the hedonic p r i c ed i s c o u n t i n g method o f de Leeuw an d Struyk 1975) i s d e s c r i b e d . De Leeuw an dStruyk used t h i s approach to convert r e n t a l expendi t ures i n t o a measure ofhousing demand. Fol1ain 1979 an d 1982 uses a s i m i l a r procedure to c o n s t r u c t ap r i c e variable to i ncl ude in a demand f u n c t i o n . Unlike the metro-wide p r i c ei n d i c e s , is p os s ib le to have a different p ric e fo r every household in thes am ple , even amon g households r e s i d i ng in the same c i ty . In Fo11a in sprocedure, a h ou se ho ld h as paid a hi gher p r i c e i f what i t has paid exceeds whato t h e r households i n th e m et ropol i t an a r ea have paid fo r housing with s i m i l a r

c i ty , one can g et r e n t e r an d owner-occupier shel ter pr ic e c o m p o n e ~ t s from the_ _ _ _ : .:_....1 __ A ...... . .. ....\.... 1 J .. .l _ __ _ _ ... ....._ .... ..: _ _ 1. : _ .:


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c h a r a c t e r i st i c s. 16 Such pr i ce v ariatio n s presumably r e f l e c t disequilibriumin th e market. These v a r i a t i o n s may al so r e f l e c t l ocal i zed i . e . i n t r a - c i t y )d i f f e r e n c e s in building c o s t s or zoning/building bylaws.

i i i ) Tax D i f f e r e n t i a l s . As noted e a r l i e r , the p rice f o r housing dependsi n p a r t on i t s tax t r e a t m e n t . Two approaches to handling ta x d i f f e r e n t i a l s havebeen c o n s i d e r e d . One approach d i s t i n g u i s h e s between th e pretax PT ) p r i c e an dth e a f t e r t a x AT p r i c e of housing. Rosen 1979a) notes t h a t , under c e r t a i nassumptions, AT = 1-rs)PT f o r owner-occupier housing in th e U.S. where i sth e consumer s budget share fo r housing a n d s i s the consumer s marginal ta xr a t e . 17 Rosen 1979a and 1979b), King 1980), an d Boehm 1981) a l l use t h i stransform ation from PT to AT. The s ec on d a pp ro a ch i s exemplified by Boehm an dMcKenzie 1982). They introduce PT and the consumer s marginal t ax r a t e as twos e p a r a t e independent var i abl es in a housing demand model.

i v ) Subsidy D i f f e r e n t i a l s . The Housing A ll ow an ce a nd Demand ExperimentHADE , described i n Section 2. 5. 2 above, of f er s another way of c a l c u l a t i n g apr i ce fo r each consumer. As outlined in Cronin 1982: pp 98-99), HADE of f er eds ub sid ie s to low income r e n t e r households according to e i t h e r a housing gap o rpercentage of r e n t formula. In e i t h e r case, i t i s possi bl e to think of thesubsidy as reducing the e f f e c t i v e price o f housing, in a manner not unlike thed i s t i n c t i o n between pretax an d a f t e r t a x pr i ces in i i i ) above. Friedman an dWeinberg 1981) and C ro nin 19 82 ) invent a technique fo r estim ating th es e n s i t i v i t y of demand to th e s i z e of th e subsidy an d hence to p r i c e . Theyi gnor e, however, an y other sources of p r i c e v a r i a t i o n .

v) Use of Assessment R atios. King 1980), in a s t u d y of th e U.K. housingmarket, used data on th e gr oss r a t e a b l e val ue GRV of a d w e l l i n g . The GRV i san a ss es sm en t o f i t s r e n t a l v alu e p ro vi de d by an o f f i c i a l a s s e s s o r . KingaSSumes t h a t th e GRV i s a measure of th e l e v e l of housing ser vi ces provided q u a l i t y , as used i n t h i s p a p e r ) . If the building i s c u r r e n t l y being rented fo ran amount A summing over a l l t e n a n t s ) , King c a l c u l a t e s th e price of housing asP = A/GRV. If P>1 , the tenants are paying more than the assessor expected an di f P


