To enter or not to enter

You are an entrepreneur, wanting to start a business. You've worked in the building trades and hope to build on that knowledge, and your business degree. You want to go into the business of building single-family homes, in the Kalamazoo area. The question you have to answer is this: is there room in the industry for a new builder?

Here are the facts and figuring (which you are to gather and do). First, you need to be able to build 20 units a year to make enough to justify going into the business. So what you are interested in knowing is if the demand for new houses is increasing enough for you to sell that many houses, without cutting into the sales of established builders.

You figure this way. Right now there are so many builders in the Kalamazoo area (the county say). They are building so many new houses each year, and each builder wants to expand their business by so many units a year. All right, say right now, this year, year 1, 400 units are being built and builders want to build 10% each year. Well then next year, year 2, established builders will want to build 440 units. Well, if the demand for new units each year goes up by say 5% (from 400 to 420) then there's no room for you in the market, unless you're willing to build a home for less than established builders are charging, which you are reluctant to do.

All right, what would determine the annual increase in the demand for new homes?

Answer: any number of things. We'll focus on one thing: real income. As real income goes up in the area (income adjusted for changes in prices), the demand for new homes will go up. How much? That depends on two things. One, the year-to-year percentage increase in average real income. Two, the income elasticity of demand for new homes. Say the first number is 15% and the second number is 2.1. Then the demand for new homes will go up by 2.1 x 15% = 31.5%. In that case, if 400 new units were demanded in year 1, that many plus 31.5% of that many would be demanded in year 2. Thus, if 400 units were demanded in year 1, 1.315 x 400 = 526 units would be demanded in year 2.

OK, in that case a new builder could be bullish about entering the market. Established builders will want to build 440 units in year 2 and demand will be 526 units. That leaves 86 units for grabs. And you only need to grab 20 of those to be in business. All right, now it's time to gather some data and do some more figuring (of the above sort).

Go to census.gov. Click as follows browse by topic; income and poverty; income; data tables; historical income tables households; Table H6, all races. Go to the section of Table H6, all races for the midwest and get mean income in 2020 $ for 2009 and 2019. Put those numbers in 1) and 2) on the answer sheet. Figure the percentage change in that income from 2009 to 2019 and put that in 3). (The column that you're getting these incomes from should have 86,638 as mean income in 2020 $ for 2000.)

Now let's see how the demand for new homes changed over that period. Go back to census.gov. Now click as follows browse by topic; housing; new housing (construction); historical data; housing units authorized in permit-issuing places. Note that the last click will open an XLS file for you. Under "annual data" get the total number of New PrivatelyOwned Housing Units Authorized by Building Permits in Permit-Issuing Places for the midwest for 2009 and 2019. (You're in the right column if the number for 2000 is 323,800.) Put the numbers you get in 4) and 5). Figure the percentage change in new housing units from 2009 to 2019 and put that in 6).

Use the numbers in 3) and 6) to estimate the income elasticity of demand for new houses in the midwest. Put that number in 7).

How in the $#%! do I do that? Good question. Go to REVNOTESelasticity. Go to the second page in that file (29 is in the lower right hand corner of the page). There you'll find the formula for estimating own price elasticity (about a quarter of the way down the page, in bold). Substitute "income" for "price" and you have the formula for estimating income elasticity. All right, you're almost finished. Suppose that income elasticity is 3.

Now when I convert the percentage change in income that you got calculated into an annual percentage change, I get 2%. So use these two numbers (3 for elasticity and 2% for the percentage change in income) to figure 8), the percentage increase in the demand for new homes in the Kalamazoo area. Use that number to figure the number of new homes that will be demanded next year if this year that demand is 400 units. Put that number in 9).

So, if customers will go to established builders before they'll go to a new builder prices the same, and if established builders will want to increase their sales of new homes by 10% next year, what would you have to be willing and able to do to enter this market with sales of 20 units? Answer: charge less than established builders. How much less? Well, that's determined by own price elasticity of demand for new houses, and the % increase in demand that you need to provoke through a price cut. You want to cut price enough to increase demand by 20/400 x 100% = 5%. Suppose that own price elasticity is .5. Use those two numbers to figure the % decrease in price necessary to increase demand by 20 units. Put that in 10) and you're done.

Answers: 1) Average household income in 2019 $, midwest, 2009 ____________ 2) Average household income in 2019 $, midwest, 2019 ____________ 3) Percentage change in household income 2009 to 2019 ____________ 4) New Privately Owned Housing Units Authorized 2009 ___________ 5) New Privately Owned Housing Units Authorized 2019 ___________ 6) Percentage change in housing units authorized 2009 to 2019 ___________ 7) Estimated income elasticity of demand for new houses ___________ 8) % increase in the demand for new homes, Kalamazoo area ___________ 9) The increase in the number of new homes demanded, Kal area ___________ 10) % decrease in price necessary to increase demand by 20 units ____________