I live in Manhattan, and it has always been a source of fascination how prices got so exorbidant. While I am somewhat protected from market forces -- I live in school-subsidized housing -- even with the help I have a room only slightly wider than my mattress and a shower just about big enough to stand sideways in.

Anyway, Free Exchange had this great post on why is so ridiculous here in Manhattan:

The problem, after all, is just as pronounced in New York's the rental market. The current vacancy rate for apartments in Manhattan is less than 1%. Rents of several thousand dollars a month for an unexceptional one bedroom are common. The rental market is further distorted by having its supply artificially limited by rent controls* and restrictive zoning regulations that won't let buildings rise higher.

For most desirable goods, when income increases the demand curve shifts out, setting a higher equilibrium price at which more goods are supplied. What appears to be happening to New York real estate, and in other desirable cities, is more extreme. Because space is limited, and the regulatory burden on providing it is high, the number of available homes to buy or rent is fixed or adjusts slowly to market conditions. Further, it seems that the demand curve has not only shifted but flattened, making the demand for homes almost inelastic. Thus even a shoebox with no windows or private bathroom will fetch more than a quarter of a million dollars.

Two things explain the change. First, real estate in Manhattan is bundled with the ability to make a lot of money in the financial industry, something it is hard to do from a mansion in Fargo no matter how lavishly appointed. And second, falling crime and better public services have made Manhattan much more attractive. This has considerably flattened the demand curve, which is lovely for well paid hedge fund managers, but a bit hard on the journalists.

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* As a classically trained economist, I once considered this practice an egregious violation of my free market principles. Then I secured a rent stabilised apartment on the park. I now realise my mistake.

That last bit is the funniest part. I have seen the staunchest free trade promoters wax poetic about the wisdom of rent control once they are the ones on the receiving end.