Economics

Several principles of economics come to play in an individual’s decision-making such as a purchase of a new house.  These include the following principles that generally, all rational consumers abide by: (Mankiw, 2001, p. 4-16):

a. In making decisions, people have to face trade-offs.  Consumers are faced with several options, especially when deciding what to purchase. If resources were unlimited, then people do not need to decide which among these options one must choose from. This is however not the case. Resources are limited while needs and wants are unlimited. Following this logic, when a major purchase decision has to be made, consumers definitely have to give up another thing that they equally like. This is the concept of trade-offs. When making a decision to buy good A, they trade off another good (good B or good C) in exchange for good A.  In the example of purchasing a new house, an individual may have to forego other things it wants to buy such as a new car, vacation, other major purchases, or savings and investment.  Realizing that life has tradeoffs guides individuals to make better decisions.
b. The cost of what one decides to buy is equivalent to the cost of what one gives up for it...  As a result of trade-offs that people face, they must then be careful in analyzing all the costs and benefits accompanying each available option.  Such is the concept of opportunity cost or what one person gives up in order to get another item.  As earlier stated, this happens because despite unlimited wants of people, scarcity of resources can not satisfy all these wants. Thus, people have to choose one thing and by choosing this, it means giving up something else. In the case of purchasing the new house, its cost is what one gives up for it, be it a vacation, or having money for savings, or having to work two jobs, or another major purchase.
c. Rational consumers think at the margins.  In reality, people do not always need to make decisions that are all or nothing. For instance, in the case of buying a new house, it is not an option of buying a house or living off the streets.  Some choices actually are made based on  “marginal changes” or what economists describe as” small, incremental adjustments to existing plans of action”. For instance, when one is deciding whether to purchase a new house, the person must compare the marginal cost of this purchase (e.g. amortization payments) vis-a vis renting an apartment (rental payments) and marginal benefits (tax shield, joy and security of owning a house) associated with owning a house. By doing this, one can evaluate whether the purchase is worth the attendant costs.
d. Incentives are a good way to motivate people.  As earlier stated, people make decisions based on the costs and benefits of each action.  Thus, when the costs or benefits change, they may decide differently.  This is because people respond to incentives.
For instance, if the rent on apartment increases, people will decide to purchase a house instead. As a result, real estate developers are encouraged to build more houses to accommodate the increase in demand. And because of this, they may hire additional helpers to help them build these houses.  All this happens because the benefit of selling houses is increased.

What are marginal costs and benefits associated with your purchasing decision?
In an individual’s decision to purchase a house, there are several marginal costs and benefits that come into play.  These have to be carefully analyzed and weighed in order to make the most rational decision for the individual (and the family).
Below are some of the marginal costs associated with the decision to purchase a new house
a. Amortization. If the individual is currently renting, and the purchase of the new house entails additional amount from the monthly rent for amortization payments, the difference in the amount is one of the marginal costs.  This is usually the case since it generally costs more to buy a house than rent.  Aside from the amortization payments, one must also consider the mortgage insurance costs that result from buying a house.
b. Travel time. Another marginal cost could be the additional travel time if the house is located farther from work or school (compared to the previous apartment). This travel time entails costs in terms of gasoline expenses, car maintenance, having to forego sleep in order to wake up earlier than usual, or sometimes having to forego sleep.
c. Maintenance costs.  If one used to live in an apartment before which does not entail too much maintenance in terms of cleaning, repairs and security, these will now have to be considered when purchasing a new house. Whereas the apartment owner was mainly responsible for many repairs and maintenance concerns, the homeowner now takes full responsibility for ensuring that their house is well maintained and secured.  All of these translate to costs. If the house comes with a yard (and they usually do), it means having to either mow the lawn or hire someone to do it. It will also mean having to spend more hours cleaning and maintaining the whole house, something that may not have been as tedious in an apartment.
d. Rental restrictions.  There are many restrictions imposed on people renting apartments.  While this encourages discipline and respect to property, this can severely curtail an individual’s freedom to move around.
Despite the marginal costs involved in buying a house, there are also several marginal benefits that one may derive from it.  Some of these are as follows:
a. Tax shield.  The government encourages people to buy homes instead of rent because of its stimulus on the economy.  Towards this end, the government offers tax shield for individuals buying their houses.  This is just one of the many benefits of owning a home.
b. Increased credit rating.  An increased credit rating allows an individual the freedom to eventually secure a bigger loan for another major purchase. This may come in handy for emergency purchases, big-ticket purchases, or even investment and business undertakings.
c. Security and comfort of owning a home.  Whether the individual buying a house is single or married, owning one’s home provides security and comfort that one can not otherwise get from renting an apartment.  One derives a certain sense of self-fulfillment in seeing the fruits of his / her labor. And with a bigger space for everyone, there is less stress and hopefully more harmony among family members. There is also freedom to be creative in designing and renovating the home.

