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Chinese Real Estate Market-Application of Game Theory

Since 2007, in order to deal with the serious problem of inflation, Chinese government has raised the interest rate 6 times and the required reserve ratio 10 times (in that year CPI reached 4.8% and hit 6.9% in November). Unlike the western market, Chinese government utilized the fiscal and monetary policies to the very extent in order to deal with the economic problems. Therefore, when analyzing the sellers’ and buyers’ market in China, the role of government is unnegligible. The goals of the developers are to make profits by selling out real estates as well as keep the capitals cycling smoothly in order to avoid the capital chain rupture. The consumers’ goal is to buy houses or apartments at a price lower or equal to the valuation for the housing. The objectives of Chinese government, however, are actually quite complex: growth of GDP, control of inflation, sustained government income, the stability of the society, the balance between different fractions inside the Communist Party and so on.

If some developers are to cut down the price of the real estate, other developers will match the price cutting in order to reduce the loss, otherwise the stock of the real estate will cause capital stagnant and the developers will probably undergo bankcruptcy because of the huge insolvent borrowings from the bank. According to Chinese National Bureau of Statistics, the debt asset ratio of 9 listed companies exceeded 70% and 7 out of 42 are between 60% and 70%. Therefore, the prior goal for most of the developers is to try every means to sell out the residential areas in order to avoid bankcruptcy. If all the developers choose to keep the current price while at the same time, keep the capital flowing in a lower rate, it is possible that in the future, central government will cease to introduce tightening policies and the developers will make huge profits by satisfying the relative inelastic demand of the consumers. In order to simplify the example, we assume that there are two complanies in the real estate market and that the market is highly competitive. the table of the payoffs is:

Developer B

Developer A

Cut down the price Keep the current price Raise the price
Cut down the price (8, 8 ) (8, 0) (11, 0)
Keep the current price (0, 10) (5, 5) (9, 0)
Raise the price (0, 11) (0, 9) (7, 7)

As you can see, since the future policy adopted by central government is unpredictable and the confidence of the public for the real estate is low, the payoffs for both A and B raising the prices are both lower than that of cutting the prices. Therefore, cutting the price becomes a strictly dominant strategy for developers in the competitive market. However, for those who beseech other submarkets of the real estate and those in monopolistic competition, cutting the price will not necessarily be the  strictly dominant stategy. For example, in order to avoid the impact of Home-Purchase Limits Policy adopted by central government, Wanke, one of the most influencial developers in China switches the target to the interior cities because the real estate market in those cities are far from being saturated and the demand is more inelastic, also, since government concentrate more on the big cities such as Shanghai and Beijing, the policies for real estate in interior cities are less tightening.  Therefore, the sales revenue is gauranteed and the possibility for capital rupture is reduced.

In addition, Chinese government also have to choose between selling the land and imposing property tax. If the government continues selling the land, the best outcome is that the resugence of the real estate market will bring back huge government income in the short run, but the risk is that the current deflationary policies adopted by central government will keep dampening the real estate market, therefore, the income obtained by auctioning the land will shrink because developers hold pessimistic view on the market and will tend to place lower value on the land. The second option is to levy property tax. The advantages are that not only government may receive tax revenue but may also correspond to the public voices to futher dampen the housing market in order to keep the stability of the society while the disadvantage is that the developers will be further discouraged by the taxes and the revenue receive from auctioning the land will drop down significantly.

The buyers are also in a dilemma situation. If they keep saving money for the expectation that the future price of the housing will drop significantly, the inevitable inflation will depreciate the currency and they will probably suffer a loss. Also since the future policies are unclear because a different fraction in the communist party will come onto the stage after next election, there is risk that if the new policies are adopted, the  real estate market will recover again and the price of housing will keep a steady gowth in the long run. However, if people choose to buy the housing right now, they will retain the value of their asset if the growth of the price in higher than that of inflation rate. But again, there is a risk of making a loss if the future price drops even more severely due to the continuing tightening policies.

As you can see, every participants in the real estate market will evaluate the pros and cons of the different strategy, which invilves the precise analysis of the market information and the correct prediction for the future policies adopted by the central government. The interactive relationship between the participants constructs a complex network.

Reference:

http://www.channelnewsasia.com/stories/economicnews/view/1127007/1/.html

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