Davies, et al (2002) states that, the immediate goal for any small to medium-sized enterprise (SME) is to survive and maintain its independence. But, sooner or later, a small company will probably want to expand. As such, there is a current trend towards global convergence and the adoption of outsourcing by firms of all sizes, growth usually means entering the international market. The aim of this paper is to examine the growth strategies and problem facing most of SMEs, and will investigate the role of strategies on which can be improve growth performance of SMEs.
Among the problems they face is inability to grow. SMEs growth depend to a large extent on the financial assistance obtained internally or externally, internal sources of funds are generated from business operations or fund from owner themselves, due to the fact that most of the time these funds are not enough external finance become important, external sources include, funds from family members or friends, debts financing from financial institutions.
This essay analyses the influence of microfinance to the growth of SME a case study of Tanzania. It is triggered by the thinking that lack of enough fund is one of the hindrance to the growth of SME’s
The question explored in the study was to look into the influence of microfinance to the growth of SME in Tanzania. More specifically the hypothesis of the study was to see whether the growth of SME in Tanzania is directly related to the services they obtained from SME’s.
As the tools for the study; various framework, theories and models regarding the concept of SME and microfinance are explored, analyzed and conclusion drawn.
2.0 CONCEPTUAL FRAMEWORK 2.1 Meaning of micro finance Refers to the extension of small amounts of collateral free institutional loans to jointly liable poor group members for the self employment and income generation (Rahman, 2001).
“Microfinance is bringing credit, savings and other necessary financial services inside the reach of people who are too poor to be served served with normal banks, as yhey are unable to provide adequate collateral.
Generally, banks are for those who have money and not for the people who are without money. (Gert van Maanen, Microcredit: Sound Business or Development Instrument, Oikocredit , 2004)
“Microfinance is based on the is based on the idea that poor people have expertise which which are unutilized or underutilized. The lack of skills is not what makes people poor . Aid is not the aid is not the answer to poverty, but only it helps poverty to continue. It makes dependency and takes away the people’s initiatives to break through poverty. Unleash of creativity and energy in human being is the answer to poverty.” (Muhammad Yunus, Expanding microcredit outreach to Reach the Millennium Development Goals, International Seminar on attacking Poverty with Microcredit, Dhaka, Bangladesh January, 2003)
Microcredit belongs to the group of financial service innovations under the term of microfinance, other services according to microfinance is micro savings, money transfer vehicles and micro insurance. Microcredit is a innovation for the developing countries. Microcredit is a service for poor people that are unemployed, entrepreneurs or farmers who are not bankable. The reason why they are not bankable is the lack of collateral, steady employment, income and a verifiable credit history, because of this reasons they can´t even meet the minimal qualifications for a ordinary credit. By helping people with microcredits it gives them more available choices and opportunities with a reduced risk. It has successfully enabled poor people to start their own business generating or sustain an income and often begin to build up wealth and exit poverty.
2.2 Micro finance institutions. Mayoy (1999) has defined MFIs as a sector of formal and informal financial institutions provide financial services to micro economic units. The terms are used as umbrella terms to refer to the range of services such as credits, savings and other financial services like pension and insurance.
The World Bank (1998), defines MFIs as agents and organisations that engage in relatively small financial transactions using specialized as well as character based methodologies to serve lower income households, micro enterprises, small farmers and others who lack access to the bank’s system. They may be informal, semi formal (that is legal registered but not under central bank regulations), or formal financial intermediaries.
Micro and Small enterprises. URT (20002), defined small and micro enterprises as those lacking access to financial services from mainstream financial institutions. Generally the definition of micro-small business enterprises is extremely diversified in such a way that definition used depends on various measure of size; depend on the purpose and the reasons. Doing the measuring for instance, in United Kingdom the definition of for small could be range from 5 to 2000 employees depending on the industrial sector, (Kibera 1996)
In Tanzania context, small and medium enterprises are those which consist uyp to four people in many cases family members, The popularity of small and medium enterprise are in informal sector, they are mostly formed by engaging between 5 and 49 employees with te employing capital of 4M to 200M to 800M. (SME Policy 2003).
3.0 MICRO FINANCE DEVELOPMENT IN TANZANIA In Tanzania micro finance is in its infancy, but growing fast, in late 1960s after the Arusha declaration, Tanzania government establish financial institutions to assist the poor farmers and small scale enterprises they were NBC and CRDB. Before restructuring, statistics indicates that the informal sector accounted for 80% of non farm employment, (Rutashobya 1991), only 0.4% or about 8000 people obtained their credit from formal banks, those who obtained their credits from cooperative societies or saving and credit cooperative organisations. A common phenomenon at work place accounted from 03%. Mlowe (1994) concluded that the gap was due to reluctance of most of the existing banks and other financial institutions to lend the rural population and low income earners because of the associated follow up and administrative costs.
Currently micro finance industry in Tanzania is growing fast following 1991 financial sector reforms, which focused on among other things creation of an effective and efficient financial system, that was partly due to the vacuum left by formal financial institutions (since they were serving the urban and people who were already established business), and also due to the recognition of the role of the private sector including the dynamic role of micro and small enterprises (Chijoriga 2001).
