+1 862 207 3288 Real estate Economics and Market Analysis
During the first half of the semester we spent a good deal of time discussing marginal efficiency of investment (capital), the definition of real estate (ie: uniqueness), how our expectations of returns should diminish as capital chases opportunity and finally how market returns ought to reflect relative risk. Much of the market that is described in The Big Short contradicts these expectations and allows for a small group of “genius” investors take a short position in the market. Please discuss the above as it relates to your reading of the book – please use specific examples drawn from the book and the lecture slides.
September 22, 2014 Class 3 Slides 1
REAL ESTATE INSTITUTE
NEW YORK UNIVERSITY
SCPS
REAL ESTATE ECONOMICS
&
Market Analysis
REAL1-GC1045
Fall 2014
September 22, 2014 Class 3 Slides 2
Urban Economics is the study of economies that are organized as
urban areas and can be defined as places with:
• A very high population density, compared to the
surrounding area; and
• A total population greater than some minimum number (to
distinguish urban areas from small towns
Most urban areas have an identifiable central point where population
density is at a peak and declines with distance from that point.
Urban economies are based on frequent contact among people and
economic activities, and high population density facilitates that
contact.
September 22, 2014 Class 3 Slides 3
Urban Economics is also the study of cities.
Cities Are:
• the heart of the modern economy and society
• economic centers of trade and finance, culture,
innovation and education
• Saddled with problems like crime, traffic congestion,
sprawl, racial segregation and discrimination
September 22, 2014 Class 3 Slides 4
Two ways to examine the economy of an urban area
The first looks at on the location patterns within the area by
focusing on the location decisions of households, firms and
industries and by analyzing the spatial pattern of population
density in an urban area
There is a recognition that location decisions are influenced by
many factors, including public policies regarding the provision
of transportation facilities and other public goods and services,
local taxation, zoning and other forms of land use control.
September 22, 2014 Class 3 Slides 5
The second focuses on the growth or decline of the economy of the
urban area itself.
Most urban areas specialize in the production of a certain group of
goods or services for export outside the urban area and have an
identifiable economic function within the larger economy
Changes in the larger economy can have sizable impacts on an urban
economy and at times may require that the urban area undergo a
significant change in its basic economic function.
September 22, 2014 Class 3 Slides 6
Urban Economics began in the 1930s when traditional
macroeconomics tools (gnp, multiplier, imports/exports,
unemployment) were adapted to study urban economies.
1959 – Anatomy of a Metropolis (Hoover/Vernon) used data to
hypothesize on firm and household location choice.
1964 – Location and Land Use (William Alonso) laid out a basic
theoretical model for location choice where firms and households “bid”
for the use of “land ” at various locations.
September 22, 2014 Class 3 Slides 7
Urban economics is about the economics of urban areas. Urban areas are
linked to the larger economy, and one critical task is to understand those
linkages.
The other major part of the agenda of urban economics is to understand
the spatial patterns of economic activity within an urban area – and how
those patterns have changed.
September 22, 2014 Class 3 Slides 8
Two Points from the book on observed demographic trends:
Very rapid population growth in the metropolitan area leads to an increase
in population densities and to the rapid spreading out of the urban area.
In the absence of population growth at the metropolitan level usually
translates into population decline in the core of the urban area because
there is an underlying trend towards suburbanization even in the urban
areas that are not growing.
September 22, 2014 Class 3 Slides 9
Three distinct schools of thought in Economics (and Urban Economics)
• Mainstream
• Conservative
• Marxist
September 22, 2014 Class 3 Slides 10
Mainstream Economics (“liberal” politically)
• Most urban economists subscribe to this school.
• Generally, mainstream urban economists take the economy as they
find it. Their first task is to understand the workings of the urban
economy, and then they make policy recommendations that are
designed to have benefits that are greater than costs.
• The ethical objective is the maximization of the utility of the
members of a society, where utility depends upon the goods a person
consumes and how a person spends his/her time.
