26.5.15

WHY ECONOMISTS SPEAK OF PRICE SCISSORS.

I used to be able to incorporate at least one newspaper howler into each principles of economics exam.  I'm out of that business now, but it's still easy to find such material.  Case in point: a recent analysis of rising house prices supposedly crushing a recovery in housing. "Sales of existing U.S. homes slipped in April due to relatively few listings and rising prices, a trend that could weigh on the recovering housing market." That's potentially good news: the foreclosures and short sales might be mostly done, and solvent sellers will only accept offers with a reasonable return on their investment.  Or it's bad news, as fewer people are relocating.

The article illustrates why economics is about impounding things in ceteris paribus.
The National Association of Realtors said Thursday that sales of existing homes fell 3.3 percent last month to a seasonally adjusted annual rate of 5.04 million. April marked the second straight month of the sales rate topping 5 million homes. Purchases have recovered from a disappointing 2014 because strong job growth and low mortgage rates have generated more would-be buyers.

But greater demand in recent months has failed to convince more people to list their properties for sale. Only 5.3 months' supply of homes are on the market, versus an average of six months in a healthy market. The number of listings actually tumbled 0.9 percent in April compared to a year ago.
Strictly speaking, we're modeling an increase in demand (a rightward shift, using my locution) that produces a ceteris paribus increase in price and in consumption. But we're also seeing a revision of long-run supply behavior of some kind.
The tight supplies have caused properties to fly off the market and prices to rocket upward. The median home sold in just 39 days last month, versus 52 days in March and 62 days in February.

Median home prices climbed 8.9 percent over the past 12 months to $219,400. That's more than four times faster than average hourly wage growth. Home values are now just $2,500 shy of the 2006 peak.

Unless more homes come onto the market, there is a cap on how much sales can rise as more buyers face bidding wars and are priced out of the market.
If you stop there, you're done. Short run supply relatively inelastic; demand increases at all prices, price increases, but some buyers are rationed.

Push further, current homeowners now face an option value in holding their houses in expectation of higher prices. (That's a hard one to teach to introductory students, although the intuition is "wait for improved information."
The shortage shows the long reach of the 2008 financial crisis and the housing bust, which continues to haunt the housing sector even as the economic recovery approaches its seventh year. Millions of homeowners still owe more on their mortgages than their homes are worth — and they're unwilling to sell at a steep loss, depriving the market of inventory.

Nearly 17 percent of mortgage holders were underwater at the end of 2014, according to the real estate firm Zillow.
So far, so good, but now the author commits an elementary error.
The lack of supply should help prices rise to a level that fixes this problem. But too swift an increase also poses a destabilizing risk for the market. If home values rise too quickly, economists warn that more buyers will be priced out of the market and demand will fall.
No, we've already accounted for that. The existing houses move relatively quickly. Additional houses coming onto the market would help some of those buyers, but there are scant incentives to put nearly underwater houses on the market, let alone to build new ones.
One way to address the shortage would be to build more homes. The government reported this week that homebuilders upped the pace of construction in April to the fastest level since November 2007. But developers say that the process of planning new developments that could provide a greater inventory of homes can take at least a year.
Yes, and the creation of new developments is a long-run response, with irreversibilities.  Higher house prices might call forth new construction, but it might also induce some of those near-underwater buyers to wind up their positions.

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