People moving to a new city perceive housing prices through the lens of prices where they
lived previously, according to new research by Professors Uri Simonsohn and George
Loewenstein published in the January 2006 issue of the Economic Journal.
So, for example, a Manhattan resident who moves to Pittsburgh will pick a more expensive
apartment than a person moving to the Steel City from Gadsden, Alabama – regardless of
how much money they make.
The reason? Housing prices are higher in New York City than in Pittsburgh, where housing
is, in turn, more expensive than in Gadsden – so the same Pittsburgh apartment that looks
like a steal to a New Yorker will seem outrageously overpriced to the Alabama transplant.
This study is the first real-world test of a phenomenon called ‘contrast effects’, in which
people determine the best price to pay for a good based on previously faced prices. It
shows that important economic decisions may be based on irrelevant, fleeting cues that are
difficult to justify on any rational basis.
Professor Loewenstein says:
‘People really have no idea how much they should spend on housing. Is an extra
bedroom worth $400 a month? If you come to Pittsburgh from Manhattan, where an
extra bedroom would cost you $800, it is likely to seem worth it. But if you come from
Gadsden, where an extra bedroom would cost you $200, it isn't.’
The study also finds that over time, movers who stay in their new city adjust the amount
they spend on housing in the opposite direction from their previous city. Thus, people will
be less influenced over time by housing costs where they lived previously, and bring their
spending in line with the housing market in their new city.
Professor Simonsohn comments:
‘This second finding is significant because it rules out that people from New York
rent more expensive apartments in Pittsburgh simply because they are richer or
have more expensive taste. If that were the case, then the amount they spent in their
second apartment in the new city would also be influenced by the city they came
from, but it is not.’
The paper, which looks at 650 movers between more than 170 US cities, has a range of
implications for the study of consumer behaviour and market activity. Traditional studies of
economic behaviour, for example, assume that consumers make decisions based on stable
and pre-existing preferences.
The research also challenges a longstanding assumption that demand always becomes
more price-sensitive in the long run, because people are able to adjust in response to rising
or falling prices.
For example, in the short term, most people cannot dramatically reduce their use of
gasoline in response to a spike in prices, because they must still drive to work and can only
eliminate a few discretionary trips. But if prices remain high over time, then consumers will
respond by buying more fuel-efficient cars, significantly reducing their fuel consumption.
But this study shows that in some markets, the opposite may occur. If prices change
suddenly, people may initially react dramatically, but then reduce their reaction after they
get used to the new prices.
This is exactly what happened to some renters in the study, who reacted strongly to the
immediate contrast between prices in their destination and origin cities, but then often undid
the initial effect by moving again within their new city.
ENDS
Notes for editors: ‘Mistake #37: The Effect of Previously Encountered Prices on Current
Housing Demand’ by Uri Simonsohn and George Loewenstein is published in the January
2006 issue of the Economic Journal.
Uri Simonsohn is at the University of Pennsylvania. George Loewenstein is at Carnegie
Mellon University.
For further information: contact RES Media Consultant Romesh Vaitilingam on 0117-983-
9770 or 07768-661095 (email: romesh@compuserve.com). Uri Simonsohn via email:
uws@wharton.upenn.edu; George Loewenstein via email: gL20@andrew.cmu.edu; or
Jonathan Potts, associate director, media relations, College of Humanities and Social
Sciences, Carnegie Mellon University on +412-268-6094 (email: jpotts@andrew.cmu.edu).