Metropolitan-Specific Estimates of the Price Elasticity of Supply of Housing, and Their Sources

Abstract

Many reviews of housing economics (and most of the papers on the subject) have noted that, relative to many other aspects of market behavior, housing supply is understudied. Surveys by John M. Quigley (1979), Edgar O. Olsen (1987) and Lawrence B. Smith (1988), to give but three examples, make this point. The market for research is in turn responding; for example, see the recent special issue of the Journal of Real Estate Finance and Economics devoted to housing supply (Stuart S. Rosenthal, 1999), and especially the review by Denise DiPasquale (1999). Despite these advances, the literature is best described as thin, especially relative to the acknowledged importance of the topic, and there is no firm consensus on the nature of housing supply. One unusual characteristic of housing supply is that the short-to-medium-run supply curve for housing embeds a fundamental asymmetry and can probably best be viewed as kinked. When housing demand falls, the market cannot easily adjust the supply of housing downward (because housing is so durable). On the other hand, absent constraints on land supply, the market should be able to absorb increases in demand via supply. Of course, it has been the case recently that the strong national market for new construction has led to material and labor shortages that have, in turn, driven up prices of materials and labor. That suggests that housing supply is not perfectly elastic in the face of increased demand, at least in the short run. Still, we would expect that in the absence of landsupply constraints, the speed of adjustment (in the DiPasquale and William C. Wheaton [1994] sense) of markets to upward shifts in demand is faster than it is to downward shifts. An assumption of imperfect elasticity is supported by, for example, James R. Kearl (1979), Robert Schwab (1983), Robert Topel and Sherwin Rosen (1988), James M. Poterba (1991), and Dixie M. Blackley (1999), who find that, at the national level, the price elasticity of supply is between 1.5 and 4. In a paper that ties econometric modeling to urban theory, Christopher J. Mayer and C. Tsuriel Somerville (2000) find housing supply on the national level to be even less elastic than their predecessors. On the other hand, Richard F. Muth (1960), James R. Follain (1979), and Malpezzi and Duncan Maclennan (1996) find much higher elasticities, with point estimates as high as 20. Malpezzi and Mayo (1997), show that there are significant differences in supply elasticities across countries, and that these differences seem to be correlated with the stringency of the regulatory framework in place for land and housing development. What is true across countries may also be true across cities, especially in a country like the United States, with significant local variation in land use and other regulatory practices. Recent papers such as John L. Goodman (1998) and earlier literature such as Raymond J. Struyk (1977) argue forcefully that supply conditions vary from place to place within the country. Despite the plausibility of metropolitan differences in supply responsiveness, to our knowledge, except for recent work by Mayer and Somerville (2000), little has been done to examine such variation directly. This paper’s focus is on estimating separate supply elasticities for individual metropolitan areas and explaining the source of differences in housing supply elasticities across U.S. Metropolitan Statistical Areas (MSAs). We posit that supply elasticity variances due to materials will not vary much by MSA (because materials are supplied nationally). In a similar vein, variances in the supply elasticity due to labor-market condi* Green: Department of Finance, School of Business, George Washington University, 2023 G Street N.W., Washington, DC 20052 (E-mail: drgreen@gwu.edu); Malpezzi: Center for Urban Land Economics Research, School of Business, University of Wisconsin, 975 University Avenue, Madison, WI 53706 (e-mail: smalpezzi@bus.wisc.edu); Mayo (deceased): Lincoln Institute of Land Policy.