Schools of Economic Thought and The Australian Housing Market

Economics: An Introduction

Economics is a social science that focuses on the description and study of the production, delivery, and use of products and services in order to enhance people’s living conditions. It reflects on the activities and relationships of economic actors within the market environments in which they work. There are many schools of thought in economics that have been developed by various organisations and researchers in an attempt to understand how the economy works and its competitive existence, which is frequently enigmatic to firms and customers alike. From this perspective, a school of thought is considered as a group of people that have common characteristics, opinion and outlook in the discipline of economics. The various distinctions in this area include but are not limited to the Classical school of thought, Marxian approach, Keynesian and Chicago schools of thought just to mention a few. As it can be seen from the names, some are named after the individuals who proposed or came up with them, for example the Marxian approach by Karl Marx, while others are from institutions such as Chicago schools.

Different Schools of Economic Thought

The classical political economy, was the first school of thought in the 18th and 19th centuries. It focused on the tendencies of markets moving towards equilibrium and on objective theories of value. This theory is mainstreamed on the concept developed on laissez-faire economic market. This laissez-faire economic market mostly known as the free market economy requires minimum government intervention or none at all. This, therefore, allows individuals to act according to their own self-interest regarding economic decisions. This makes economic resource allocations given to the individuals that are willing to do business in the marketplace. Classical economics borrows from the value theory to determine pricing in the economic market. Classical economy believes in the forces of consumer spending and business investments rather than government spending. This in the classical economics view, government spending does away with valuable economic resources required by the individuals and businesses which retards economic growth through encouraging the growth of public sector at the expense of the private sector. Neoclassical economics, on the other hand, derives from this school as well but differs as it is utilitarian in value theory uses the marginal theory as the base of modeling and equations. Utilitarian meant satisfaction of the clients was important. Therefore, the value of the commodity emphasized rather than just providing the goods and services. Several economists in the 1870s and 1880s based value of the goods and services on the relationship between costs of production and the output goods and services consumed. This with time became the terms now known as supply and demand. This was a marginal revolution in economics bringing forth the neoclassical economics. Neoclassical economists enable buyers to maximize the gains derived from goods and services provided by increasing the purchases of a certain good or service till gaining of an extra unit they have used to obtain the good or service thus, maximizing utility (Weintraub, 2002). Producers, on the other hand, avail goods and services in such a way that the cost of production of the extra unit is balancing with the revenue generated hence maximizing the profits. This is extended to the employment of staff as well, employees are employed to the point that the cost of additional hiring is balanced with the value of output offered by the additional employee hired. It envisages the presence of economic agents such as households or firms optimizing the revenue despite all the challenges and constraints. Additionally, the value is linked to a high demand of goods and services that collide with a low supply of the same. The assumptions of neoclassical economists are that people have rational preferences in the final output of goods and services, as individuals aim at attaining maximum utility from a product the firms aim at maximizing profits and that people tend to act independently whenever there is reliable relevant information (Becker 1976, p. 273).

Marxism: Labor Theory of Value

Marxism has its main pillar anchored on the labor theory of value in which Karl Marx claims that the value of a commodity having a direct linkage to the average number of labor hours taken to produce the said commodity. Marxists are of the same view that the value of a commodity determines its pricing and its demand. This can further mean that utility maximization is a pre-requisite. Although, Marxist dwell on the base that, the value can be increased through full utilization of the labor force. Max argues that, in the long - run, wages received by employees depends on the number of labor hours it takes to produce a commodity (Dow 1985, p.150). Marx highly fated capitalism as it estranged the masses. Max reasoned out that as much as the workers produced commodities for the market, market forces rather than workers control the pricing. The labor force works for capitalists who actually run production and maintain power in the workplace. He further argued that in this case, work to be done by machines rather than being done freely by creative individuals. Capitalism blocked the capacity to create a humane society. He had the assumptions that, people had the ability to abolish an advanced market-based society to replace it with a democratic, comprehensively planned society. This was mainly because people worked vehemently in poor working conditions, less paying jobs, or for the reason that the labor force competes in the marketplace, this has a tendency of placing profitability above human need. The capitalist that claimed there was no alienation as Max had alluded criticized this theory, they said one could not be separated from his or her potential creatively planning and managing the collective fate (Rahman, 2008).

