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CHAPTER • Uncertainty and Consumer Behavior 187 actually fell slightly (about percent in nominal terms) Then, in 2007 prices started falling rapidly, and by 2008 it had become clear that the great housing boom was just a bubble, and the bubble had burst From its peak in early 2006 through 2011, housing prices fell by over 33 percent in nominal terms (In real terms they fell by nearly 40% percent.) And this drop is an average for the United States as a whole In some states, such as Florida, Arizona, and Nevada, the bubble was far worse, with prices dropping by over 50 percent The United States was not the only country to experience a housing price bubble More or less the same thing happened in Europe In Ireland, for example, a booming economy and increasing foreign investment—along with widespread speculation— pushed housing prices up 305% between 1995 and 2007 (641% between 1987 and 2007—both in nominal terms) After over a decade of above average growth, Ireland’s bubble burst By 2010, housing prices had fallen over 28% from their 2007 peak Spain and other European countries suffered similar fates, contributing to a worldwide debt crisis Other apparent bubbles have yet to deflate Many Chinese cities, including Shanghai and Beijing, have seen rapidly rising housing and land prices, with some apartments reportedly doubling in value in mere months.21 Informational Cascades Suppose you are considering investing in the stock of Ajax Corp., which is trading at $20 per share Ajax is a biotech company that is working on a radically new approach to the treatment of chronic boredom (a disease that often afflicts students of economics) You find it difficult to evaluate the company’s prospects, but $20 seems like a reasonable price But now you see the price is increasing—to $21, $22, then a jump to $25 per share In fact, some friends of yours have just bought in at $25 Now the price reaches $30 Other investors must know something Perhaps they consulted biochemists who can better evaluate the company’s prospects So you decide to buy the stock at $30 You believe that positive information drove the actions of other investors, and you acted accordingly Was buying the stock of Ajax at $30 a rational decision, or were you simply buying into a bubble? It might indeed be rational After all, it is reasonable to expect that other investors tried to value the company as best they could and that their analyses might have been more thorough or better informed than yours Thus the actions of other investors could well be informative and lead you to rationally adjust your own valuation of the company Note that in this example, your investment decisions are based not on fundamental information that you have obtained (e.g., regarding the likelihood that Ajax’s R&D will be successful), but rather on the investment decisions of others And note that you are implicitly assuming that: (i) these investment decisions of others are based on fundamental information that they have obtained; or (ii) these investment decisions of others are based on the investment decisions of others still, which are based on fundamental information that they have obtained; or (iii) these investment decisions of others are based on the investment decisions of others still, which in turn are based on the investment decisions of still more others, which are based on fundamental information that they obtained; or etc., etc You get the idea Maybe the “others” at the end of the chain based their investment decisions on weak information that was no more informative than the information you started with when you began thinking about Ajax In other 21 Fearing a sudden collapse, the Chinese government took steps to curtail skyrocketing housing prices, tightening lending requirements and requiring purchasers to put more money down See http://www.businessinsider.com/the-chinese-real-estate-bubble-is-the-most-obvious-bubbleever-2010-1#prices-are-way-out-of-whack-compared-to-global-standards-3
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