Homo Economicus and Home Buying Economics

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The Psychology of Homebuying: Understanding the Escalation Clause

When it comes to making big financial decisions, such as buying a home, economists are often criticized for using the model of homo economicus – a perfectly rational being making decisions solely based on monetary factors. While this model has its uses in certain economic analyses, it can be counterproductive in real-life situations, such as homebuying.

One interesting concept in the realm of homebuying is the use of an escalation clause in offers. Similar to the bidding system on eBay, an escalation clause allows buyers to automatically increase their offer in set increments up to a specified maximum amount whenever another offer is made.

However, real estate agents often advise against using escalation clauses in offers. Despite the potential benefit of automatically increasing your bid, offers with escalation clauses are more likely to be passed over in favor of lower bids without such clauses.

So why does this strategy backfire in the real estate market? Unlike in online bidding, where bid amounts are asymmetrical information, an escalation clause explicitly reveals the buyer’s maximum willingness to pay. This transparency can make sellers feel like they are not receiving the buyer’s best offer, leading them to choose lower bids that make them feel more respected.

Nonmonetary factors play a significant role in decision-making, even in economic transactions. Just as astronauts accept lower wages for the nonmonetary benefits of their job, buyers and sellers in the real estate market are influenced by factors beyond money.

As you navigate through important decisions in your life, consider the nonmonetary benefits and costs that may impact your choices. Understanding the psychology behind these decisions can help you make more informed and successful transactions.