Our modern understanding of supply and demand owes a great deal to Alfred Marshall and his textbook “Principles of Economics.” In this seminal work, he describes many aspects of price theory that are still taught in an essentially unchanged form today; indeed, at the beginning of Milton Friedman’s career, it was still used as a textbook for entering Ph.D. students at the University of Chicago. Yet, in this work, the terms buyers’ market and sellers’ market are never used. 

Though many businessmen are assured that these concepts make up a core of economic thought, they are surprisingly unamenable to a rigorous presentation: After making some general remarks, we will how this term fails most spectacularly when describing the current real estate market.

Limitations of the “Buyer’s Market” and “Seller’s Market” Concepts

The terms “buyer’s market” and “seller’s market” are inherently subjective and lack precise definitions. First thing, to claim that buyers or sellers have an advantage requires the selection of a “reference period” that is inherently arbitrary: If prices are down over the last month but up over the last year, are we in a buyer’s or a seller’s market? This difficulty also cannot be avoided by focusing entirely on supply either as the same problem applies there; supply could be down over the last month and up over the last year. Beyond this inherent ambiguity, the use of these terms implies a binary classification of markets, overlooking the continuum of market conditions that exist in reality: For example, there are markets where supply and demand fall or expand in tandem.

These terms also imply that sellers suffer in a buyer’s market and vice versa. Yet, if new suppliers come into the market and pull prices down by expanding supply, prices will drop, thereby creating a “buyer’s market” even though clearly sellers still consider the circumstances beneficial to them relative to other markets or they would not be entering: In short, the idea fails to consider the most essential concept in economics, even more than the notions of money and price, opportunity cost.

A market might still represent a beneficial opportunity for sellers relative to others even as the entry of competitors pushes prices downward. For these reasons among others, economists prefer to analyze markets through a more comprehensive framework based on economic principles such as supply and demand, equilibrium, price elasticity, and allocative efficiency.

Read more: Impact of dual agency home sale prices

Why It Fails Spectacularly Regarding Real Estate

These terms especially fail when accounting for the wide range of factors influencing real estate transactions. As a result, they may lead to misinterpretations and misjudgments by market analysts. Real estate markets often exhibit varying degrees of competitiveness, influenced by factors like inventory levels, interest rates, government policies, and demographic trends. Thus, characterizing a market solely as a “buyer’s” or “seller’s” market overlooks the dynamic nature of supply and demand.

For example, supply could increase in aggregate but the supply of a particular kind of housing—for example starter homes—could remain quite tight; in short, real estate is not a single market but an assembly of sub-markets. Indeed, regulations like minimum lot sizes often produce just this effect—the prices of starter homes can go up even if prices are falling throughout the rest of the market. Attempts to summarize even a geographically localized market using the terms “buyer’s/seller’s market” could obscure important points.

Inventory levels

While inventory levels are a key part of real estate market analysis, interest rates are as important: The use of the term buyer’s market overlooks the possibility that demand might slump because interest rate hikes have made homes unaffordable. In that circumstance, a buyer might find himself in a “buyer’s market” while wishing he were shopping in a “seller’s market” created by the much lower interest rates.

In short, most buyers care much more about the size of their mortgage payment than they do about the actual amount they must pay for the home; cash buyers are a minority, after all. Here this fundamental ambiguity, that cash buyers may have an advantage while buyers using credit are suffering, cannot be captured by the term “buyer’s market.”

Conclusion

While the terms “buyer’s market” and “seller’s market” are often used in real estate discourse, they are fraught with limitations and may not accurately capture the complexities of market dynamics. Economists generally avoid these terms in favor of more rigorous analytical frameworks grounded in economic principles. By examining supply and demand dynamics, demographic trends, regulatory effects, and other factors, economists provide a more nuanced understanding of real estate markets, enabling informed decision-making by buyers, sellers, and policymakers. It is wise to critically evaluate the use of deceptive terminology and strive for a deeper understanding of the economic forces shaping real estate markets.

Neither-Nor: Why We Need to Stop Referring to Buyer’s and Seller’s Markets was last modified: May 21st, 2024 by Franklin Carroll