Micro financing institutions such as credit granting, provide micro or small loans without collateral at market interest rates or slightly above them to small scale clientele, mostly non farm enterprises, typically, the MFIs enable to extend loans based on the borrower’s cash flow and to tailor-fit the loan repayments in accordance with cash flows. It follows the simplest documentation leading mechanisms such us peer pressure, and joint liability groups to ensure borrower discipline, incentives to motivate clients’ good behaviour, good loan offers, and threat of cancellation of future loans for defaulting borrowers, among others, (Liento 2003)
3.1 Micro finance institutions currently found in Tanzania According to currently literatures, micro finance business emerged in Tanzania either as micro finance institutions or financial NGOs, i.e. FINCA, PRIDE SEDA, and others, also some of the banks do provide micro finance services i.e. CRDB, NBC, ACB and others, apart from them institutions the government also is no left behind on this war against poverty eradication, its provide micro finance loans to its people i.e.
through TASAF, SELF, RFSP, all these institutions and various government programmes work jointly so that to eradicate poverty.
SIGNIFICANCE OF CREDIT FACILITIES TO MICRO AND SMALL ENTERPRISES Literatures has been indicated that micro finance is potential tool to contribute considerably to the economic development of the country, Tanzania is like many other developing countries and is classified as the poorest nation . according to household budget survey (HBS), the most commonly measure for poverty analysis , depicted that in year 2001/2 about 34% of the population was considered to be poor and 82% of the poor were in rural areas, (poverty eradication paper, 2002). Therefore by extending credit to MSEs will offer so many benefits i.e. creation of employment, expanding business, improving standard of living, capacities in investing as well as saving to the people in the country hence development of the nation.
4.1 POVERTY ALLEVIATION AND IMPROVING LIVING STANDARD, EMPLOYMENT CREATION. In Tanzania about 75% of households depend highly on informal business and earn their living normally through this type of activity, (Rutashobya 1999), since micro finances and small enterprises tend to be labour intensive, they create employment at relatively low investment levels per job created .presently, unemployment in Tanzania is a significant problem. Estimates show that there about 700,000 new entrants into labour force every year. About 500,000 of them are school leavers with few marketable skills. The public sector absorbs only 400,000 of the new entrants into labour market, leaving about 300,000 to join the unemployed. Most of those people end up in micro and small enterprises sector, and especially in the informal sector. According to the informal sector survey of 1991, micro enterprises operating in the informal sector alone consisted more than 1.7 million engaging about 3million person that was about 20% of the Tanzanian labour force. (SMEs Development policy)
5.0 THEORETICAL FRAMEWORK FOR SMALL BUSINESS DEVELOPMENT Over the last few years, many African countries have moved or are in the process of moving toward western type political democracies with their economies from socialist based to capitalist/free market oriented economies. These transitions however, are not smooth. They are associated with painful economic and social consequences. People in third world, most of the time carry the burden of these transitions’ consequences. People, i.e. impact of structural adjustment programme (SAP).
As the population increases, the government agencies or large companies will not be able to create sufficient jobs for present unemployed and projected increase in population. It is estimated that 700,000 people join labour market annually while the formal economy only can absorb 40,000 people. In this regard the informal sector through the small businesses will be the ones to create the needed jobs for their ever growing population and hence to take advantage of the situation. To get the economies moving on the road to sustainable growth with equity, African countries need to take critical look at the past experience, present constraints and future prospects for small and medium business development. (URT, 2001).
The economic transformation occurring around the globe dictates the emergence of the small and medium enterprises. The market demands for the availability of several differential products makes customized and not mass production to be an appropriate production plan. This can be done via small medium enterprises, (julien, 1998).
Despite micro finance are very important for the development of the nation, in Tanzania it took time to create policy environment that was conducive to SMEs, it was not until the year 2000 that the national micro finance policy was launched by the minister of finance and bank of Tanzania.
5.1 THE ROLE SMES IN THE ECONOMY. SMEs are considered to have great potential for making the highest contribution to employment growth through labour intensive technologies to reveal an immediate impact on the employment generation (ILO, 1993 and Kitine 2000). SMEs contributing to increase income, saving and encouragement of business ownership and management at enterprise level. About 70%of people in sub Saharan Africa rely on the small enterprises for their livelihood, (Rutashobya 1995, Masawe 2000).
In Tanzania, small and medium business contributes substantially to the country’s GNP and employment in the country (Olomi 2001, URT 2001). However SMEs about 1/3 of the GDP of the country and that about 20% of the labour force is employed by the sector (URT, 2001). However SME sector in Tanzania is not centrally documented to find reliable data on the stated estimates (word bank, 2000).
5.2 Importance of SMEs in Economy. SMEs tend to be more effective in the utilization of local resources using simple and
affordable technology, by so doing they add value to local resources, Tanzania is endowed with abundant of natural resources which are yet to be fully tapped, on the other hand , development of SMEs facilitates distribution of economic activities within the economy and that fosters equitable income distribution .that means SMEs are used as engine of producing indigenous people in the business, and therefore they used to distribute wealth among indigenous people (ACS and Audtresch, 1990)
The importance of SMEs to world economies is well documented .SMEs (firms with 200 or less employees) make up the largest business sector in every world economy ( Wang, c. et al 2000), and governments around the globe are increasingly promoting and supporting SME growth as part of their overall national development strategy. While they dominate in terms of absolute numbers, SMEs are also important because they are key drivers of employment and economic growth. At a macro level, SMEs have created the majority of new jobs in OECD countries since the 1970s (Robertson, 2003) and their collective contributions to respective GDPs.