The State of Australian Housing Market

In the recent past, in late 2015, as a response to the macro-prudential reduction deployed by APRA was temporal. Price gains are on the rise, auction clearance rates, as well as lending to property investors, have bounced back. For instance, in Sydney dwelling prices have risen to 73% while in Melbourne prices are up 47%. This makes the Australian housing market cause trouble around poor affordability and high household debt. The 2017 Demographic Housing Affordability Survey done indicated that the median multiple of house prices in cities, over 1 million people to household income is 6.6 times in Australia versus 3.9 in the US and 4.5 in the UK. Whereas in Sydney it is 12.2 times and Melbourne is 9.5 times. This makes the housing market in Australia overvalued. The surge in the Australian home prices is attributed to the shift from high to low-interest rates that have boosted borrowing and buying power. This has taken Australia’s household debt to income ratio from the low end of OECD countries 25 years ago to the top end. The inadequacy of supply as compared to the demand has increased the pricing of housing units as well (Oliver 2017, p.1).

Factors Influencing the Australian Housing Market

Another underlying factor that leads to overvaluing of housing units is the negative gearing and the capital gains tax discount, foreign buying and SMSF buying. Although, the interaction with the capital gains tax discount by enhancing the after-tax return available to property investment results in higher investment activity.

The Australian Housing Market and the Free Market Economy

This Australian housing market borrows from the classical theory that encourages the free market economy. This is driven by the demand of housing units in relation to the demand in the country. The private sector has been given the powers to borrow funds at low interests to spur the growth and development of the housing units. It is a free market economy. The desires of individuals and business in the marketplace have been allocated and they are acting on their own self-interests in terms with regarding the economic decisions.

Challenges and Potential Solutions of the Australian Housing Market

From the research done, it can be determined that indeed the markets are not reconciling the self-interests with the public interest. As established from the Australian housing market, it is evident that most households are in huge debts. This indicates that the valuation of housing is high as compared to other regions. The self-interests of markets are providing the housing units that are in demand dictating the pricing and value of the units. This to the markets it optimizes profits as opposed to the amount the public interest is willing to offer in terms of rent thus the accrued debts witnessed in Sydney and Melbourne. As much as the taxation and borrowing interest rates being low, the housing units are nor affordable to the people (Chen, et al. 2013, p.79).

Conclusion

The three economic schools of thought agree that the value of commodities should be the one to determine the pricing. This is of course in relation to the demand and supply of the commodity while Karl Max emphasized on the labor force as an integral part to realize the value of the product. Free economy improves the competition in the economic sector as investors and buyers have the leeway to venture into any field of business with fewer restrictions as well as buyers making their own decisions on whomever to buy. In the case of the Australian housing markets, the market prices are inflated because there is demand. This though can be fixed by tightening the lending standards. Policies are made to help address poor housing affordability and focus on boosting the new supply of standalone homes. Lessen the land use restrictions, faster releasing of land, speed up the approval process and encouraging decentralization. This will encourage public urge to develop their housing units. Finally, the state to introduce tax reforms that include replacement of stamp duty with land tax, remove capital gains tax discount, reduction of income tax rates to deal with negative gearing that is aimed at evading taxation.

References

Becker, G. S., 1976. The economic approach to human behavior. Chicago: University of

Chicago Press.

Chen, R. D., Gan, C., Hu, B. & Cohen, D. . A., 2013. An empirical analysis of house price

bubble: A case study of Beijing housing market. Research in Applied Economics, 24 January, pp. 77-97.

Dow, S. C., 1985. Macroeconomic thought: A methodological approach.. Oxford: B. Blackwel.

Oliver , S., 2017. The Australian housing market – what are the key issues?. Australian Property Journal, p. 1.

Rahman, M. M., 2008. Australian housing market: Causes and effects of rising price. [Online]

Available at: https://eprints.usq.edu.au/4614/2/Rahman_2008.pdf[Accessed 12 May 2017].

Weintraub, R. E., 2002. Neoclassical Economics. [Online]

Available at: http://www.econlib.org/library/Enc1/NeoclassicalEconomics.html[Accessed 12 May 2017].