Tuesday, December 30, 2008

Theme from the Bottom - Part Two

Lest anyone think I am a “bottom” dweller and focused on the negative, please know that I am not. I was simply interested in the rudimentary economic theory and the opportunity to learn just how the market got to where it is, what we can do to improve it, and what we can do to prevent future demand shortfalls. That said, let’s sink back to the bottom.

The last entry left off with an introduction to Demand Overestimation (DO), Optimism Bias (OB), and Strategic Misrepresentation (SM). I came across these concepts while boning up on supply and demand theory. They were cited as causes of Demand Shortfall, which is what we are experiencing here in Southwest Florida. This entry will define each of the concepts in a bit more detail. I would then like to have open comment and discussion about how each of these concepts might have contributed to our Demand Shortfall.

Here’s a synopsis of what I learned over at Wikipedia. A Demand Shortfall (which, of course, is a lack of equilibrium between supply and demand and which causes a decrease in price) is the result of DO. DO is just what it sounds like – the overestimation of demand for any given product. DO is caused by our two other players, OB and SM. “OB is the demonstrated systematic tendency for people to be over-optimistic about the outcome of planned actions. This includes over-estimating the likelihood of positive events and under-estimating the likelihood of negative events.” Put another way, OB is overconfidence in the face of a starkly contrary reality. “SM is the planned, systematic distortion or misstatement of fact—lying—in response to incentives in the budget process.” Outside of its budgetary context, I think the concept of SM is nonetheless applicable in the real estate business, where many of our professionals are compensated on a commission basis and “in response to incentives.”

So here we are in a Demand Shortfall. Let’s think for a minute about examples of each of the Shortfall’s causes defined above. What do you remember from late 2005 that resembled Demand Overestimation? What about Optimism Bias? And Strategic Misrepresentation?

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