Every cloud has a silver lining. Yes, housing prices are dropping at the sharpest rate in decades. Yes, existing home sales just fell for the fifth consecutive month. On the other hand, I have great new examples of demand shifters to use in the microeconomics course I start teaching next week.
Demand deals with what we are willing to pay for a particular product or service at a particular time. Demand shifters include all factors, besides price, that influence such willingness to buy.
One such factor is the price of related goods. The price of ground beef goes up and people will buy more chicken, even if its price stays the same.
Another factor is tastes and preferences. People wanted leisure suits in the 1970s but don’t now.
And then, there are expectations. If you think a product will increase in price or become unavailable, you are more willing to pay for it now than if you thought nothing would change. When people hear hurricane warnings, they clear store shelves. When anthrax threats dominated the news, clients assailed doctors with pleas for Cipro prescriptions.
In financial markets, expectations are powerful. In the late 1990s, people piled into Nasdaq-listed stocks because they expected these shares to increase in value, just as they had snapped up such conglomerates as Gulf +Western in the mid-1960s.
Housing markets also are expectations-driven. A few years ago, people jumped at the asking prices of newly listed homes because if they didn’t, someone else would. Sellers probably had already priced the house optimistically, knowing they had the upper hand. If you were cautious in going after a house, it seemed you would lose it and would be doomed to pay an even higher price later.
People with no experience in real estate fell all over themselves to buy Florida condos, expecting to re-sell them for tidy profits in six months.
The problem is that expectations are at least as strong on the way down as on the way up. When housing prices fall, first-time buyers are chumps to grab the first house they like. Better to stay in the apartment another few months and see if prices keep dropping. People who already own homes don’t make offers on houses they would prefer, because they don’t know if they can sell the one they are in now.
Such downside expectations can become a self-fulfilling prophecy. Just ask the Japanese. They rode real estate and stock markets down for a decade. Nearly 20 years after Japanese asset bubbles maxed out, most Japanese housing prices remain below 1989 levels. The Nikkei stock index is less than half as high.
This does not mean our economy is doomed to repeat Japan’s long travail. But markets do tend to overshoot on the way down just as on the way up.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.