Question

(Related to the Chapter Opener on page 820) According to an article in the Wall Street Journal, KB Homes and other builders found demand for new homes increasing in 2017 as a result of an increase in the formation of new households. In the long run, formation of new households depends on population growth. Are firms like homebuilders that sell products whose demand depends partly on demographic factors likely to be more or less affected by the business cycle than are other firms whose products are less dependent on these factors (holding constant other factors that affect the demand for new homes)? Briefly explain.

Short answer

Firms like homebuilders that sell products whose demand depends on demographic factors are likely to be less affected by the business cycle compared to other firms. This is because these demographic factors continue to drive demand even during economic fluctuations. However, these firms are not completely immune to the business cycle as overall economic conditions still affects consumer purchasing power.

Step-by-step solution

Understanding of business cycle and demand

The business cycle refers to the fluctuations in economic activity that an economy experiences over a period of time. It consists of expansions - or periods of economic growth, and contractions - or periods of economic decline. Demand, on the other hand, is the consumer's desire to purchase goods and services at given prices.

Understanding demographic factors and demand

Demographic factors such as population growth can influence the demand for certain products. In this case, an increase in the formation of new households suggests an increase in demand for new homes. Firms like homebuilders that sell products whose demand depends on these factors are likely to see an increase in demand as demographic factors change.

Comparing the impact of the business cycle

All firms are affected by the business cycle to some extent. However, products that are dependent on demographic factors could theoretically be less affected by the business cycle. This is because despite economic fluctuations, demographic factors such as population growth continue and create demand for certain products. However, it's important to note that while these firms might be somewhat sheltered from the business cycle, they are not completely immune. The purchasing power of consumers still impacts their sales, and during a recession, even necessary purchases like homes could decline.

Key concepts

Economic Fluctuations

Economic fluctuations, more commonly referred to as the business cycle, consist of periodic expansions and contractions within an economy. Expansions, or boom periods, are characterized by increases in employment, consumer spending, and production. Conversely, contractions, or recessions, see declines in these areas. Understanding the ebb and flow of these cycles is crucial for both businesses and consumers.

An essential element of the business cycle is its impact on demand. During an expansion, demand typically rises as consumers have more income and confidence to purchase goods and services. However, during a contraction, demand often falls due to uncertainty, decreased income, and increased unemployment. These periods can significantly influence a firm's sales and operational strategies, making it integral for businesses to adapt accordingly to sustain performance.

Demographic Factors

Demographic factors encompass the various characteristics of a population that can influence market demand, such as age distribution, family size, and population growth. These factors are critical in anticipating and planning for consumer demand. For example, an aging population may increase the demand for healthcare services and retirement homes.

In the housing industry, demographic shifts can play a significant role. As population characteristics change, the types of housing needed can transition as well. Larger family sizes may lead to greater demand for bigger homes, while single-person households could boost the market for smaller apartments or condos. Businesses attentive to these demographic trends can tailor their offerings to match the evolving needs of their consumer base.

Population Growth

Population growth is a pivotal demographic factor affecting economic activity, including the demand for new homes. It is measured by the increase in the number of individuals in a given population over time. This growth can result from natural factors, such as birth rates exceeding death rates, or through immigration, where more people move into an area than leave it.

When population growth occurs, it usually leads to an uptick in the formation of new households. This translates into a higher demand for housing as more individuals or families require their own living spaces. For homebuilders, monitoring population growth trends is key in predicting future housing needs and planning development projects accordingly. Cities or regions experiencing rapid population growth may need to expand housing infrastructure to prevent shortages and inflated real estate prices.

Demand for New Homes

The demand for new homes is a market indicator expressing the rate at which potential buyers are seeking to purchase newly constructed housing. This demand is influenced by a variety of factors including economic conditions, interest rates, and demographic changes. Notably, the formation of new households, often a direct result of population growth, underpins the consistent demand for residential real estate.

For homebuilders, understanding this demand is vital for inventory management, pricing strategies, and forecasting. Typically, a steady increase in the formation of new households suggests a stable or growing demand for new housing units. Even in times of economic downturns, while the overall demand for goods might decrease, the necessity for housing can sustain a certain level of demand for new homes. Consequently, businesses that respond effectively to these indicators can optimize their position in the market and drive their long-term success.