Inelastic

Key Takeaways

• Demand or supply is inelastic when a percentage change in price produces a smaller percentage change in quantity, such as a 5 percent price move that shifts quantity demanded by only 3 percent.
• Elastic is the opposite: a 5 percent price move that shifts quantity demanded by 7 percent describes sensitive, elastic demand.
• Demand for real estate is treated as relatively inelastic, while the supply of new construction is relatively elastic because builders respond to price over time.
• In Washington, RCW 36.70A.110 requires counties planning under the Growth Management Act to draw urban growth areas, outside of which growth can occur only if it is not urban in nature.

What It Means

Inelastic is an economics word for insensitive. It describes how much the quantity of something bought or produced moves when its price moves. If a 5 percent price increase cuts the quantity demanded by only 3 percent, demand is inelastic, because the quantity response is smaller than the price change that caused it. If the same 5 percent increase cuts quantity by 7 percent, demand is elastic, or sensitive.

Demand for real estate is usually described as relatively inelastic. People still need somewhere to live, so a price move does not push a proportional share of buyers out of the market. Supply behaves differently depending on what is being counted. New construction is relatively elastic, since builders start more projects when prices rise, but the land underneath is fixed, and adding buildable lots takes permits, infrastructure, and time.

The practical payoff is price volatility. When demand barely bends and supply cannot expand quickly, small shifts in the number of buyers translate into large moves in Market Value. That is the mechanism behind the sharp swings brokers see in a tight market, and it is why Appreciation in a supply constrained submarket can outrun income growth for years.

How It Works in Washington

Washington has a statute that pushes housing supply toward the inelastic end of the scale. RCW 36.70A.110, part of the Growth Management Act, requires each county planning under RCW 36.70A.040 to designate an urban growth area or areas within which urban growth shall be encouraged and outside of which growth can occur only if it is not urban in nature. The same section requires the county and its cities to include areas and densities sufficient to permit the urban growth projected for the succeeding twenty year period. Urban density housing goes inside the line, and the line does not move on a builder's schedule.

That is a supply story, not a demand story, and brokers should keep the two separate. Demand can be inelastic for the ordinary reason that housing is a necessity. Washington adds a second constraint on top of that, namely where the Comprehensive Plan and Zoning permit urban development at all. When a county reviews its urban growth area, buildable land inside the boundary is what changes. Our buyer and seller markets guide reads those conditions from the sales side, and our interest rate guide covers the demand side, where financing costs move the number of qualified buyers.

Example

Broker Tessa Nguyen tracks a Kitsap County submarket that closed 1,000 sales last year at a median price of $520,000. This year the median rises 5 percent to $546,000 and closed sales fall to 970, a drop of 3 percent. A 5 percent price move produced a 3 percent quantity move, so demand in that submarket is inelastic: buyers absorbed most of the increase instead of leaving. Tessa checks the other side of the ledger and finds 62 new single family permits issued, up from 48 the year before, a 29 percent jump on the same 5 percent price move. Construction is behaving elastically. Her conclusion for a seller pricing in that market is that a modest price increase is unlikely to cost many buyers this year, but the permit surge signals more competing inventory in the next 18 to 24 months.

Common Mistakes and Exam Traps

• Inelastic does not mean quantity never changes. It means the percentage change in quantity is smaller than the percentage change in price that produced it.
• Elastic and inelastic are easy to reverse under time pressure. Elastic demand is sensitive to price, inelastic demand is insensitive to price.
• Supply and demand can have different elasticities in the same market. Real estate demand is relatively inelastic while the supply of new construction is relatively elastic.
• Inelastic demand cuts both ways. A weak quantity response lets prices fall hard in a downturn too, not only rise hard in a boom.