The past posts
have delved on different instances wherein economics can explain the real life
phenomenon. As noted earlier too, many instances we encounter often have an
underlying economics angle to them whether consciously or subconsciously. To an
economics graduate seeking to apply theories learnt during the course into real
life, the posts offer a structured way of implementing the same. Yet many who
might not have taken economics as a subject but still would have applying the
concepts into their daily life thanks mainly to the life experience curve. The current
post takes the past forward into understanding examples from the real estate,
construction and the housing industry.
There are many
factors that determine the demand function for purchase of a flat or a house. The
hedonic attributes might vary from location to the size of flat or house, the
built up area, the area available outside for aesthetic or utilitarian
purposes, the price of the land, the neighbourhood, the distance from the work
place and other amenities, the ease of transportation from the house to other
places of utility, the additional amenities that are offered as a package with
the house etc. Implied in the same would be an extensive due diligence before purchasing
the house. Moreover, to many there would be very few occasions or perhaps only
one occasion in life to purchase a house and thereby needs to avoid the trap of
adverse selection.
Due diligence implies
an extensive surveying of the houses available in the locality. Given the search
costs, many deem it prudent to hire a broker. The broker functions also as an
information intermediary and minimizes the search costs. The broker meanwhile h-as
also an self interest. To a broker, the payoffs emerge through the commission he
secures from both the buyer and seller. The seller has to offer higher
commission if the property under sale might not possess certain hedonic
attributes the buyer would seek. The broker therefore has a greater interest in
selling these properties to the buyers. Secondly, higher the value of the
property, higher would be the commission. Hence to the broker, it serves her or
his payoffs if they manage to lure the customer to purchase higher valued
properties than their initial budget.
In the course of
due diligence and property transactions, sellers demonstrate certain tricks
which are of course time tested and yet keep trapping the customers. These tricks
interestingly have some economics behind it. A couple of examples might be in
order to highlight the same.
A person
desirous of buying a house approaches a broker with her requirements. The broker
would perhaps show them different properties coaxing them to choose one. Let us
assume the broker shows them two properties one would be costing Rs. 50 lakhs and
another with far superior attributed priced let us say at Rs. 75 lakhs. The buyer
might decide to for the one with lower price perhaps, the marginal utility generated
through the additional features that the higher priced property offers is not
sufficient enough to make the jump. Yet to the broker, the objective would be
to sell the higher priced property. In normal economic modelling, if choice A
is preferred to B and B is preferred to C, A is deemed to be preferred to C.
This, is what is known as law of transitivity.
The broker
introduces to the buyer, a new property let us say worth Rs. 70 lakhs. This property
would be similar to the one with Rs. 50 lakh price but might have less inferior
features compared to that one. In essence. A would be preferred to C and B
would be preferred to C and A preferred to B thus following law of
transitivity. Yet something different happens as observed in anecdotal evidence
the resultant of which is the brokers following this strategy time and again. The
buyer now compares not the three but the two properties at Rs. 70 and Rs. 75
lakhs finding the latter very alluring. The choice of the lowest priced goes
out of the picture thus invalidating the transitivity principle. To a buyer,
what emerges is the framing of choices. When confronted with multiple choices,
the cognitive constraints of processing information make the buyer process very
limited choices thus restricting the comparison. This would now become a case
of bounded rationality. The framing of choices thus eliminates one choice and
focuses on comparison between the other two thus tilting the choice what was
undesirable in the earlier instance. Thus at some subconscious level economics
plays a significant role in exercising choices in purchase of property.
Another instance one finds such examples of
economics is in selling of flats. There are many apartments on which prominent
poster is displayed saying very few flats available and book fast. If the
apartments are located at convenient places and offer hedonic attributes as
suggested above, the buyers would want to close the deal fast. To a seller, the
desire is to sell the slow moving flats first. Within an apartment, there can
be many differences in flat attributes leading buyers to go in those with most
prized attributes. The seller however not want to sell the non-prized flats at
lowers prices which is what market model would suggest. The answer lies in the
information asymmetry between the buyer and seller. The buyer does not know how
many flats are sold. The buyer can believe the poster or not believe the
poster. If the buyer desires to buy a certain flat, the seller can dissuade by
stating it has sold though it might not have got sold. The seller might be
interested in getting higher price for the same. Therefore, there are differences
in payoffs between buyer and seller thus the information asymmetry works to the
advantage of the seller. The seller would be able to sell the relatively less
hedonic and wait for those with higher hedonism which are anyway fast moving products.
The above two examples
are just among the many examples that abound in the industry. To many who ply
their trade in their industry, economics hardly would occupy their mind space. Their
learnings are what Taleb would describe as grandmom’s tips. It is the learning curve
accumulated over ages that is at play. Yet to the economists, studying the
process, this offers great insights into the paradigms of information asymmetry,
rationality and choices, framing of choices, transitivity and its applications,
hedonism and marginal utility, adverse selection, among many others.
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