(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 211

186 PART 2 • Producers, Consumers, and Competitive Markets

E XA MPLE 5.7 THE HOUSING PRICE BUBBLE (I)
Starting around 1998, U.S. housing prices began rising sharply.
Figure 5.10 shows the S&P/CaseShiller housing price index at the
national level.20 From 1987 (when
the Index was first published) to
1998, the index rose around 3 percent per year in nominal terms. (In
real terms, i.e., net of inflation, the
index dropped about 0.5 percent per year.) This
was a normal rate of price increase, roughly commensurate with population and income growth and
with inflation. But then prices started rising much
more rapidly, with the index increasing about 10
percent per year until it reached its peak of 190 in
2006. During that 8-year period from 1998 to 2006,

many people bought into the
myth that housing was a sure-fire
investment, and that prices could
only keep going up. Many banks
also bought into this myth and
offered mortgages to people with
incomes well below what it would
take to make the monthly interest and principal payments over
the long term. The demand for housing increased
sharply, with some people buying four or five
houses under the assumption that they could “flip”
them in a year and make a quick profit. This speculative demand served to push prices up further.
However, in 2006 something funny happened.
Prices stopped going up. In fact, during 2006, prices

190

Home Price Index

170
Housing Price Index
(nominal)

150
130
110
90
70

Housing Price Index
(real)

50
1987

1989

1991

1993

1995

1997

1999
Year

2001

2003

2005

2007

2009

2011

F IGURE 5.10

S&P/CASE-SHILLER HOUSING PRICE INDEX
The Index shows the average home price in the United States at the national level. Note the
increase in the index from 1998 to 2007, and then the sharp decline.

20
The S&P/Case-Shiller index measures the change in housing prices by tracking repeat sales of
single family homes in 20 cities across the United States. By comparing a home’s original sale price
with its price in subsequent sales, the index is able to control for other variables (i.e., size, location,
style) that might also lead to rising home prices.