• The society is constrained by the availability of resources including
land, capital and the time of its members.
• The goal of “maximization” subject to constraints leads to the
familiar normative proposition that marginal benefit of a particular
good or activity (and hence price) should equal marginal cost.
September 22, 2014 Class 3 Slides 11
• Mainstream Economists believe that the allocation of resources
to their various uses is for the most part best handled by the
market.
• Mainstream Economists argue that monopoly (and oligopoly),
externalities (pollution and congestion), information problems
(such as murky accounting firms) and public goods all call for
public action to improve the allocation of resources.
• They also acknowledge that the market economy produces a
distribution of income that is unequal and they generally favor
public policies to reduce income inequality. They recognize that
there may be some loss of efficiency caused by income
redistribution policy but they suggest that society might tolerate
some inefficiency in order to achieve a more equitable income
distribution.
September 22, 2014 Class 3 Slides 12
Mainstream Economists:
• They believe that government intervention in
these situations will improve matters.
• They believe that the government is capable of
using monetary and fiscal policy to stabilize the
economy in the short run and to promote growth in
the long run.
• A fair amount of their research focuses on the
costs and benefits of various policy actions or
proposals.
September 22, 2014 Class 3 Slides 13
Conservative Economics (“conservative” politically)
Milton Friedman and Freidrich Hayek (both Nobel
Prize winners) are the most famous practitioners.
Conservative urban economists normally are distrustful
of the ability for government to undertake policies that
enhance individual freedom.
Their research agenda will often include finding out
why the market outcome is the best outcome.
Concerned with the progressive replacement of
competition with planning, or the central direction of
the nation ’s resources toward “some objective.”
They see the danger is people who advocate goals for
the society other than freedom and liberty.
September 22, 2014 Class 3 Slides 14
The pursuit of social goals (except for those with unanimous
agreement) restrict the freedom of individuals.
The decision to engage in central planning of a particular sector of
the economy will lead to a delegation of substantial power to
planning agencies.
They are against Fiscal and Monetary policy – in fact Friedman
suggests that the Federal Reserve should increase the money
supply by a fixed percentage per year (a rule) rather than attempt
to engage in discretionary monetary policy.
Increasing reliance on administrative discretion rather than the rule
of law would ultimately result in socialism.
For Friedman the basic proposition is that human freedom is the
ultimate end and that competitive capitalism is a system of
economic freedom that is a necessary condition for political
freedom.
September 22, 2014 Class 3 Slides 15
Government should be limited to certain functions that support the
competitive market economy – such as “pure public goods”
(common defense, maintenance of law and order, enforcement of
contract, definition and enforcement of property rights, and provision
of a monetary system)
Governments should not regulate or operate monopolies nor should public
policy attempt to correct for externalities (neighborhood effects) or
informational problems.
If property rights are fully defined and enforced and the costs of entering
into private contracts are trivial then externalities will not cause
inefficiencies. Private negotiations can be used to arrive at an efficient
allocation of resources. (a factory and noise – who owns the right to the
noise? Or the right to peace and quiet?)
September 22, 2014 Class 3 Slides 16
Society should follow a simple rules of law rather than rely on
bureaucratic judgments of people such as officials of the EPA
and social workers.
Acknowledge the “free rider ” idea with regard to the use of
charity to alleviate poverty therefore it must be a public
program hence the negative income tax.
September 22, 2014 Class 3 Slides 17
Marxian Economics (Socialist/Marxist politically)
The overriding theme in Marxism is the class struggle between the two
classes that are associated with the two primary factors of production –
capital and labor.
According to Marxists, conventional economics omits class conflict as an
important factor to consider.
The Marxist urban economist seeks to find the locus of the crisis of
advanced capitalism that will lead eventually to socialist revolution.
Marxists seek to make clear the underlying “structural ” reasons for social
problems in our capitalist economy.