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clear . Is the a s s e s s o r taking in to account lo ca l v aria tio ns in building c o s t s ,building technology, zoni ng/ bui l di ng bylaws, or l o c a t i o n in computing t hese RVI f an y of these are being considered by the a s s e s s o r , then the RV w i l l inc ludep a r t of the v ar ia ti on t ha t should be in P.

v i) Cost Function Approach. In Se c tion 2 . 1 . 2 , the c o s t funct i ond i s c o u n t i n g approach of Polinsky an d Ellwood 1977) is di scussed. By assumingcompetitive markets i n long ru n e q u i l i b r i u m , they a re able t o come up with ap r i c e index for each propert y. For each p r o p e r t y , on e must know the c o s t perm2 of l a n d , the c o s t p er m2 of c o n s t r u c t i n g res iden t ia l f l o o r s p a c e ,an d the form of the housing production f u n c t i o n . Polinsky and Ellwood assumethe same production function fo r every u n i t of housing. Therefore, the i r p r i c eindex v a r i e s from on e dwelling to the next only as land c o s t s an d floorspacec o s t s vary. However, some of thei r p r ic e v a ri at io n would, in fac t , be q u a l i t yv a r i a t i o n as we use the term. Fo r example, some land p r i c e v a r i a t i o n ref lec tsl o c a t i o n an d some of the fl oorspace c o ns tr uc ti on c os ts ref lec t v a r i a t i o n s in theq u a l i t y of c o n s t r u c t i o n . There i s , f u r t h e r , no allowance in th i s approach fo rp r i c e v a r i a t i o n s a r i s i n g from d i s e q u i l i b r i u m .

vi i ) S p a t i a l Pri ce Approach. The above approaches do not t rea ts l o c a t i o nexpl ic i t ly as a q u a l i t y a t t r ibu te , nor do they c o n t r o l fo r i t in e s t i m a t i n gp r i c e . Straszheim 1973 and 1975) and Quigley 1976) have proposed approachesto th i s . Straszheim notes that , i n a spat ia l e q u i l i b r i u m , housing c o s t s varywith l o c a t i o n because of dif ferent ia l cost s of commuting or o t h e r forms of t r ipmaking). Therefore, a consumer chooses a dwelling by t r a d i n g o ff commutingc os ts a ga in st d i f f e r e n t kinds of housing c o s t s , r a t h e r than s im pl y h ou si ng cost sal one. Straszheim co ntro ls fo r location by c a lc u la t in g s ta n d ar d iz e d p r i c e s .A st andardi zed p r i c e is the p r i c e of a housing u n i t with s p e c i f i e dcharacterist ics and a p a r t i c u l a r l o c a t i o n with res p ec t to th e consumer sworkplace. 18 S tr as zh ei m u se s t he se s ta nd a rd iz ed p r i c e s in h is demandf u n c t i o n s ; i n ot her words, he does not use the p r i c e s the consumer a c t u a l l y paysbecause of the effect of l o c a t i o n . Quigley 1976) uses a g r o s s p r i c eapproach. He sums the housing cost an d the commuting c o s t of a g iv en d we ll in gto g e t a gr os s p r i c e . Quigley argues t h a t a consumer makes two choi ces: type ofdwelling an d l o c a t i o n . He bel i eves that the consumer w i l l tend to choose ad wellin g o f a c e r t a i n type i f i t has the minimum gro s s p r i c e of a l l dw e llings of


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that type. F u r t h e r , the consumer w i l l tra d e o ff among d i f f e r e n t dwelling typesby comparing th e features of each dwelling type against i t s minimum gross p r i c e .T hu s, Q uig le y uses the minimum gross prices fo r each dwelling type in thehousing demand equation r a t h e r than th e a c t u a l p ric e s the consumer pays. Inb ot h a pp ro ac he s, two d i f f e r e n t consumers may well face d i f f e r e n t p r i c e s fo r thesame dwelling depending on t h e i r commuting costs from th e d we ll in g. These twoapproaches at t empt to c o n tro l fo r th e impact of l o c a t i o n on p r i c e . However,th e s e approaches n e g le c t th e o th e r f a c t o r s t h a t a ls o create q u a l i t y v a r i a t i o n .In t h e i r models, such q u al it y v a ri at io n s are mistakenly i n t e r p r e t e d as p r i c ev a r i a t i o n s .