According to Smallbone, D. et al (1995), at a micro level, SMEs are popularly looked upon by governments as a keystone to regional economic and community regeneration. Since the early 1980s, considerable restructuring particularly in large firms (e.g., rationalizing, downsizing, outsourcing and job exporting) has seen a general shedding of jobs. It is primarily through the growth of SMEs that employees made redundant by large firms have been absorbed back into the work force through a multiplier effect; this employment provides income to regions which stimulates local economic activity which in turn, drives wealth and further creation of employment (Wang, c. et al 2000).
6.0 FINANCIAL REFORMS. In Tanzania the banking and financial institution act 1991, marked the beginning of the on going financial reforms, the law among other things permitted entry of private banks and provided the supervision and regulation framework for the financial sector. (Llwiza and Nwako, 2002).
A large body suggest that financial development contributes significantly to growth of the economy, (word development report, 20002). Through its strong effort on overall economic growth, financial development is centrally to the poverty reduction, research done by world also shows that financial development directly benefits the poorer segment of the society and it is associated with improvement in income distribution. (World development report, 2002).
6.1 Introduction to micro finance. The term micro finance institution is widely used, it generally address all types of entities engaged in microfinance , micro finance is not a to the African societies .there are many forms of informal and formal saving and loan associations that have been operated traditionally at the village and group level. Modern micro finance scheme, solidarity group, village banking and others, have been operating for twenty years. Micro finance institutions have been involved as effective tool for provision of financial services on sustainable bases to the to the small business sector, but at a very low level of out reach. Only a small fraction of the productive poor have access to even the micro finance services that are available.
Many MFIS are doing well, are doing excellent job of reaching the market providing basic loan services. Micro finance as involved as an effective tool to provide credit on sustainable basis for small business sector, but at a very low level of outreach. Only a small fraction of a productive poor have access to even available services of micro finance. MFIs have become an important financing source for the development of micro entrepreneurs (Hulme, 1999). And also they have become of an increasing important component of strategies to reduce poverty and promote SMEs development.
6.2 Concept of Business Growth. The term of business growth is used in ordinary language to mean two different connotations. Sometimes it meanly means increase in amount ie sales or export. At other times, it is used in its primary meaning implying increase in size, improvement of quality as a result of a process of development (Penrose, 1959).
The business economic performance will reflect its value in the society. The length of the business has been performing in the market can predict its growth stage as indicated in the product life cycle theory (Kotler, 1997). There are two types of growth, qualitative and quantitative growth. (Olomi 2002).qualitative growth can occur through change or sophistication in the firm and its owner, quantitative growth has to do with changes that are readily measurable, such as work force size, sales revenue, profitability, total investment, product mix etc.
High growth can be achieved by firms with a variety of size, sector and age characteristics. One of the most important factors is the commitment of the leader of the company to achieving growth. To grow successfully over an extended period, firms needed to develop their internal organization structure in ways that enabled the leader of the firm to delegate responsibility for operational tasks and focus more on planning and higher level strategic functions. My analysis demonstrates the importance of recognizing the sectoral Context as a framework for considering the strategies associated with growth. It is the sector which defines the factor and technology choices, and often the opportunities.
However, the factor that must be recognized in any analysis of growth performance in SMEs is that not all small businesses are growth-oriented (Smallbone, et al 1995). In small firms, where ownership and management are typically combined in one or more individuals, future goals for the business may be determined as much by personal lifestyle and family factors as by commercial considerations. Thus it is not surprising that one characteristic which did distinguish the best performing firms from other firms in the study was their commitment to growth.
Oke, et al (2007) has shown that entrepreneurs create new jobs, increase local incomes and wealth, and connect the community to the larger, global economy. The acknowledgment of the importance of innovation and SMEs has led to the development of the National Systems of Innovation in several countries. For instance, (Birch, 1989) coined the term “gazelle” to refer to SMEs that have a high growth rate. It has been suggested that SMEs (e.g. “gazelles”) operating high growth businesses are the engines of the economies and provide the majority of new jobs. What has been lacking in many of the studies in this stream is the important role that innovation plays in fueling such growth in the SMEs.
More recently the EU has begun to focus on entrepreneurship as part of its industrial policy rather than focusing mostly on large-scale innovation. According to Floyd and McManus (2005) Small firms tend to be more flexible and engage in adaptive innovation that brings further economic benefits. Product differentiation and lateral thinking help create a broader product range in order to create more choice and employment opportunities. Policies have included advice on exporting as well as money for start up. Information technology training has also been seen as a vehicle for entrepreneurs since small firms tend to benefit from flexible working hours.
6.3 Access and outreach of MFIs for SMEs. 0utreach refers to the to the extent to which all segments of population including low income people have access to financial institutions and their services .if micro finance is to have a significant impact on alleviating poverty and stimulating the business sector, it has to have wider outreach (Oyer and Levisky, 1999).the emphasis on the accessibility and outreach is highly relevant as far as the question of economic growth is concerned.
