Monday, January 02, 2006

Real Estate Prices and the Problem of Averaging

Paul Krugman in No Bubble Trouble? writes on housing prices and the recent study that said, on average, Americans still spend a lower percentage of income on housing than at times in the past:
"Last summer I suggested that when discussing housing, we should think of America as two countries, Flatland and the Zoned Zone.

In Flatland [most of the country], there's plenty of room to build houses, so house prices mainly reflect the cost of construction. As a result, Flatland is pretty much immune to housing bubbles. And in Flatland, houses have, if anything, become easier to afford since 2000 because of falling interest rates.

In the Zoned Zone [Northeast coast, West Coast, etc.] , by contrast, buildable lots are scarce, and house prices mainly reflect the price of these lots rather than the cost of construction. As a result, house prices in the Zoned Zone are much less tied down by economic fundamentals than prices in Flatland."
His point is that discussion of averages misleads. It's a reminder useful not only in discussing housing, but in other areas of national debate.

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