Tuesday, September 20, 2005

The Beauty of Simple Economics

Economists sometimes tend to forget how simple tools can go a long way in helping us to understand the real world. So we spend a great amount of time trying to construct complicated models that ironically driving us further and further away from reality.

A lot of real world puzzles can indeed be explained by concepts as simple as demand and supply. Take the example of the real estate boom in the US. Many pundits have pointed their fingers to irrational expectations on the part of buyers' as the root cause of the recent housing boom. That may be true. But we have also learned from Econ 101 that prices are determined by supply and demand.

Irrational acts on the part of buyers that result in high prices do not explain why suppliers of housing fail to profit from the high housing prices by simply building more houses. So what is the reason that prevents suppliers from taking profit from the real estate boom in the US. Steven Landsburg at Slate has the answer, read on. Once you finish reading it, you may not yell eureka but I bet you will agree with me that simple economics does go a long way in helping us to understand the real world.

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