According to the research done by Chijoriga (2000) in Tanzania, most of MFIs operate only in the municipalities, cities and towns in which they are registered, showing high concentration in the urban areas; few of these schemes reach rural people. The gap of financing is therefore there, especially for the agricultural sector and in particular for small farmers.
6.4 Some of the Problem facing SMEs in accessing credits Financing has been identified in many business survey as the most important factor determining the survival and growth of medium and sized enterprises in both developing and developed countries access to finance allows SMEs to undertake productive investment to expand their businesses and to acquire the latest technology thus insuring their competitiveness and that of the national as a whole. Poorly financial systems can seriously undermine the microeconomic fundamentals of a country, resulting in lower growth in income and employment. Chijoriga (2002)
Despite their dominant number importance in job creation, SMEs traditionally have faced difficulty in obtaining formal credit. I.e. maturities of commercial banks loans extended to SMEs are often limited to a period which is very short to pay off sizeable investment, mean while access to competitive investment is reserved for only few selected blue-chip companies while loan interest rates offered to SMEs remain high. Chijoriga, (2000).
According to Chijoriga, (2000) traditionally commercial banks and investors have been reluctant to service SMEs, for a number of well known reasons some are,
³ SMEs are regarded by investors as high risk borrowers due to insufficient assets and low capitalization, vulnerability to market fluctuations and high mortality rates.
³ information asymmetry arising from SMEs, lack of accounting records, in adequate financial statements or business plan make it difficult for creditors and investors to assess the credit worthiness of potential SMEs proposals.
³ High administrative/transaction costs of lending or investing small amounts do not make SMEs financing profitably business Chijoriga, (2000) .as a results commercial banks are generally biased toward large corporate borrowers who provide better business plains, have credit ratings, more reliable financial information, better chances of success and higher profitability for banks. When banks do lend to SMEs, they tend to charge them a commission for assuming risk and apply tougher screening measures which drive up costs on all sides.
Many researchers and practitioners attribute “Poor Management” as the major cause of small business failure. Whether the causes are labeled as financing, competition, marketing, inventory, etc., they can be safely avoided if good management was in place. Although it has become difficult to explain what constitutes ”poor management”, small business owners/managers need to develop basic managerial skills and knowledge Temtime, T. Z and Pansiri, J. (2006). If they are to succeed, managers need to have sufficient skills in the area of planning, organizing, directing and controlling organizational resources. The respondents have clearly known the importance of managerial adequacy and competency as critical success factors. Managerial competency is measured by seven factors.
The main contributor to the critical role of the managerial factor is the use of external advisors, focus on strategy formulation and implementation rather than focusing on operational bits and pieces, aiming for long term competitive advantages rather than short-term profits, and developing strong interest for non-financial benefits such as need for achievement and recognition Visagie, J.C. (1997). Most SMEs in developing economies lack strategic orientation and long-term vision. They put greater emphasis on short-term profits rather than building long-term competitive potential.
7.0 PRACTICAL REVIEW BASING ON TANZANIA PERSPECTIVE. Because the study aiming at studying the influence of MFIs on the SMEs growth, it is important to understand MSEs growth achieved by different MSEs owner managers in various countries,
³ Kashf, Pakistan Is one of micro finance institution operates in Pakistan. In the study on influence assessment of kashf’s micro finance and kanan enterprises development programme, conducted in 20001 arjumand and associate consultants. They surveyed 2000 Kashf clients as well as a comparison group of non clients; non clients were similar to clients in most respect except that 40% were salaried workers, compared to only 16% of kashf clients, and however their initial incomes were nearly identical. One year later kashf clients increased. At the time of survey, US$ 1 was equivalent to 59 rupees (oanda. Com), measuring the influence of micro finance average income by 31% to rupees 7039 versus rupees 6206 for the comparison group. The report specifically states that kashf “focuses on the working poor as opposed to people who were employed” it is the poorer of kashf’s clients that showed the strong impact. The poverty among kashf members decreased by 20%
³ According to paper presented in world export development forum in Switzerland, 0ctober 2007 basing on Tanzania as a background country stated that, in Tanzania the SME sector is prime mover of economic undertakings but is still facing a number of problems, financing investment in Tanzania is a major constraint. Adequate finance is not being provided to allow for the development of the sector due to the fact that banks do not cooperate with SMEs, some banks operated in limited areas, lack of adequate guarantee schemes to back up banks financing SMEs, technology transfer and advancement are recognised as important aspect for SMEs development.
7.1 CONTRIBUTION OF MFIS TO THE IMPROVEMENT OF HOUSEHOLDS’ INCOME According to the Littlefield (2003), MFI is an attractive development strategy, which finally leads to help poor population, the potential for reaching and assisting large numbers of households on sustainable basis made MFIs a popular development investment in 1990s. Today there are thousands of MFIs programmes established with benefit of development funding.