Many contemporary Marxists think that the inevitable class struggle
between capital and labor is taking place in America ’s central cities and
includes conflict over the use of land.
September 22, 2014 Class 3 Slides 18
REAL ESTATE
September 22, 2014 Class 3 Slides 19
What is Real Estate?
The most common definition of real estate is the national stock of buildings,
the land on which they are built, and all vacant land.
All land (including that beneath existing buildings) is considered an asset and
counted as wealth or “stock”.
When defined this way, the value of all real estate makes up the largest
component of national wealth.
September 22, 2014 Class 3 Slides 20
The yearly value of new buildings put in place represents an
annual investment in the nation ’s stock of capital . The dollar
value of these new buildings has been the largest single category
of national investment in recent years – representing
approximately 7% of Gross Domestic Product (GDP).
Of this 7% roughly 60% is payment to the construction sector
(for labor, equipment, etc.) and the remaining 40% going to the
producers of building materials.
US Real Estate is the largest single component of national
wealth and the largest component of annual net private
investment.
September 22, 2014 Class 3 Slides 21
Land is not is counted as part of investment (GDP) since it s not
a produced commodity.
September 22, 2014 Class 3 Slides 22
• Location Decisions of Firms and Households
• Location Theory
• Other Factors in Firm Location Choice
• Agglomeration Economies
• Localization Economies
• Urbanization Economies
Next Topics:
September 22, 2014 Class 3 Slides 23
Cities are formed by the location decisions of firms,
households, and governmental bodies.
The general problem faced by a firm is to choose a
location at which it will assemble inputs and from which
it will distribute its output to customers.
Both inputs and the customers may have dispersed
location patters, and both inputs and output are subject to
transportation costs.
September 22, 2014 Class 3 Slides 24
Location Theory:
• Both the inputs and the customers may have
dispersed location patterns.
• Both inputs and output are subject transportation costs.
• To simplify these issues economists emphasize two
simple versions of the problem – focusing mainly on
transportation costs.
September 22, 2014 Class 3 Slides 25
One Input – One Market Model:
• One Input available at one location and one output sold at
another location
• Book uses the tree/firewood example as a weight-losing
process.
• Book uses Coca-Cola bottling as a weight-gaining process
September 22, 2014 Class 3 Slides 26
I = Input Location
I* = Cost of Transporting the Input
M = Production site for Output for the Market
M* = Cost of Transporting the Output
The slope of the lines represents the costs
of transporting the input/output one more
mile.
The positive and negative slope lines
indicate the transportation costs increase/
decrease as the distance to market changes.
One Input – One Market Model
(Weight-Losing Process)
September 22, 2014 Class 3 Slides 27
One Input – One Market Model (weight losing process):
• It is cheaper to cut the trees into firewood at the forest and
haul firewood (the finished product) to the city compared to
hauling the trees to the city first.
• Furthermore, the firm will not choose a point in between the
forest and the city because hauling 12.5 tons of raw lumber
even one mile is more expensive than hauling 10 tons of
firewood.
• Therefore, the firm will chose to locate at the source of the
raw materials.
September 22, 2014 Class 3 Slides 28
I = Input Location
I* = Cost of Transporting the Input
M = Production site for Output for the Market
M* = Cost of Transporting the Output
The slope of the lines represents the costs
of transporting the input/output one more
mile.
The positive and negative slope lines
indicate the transportation costs increase/
decrease as the distance to market changes.
One Input – One Market Model
(Weight-Gaining Process)
September 22, 2014 Class 3 Slides 29
One Input – One Market Model (weight-gaining process):
• It is Coca-Cola ’s secret syrup that is produced at point I.
It is the main Input for the firm.
• The other input is water. The market for bottles is at M.
• It is much cheaper to transport the syrup (input) than the
bottles (output) – therefore the transportation costs make it
advantageous for the firm to locate at the market for the
bottles.
