Income Inequality and Housing Affordability

Rising income inequality poses significant challenges to housing affordability. Using a general equilibrium search model with heterogeneous buyers and sellers, this study explores the relationship between income inequality and housing market outcomes. Our theoretical framework unveils three distinct equilibria: affordable (integrated), pooled (partially segregated), and vertical (fully segregated). We demonstrate that a mean-preserving increase in income inequality leads the market to transition from an affordable matching equilibrium to a vertically segmented one, passing through a region of multiple equilibria where small shifts in fundamentals can generate large, discontinuous changes in market outcomes. Similar market dynamics are predicted by increasing the proportion of rich buyers. Through the externality related to the composition of sellers in the market, poor buyers are worse off and rich buyers are better off as the market transitions from affordable to vertical equilibria. Leveraging Chinese data, we illustrate the model’s applicability to real-world scenarios. Our findings have important policy implications, such as progressive taxation and redistribution, targeted affordable housing policies, and policy signalling, for addressing housing affordability challenges in an era of rising income inequality.