Guli (1998) points out that micro finance should be seen as the provision of small scale financial services to business and household traditionally kept outside the financial system rather than more narrow view of micro finance as services for the poor micro enterprise owners
8.0. CONCLUSION SMEs continue to play an important role in the development of world economies however they continue to face enormous challenges to grow and develop as compared to rival bigger firms. But it is pleasing to note that of late major financing institutions like the EU and World Bank etc and mostly developing countries are coming up with deliberate policy that will fuel the development and growth of SMEs as their existence has proved worthwhile to the development of various economies through poverty reduction as they continue to be a major source of employment.
The Different Determinants Of House Prices Economics Essay
House prices are determined by demand and supply. If demand rises (shift to the right) or if supply falls (shifts to the left), the equilibrium price of houses will rise. Similarly, if demand falls or supply rises, the equilibrium price will fall.
So, the house prices rise so rapidly in the 2000s, but fall in the 2008. The reasons lies primarily in change in the demand for housing. There are various factors that affected the demand for housing are describe in the below;
Incomes (actual and anticipated):- In the begging of the 2007 was time for rapidly rising incomes. The economy was experiencing an economics “boom”. Many people wanted to spend their extra incomes on housing; either buying a house for the first time, or moving to a better one. Many people thought that their incomes would continue to grow and were thus prepared to stretch themselves financially in the short term by buying an expensive house, confident that their mortgage payments would become more and more affordable over time. In 2008/09 by contrast, were periods of recession, with rising unemployment and either is falling or much more slowly growing incomes. People had much less confidence about their ability to afford large mortgages.
The cost of mortgages:- in early 1990s the mortgages rates was less than now. That meant people could afford larger mortgages and thus afford to buy more expensive houses. But mortgages interest rates were now rising. Many people found it difficult to maintain existing payments, let along to take on a larger mortgage. In 2003 mortgages rates were generally reduced again, once more fuelling the demand for houses. Even when the interest rates rose gradually over the period from 2004 to 2007 they didn’t come close to the rates reached like before. By 2008/09, however, higher mortgage interest rates were becoming increasingly unaffordable for many people and this was one factor contributing to the initial downturn in housing prices.
The availability of mortgages:- in the housing boom in 2003 to 2007, mortgages were readily available. With house prices rising, banks and building societies were prepared to accept smaller deposits on houses and to lend a larger multiple of people’s income. After all, if borrowers were to default, lenders would still have a very good chance of getting all their money back. In the begging of the 2008 banks and building societies were more cautious about granting mortgages. They were aware that, with falling house prices, rising unemployment and the growing problem of negative equity, there was an increased danger that borrowers would default on payments. In 2008/09 the problem was compounded by credit crunch, meaning that banks had less money to lend.
Speculation:- in the housing boom, people generally believed that house prices would continue rising. This encourages people to buy as soon as possible and take out the biggest mortgage possible, before prices went up any further. There was also an effect on supply. Those with houses to sell held back until the last possible moment in the hope of getting a higher price. The net effect was rightward shift in the demand curve for houses and leftward shift in the supply curve. The effect of this speculation, therefore, was to help bring about the very effect that people were predicting. In 2008, the opposite occurred. People thinking of buying houses held back, hoping to buy at a lower price. People with houses to sell tried to sell as quickly as possible before prices fell any future. Again the effect of this speculation was to aggravate the changes in prices- this time a fall in prices.
Speculation in recent years has been compounded by the growth in the “buy to let” industry, with mortgage lenders entering this market in large numbers and a huge amount of media attention focused on the possibilities for individuals to make very high returns.
The relationship between demand and price:- When the price of a good rises, the quantity demanded will fall. This relationship is known as the law of demand. There are two reasons for this law:
People will feel poorer. They will not be able to afford to buy so much of the good with their money. The purchasing power of their income has fallen. This is called the income effect of a price rise.
The good will now cost more than alternative or substitute goods and people will switch to these. This is called the substitution effect of a price rise.
Similarly, when the price of a good falls, the quantity demanded will rise. People can afford to buy more and they will switch away from consuming alternative goods.
The demand curve:- ( show the demand curve for the housing price in uk) Other determinants of demand:-
Distribution of income:-
Movement along and shifts in demand curve:- it is assumed that none of the determinants of demand other than price changes. The effect of a change in price is then simply illustrated by a movement along the demand curve. But when any of the determinants change then new demand curve needs to be creates. If a change in one of the other determinants cause demand to rise like price raises then the whole curve will shift to the right. This shows that at each price more will be demanded than before.
As UK housing price rise than the demand curve in the right shift in the last few years but when the housing price fall down then the demand for the house will be the left curve.
Give the diagram pp35
Supply and price:- When the price of house rises the quantity supplied will also rise. There are three reasons for this:
As firm supply more, they are likely to find that beyond a certain level of output, costs rise more and more rapidly. In that case housing agent want to build more and more house.
The higher the price of the housing market, the more profitable to do housing business. So, housing agent will thus be encouraged to sale more house by switching from the less profitable housing business.
Given time, if the price of the house remain high new people will be encourage to set up business but the people will not to able to buy house if the income is not increase.
Other determinants of supply:-
Like demand , supply is not simply determined by price. Other determinants of supply are as follows;
The Costs of production:- the higher the costs of production, the less profit will be made at any price. As costs rise, housing agent will cut back to the sale house. The main reasons for change in costs are as follows:
Change in input prices: cost of production will rise if wages, raw material prices, rent, interest rates or any other input prices rise.
