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China is currently facing problems of high demand for property due to the intrusion of large number
of property speculators in the market. Supply of housing fails to meet the increasing demand,
resulting in overheating of property market in well developed cities such as Shanghai, Beijing,
Chongqing and Shenzhen. Nevertheless, it had caused social concerns among the people in China.

China government decides to implement new government policies and to enforce stricter measures
on property buyers with the intention to discourage speculators from investing heavily in property,
hoping to curb the climbing of property prices.



     
 
 

In January 2009, after the hit of the economic crisis, the government of China decides to flood the
economy with money supply to stimulate growth of the economy. (China¶s Foreign reserves hit
$2399bn, 15/01/2010) Therefore, Central bank of China came out with stimulus package that
includes lowering of interest rates and reduction in reserve ratio to encourage people to spend more
and save less so as to ensure money liquidity in the market.

The tendency for people to spend is always higher when interest is low because quantity of money
will increase, people can afford to buy more goods and services. In addition, the reduction in the
reserve ratio increases the amount of money available for loans. Hence, with low interest rate and
more money available for loans, it encourages investors to grab the opportunity to invest in
properties with the purpose to gain higher returns.

Soon after the implementation of the government stimulus packages, reports had shown that banks
have approved a total of Rmb9590 billion of mortgage loan in the year 2009. (Chinese Property
sales soar on easy credit, 19/1/2010) The after effect was almost immediate; the increase in
mortgage loans borrowed was reflected on the sales of property which has rose up to three quarter
in china. These have thus fueled buyer¶s appetite for more property. (Chinese property sales soar on
easy credit, 19/01/2010)

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Ghen demand for property increases, the need for resources/ materials to construct buildings will
increase simultaneously. As explained by experts, real estate is important in China because it is
related to 60 sectors in the market such as cement, steel etc. (Measures to cool property already
working, 08/05/2010) Based on what was mentioned earlier, we can conclude that the price surge of
real estate will have a direct impact on the prices of all goods and services in the market.

Referring to Diagram 1.1, when there is a need for more resources/ materials, the aggregate demand
curve will shift towards the right, which will then project an increase in Real GDP to $14 trillion
outperforming the potential GDP of $12 trillion. Inflationary gap is inevitable when there is growth
in Real GDP. At the same time, price level is increase by 50% on all goods and services because
supply for resources is in need to build more buildings to cater to the demand for property. This is
what we called the demand pull inflation where inflation is driven by increase in aggregate demand
for goods and services. In such cases, the government will normally intervene to ensure stability in
the economy before the situation go beyond control.

Diagram 1.1 Increase demand for materials

Potential GDP
LAS

SAS1
(Deflator: 2000=100)

150 
Price level

100 


AD2
AD1
Real GDP
12 14 (Trillion dollars)
Inflationary Gap

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The Government has implemented several measures to bring down inflation. The measures stated in
the article ³China takes tough steps to cool property market´ were as follows:

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1.‘ Restrictive down payment requirements increase of down payment from 20 percent to 30
percent for first home buyers with more than 90 square meters. 50 percent rise in subsequent
purchases of second and third home.
2.‘ Ban on lending for third home purchases
3.‘ Increase Scrutiny of developers financing
4.‘ Higher interest rate for loans, minimum mortgage loan rate on second homes is 1.1 times the
central bank¶s benchmark interest rate.

The purpose of all the above measures is to assist in the elimination of speculations in the market
and to bring down the continuous surge of property prices. It is only a temporary measure to create
hurdles for speculative buyers of property which had directly boosted the prices of property. Mr Qi
Ji, vice minister from urban-rural development commented that excessive gains in prices are mainly
due to the shortage of supply whereas the major demand for housing is due to unreasonable demand.
(Measures to cool property already working, 08/05/2010) In Diagram 1.2 shows the ideal impact of
decline in prices of goods and services with the drop in property demand after the implementation
of the new government measures.

Diagram 1.2 After implementation of measures

Potential GDP
LAS

SAS1
(Deflator: 2000=100)

150 
Price level

100


`
AD2
AD3
Real GDP
12 14 (Trillion dollars)

Aggregate demand curve will decrease (shift to the left) upon the plummeting demand for property
in the market after the implementation of the measures in China. The real GDP will then decrease
back to its potential GDP of $12 trillion and reflect a price decline in goods and services in the
market.


