Cutsinger’s Solution: Housing Quantity and Price

Housing is a highly durable good and often lasts for many decades. Consider the housing market in Cleveland.

Suppose that in 2026:

Cleveland has 250,000 existing homes, all built before the year 2000.
Homes never depreciate.
No new homes have been built in Cleveland over the past 26 years.
The marginal cost of building a new home in Cleveland is $200,000, and the construction industry has constant returns to scale.

(a) Using a standard supply and demand graph, draw Cleveland’s aggregate housing supply curve in 2026. Be sure to clearly label any key prices and quantities.

(b) Suppose demand for housing in Cleveland increases. Using your diagram, explain how this affects the equilibrium price and quantity of housing.

(c) Now suppose demand for housing in Cleveland decreases. Using your diagram, explain how this affects the equilibrium price and quantity of housing.

(d) Do increases and decreases in housing demand have symmetric effects on housing prices and quantities in Cleveland? Explain your answer using your supply curve.

Solution:

According to the question, The housing market in Cleveland is characterized by two key features. First, there is an existing stock of 250,000 homes that were all built prior to 2000 and do not depreciate. Second, new homes can be constructed at a constant marginal cost of $200,000. These two facts—durability and constant construction cost—determine the shape of the supply curve and, in turn, how the market responds to changes in demand.

Start with supply.

Because homes do not depreciate, the existing stock of 250,000 homes is fixed. At any price below $200,000, no new homes will be built. Builders would incur a loss if they attempted to construct at those prices. As a result, the total quantity of housing supplied is fixed at 250,000 units. In a standard supply and demand diagram, this corresponds to a vertical supply curve at 250,000 homes for all prices below $200,000.

Now consider what happens at $200,000. At this price, builders are just willing to construct new homes. Because the construction industry exhibits constant returns to scale, the marginal cost of building an additional home remains $200,000 regardless of how many homes are built. This implies that once the price reaches $200,000, builders are willing to supply any additional quantity of housing at that price. Graphically, the supply curve becomes horizontal at $200,000 for quantities greater than 250,000 homes.

Taken together, the supply curve has a kink. It is vertical at 250,000 homes up to a price of $200,000 and horizontal at $200,000 beyond that point.

With the supply curve in place, consider how the market responds to changes in demand.

Suppose demand increases. Initially, the equilibrium lies on the vertical portion of the supply curve. Because the quantity of housing is fixed at 250,000 homes, the increase in demand raises the price of housing without changing the quantity. Buyers compete for the existing stock, bidding up prices.

As demand continues to increase, the price eventually reaches $200,000. At that point, new construction becomes profitable. Builders enter the market and begin supplying additional homes. Further increases in demand do not raise the price above $200,000. Instead, they increase the quantity of housing through new construction. The price remains pinned at $200,000, while the quantity expands.

Importantly, this process changes the supply curve itself over time. When new homes are constructed, the total housing stock increases. What was previously a vertical supply curve at 250,000 homes shifts to the right—to, say, 260,000 or 275,000 homes—reflecting the larger stock of existing housing. In this sense, past increases in demand leave a permanent imprint on the market by expanding the housing stock. The vertical portion of the supply curve is not fixed forever; it moves outward as new homes are added.

Now consider a decrease in demand.

When demand falls, the equilibrium remains on the vertical portion of the supply curve. The existing stock of homes—now potentially larger due to past construction—does not change. There is no mechanism for reducing the quantity of housing in response to lower demand. Homes do not disappear, and no one can “unbuild” them. As a result, the entire adjustment occurs through prices. A decrease in demand leads to a lower equilibrium price, while the quantity of housing remains fixed at the existing stock.

This highlights the asymmetry. Increases in demand raise prices and eventually induce new construction, which expands the housing stock and shifts the supply curve outward. Decreases in demand, however, do not reverse this process. The housing stock does not contract. Instead, prices fall to clear the market.

This asymmetry has important real-world implications. In cities that experience sustained declines in demand—due to population loss, deindustrialization, or changing economic conditions—the housing stock remains in place even as demand weakens. The result is persistent excess supply at prevailing prices, which manifests as falling home values, rising vacancy rates, and underutilized housing. In extreme cases, this can contribute to urban blight, as properties are abandoned or poorly maintained because their market value falls below the cost of upkeep.

The key constraint is simple: housing can be added, but it cannot easily be subtracted. When demand rises, prices eventually trigger construction, expanding the housing stock and shifting supply outward. When demand falls, that adjustment margin disappears—quantity is pinned by the existing stock, so prices do all the work. The result is an inherent asymmetry: upward demand shocks translate into both higher prices and more housing, while downward shocks translate primarily into lower prices. This is not unique to housing. In any market for durable goods, past production decisions constrain current adjustment, and those constraints determine how prices and quantities respond.