Change in technology: technology advances can fundamentally alter the costs of production.
Organisational change: various kind of cost saving policy by the organisation demand could be changes. Like lots of organisation having downsizing the staffs because of that having unemployment and people have losing job. As a result, income going down and demand for the house decreasing.
Government policy: cost will be lower by government subsidies and raised by various taxes. Same as housing price in the UK effected by government policy which are the favour of the people or not, if the policy from the government is good for the people than people will buy house otherwise not.
A change in demand:- if one of the determinants of demand changes other than prices, the whole demand curve will shift. This lead to a movement along the supply curve to the new intersection point. If the rise of the house buyer’s income rise than demand of the house will increase. Also, if the income not change the demand will stay remain.
A change in supply:- if one of the factor of supply changes other than price the whole supply curve will shift. This will lead to movement along the demand curve to the new intersection point. When the housing price rise because of the less supply and high mortgage rate than automatically the supply for the house decrease.
Diagrame pp-45. house-prices-85-09.jpg
YES House Prices may Fall The ration of house prices to Incomes has risen to an all time high. This means that the average worker is unable to afford a house in many areas, this will lead to a fall in prices
Demographic factors suggest the population is likely to fall soon. Therefore there will be less people willing to buy houses.
Low Interest rates have helped keep the housing market strong however they may rise in the future as the economy picks up and inflation rises above its inflation target.
Rising house prices have encouraged speculation. This means people buy houses as a way to make capital gains. However as prices start to fall these people will start to sell causing a bandwagon effect of an ever increasing rate of falling house prices.
Some areas of the country are more vulnerable to falling prices these are the areas which saw the biggest increases in the 90s
With changing social attitudes. Couples may be more likely to live their parents for longer
NO- House Prices are Unlikely to Fall The ratio of house prices to incomes has increased but this is sustainable because inherited wealth is increasingly being used to buy houses.
Housing has a high income Elasticity of Demand (YED), therefore people are willing to spend a higher % of their income on housing
Despite a stagnant population there is an increasing tendency for smaller households e.g. single parents single old people and children leaving home earlier.
Supply of housing has not been increasing. The number of new house built was the lowest since the war, also many council houses built in the 1960s are being knocked down, because they were associated with various social problems
Many houses in London have been bought by foreigners
In depth Reasons Why House Prices are Falling 1. Shortage of Mortgage Finance
At the moment, the lack of mortgage finance is one of the most significant factor in falling demand for housing. The Council of Mortgage Lenders suggest that mortgage approvals have fallen to the lowest levels since 1991. Upto July 2007, mortgage lenders were very competitive and eager to attract customers with mortgage products such as 100% mortgages and high income multiple mortgages. However, the credit crisis has led to banks struggling to raise finance, therefore they have had to reduce their mortgage lending. To ration mortgages, they have removed many mortgage products, especially ‘subprime’ products. They have also increased the cost of many other mortgages.(see: credit crisis explained) In particular, mortgage lenders are requiring large deposits. This makes it difficult for first time buyers to get a mortgage.
2. The ratio of house prices to incomes has risen to an all time high.
In the UK the ratio of house prices to incomes is 50% higher than the long term average (1975-2005) Source : Economist (1) This means that many potential buyers are struggling to be able to get a mortgage. This problem has been exacerbated by the credit crisis(see also: ratio of house prices to income UK)
3. House Prices Unaffodable for First Time Buyers.
In particular, it is becoming increasingly difficult for first time buyers to get on the property ladder. This is mainly due to the rise in house price to earnings ratio. In the past this problem was got around by banks being willing to offer ‘generous’ mortgages (e.g. interest only, self certification, 100% mortgages). For example, in the past, the Abbey National lent 5 times a borrowers salary. This increased generosity in lending helped to keep the market buoyant without addressing the underlying problem of overvalued house prices. The Credit crunch has now made this difficult. (see also: ratio of house prices to income for first time buyers)
4. House Prices can Fall – even with limited Supply.
For those who believe house prices can never fall, it is worth remembering the case study of Japan. In the 1980s there was a similar boom in house prices in Japan. But since the peak of 1991 house prices in Japan have fallen for 14 consecutive years, leading to considerable economic problems such as lower consumer spending. House Prices have also started to fall in the U.S.A. US prices have now fallen considerably since their peak in 2007.
5. Speculation in UK Housing Market.
Traditionally, the view of the housing market is that it is not just an asset, but a place to live. Therefore, unlike the stock market, house prices won’t rise and fall due to speculation. However a lot of demand for UK housing is coming from buy to let investors. Many buy to let investors are in the market for the long term; however, now that prices are falling, some of these speculators are likely to leave the market causing a significant drop in demand.
6. Herding Effect of UK Housing Market.
In a research paper Alex Hamilton argues that much of the housing market is dominated by herding behaviour. (Source 2) This means that a lot of the rise in demand is caused by market sentiment rather than economic fundamentals. Now the market sentiment has changed people are less confident about buying. In a recent paper, the OECD stated that 15% of UK house prices were not reflected in economic fundamentals but ‘froth’ and ‘speculation’. As house prices fall, there is no incentive to buy. Many are waiting for house price falls to end.
