Don’t Reason from a Quantity Change, Either

During my recent winter break, I ventured back to Massachusetts to spend some family time over the holidays. Our discussions inevitably meandered toward the striking differences in the cost of living between my native state, Massachusetts, and my adopted home, Louisiana.

The contrast is jaw-dropping. As per the World Population Review’s Cost of Living Index, living expenses in Massachusetts are approximately 1.5 times higher than those in Louisiana. The housing disparity is even more pronounced, with homes in Massachusetts being around 2.3 times pricier than in Louisiana. For instance, I purchased my 1,200 sq ft, 2-bedroom, 1.5-bath condo for $142,000 last August, while a comparable condo in Worcester, Massachusetts recently sold for nearly $400,000. This exorbitance has led to a situation where Massachusetts experiences a net outflow of roughly 30,000 residents seeking greener pastures in other states.

As a staunch advocate for free markets and the YIMBY (Yes In My Back Yard) movement, I firmly believe that Massachusetts needs to embrace a “build, baby, build” mentality. My aunt, however, contested this notion, highlighting the significant amount of construction already underway. She was not wrong; around 90,000 housing units are currently under construction in Massachusetts. My retort, however, was, “That’s still not enough housing.”

In that moment, I made an elementary mistake common in economics: I was reasoning from a quantity change. This misstep is akin to the issues my former co-blogger Scott Sumner frequently discusses—reasoning from a price change.

When one reasons from a price change, they assess how the quantity demanded will shift given a price fluctuation. For example, one might assume that if prices are climbing, the quantity demanded will likely decrease. Such reasoning can lead to errors because it overlooks the critical element of why those prices have risen, which is essential for predicting the equilibrium quantity.

Without grasping the why, making accurate predictions about the what becomes nearly impossible. Price increases can stem from either rising demand or dwindling supply, and the implications for quantity will vary significantly based on which factor is at play. If prices rise due to decreased supply, the market quantity will likely drop since suppliers will be less inclined to sell at previous levels. Conversely, if the price hike results from increased demand, market quantity may actually rise, as buyers are willing to purchase more at elevated price points.

The same logic applies when one considers a quantity change. Just as a price change does not clarify what alteration in quantity to anticipate, a change in quantity fails to specify the expected price adjustment.

Quantity changes arise from shifts in supply and demand dynamics. When demand declines, the quantity exchanged in the market diminishes as well, leading to lower prices; consumers become less willing to buy at existing price levels, prompting producers to cut back on production to minimize losses. Alternatively, if supply contracts, prices will rise, as production costs for firms increase, leading to reduced output.

In the Massachusetts housing scenario, the fluctuations in housing quantity—i.e., the ongoing construction—can be attributed to either increased demand or enhanced supply.

Should housing demand in Massachusetts be on the rise, then homebuyers are likely willing to pay more, prompting suppliers to increase construction to keep pace with these escalating prices on the demand curve. They perceive that potential homeowners are prepared to shell out more, and thus they respond by building more homes.

On the flip side, if the uptick in new homes is a consequence of improved supply, then we should expect prices to drop as the market sees an influx of available properties. Builders might have to reduce their prices to attract buyers. (Speculating on which factors are influencing the Massachusetts housing market is beyond the scope of this discussion.)

While it is feasible to temporarily suppress prices by merely increasing the quantity supplied, such measures are short-lived. If the quantity supplied surpasses the quantity demanded, the market will face a surplus, compelling sellers to lower prices to clear unsold inventory. However, this decline will persist only until the market reaches equilibrium. The equilibrium price itself won’t necessarily drop unless there’s a genuine increase in supply, not just quantity.

Thus, my assertion to my aunt was misguided. What I should have conveyed was: “To make housing more affordable, we must tackle the costs associated with building homes in Massachusetts. Increasing the number of homes available will not suffice if demand rises concurrently. We need to address the barriers to affordable housing, such as the permitting process, zoning laws, and construction regulations. Effectively lowering building costs and increasing overall supply is the only sustainable strategy to alleviate housing expenses.”