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Buying a New House--An Economic Decision

Updated on February 21, 2012

Introduction

It is important for people to learn about economics. Knowing how money works, what causes prices to rise or falter, and how to get the most for your buck, is a benefit to anyone in modern society. Looking at the choices people make on a daily basis, one must wonder what goes through the mind of the average individual. When it comes to purchasing car, a new home, or even some fast food on the go, there must be benefits and cost properly weighed. By failing to weigh the cost and benefits properly, one could easily lead themselves down the road of financial ruin. For this paper, we will take a look at what an average American citizen must consider when they are investigating whether to purchase a new home.

The 10 Principles of Economics

According to Mankiw, there are ten constants in economics. The first principle is “people face trade-offs.” This mean that there is a cost for everything—an opportunity cost. By deciding to place resources into one thing, we cannot dedicate those same resources to another item. When we compare and contrast the cost and benefits of two or more alternatives, we are dealing with the second principle: “the cost of something is what you give up to get it.” Cost is not just a matter of dollars and cents; it also represents what we must give up in order to get something else. If I buy a truck instead of a car, for example, part of the cost of that truck is not getting the car. The third principle Mankiw goes over is “rational people think at the margin.” Of course, there are those who think well beyond the margin, and that is why this statement has a qualifier. Thinking at the margin means people are trying to stay within their means, but often must face the choice of just a little bit more versus just a little bit less. “People respond to incentives” is the fourth principle of economics. This makes sense. The more someone can get for their investment—be it work effort, money, time, or similar commodity—the more likely they are to invest. In the text, we see the fifth principle that “trade can make everyone better off.” This allows individuals, companies, even countries to focus on their strengths while gaining the benefits from others’ strengths. It means that we get more competition, which enriches the market, keeps prices down, and provides us all with a wider variety of choices. Mankiw’s sixth principle is “markets are usually a good way to organize economic activity.” This principle puts forth that the economy, as a rule, benefits from competition and free industry. The seventh principle indicates that the government, while not wholly in charge, can help spur the economy. “A country’s standard of living depends on its ability to produce goods and services” serves as the eighth principle of economics. Think about it. The better one is at producing, the more income can be generated, which means more can be purchased and established. In a modern economy, purchasing power does equal standard of life. The ninth principle put forth by Mankiw is that of inflation. It stands to reason that when there is too much money in circulation, the money loses its value which in turn increases the price of goods and services. Finally, the tenth principle tells us that it is a precarious balance to find ourselves between inflation and unemployment. This is because as we inject money into an economy, more people are likely to buy. With more people buying, there is a higher demand for employees to provide the consumer with goods and services. If we inject too much, the economy crumbles. If there is not enough money in circulation, then we see purchases dwindle, which causes fewer employees to be needed, which leads to unemployment, which is another way disaster can strike an economy (2007).

Applying the 10 Principles

While the average American does not go into the all of these theories when choosing to purchase their own house, they do—or at least should—go through a number of them. The first and second principles go hand in hand, and this is one people consider for all sorts of purchases. Whether to buy a burger, shoes, car, or home, one must take into account its cost. Is the item within an acceptable price range? What will one give up if they spend their money here instead of elsewhere? Aside from cash cost, will there be additional costs? Does one need to drive out of their way, spending more in gas, and missing time? In the case of a new home, there are many things to consider. Will one be closer to or further from work? If one has children, will they stay in the same school or move to a new school? How will travel be effected? Many renters do not pay some utilities; how much of an increase will this be? Even with utilities renters do pay, will there be more space, so we can expect higher utility bills? If one were to buy a house now, where would they need to cut their spending? We must also consider that a rational consumer will not purchase a house unless it fits within their budget. No one wants to stretch themselves so thin financially they one slight misstep and the house is gone, along with the initial investment and accumulated mortgage payments. Another part of that decision is to consider the incentives offered for buying a new home. There are many incentives, particularly for the first time home buyer. Federal programs such as FHA can be a major boon (United States Department of Housing and Urban Development, n.d.). Right now there is an $8,000 tax credit for first time home buyers as well (National Association of Home Builders, n.d.). Because of the economy, we are in a buyer’s market, which is an inventive in and of itself—low prices. The thought that everyone can benefit from trade also comes into play here. Lots of people are trying to sell houses, and they are competing with one another for buyers. This keeps prices low. In a free market, we are faced with a lot of competition. This is true in the house market of today. This brings consumers many great deals. Unfortunately, it also gives the consumer a lot more information to sort through before they can make their decision. The seventh principle ties into buy a house, especially in America today. There are several loan and grant programs subsidized by the United States government to encourage people to buy a home. If you consider the eighth principle looking at a family rather than a country, this can also be useful. The better the family unit is at making money, the bigger, better a home they can afford. The ninth and tenth principles tie together. While they may not directly figure into one’s decision to buy a home, the do figure into the current state of the economy. The potential buyer’s observation of the economy should influence their decision as to whether to buy a new house or not.