7. Volatility of UK Housing Market.
The UK housing market suffers from severe supply constraints as a % of the total housing stock. The number of new houses built is relatively small. Therefore a change in demand magnifies any change in price. It only takes a small rise in demand to increase prices. But similarly it could only take a small fall in demand to cause significant price falls as in 1991.
8. UK Sensitive to any Change in Interest Rates.
There are record levels of consumer borrowing in the UK. This is a combination of mortgage borrowing and personal debt like credit cards. The total level of debt is £1.168 trillion. Source (3) Therefore even a modest rise in interest rates could have a very adverse effect on consumer confidence and spending. Therefore the housing market is particularly vulnerable to any rise in interest rates that may occur. – even if it is only through an increase in bank rates (as opposed to base rates). Also, even though the Bank of England have cut interest rates, many homeowners are not seeing these rate cuts passed onto them. Mortgage costs have been stubbornly high.
Living costs are also been squeezed by oil, electricity and food prices.
9. Predictions for House Prices UK.
Many economists predict significant house price falls. For example Mr Calverley, argues in his book, ‘Bubbles and how to survive them’, that house prices could fall by 50%. Former advisor to Gordon Brown David Miles also predicts falls in house prices. He points that much of the rising demand for housing is speculative. As David Miles states:
“However, one third to one half reflects changes in expected house price inflation – that is a speculative element of demand, which is likely to be volatile,”
See also: (economists predict 20% fall in prices)
10. Sub Prime Mortgage collapse
The problems in the US Housing Market have adversely affected investor confidence. Therefore, it is becoming more difficult to sell mortgage debt. It is likely banks will become more conservative in mortgage lending. See: Credit Crisis explained
11. Northern Rock and effect on consumer Confidence
The problems at Northern Rock, HBOS and the general malaise in the mortgage industry have severely dented consumer confidence in the Mortgage industry and consumer confidence
House price falls are necessary for the housing market to readjust. However, in the short term, this adjustment is been exacerbated by the shortage of mortgage finance.
demand and supply for housing The determination of prices in local and regional housing markets is a classic example of microeconomics in action! We are seeing the interaction between buyer and seller with prices being offered and agreed before a final transaction is made. In this section we focus on the demand and supply side factors that determine the value of properties in a market.
Each housing transaction in the UK depends on
(a) The price that the seller is willing to agree for their property with the prospective buyer
(b) The actual price that the buyer is willing and able to pay.
Buyers place offers for a property that the seller can either accept or reject
A Sellers Market When the market demand for properties in a particular area is high and when there is a shortage of good quality properties (i.e. supply is scarce) then the balance of power in the market shifts towards the seller. This is because there is likely to be excess demand in the market for good properties. Sellers can wait for offers on their property to reach (or exceed) their minimum selling price.
A Buyers Market Conversely when demand both for new and older housing is weak and when there is a glut of properties available on the market, then the power switches to potential buyers. They have a much wider choice of housing available and they should be able to negotiate a price that is lower than the published price.
When the demand for houses in a particular area increases (perhaps because of an inflow of population into the area, or a rise in incomes following a fall in unemployment), there is upward pressure on market prices.
Often the supply of available housing in the market is relatively inelastic. This is because there are time lags between a change in price and an increase in the supply of new properties becoming available, or other homeowners deciding to put their properties onto the market.
When demand shifts outwards and supply is inelastic the result is a large rise in market price and a relatively small expansion of the quantity of houses traded. As supply becomes more elastic over time, assuming the conditions of demand remain unchanged, we expect to see downward pressure on prices and a further increase in the equilibrium quantity of houses bought and sold.
The Aggregate Demand for Housing in the UK The market for owner-occupied housing is sensitive to changes in market demand and supply. The strength of these factors often explains disparities in house price inflation between and within the major regions of the United Kingdom.
Demand conditions for housing influence both the willingness and ability of people to make house purchases. Some of the most important conditions of demand are listed below
Growth of real incomes – privately owned housing is a normal good for most people. As average living standards rise, the total demand for housing expands, as does the demand for more expensive properties as people look to move “up market”.
Consumer confidence – confidence is vital in the housing sector. If expectations for the future performance of the economy deteriorate and people become less optimistic about their own financial circumstances, they are tempted to curtail their search for a new home or delay entry into the owner-occupied sector.
Equally when the economy is enjoying sustained growth and rising prosperity – improved confidence raises the number of home buyers and shifts the balance of power in the market towards the seller if properties are in short supply.
Jobs – because financing a house purchase involves making a long-term commitment through a mortgage lender, changes in unemployment levels exert a significant impact on housing demand. For example in areas when unemployment remains persistently above the national average, average incomes are likely to be lower and confidence among buyers will be negatively affected
These three factors, incomes, employment and confidence are critical in determining the direction of house prices. When these three factors are rising the conditions are normally in place for sharp upward movements in prices. However other economic variables also come into play.
