A Dynamic Model of Housing Supply

Figure 13: Time Trend of Fixed Costs7 Implications of Dynamic BehaviorWith observed historical patterns of price and cost cycles and trends, it is clear that a dynamicmodel is necessary to understand the primitives that drive housing supply. Given the focus inthe literature on prices, a naïve model which ignored expectations about cost patterns wouldpredict very large levels of construction volatility. In the extreme case where prices were perfectlypredictable, discounting of future profits is low, and costs were constant, we would expect tosee construction only at the peak of prices. In reality, a sizeable amount of construction occursprior to the peak. Various explanations for this observed pattern could be offered: prices arenot predictable, parcels owners heavily discount future profits, the time to build is large, andcosts are pro-cyclical. I can examine these different accounts and, using the estimates of thestructural model, attribute the primary role to pro-cyclical costs.If the time required to build was sufficiently long relative to the typical cycle of prices, itwould make sense for parcel owners to begin building early in the price cycle. However, empiricalevidence does not support this. According to figures from the Census of Construction, 54% ofconstruction in the West Census Region is completed within six months and 91% is completedwithin twelve months. 52 These time periods are short when compared with the length of the52 See Coulson (1999) for an analysis of the relationship between starts, completions, and housing inventory.44