20 July 2011

Definition of a bubble (part 2)

In Definition of a bubble (part 1), I aimed to prove that high house prices during a bubble are not caused (or justified) by any of the ‘fundamental’ reasons claimed by spruikers. 

The question then arose: if it wasn’t fundamentals, what did cause the over-valuation in Aussie house prices?

Going back to economics 101, you learn that when the price of something goes up, all other things being equal, the demand for it comes down. For example, when the price of petrol rises, public transport becomes a more attractive option. This reduces the demand for petrol, which puts downward pressure on price.