Tuesday, August 24, 2010

Housing market has excess supply

For perishable items, like flowers and hotel rooms, price will adjust so that quantity demanded equals quantity supplied.  Excess supply will lead to lower prices which will reduce the number of sellers and increase the number of buyers.  Price will keep falling until the market "clears," when the number of buyers equals the number of sellers.

For a durable good like housing, sellers have the option of holding onto inventory, in the hope that price will increase.  For this reason, markets need not clear instantaneously, as the above graph demonstrates, taken from Calculated Risk.  The blue line is the excess supply, computed as the number of months (above 12) it will take to sell off the houses currently listed for sale.  The last time it climbed that high, housing prices eventually fell.  Th black line denotes the monthly change in housing prices.

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