Marginal Cost vs. Marginal Benefit

One must always weigh the concept of marginal cost versus marginal benefits. With a large purchase the numbers are inflated, which makes the decision all the more important. Trying to weigh marginal benefits and marginal cost, particularly when buying a home is not always easy. There are many things that factor into the decision, and not everything can have a price tag on it (CreditAnswers, LLC, n.d.). Is it worth moving to a part of town that is further away from work, because the area is better? How much better? How much further? There will be some added cost, such as the expense of gas and mileage on one’s vehicle, but few can put a dollar amount on safety. Will the house be bigger, providing one with more room for a growing family? Will mortgage payments be less than or more than current rent payments? What other incremental costs will arise as part of the decision to buy a home? Insurance, extended utilities, moving expenses, and more are all things we can put a dollar amount on. We cannot, however, place a dollar amount on pride of ownership, perhaps enhanced convenience, more space, and other things that simply make like better.

An Economy in Turmoil

The American economy is in turmoil. This would enhance the importance of marginal benefits and costs, because one has more at stake. Will their job be there tomorrow? Will the home go up in value or continue to fall? We can look at the falling value of the dollar in comparison to the American economy. Trust in the American economy has faltered on a global scale. “With world capital markets interconnected as never before -- financial problems at U.S. banks are affecting pension funds in Japan as well as depositors in California -- a mounting sense that America's financial crisis is still far from touching bottom is adding to global troubles, including rising overall inflation and soaring energy prices” (Faiola & Irwin, 2008). All around the world, America’s economic woes are being felt. The repercussions are not lost on those here within the States either. Plans have been put into place to spur on economic growth, but none have been successful as of yet.

Conclusion

If things were different, one could come up with a completely different choice. If our economy was stronger, and a house was more likely to stay at a stable price or rise in value, the choice might be easier. The house might most likely also be more expensive. Some of the government plans would no longer be available, because there would not be such a strong push to bring cash flow into the market. It would be harder to get a loan, so many would be without the options that they have now. It is still a risky venture, unless one is in a wholly stable financial situation. Is the risk worth it? To some it is. To others: one bitten makes twice shy.

References

CreditAnswers, LLC. (n.d.). What is marginal cost?. Retrieved February 10, 2010 from http://www.creditanswers.com/what-is-marginal-cost.php

Faiola, A., & Irwin, N. (2008, July 16). An economy thrown into turmoil: U.S. financial crisis increasingly infecting the rest of the world. The Washington Post. Retrieved February 10, 2010 from http://www.washingtonpost.com/wp-dyn/content/article/2008/07/15/AR2008071500999.html

Mankiw, N. G. (2007). Principles of economics (4th ed.). Mason, OH: South-Western Cengage Learning.

National Association of Home Builders. (n.d.). Home buyer tax credits. Retrieved February 12, 2010 from http://www.federalhousingtaxcredit.com/

United States Department of Housing and Urban Development. (n.d.). Common questions from first time buyers. Retrieved February 12, 2010 from http://www.hud.gov/buying/comq.cfm

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