During winter break, I returned to Massachusetts to visit family for the holidays. The conversation turned to the cost of living difference between my home state (Massachusetts) and my adopted state (Louisiana).
The difference is obvious. According to the World Population Review’s Cost of Living Indexthe total cost of living in Massachusetts is about 1.5x greater than in Louisiana. The difference in housing costs is huge, with housing in Massachusetts costing 2.3 times more than in Louisiana. To give a concrete example of what this looks like, I bought my 1,200 sq ft, 2 1.5 bath condo for $142,000 in August. A similar condo in Worcester, Massachusetts sold for just under $400,000 this past fall. The cost of living in Massachusetts is very high they have a total population of about 30,000 inhabitants moving to other states.
I am a big supporter of free markets and YIMBY (Yes In My Back Yard, the movement to increase housing availability/reduce building restrictions). My position is that Massachusetts should “build, baby, build.” My aunt refused, pointing out that there was a big building going on in Massachusetts. And you are right; others 90,000 units are under construction in the province. My answer was “There are not enough houses.”
In that answer, I made an Econ 101 mistake: I was thinking about price change. Thinking from a value shift is a companion problem to a problem my colleague Scott Sumner often writes about, reasoning from price changes.
In reasoning from price changes, one makes a decision about the direction of price given the change in price. For example, the assumption is that the quantity demanded in the market will decrease because prices are increasing. Thinking about price changes is a mistake because one needs to understand why prices go up to make a decision about what will happen at the same price.
Without understanding i whyone cannot make a rational decision about what. Prices can rise for two reasons: an increase in demand or a decrease in supply. Depending on which event occurred, the quantitative impact will vary. If prices rise due to a decrease in supply, the market price will fall because each supplier will now be willing to sell fewer units at any price. However, if prices increase due to increased demand, the market price will increase because consumers as a group are willing to buy more at any price.
The same problem applies when you think from a change of dose. Just as with inferences from price changes, where price changes do not tell us what the expected price change would be, price changes do not tell us what the price change will be.
Price changes also come from changes in supply and demand. If demand falls, the market price falls, too, because the price is lower. People are willing to buy fewer units at any price, so manufacturers reduce production to lower costs and protect profits. When imports fall, prices rise as it becomes more expensive for firms to produce and production falls because it is more expensive to produce a marginal unit.
In the Massachusetts example, there are two explanations for a change in the price of housing (ie, the entire building): an increase in demand or an increase in supply.
If the demand for housing in Massachusetts increases, then the price home buyers are willing to pay for housing also increases. Suppliers may produce more just to meet the supply price such that prices rise in the altered demand curve. They see that Massachusetts homebuyers are willing and able to pay the extra money to buy a home and simply provide those expenses.
Conversely, if new homes are being built because supply is increasing, then prices will fall as more homes are built. Builders will do it below the prices they charge for houses to lure buyers into their homes. (What factors are driving the Massachusetts housing market is not something I will speculate on as it is not relevant to this post).
It is possible to reduce prices temporarily by simply increasing the quantity supplied. If the quantity supplied exceeds the quantity demanded, then the market is overstocked. If so, firms (and retailers) will lower prices as they look to move unsold inventory. But the resulting decline in housing prices will only continue until the market reaches equilibrium. The equilibrium price will not fall as much as it would if supply, and not just quantity supplied, were increasing.
So, what I said to my aunt was wrong. I wish I had said: “If we want to make housing more affordable, we need to reduce the cost of building homes in Massachusetts to increase the amount of housing that will be provided when all the homes for sale are built. Just building more will not make housing more affordable if the demand for housing increases and the amount supplied.” barriers to affordable housingsuch as the permitting process, zoning, and other building regulations. Making it less expensive to build [that is, increasing supply] it is the only sustainable way to reduce housing costs.”
