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Lecture 10

ECON202 Lecture Notes - Lecture 10: Normal Type, Complementary Good, Socalled

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Harvey King

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Applied Analysis 2.1: The Housing Market Boom and Bust (and Boom and Bust Again in
One part of the story of the 2008-09 recession is the housing market boom and bust in Canada
and the United States, especially in the United States.
Figure AA2.1.1 below shows the housing price indices for Canada, the United States and
Saskatchewan over the past 20 years.
We can see the strong run-up in prices (especially in the U.S.), and the subsequent collapse in the
housing crisis of 2006-08, and the recent recoveries can we use our tool of demand and supply
analysis to explain these two events?
Be careful about the index values: they are indexed to January 2000=100, the fact that the
Saskatchewan values are above the Canadian and U.S. values just means that the Saskatchewan
values have risen more since 2000 than the U.S. or Canadian values, not that they are higher in
The Housing Boom: ARMS and Ninja's
The initial housing boom (2002-2006 in the U.S. and somewhat later in Canada and
Saskatchewan) was caused by a very strong increase in the demand for housing.
Housing demand depends on the normal types of factors that affect demand: price, income
effects, population growth, and prices of substitute and complement goods, etc.
A very crucial aspect of the price of a house is the financing costs: the price of the mortgage that
a typical household faces when they borrow to buy a house the financing can be thought of as
a complementary good.
There were three crucial changes to financing costs in the period after 2000 that increased the
demand for house prices so strongly:
First, there were changes to the terms around mortgage borrowing.
o The required down payment as a percent of the house price was changed from the
previous minimum of 10% (25% preferred) to 0%.
o The maximum length of loans was increased from 25 years to as long as 40 years,
reducing the needed monthly payments.
o Banks also instituted ARMs: Adjustable Rate Mortgages, which started out at very low
interest rates, with future upward adjustments planned.
Second, there were strong reductions in the required household income needed to get the
loans banks and mortgage companies moved to NINJA loans (No Income No Job or Assets)
the so-called subprime mortgages.
Third, monetary policy and other factors led to dramatically lower interest rates, as shown in the
following table of mortgage interest rates adjusted for inflation (Source: Bank of Canada website):
2002 - 3.55%
2003 - 1.26%
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