Housing markets in a number of countries have in recent years shown a puzzling kind of behaviour, where an apparent shortage of homes is accompanied by an unusually low transaction rate. People need houses, but they aren’t buying them. A good example is Canada. In 2023 it saw a population increase of 3.2 percent, the highest in decades. Politicians are trying to ramp up the supply of new homes to match this influx. But at the same time, metropolitan areas such as Toronto also experienced one of the slowest housing markets on record. There are more unsold condominiums in Toronto than at any time in history.

According to classical economics, the law of supply and demand states that the price for any commodity including a roof over your head will adjust so that the market clears. However, instead of clearing, housing markets are going dark. So what is going on? To understand this conundrum, a useful analogy can be found in an even more vexing phenomenon, which troubled physicists at the turn of the previous century: the photoelectric effect.

Making a spark
The photoelectric effect refers to the tendency of some materials to emit electrons when light is shone on them. In the late 19th century, physicists demonstrated it by experiments in which they placed two metal plates close together in an evacuated jar, connected the plates to the opposite poles of a battery, and shone a light on the negatively charged plate. If conditions were right, then the light would dislodge electrons, which raced across to the other, positively charged plate, in the form of a sudden spark. According to classical physics, the energy of the emitted electrons should depend only on the intensity (brightness) of the light source. Shine a bright light, get a bigger spark. But in practice, it turned out that what really mattered was the colour: blue light created a bigger spark than red light. And depending on the material, for some colours no amount of light would work.

What counts is not the total number of buyers (the brightness) but how much each buyer can actually spend (the colour)

In a 1905 paper – one of a stream of results including his famous formula E=mc2, which would define the new physics – Albert Einstein showed that the photoelectric effect could be explained by the idea, recently proposed by Max Planck, that energy is transmitted only in discrete chunks known as quanta, from the Latin for ‘how much.’ According to this theory, electrons were emitted when individual quanta of light struck individual atoms – which meant what counted was not the total energy, but the energy of each quantum of light. And this was measured by colour.

Think of the metal plate as a marketplace of atoms, each selling electrons at a particular price. The quanta of light represent the spending power of individual shoppers. Shining red light onto the plate is like sending a lot of low-budget shoppers into a high-end store. No matter how many there are, the expensive electrons stay firmly locked inside their cases. High-frequency blue light, on the other hand, is like a cruise ship full of high-spenders ripping the electrons off the shelves.

Down payment blues
Einstein of course did not use a shopping metaphor – he gave his paper the cautious title ‘On an heuristic viewpoint concerning the nature of light’ – but it was clear that, unlike most of his contemporaries, he saw these light quanta (now known as photons) not as mathematical abstractions, but as real things. As he wrote, “Energy, during the propagation of a ray of light, is not continuously distributed over steadily increasing spaces, but it consists of a finite number of energy quanta localised at points in space, moving without dividing and capable of being absorbed or generated only as entities.”

This sounds mysterious when applied to light, but again is similar to the way that we make financial transactions. When you pay at a store, there isn’t a little needle which shows the money draining from your account – instead it goes as a single discrete lump. When you buy a house, you need a quantum of cash for a down payment – and you can’t usually band together with other people, at least if you expect them to not live there with you.

In fact the comparison with photons is more than an analogy, because as shown by quantum economics it turns out that you can model transactions using the same kind of mathematics as is used to model particles of light. So for a model of the housing market, again what counts is not the total number of buyers (the brightness) but how much each buyer can actually spend (the colour).

Central banks will no doubt try to jump-start the markets by further lowering interest rates, in the hope of generating a spark. In the meantime, if you want to buy a house in a country like Canada, then what counts is the colour of your money.