Induced Demand and Housing

So been noodling on this idea for a while and generally thought it had some merit, but then went back to the basics and asked myself: what are the key principles of induced demand as we understand them in transportation planning? According to Anthony Downs, it’s the following triple-convergence:

  • drivers who used to take alternative routes during peak hours will switch to the improved route (spatial convergence);
  • drivers who used to travel outside of peak hours start traveling during those hours (time convergence); and
  • commuters who used to take other modes (cycling, transit, etc) during peak hours may now switch to driving, since it has become faster (modal convergence).

So what would the triple convergence be for housing? Let’s consider:

  • People who would have rented for longer before buying may now be able to buy sooner, adding to homebuyer demand;
  • People who would have been priced out due to rising rents may now be able to stay, as either they can find alternate options in case their rent goes up or their landlord is unwilling to compete for a new tenant who may have more options;
  • People who would not move to the city/neighborhood because they couldn’t afford it previously may now move there because prices are within their range.

Reading the three points above, one would think that increasing supply would also correspondingly increase demand, and nothing will change? But that’s not right – note in all three points above, the key factor is that prices/rents need to come down first!

According to the most basic definition of induced demand (wikipedia):

In economics, induced demand – related to latent demand and generated demand[1]– is the phenomenon whereby an increase in supply results in a decline in price and an increase in consumption. In other words, as a good or service becomes more readily available and mass produced, its price goes down and consumers are more likely to buy it, meaning that demand subsequently increases.[2]

The price has to come down for demand to increase. In effect, this is what the supply arguments rest on: it doesn’t matter if demand increases because the point is that prices may come down to allow more people to keep, buy or rent new housing. In the worst case, prices may stabilize, but if prices keep going up, it negates any induced demand.

Now of course, there is a nuance here in that we’re assuming everyone in those three categories are in similar socioeconomic conditions. There’s still the potential that prices may converge closer to a median, allowing more people on the higher incomes in the distribution to enter the market at the expense of those on the lower side. In the early years of a supply-constrained market, this is likely to occur until the housing market stabilizes, which depends on a number of variables and can take anywhere from several years to more than a decade.

If that’s a logical way to frame this, then tenant protections would need to be implemented first, so that shifts in the market don’t adversely impact lower-income residents during the early years before the housing market has stabilized.