2. IN OME ND DEM NDMuch of th e l i t e r a t u r e has emphasized th e r o l e of income in shaping housing

demand. Income, o r more c o r r e c t l y the a b i l i t y to a f f o r d , i s widely seen as anim po rta nt d ete rm in an t o f demand. Unfortunately, th e re seem to be almost as manyd i f f e r e n t concepts of income as th e re a re housing demand s t u d i e s . In l a r g ep a r t th e s e d i f f e r e n c e s a r i se becaus e of differences in the way t h a t aconsumer s a b i l i t y to a f f o r d i s perceived.

The design of many of the d a t a s e t s used in housing demand re s e a rc hexacerbates t h i s problem. In a t y p i c a l survey , the household i s ask ed about i t sc u r r e n t dwelling an d i t s income in the p re ce di ng y ea r o r ca len dar y e a r. Thus, ahousehold s dwel l i ng choice ends up being linked to an income t h a t may notr e f l e c t i t s c u r r e n t a b i l i t y to a f f o r d . Fo r many households t h i s i s not aproblem, because t h e i r c u rre n t income bears some resemblance to the pr evi ousy e a r s . However, f o r c e r t a i n groups such as th e young, th e unemployed, or ther e c e n t l y - r e t i r e d the measurement problem ca n be s i g n i f i c a n t .

Three d i f f e r e n t classes of income measures have been employed in attemptsto get a good a f f o r d a b i l i t y - t o - a f f o r d measure: those measures based on 1)c u r r e n t income, 2) an augmented c u rre n t income, an d 3) a permanent income.The l a s t of these leads n a t u r a l l y into a d is c u s s io n of th e role of w ealth i nhousing demand.


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2.7.1 INCOME ME SURES SED CURRENT INCOMEPerhaps the most wide ly u sed measure is gross income. Although the

defini t ion does vary somewhat among surveys, gross income typical ly includeswages and sa lar ies self-employment income, net income from investment,gove r nme nt t ransfer payments, private pensions and other benef i t s , andmiscellaneous income. I t typical ly does not include capi ta l gains , t ransferpayments or gif t s from re la t ives or fr iends, nonpecuniary job benefi ts such as acompany car or the imputed in terest on equity in an owner-occupied dwelling.I t also does not consider as income the l iquidat ion of asse ts : e .g . se ll in g aused car to get money to buy something else . In certain circumstances, i t canbe argued that some or a l l of these help to determine abi l i ty- to-afford .

Even i f we agree on the items to be included in an ab i l i ty to affordmeasure, there remains the question of the individuals over whom i t i s measured.Some researchers use gr o s s household income: the sum of the incomes of a l lhousehold members. 19 Others prefer to use the income of 1) the head ofhousehold alone, 2) the head and spouse i f any, 3) the primary nuclear family,or 4) the primary economic family.20 The disagreement here has two bases.Firs t there is a debate as to whether the incomes of secondary individuals thos e out sid e the primary n uclea r, o r economic, family) are taken into accountwhen a household chooses a dwelling. Second, there i s d is ag reemen t a s towhether the incomes of other primary nuclear family members i . e . spouse and/orchildren) should be regarded as t ransi tory or permanent the notion ofpermanent income i s discussed in the next section).21

Final ly, there i s a lack of uniformity in the treatment of taxes. Someanalys ts have used gross income while others have used income net oftaxes . 22 Presumably, net income i s a bet te r measure of abi l i ty to afford.Net income, however, i s not a frequently collected datum in housing demandsurveys. Further, net income is not necessarily a good indica tor of what i sdisposable i f we equate disposable with take home pay. In par t th is i sbecause of the range of o th er p ay ro ll deductions - - pension, medical insurance,union fees, and so on - - which can vary substantia l ly from one worker to thenext. In par t i t is also because of tax schemes l ike RRSP and RHOSP which canreduce taxes at yearend, albei t with a cashflow consideration, leading to anoverestimate of take home during the year.