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However, quoted from Chairman of Huayuan Property Mr Ren Zhiqiang, he explained that these
measures can help to stabilize home prices for a period of time, but the prices might show a
³revenge´ rally as developers withdraw their investment.

Ghen people expect inflation to occur, workers will apparently demand for higher wages to sustain
their daily life as goods and services in the market are getting more expensive. Such example is
supported by the article ³Shanghai Raise in wage 15% and aid with housing´. It states that Shanghai
plans to increase the wages of the low income citizens to cope with the high property prices.
(Shanghai Raise in wage 15% and aid with housing, 31/01/2010) In another words, production
costs of materials will increase too because workers are paid more to work, resulting in a fall in
supplier¶s profit. Moreover, with the implementation of measure to discourage people from
speculative buying of houses will further reduce supplier¶s motivation for more production as the
supplier will perceive that resources/ materials are no longer in high demand.

Referring to Diagram 1.3, the effect would lead to a decrease in aggregate supply (SAS1 curve shift
left) in the market when production is reduced. Prices of goods and services will shoot up once
again because of limited supply in the market resulting in higher chances of having an acute rise in
property price when developers withdraw their investment.

Diagram 1.3 Decrease in production

LAS SAS2

SAS1
(Deflator: 2000=100)

150

Price level

100 


AD3
Real GDP
10 12 (Trillion dollars)
Recessionary Gap

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As compared to the previous price increase mentioned earlier in Diagram 1.1, the situation this time
round is slightly different. Real GDP is performing at $2 trillion lower then potential GDP of $12
trillion deriving in a recessionary gap. At that point of time, the government will make adjustment
to its policy to salvage the downturn in real GDP, mentioned by Chairman of Huayuan Property Mr
Ren. (Measures to cool property already working, 08/05/2010)

The government understands that the measures to curb inflation are just temporary solutions to
suppress rising property prices. Therefore as a long term solution to the issue, they intend to build
more affordable low rent housing for low income families to satisfy the demands in the market.
Explained by vice minister of housing and urban rural development, China may take 30 years to
build homes affordable to the people. (Measures to cool property already working, 08/05/2010) The
rationale of building more low rent housing is to ensure more supply of housing is available in the
market. That is when property prices will naturally drop with increasing housing supply.
Concurrently, all the social issues that arise due to the increase in property prices will also be
resolved with more availability of low rent housing. This is the ultimate outcome that the
government is looking forward to.

  

From the analysis above, we can conclude that the government¶s intervention in the economy is
critically important. Githout the government¶s effort to bring down inflation, it will likely spread to
all other regions. (Measures to cool property already working, 08/05/2010) Nevertheless, high
inflation rate in property will also cause citizens discontentment because average to low income
families may not be able to cope with the high property price. This would result in the widening of
income disparity between the rich and the poor over time. Although some may still question the
effectiveness of the government¶s measure, but to a certain extend, the government measures
implemented still plays a part in cooling off the overheating market.

 

 
 

  

  

The use of ASAD graph is effective to illustrate impacts of supply and demand on Real GDP and
price level of goods and service in the market within a short period of time. It is able to show how
intervention of the government will impact the economy at the specific time of occurrence.
However, an ASAD graph is unable to display the fluctuation of the economy across a longer
period of time. The time factor is never shown in an ASAD graph. According to Michael Parkin, a
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recession is defined as a period during which real GDP decreases for at least two successive
quarters. It makes us difficult to determine if the economy is indeed going through recession or it is
just a temporary downturn.

Number of Gords: 1640

References:

Parkin, Economics Ninth Edition, Denise Clinton

www.Chinadaily.com.cn, China¶s land sale revenue close to $233 bln in 2009, 02/02/2010

www.FT.com, Chinese property sales soar on easy credit, 19/01/2010

www.Foxbusiness.com, Shanghai Raise in wage 15% and aid with housing, 31/01/2010

www.Reuters.com, China takes tough steps to cool property market, 15/04/10

www.Chinadaily.com.cn, Measures to cool property already working, 08/05/2010