Explain how the strength of the economy as a whole affected the marginal benefits and the marginal costs associated with that decision.
There are several possible economic indicators that may prod one to decide to purchase a house, be it a first house or a second one.  A rational individual must only decide to purchase a house if one is willing and able to do it, and carefully considered all the costs and benefits of that decision.
A large part that figures in one’s decision to make a major home purchase is the state of the economy. Why is this so?  When economy is strong, and interest rates are high, and the demand for houses is also high, the cost of houses is usually also high. With the prospect of high amortization payments a person might be discouraged to buy a house and postpone this decision to a later date. This, of course, assumes that rental payment is much lower compared to buying a house.  If, however, a strong economy means that there are several jobs offering very competitive salaries, then an individual might take a high-paying job (assuming one is qualified for it) and buy a house.
In the case of a weak economy, such as what the US economy is going through right now, the interest rates are constantly falling, and there is a weak demand for houses. As a result, the prices of real estate usually drop. An individual who is still assured of a monthly income (either through a job or a business) might find this the perfect time to buy a house where amortization is decidedly lower.  All other costs are lower, including insurance costs, maintenance costs, and other taxes and insurance. Of course, this scenario assumes that rental payment, while low, is not too low because a vast difference in amortization payment and rental payment might make an individual rethink the decision to buy.

Consider the roles of the domestic economy and international trade in your assessment of the strength of the economy.
The domestic economy is part of the vast network that makes up the global economy.  The behavior of the global economy, therefore, reflects the behavior of the domestic economies that all together make up the global economy.   When there is weak demand in the domestic economy, then it affects manufacturers, causes job losses and in a vicious cycle weakens demand. When there is weak demand in the domestic economy, it may be compensated by an increase in demand in international markets. By absorbing the excess supply of a domestic economy, jobs are saved and this may cause recovery in that domestic economy.  Unfortunately, weak domestic demands are usually a reflection of an international situation. Hence, international trade is usually negatively affected.  Without any demand from domestic economy and international markets, the local economy will eventually weaken too.  This happens if the government does not intervene to arrest the worsening situation and it usually does this by bailing out companies, providing more fiscal (tax) and monetary incentives (interest rates) and pump-priming the economy. By pump-priming the economy, demand is stimulated and this will trigger an upturn in manufacturers’ supplies.  Successful management of economic crisis creates a stimulus not only in the domestic economies, but in countries it trades with.

Determine what situations or conditions could have led you to make a different decision.
Instead of buying a house, one chooses  to remain in his apartment instead, it could be  for the following reasons:
a. Rent is significantly lower compared to buying my own house.  After scouring the neighborhood for potential houses, and diligently computing monthly amortization payments (along with all the attendant payments such as amortization insurance, maintenance costs, renovation costs, costs of moving, among others), yet find that rental payment is still significantly lower than buying a house,  a person may still prefer to rent instead.
b. High amortization.  After carefully factoring all costs involved in buying a home, a person may still not decide to buy one he can not afford it. If a person must keep up with monthly amortizations and drastically change his lifestyle in the process, like having to keep odd jobs, foregoing social activities, then he may not be persuaded to buy one.
c. Interest rate is unstable.  An unstable interest rate (as a result of an unstable economy) means that there is no assurance of a fixed rate over the years. It will severely affect amortization payments (and other costs).  If this is the situation,  a person would prefer to wait for a more stable economy before making such a huge decision.
d. Lack of job security.  If current economic scenario persists, and a person’s job security is threatened, he may need to postpone buying his own house.  There is simply no point in buying a house, despite the security and comfort it offers, if there is no assurance that a person can keep up with the monthly payments. Otherwise, a person will have to face foreclosure, and this is not an attractive option for anyone.
e. More pressing needs.  If for instance, one needs to spend on another more urgent concern, such as health-related matters that require long-term treatment (and not anymore covered by medical insurance), or that person’s child needs to go to college, he may gladly defer any decision to buy a house.
f. Travel time.  If buying a house and transferring to it requires longer travel time, this may not be an attractive option for any person considering the high and fluctuating cost of fuel these days. In the long-term,  the additional cost in fuel and car maintenance might hinder a person from fully appreciating the beauty of his own home.  This is also the same case if there are kids enrolled in a school nearby the apartment and uprooting them means a lot of troubles.
g. The house I can afford is not the best.  Buying a house entails not only computing the costs, but several other factors as well (as discussed earlier).  If buying a house will take me too far away from work, family and close friends,  I may not proceed with it. While sound investments are good in the long-term,  there are other equally important factors to consider in buying a house.  Will the family be happy with it? Will it cut his ties with friends and other family members?  If the answers to these are YES, then the house is not the best there is for that person. Such a major purchase must satisfy the needs beyond shelter.