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2.7.2 INCOME ME SURES SED ON UGMENTED CURRENT INCOMEBecause income as defined above may not be a good indicator of abi l i ty to

afford, a number of analysts have attempted to extend this measure by includingother components.The most frequently cited shortcoming of current income defini t ions i s that

they ignore the imputed income on a home owner s equi ty. The argument iswell-known. If a household were to choose to rent, i t could invest the foregonedownpayment and earn income from i t . By instead choosing to own the householdcan be thought of as a landlord collecting an impu ted rent from i t se l f as thetenant. I t i s incorrect to assume, th er ef or e, t ha t two households, a renter andan owner, with the same measured income have the same abi l i ty to afford.

Several studies have e st imat ed t he imputed income from homeownership. 23 The problem here i s in estimating j us t how large the imputedrent i s . Most studies use of the household s equi ty. However there is nodiscussion of why or any o th er f ig ur e i s appropriate.Few analysts have t r ied to include other income components as well. Lee

and Kong (1977: p 302) define a f u l l income which includes regular moneyincome, imputed rental value of the owner-occupied home equi ty, rental value ofhousing received free of charge, value of free help received, and to ta l amountssaved on car repair s additions and repairs to home meals at work or school,home-produced food, government food stamps, and other free food . However, noaddi t ional deta i ls are provided on the calculat ion of these amounts forindividual households.

2.7.3 INCOME ME SURES SED ON PERM NENT INCOMEArtIe and Vara iya (1978: p 38) present a lucid rat ionale for the use of

permanent income.In Irving Fisher s idea l loan market , a household sconsumable resources are defined by i t s wealth. At any point intim e, the household s wealth i s defined as the sum of i t s nonhumanwealth, net l i ab i l i t i e s and the present value of i t s prospectiveearnings from work. Within the bound o f so lvency se t by thisconcept of wealth, the Fisherian household wil l engage inborrowing and l n i n ~ (saving and dissaving) in order to make i t srate of consumption more nearly uniform over t ime.Modigliani and Brumberg (Util i ty Analysis and the


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Consumption Func tion: An I n t e r p r e t a t i o n of C r os s- H ec ti o n D a ta . InK. Kurihara ed. 19 54 ). P ost-K ey nesian Economics. RutgersU ni versi t y Press e l a b o r a t e d on th is i d e a and formulated what hassince become known as the l i fe cycle theory of saving an dconsumption. A major t e n e t of the i r theory holds t h a t ani n d i v i d u a l s c u r r e n t r a t e of consumption and saving ca n besa t i sfac tor i ly explained, not by the i n d i v i d u a l s c u r r e n t rate ofincome, but by the i n d i v i d u a l s c u r r e n t p o s i t i o n descri bed byag e and p r e s e n t wealth in the l i fe c y c l e . In par t icular , th er o l e of savi ngs is to s e r v e as a cushion a g a i n s t v a r i a t i o n s inincome during the l i fe c y c l e , an d to provide fo r r e t i r e m e n t an demergencies.

The concept o f permanent income i s at t rac t ive but i t is a l s o di f f i cu l t too p e r a t i o n a l i z e . To estimate i t direc t ly , one must know the consumer s f u t u r ee ar ni ng s s tr ea m. At b e s t , we know th e consumer s recent h i s t o r y ofe a r n i n g s . 24 In the absence of d a t a about the f u t u r e , how can a permanentincome measure be derived? The following six approaches have been used.

i Normal Income. A norm al income i s defined to be the incomerecei ved by a household in an o rd in ar y y ea r. Usually, i t i s c a l c u l a t e d as asimple average of th e incomes received over a number of y e a r s . The in ten t isto average out small v a r i a t i o n s in income from one year to the next ar i s ingfrom unemployment, i l l ness , u nu su al o v er ti me pay, and so on. Normal income isarguably l ike a househol d s permanent income in t h a t i t smoothes out some ofth e var iabi l i ty in c u r r e n t income. 25 Other analysts use a w ei ght ednormal income m ea su re w hi ch a s s i g n s a l a r g e r weight to more recentincomes. 26 The idea here is to approximate t he h ou se ho ld s own p e r c e p t i o nof i t s n orm al i nc om e, in th e b e l i e f t h a t the household i s s t r o n g l y influencedby more r ec en t e ve nt s.

i i Expenditures. The Fisherian household consumes a t a l e v e lcorresponding to i t s permanent income. T herefore, in the absence of bet

economics case 1

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