Wisest of the crowds
- solving problems one market at a time
Raise prices you *&^%% idiot!
By karim May 4, 2007
Yesterday, Russel Shaw at Bloodhound Blog posted a note he received from a young person sniffing the real estate industry. Entitled “I’ll bring you a big basket of cash if you’ll let me sell your house for free” Shaw responds to the young persons overt question whether the industry is crowded and the covert question as to whether pricing can be used as a competitive weapon. Shaw tells the young person not to use pricing to differentiate (and yes there are too many agents). This got me thinking. If EVERY industry has price discrimination, why doesn’t housing? (yes there are firms like Redfin and FSBO’s but traction is light) This is not whether orange people get better prices than purple people. Not that kind of discrimination. This is you using e-trade for stock execution rather than Morgan Stanley. Does variation in transaction costs make sense for housing?
I am not an economist but here goes.
The graph above is what Shaw is saying. There is one price for transactions (or something like that) and that you should stick to it. An economist would say that given the demand at that price, sales will be S1. Lets see if we add new prices…..
So by adding new prices, we tap into a larger amount of the total demand. From an industry perspective, price discrimination (price variation) yields HIGER total number of transactions. This is why airlines use it. This is why software companies use it. This is why EVERYONE uses it. Ever clipped a coupon? Ever cashed in on frequent flier miles? This is price discrimination at work.
So the one thing to consider that might debunk this basic economic notion is whether the demand curve (in blue) is in fact oddly shaped. Lets take a look….
So if demand is the same regardless of price then Mr. Shaw is correct. In fact, if demand in the real estate industry is oblivious to transaction costs than Mr. Shaw and all the other realtors are bloody idiots for not raising prices. So I guess the question is this: is demand for housing sensitive to transaction costs or not? If it is, like most things, then everyone stands to be better off by offering differing levels of pricing (and service). If demand for housing is not sensitive to transaction costs…then put your orders in for those new german cars because margins are about to get much better.
Giddy up little doggy!
Tags
real estate, housing, economics, housing industry, redfin, housing analysis, Existing home sales, economy, home values, transaction costs, price
Comments
Greg Swann says
8:03 pm, May 4, 2007
Is it your belief that a lower marginal transaction cost — representing at most 10% of the purchase price, including all closing costs, and dipping no lower than 3% under any circumstances — would induce significant numbers of people to need or want or actually use more residential real estate?
This topic has come up before, and I find it implausible. The number of pillows you can use at any given time is determined by the number of heads you have. Reducing the marginal cost of real estate transactions — a notion that ignores the trade-offs inherent in limited-service business models — seems unlikely to increase your actual need for real estate. Overbuying as a status symbol might increase if costs went down, but by how much, taking account that the potential savings nets out to an absolute maximum of 7% of the total purchase price?
dougco says
10:02 pm, May 4, 2007
You tell it like it is my man!
karim says
7:11 am, May 5, 2007
Greg, thanks for the comment. I certainly see your point and I think it is a reasonable position. The bottom line answer is I don’t know if new buyers would emerge if transaction costs had more variety. Intuitively it seems so but I have no substantial evidence of this. The sub-prime mess was born of, among other things, back loading these marginal expenses of housing and naturally you saw home ownership in this country rise - substantially in some markets. Of course this is all unwinding now but clearly marginal buyers emerged when marginal friction was removed (hidden).
You are feet on the ground and so if you think demand is inelastic, then it seems that there may be greater economic rents you could extract (you can charge higher prices). When I think of the housing market here in SF and see people compete and someone walks away with the prize based on paying less than a half of one percentage point of value versus another person, it seems that demand has substantial elasticity.
The opposite question you might consider is what would happen if everyone RAISED prices. Do you think demand would change?
Wisest of the crowds » Discrimination at Redfin! says
9:10 pm, May 13, 2007
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