Date Added: Apr 2010
Inventories and price changes are correlated. The inverse relation is most obvious in housing where inventories build in low demand markets and shrink in high demand markets. This is a puzzle. If sellers and buyers had symmetric views of the world, one would think that sellers would lower their reservation value at the same rate that buyers lower their offer price. Because there is heterogeneity among buyers in the valuation of a given house and because houses are not homogeneous, sellers set prices strategically. When demand falls, it is optimal for sellers to lower their prices but not by enough to keep the probability of sale constant. As a result, inventories grow.