Estimating the weight of opportunity costs in housing consumption

ABSTRACT

Behavioural economics suggests that people tend to neglect or underweight opportunity costs. However, strong empirical evidence for the size of the underweighting appears to be largely absent from the literature. What are the weights people attach to opportunity costs relative to out-of-pocket costs? In this article, I estimate the weight of opportunity costs in probably the largest economic decision that households make: buying a house. I show that homeowners attach approximately twice as much weight to out-of-pocket costs of their housing consumption than to the opportunity costs associated with this.

KEYWORDS:

• Opportunity costs
• out-of-pocket costs
• housing consumption

JEL CLASSIFICATION:

• D11
• D12
• R21

Acknowledgements

I am grateful to Leon Bettendorf, Jan Boone, Wolter Hassink, Arjan Lejour, Gerbert Romijn, Wouter Vermeulen and an anonymous referee for providing useful comments on earlier versions of the manuscript. Further, I would like to thank Arie ten Cate for his technical assistance on some methodological issues and Annemarie van der Zeeuw for her help on improving the readability of my research.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Ashraf, Camerer, and Loewenstein (2005) show that Adam Smith already drew attention to the distinction between out-of-pocket and opportunity costs.

² The logarithmic transformation generates a highly symmetric distribution of residuals.

³ The collection of data and the survey is repeated every 3 years. WoON 2012 was delivered in 2013 and was not yet accessible while the analyses in this article were being carried out.

⁴ Setting this rate a 3% or 5% has only a very small effect on the estimation results below.

⁵ Increasing or decreasing gross user costs by 1% point again has only a very small effect on the estimation results.

⁶ At this rate, the total fiscal subsidies in the database match the macroeconomic data on fiscal subsidies in 2005.

⁷ By excluding maintenance from out-of-pocket cost, I run the risk of underestimating these. The database I use contains some (categorized) information on the costs of maintenance and rebuilding carried out in the year previous to the survey. However, it is unknown whether these were paid in cash or financed by a loan. In the Netherlands, it is common practice though to finance larger construction jobs by a mortgage loan, particularly at the time when people buy another home. In general, interest on these loans is tax deductible, which makes these loans relatively attractive. Therefore, I expect a minor effect of ignoring out-of-pocket maintenance costs. As an indirect robustness check, I ran the regressions in the next section separately for the group of households with low (<2500 euro) and high (2500 euro and higher) reported maintenance cost. I found no significant differences in any of the estimated demand parameters.