Economics 101

I think we should implement a new corollary to Godwin’s Law — call it McArdle’s Law, after this blog entry at Free Exchange — saying that any time someone mentions “Economics 101″ in a debate, they’ve automatically lost. The point of the Free Exchange blog is that people who criticize arguments as being “Economics 101″ are generally on the wrong side of the argument. But then again, people who praise arguments as being “Economics 101″ are generally equally wrongheaded. For instance:

With rising distressed sales of foreclosed homes and of homeowners unwilling or unable to service their mortgages, the future supply of existing homes will go up this year and next and, given downward price adjustment, the equilibrium level of existing home sales will increase over this year and next. Thus, observation of increases in the sales of existing homes over time – as long as existing home prices fall – will be signs of further distress in the housing market, not improvement. Basic economics 101 suggests that.

Yes, if you’ve taken Economics 101, then a rise in existing home sales is a sign of distress in the housing market. (Does this mean that a fall in existing home sales would be an indication that everything was tickety-boo?) I can see the argument: demand can rise as prices fall, so rising sales can be consistent with housing-market distress. But it’s a bit of a leap from that to saying that they’re a sign of housing-market distress. And it’s a jump of Knievel proportions to say that such an inference is “Economics 101″ — and I’m quite happy saying this despite the fact that I’ve never taken an Economics 101 course.

It seems to me that the housing market is not all that different from the stock market in some respects. If you want a good gauge of how the stock market is doing, you look at prices and volumes in the secondary market, not the IPO market. Similarly, existing home sales are a good indication of how the housing market is doing: it’s worth remembering that every homeowner in the country lives in an existing home, which means that it’s the market in existing homes that they’re really invested in. And if existing home sales rise, surely that’s a good thing, ceteris paribus, for the housing market as a whole: it shows that housing prices, even if they’re depressed, are at least realistic and set at a market-clearing level.

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2 Responses to Economics 101

  1. BR says:

    Somehow all this econ talk is just making my head spin around. More on this issue here:

    http://calculatedrisk.blogspot.com/2007/03/new-vs-existing-home-data.html

  2. dsquared says:

    I don’t think it’s an invalid critique at all (although it can be used invalidly) – if people are making arguments based on oversimplified models (like applying Marshallian supply-and-demand models to the labour market, or using aggregate production functions), and those arguments are based on demonstrable fallacies which are covered in higher level courses, whatcha gonna do?

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