Expectations of future price movements – is housing to be regarded as a consumer durable that provides a flow of services to the owner over a long period? Or should we think of a house purchase, as a major financial investment that we expect will provide us with substantial capital gains in the long run? The answer is probably a mix of the two! Certainly in the 1980s the housing sector boomed because of a strong speculative demand for properties.
Changes to the system of housing taxes and subsidies – government policies affect the housing sector in a myriad of different ways ranging from benefits for council taxpayers on low incomes to the payment of stamp duty on the most expensive properties.
Throughout most of the 1980s and 1990s the government offered home buyers an explicit subsidy in the shape of mortgage interest relief at source or MIRAS. Chancellor Brown decided to phase this subsidy out of the system – MIRAS has now disappeared. The effect has been to dampen down housing demand, but do little substantial to stop house prices rising.
Factors That affect House Prices in UK house-price
Graph shows volatility of UK House prices
House prices are affected by a combination of supply and demand factors.
Demand Side Factors: 1. Economic Growth / Real income.
Rising incomes enable people to spend more on buying a house. Traditionally, there was a mortgage ratio of 3 times your salary. Basically if you earnt £20,000 the building society would lead £60,000. Therefore rising incomes enable house prices to rise.
However, the ratio of house prices to income can vary considerably. For example, between 1995 and 2007, the ratio of house prices to incomes have increased significantly. see: House Price to Incomes ratios
If the economy goes into a recession and unemployment rises, the demand for buying houses would fall significantly.
2. Interest rates.
Interest rates affect the cost of paying for a mortgage. Interest rates are very important as mortgage repayments are usually the biggest part of a homeowner’s monthly spending.
In the UK, the majority of homeowners have a variable mortgage which means an increase in rates will cause the cost of mortgages to rise, detering people to buy.
People on fixed rate mortgages will be insulated from fluctuating rates for 2-10 years. Therefore changes in interest rates can have a time lag of upto 18months before there full effect is noted on demand for housing.
It is also important to consider real interest rates (interest rates-inflation)
The Bank of England set base rates and these usually affect all commercial rates. However, sometimes the Bank of England cut interest rates, but, commercial banks don’t pass these cuts onto consumers. In the first half of 2008, the Bank of England cut rates by 0.5% from 5.5 to 5.0%, but the cost of mortgages is still rising.
3. Consumer confidence
During times of high consumer confidence, people are more willing to take out risky mortgages to be able to buy a house. For example, in the period 2001-07 100% mortgages and interest only mortgages were quite common. In the early 00s, people were optimistic about the housing market and so took out mortgages with a higher debt to income ratio.
4. Availability of Mortgage Finance
In the 50s, 60s and 70s, there were stringent restrictions about the availability of finance. However, with deregulation of the banking sector increased competition has seen a rise in the number of mortgage products. Products such as interest only, self certification mortgages and mortgages up to 6 times income have enabled people to get more mortgages, thereby increasing demand for housing. However, during the credit crunch of 2008, the number of mortgage products on offer fell due to a shortage of finance in the money markets.
See: Credit Crunch Explained
5. Demographic factors
There has been a rising number of households in the UK. The number of households can rise faster than the population if the average family size decline and there are more single people living alone.
Demand for housing in the UK has been increasing for various reasons such as:
an increase in divorce rates
an increase in net immigration from Eastern Europe.
Increase in life expectancy and more old single people
Children leaving home early
6. Speculation Not everyone buys a house to live in it. An increasing number of property investors buy houses to try and make both capital gains and income from renting. This buy to let investor is typically more volatile, they will buy when house prices are rising and sell when the market appears to turn. This makes house prices more volatile because speculators will buy in a boom and sell in a bust. The number of buy to let investors in the UK has risen in the past decade.
However, there are quite high fixed costs in selling a house, such as stamp duty and estate agent fees. It is not like dealing in shares where you can easily buy and sell. Many buy to let investors claim they are in in for the long term.
The price of rented accommodation Although UK house prices have increased faster than inflation, renting has also become expensive which is the main substitute to buying a house
7. Inherited wealth.
Many people use inherited wealth to buy houses. This might explain why there has been rising ratios of house price to incomes. It is also becoming more common for parents to lend children a deposit to help get their first house. In other words higher house prices are not detering people from buying a house – people are finding ways around it.
8. Unemployment Low unemployment is often associated with rising demand for houses.
Supply side Factors In the short run Supply of housing is fixed because it takes time to build houses. Therefore in the short run demand affects prices more than supply
However if the supply of housing is inelastic then an increase in demand will lead to a big increase in price.
Long Run Supply In the long Run the supply of housing is affected by many factors: Availability of planning permission. This is difficult to obtain in rural areas
Opportunity cost for builders e.g. are there better returns from other types of investment
Existing houses may be knocked down because they are deemed unfit to live in.
An increase in the cost of building new houses will shift supply to the left
In the UK, it is argued there is a significant shortage of housing is this explains why house prices have risen much faster than inflation and earnings. However, in the US, the supply of housing increased in the period upto 2008 and therefore, the excess supply and falling demand led to a big fall in demand. However, it is important to note that house prices can still fall, even if there is a shortage of supply. In 1992, house prices in London fell over 20%, even though we can say supply is inelastic. A shortage of supply just means they will be on average higher. It doesn’t mean they are incapable of falling.