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Can Free Entry Be Inefficient? Fixed Commissions and Social Waste in the Real Estate Industry

  • Chang-Tai Hsieh
  • Enrico Moretti

Real estate agents typically charge a 6 percent commission, regardless of the price of the house sold. As a consequence, the commission fee from selling a house will differ dramatically across cities depending on the average price of housing, although the effort necessary to match buyers and sellers may not be that different. We use a simple economic model to show that if barriers to entry are low, the entry of real estate agents in cities with high housing prices is socially inefficient. Consistent with our model, we find that when the average price of land in a city increases, (1) the fraction of real estate brokers in a city increases, (2) the productivity of an average real estate agent (houses sold per hour worked) falls, and (3) the real wage of a typical real estate agent remains unchanged. We cannot completely rule out the alternative explanation that these results reflect unmeasured differences in the quality of broker services. However, we present evidence that as the average price of housing in a city increases, there is only a small increase in the amount of time a buyer spends searching for a house, and the average time a house for sale stays on the market falls.

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File URL: http://dx.doi.org/10.1086/376953
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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 111 (2003)
Issue (Month): 5 (October)
Pages: 1076-1122

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Handle: RePEc:ucp:jpolec:v:111:y:2003:i:5:p:1076-1122
Contact details of provider: Web page: http://www.journals.uchicago.edu/JPE/

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  1. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
  2. Michael A. Arnold, 1992. "The Principal-Agent Relationship in Real Estate Brokerage Services," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 20(1), pages 89-106.
  3. Steven Berry & Joel Waldfogel, 1996. "Free Entry and Social Inefficiency in Radio Broadcasting," NBER Working Papers 5528, National Bureau of Economic Research, Inc.
  4. Sirmans, C. F. & Turnbull, Geoffrey K., 1997. "Brokerage Pricing under Competition," Journal of Urban Economics, Elsevier, vol. 41(1), pages 102-117, January.
  5. H. Peyton Young & Mary A. Burke, 2001. "Competition and Custom in Economic Contracts: A Case Study of Illinois Agriculture," American Economic Review, American Economic Association, vol. 91(3), pages 559-573, June.
  6. David Genesove & Christopher Mayer, 2001. "Loss Aversion and Seller Behavior: Evidence from the Housing Market," NBER Working Papers 8143, National Bureau of Economic Research, Inc.
  7. Jeremy C. Stein, 1995. "Prices and Trading Volume in the Housing Market: A Model with Down-Payment Effects," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 379-406.
  8. Geoffrey K. Turnbull, 1996. "Real Estate Brokers, Nonprice Competition and the Housing Market," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 24(3), pages 293-316.
  9. Spence, Michael, 1976. "Product Differentiation and Welfare," American Economic Review, American Economic Association, vol. 66(2), pages 407-14, May.
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