[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Thinking Like an Economist
INCENTIVE AND INFORMATION PROBLEMS
IN THE HOUSING MARKET
For most Americans, buying or selling a house is likely to be
the largest financial transaction they ever engage in. For people
selling houses, setting the right price is critical. Set the price
too high, and the house may remain unsold for months; set it
too low, and the house sells quickly but the seller ends up with
less money. Most people rely on a real estate agent to help
them sell their homes, and the agent’s job is to recommend a
price at which to list the home, advertise it to attract potential
buyers, and help the owner negotiate a final sale.
Because real estate agents know more about the local
housing market than the typical client does, they can use
their informational advantage to help sell the home. In their
book Freakonomics, the University of Chicago economist
Steven Levitt and his co-author Stephen Dubner highlight
some of the ways real estate agents signal information about
a house to other agents and to potential buyers. Words in
ads such as “fantastic,” “spacious,” “charming,” or “great
neighborhood” actually are associated with lower sales prices,
while “granite,” “state-of-the-art,” “Corian,” “maple,” and
“gourmet” are associated with higher sales prices. Levitt
and Dubner argue that the second set of descriptive terms
tell potential buyers about particular attributes of the
house. If all you can say about a house is that it is “spacious,”
potential buyers may take that as a signal that the place isn’t
all that great—otherwise, the ad would list its specific
attractive features.
Interestingly, when real estate agents sell their own homes,
they are much more likely to employ specific terms like “granite”
or “maple,” knowing that doing so is likely to yield a higher
sales price.
Why then would they use adjectives like “fantastic” when
they are hired to sell the homes of others? The answer lies in
the incentives agents face. Suppose an agent lists her own home
for $400,000. If she receives an offer of $380,000, she may
decide to reject it and wait longer for the higher asking price.
After all, she gives up $20,000 if she accepts the offer. But when
it is your home she is selling, the situation is quite different.
The agent typically receives a commission that is equal to a
percentage of the sales price. After the costs of advertising
and the share that goes to the agent’s company are subtracted,
only 1.5 percent of the sales price ends up in the agent’s pocket.
So if you reject the $380,000 offer in hopes of getting an offer
of $400,000, the agent stands to gain only about an extra $300
(1.5 percent of $20,000), a far cry from the $20,000 she would
gain if it were her home. In selling her own home, the agent
has a big incentive to reject the lower offer; but when it comes
to your home, the agent’s incentive is to encourage you to accept.
Giving up the chance of an extra $300 is too small a gain to
make the agent want to pass up a sale that guarantees her a
commission of $5,750 (1.5 percent of $380,000).
SOURCE: Steven D. Levitt and Stephen J. Dubner, Freakonomics (New York: William
Morrow, 2005).
the shoes plus the service of having the shoes fitted. And the more expensive store
is providing a higher-quality service.
Yet as we know from experience, essentially the same good may be sold at different
stores for different prices, and it is not always possible to account for the observed
differences in prices by differences in other attributes, such as the location of the
store or the quality of the service provided. In these cases, we say there is price
dispersion. If the act of finding out all prices were itself costless (or information
were perfect, as in the standard competitive model), consumers would search until
they found the cheapest price. And no store charging more than the lowest price
on the market would ever have any customers. But in a world of costly information,
THE SEARCH PROBLEM ∂ 343