Ever since China released the housing policy State Council Document Number 10 on April 17, 2010, its housing market has experienced many changes. Various actions affecting the market include tightening mortgage rates, rising down payments for second homes, restricting house purchases, and rising property taxes.1 China’s government used these instruments to slow down the soaring housing prices and make houses affordable for the public. We are interested in the effects following the implementation of these policies, and whether the housing market became more efficient or just pulled back from the rising prices. Regarding the new and second-hand housing markets, this article focuses on comparing the situations during pre- and post-policy shock periods. Following Parkin (2014), we define a market failure as a situation in which a market delivers an inefficient outcome. In order to evaluate a situation, we develop a dynamic equilibrium E-mail address: wdchen@thu.edu.tw. 1 The government tested new property taxes in Shanghai and Chongqing. The property tax rate in Shanghai is set between 0.4% and 0.6% and in Chongqing between 0.5% and 1.2%. model, whereby we reveal the relationship between transaction cost and market failure. Because houses are unique and sellers usually post their selling price higher than the equilibrium to maximize their own profit (or increase their surplus), vacancies always exist, which provide buyers with more choices. If the number of vacancies is large, this indicates buyers might have more searching work to explore the suitable objectives. According to Commons (1931), transaction cost includes searching costs, bargaining costs, and policing and enforcement costs. It is a well known fact that, China’s economy features a high degree of income disparity. A report by the Peking University Institute of Social Science Survey showed that income inequality among Chinese citizens in 2014 had reached a severe condition, as the richest 1% of China’s population possessed 1/3 of the country’s wealth, while the poorest 25% of Chinese citizens owned only 1% of the country’s wealth. Due to the perceived low risk of real estate, owning a house has always been one of the favored investments for wealthy Chinese. Compared to other countries, China’s real estate tax is relatively low, with the tax for self-occupancy at 0% and non-self-occupancy between 0.4% and 0.6%, which are far below other countries, like Singapore, at 4% (self-occupied) and 10% (not self-occupied).