September 22, 2014 Class 3 Slides 30
What does this have to do with cities?
Firms choose to either locate at the input location or the market not
somewhere in between.
Firms either contribute to city growth or the cumulative effect of their
location decisions contribute to the creation of new cities.
September 22, 2014 Class 3 Slides 31
One Firm Location – Multiple Market Locations
Assumes input and production costs do not vary from place to place
September 22, 2014 Class 3 Slides 32
Principle of Median Location:
States that transportation costs are minimized if the firm is located at the
median customer.
The location of the most distant customer makes no difference in
location choice.
September 22, 2014 Class 3 Slides 33
The Principle of Median Location – provides a reason why cities grow
because firms will locate closest to most of their consumers.
This market dense location choice encourages the growth of the city and
thus more density.
More density = more customers which leads to more firms locating in
the city.
September 22, 2014 Class 3 Slides 34
Other Factors in Firm Location Choice:
• Labor Costs
• Other Inputs – Energy, Capital and Land
• Intermediate Inputs
• Knowledge Input
• Taxes and Government Services
September 22, 2014 Class 3 Slides 35
Labor Costs:
• The Wage Rate (before taxes)
• Quality of the Workforce
• Availability of Skilled Workers
• Business Climate (work rules) conducive to efficient operations
• Quality of Life – conducive to attracting quality workers
September 22, 2014 Class 3 Slides 36
Other Inputs:
• Availability of consistent and inexpensive energy
• Availability of Capital – particularly for smaller firm looking at
local markets for capital
• Land – cost and availability of land (real estate)
September 22, 2014 Class 3 Slides 37
Intermediate Inputs:
• Raw Materials, Parts, Business Services
• Mostly purchased from other firms and many may be available
in the local economy.
September 22, 2014 Class 3 Slides 38
Knowledge Input:
• Knowledge of the Industry
– Locations where the firm can stay up-to-date on the latest
trends in their industry.
• “In The Air” locations
– Highly interactive labor market.
September 22, 2014 Class 3 Slides 39
Taxes and Public Services:
• Taxes and tax incentives
• Public Goods and Services
– roads, highways, reliable mail service, etc.
September 22, 2014 Class 3 Slides 40
Agglomeration Economies
September 22, 2014 Class 3 Slides 41
Agglomeration Economies
The notion of an economy of agglomeration is one of the central concepts
in urban economics.
Cost reductions occur because economic activities are located in one place.
The idea is attributed to Alfred Marshall (1920) when he referred to
“localized economies” and the idea that knowledge was “in the air ” in
locations with a relatively high density of same skilled trades.
September 22, 2014 Class 3 Slides 42
Agglomeration Economies
• Internal Economies of Scale
• External Economies of Scale
Localization Economies
Urbanization Economies
September 22, 2014 Class 3 Slides 43
Economies of Scale within the Firm
• Economies are created by expanding production at a
single location
• Average cost declines as output at that location increases
• Arises for a variety of reasons:
– Spreads fixed costs over a larger output
– Greater specialization and division of labor
– Cost reductions through bulk purchases
September 22, 2014 Class 3 Slides 44
Economies of scale arise when an increase in the scale of activity reduces
the long-run cost per unit of output produced.
Internal economies of scale arise when average cost at a given factory
declines in response to an increase in the level of activity at the factory.
September 22, 2014 Class 3 Slides 45
External economies of scale exist when long-run average cost falls in
response to an increase in the size of the city or the size of an industry in a
city.
September 22, 2014 Class 3 Slides 46
Localization Economies
• External to the individual firm
• Arise from the size of the local industry
• Basic Premise is that as the local industry grows, its total
costs are reduced which leads to a larger local industry.
September 22, 2014 Class 3 Slides 47
Three Types of Agglomeration Benefits
• Input Sharing
• Labor-Market Pooling
• Knowledge Spillovers:
September 22, 2014 Class 3 Slides 48
Agglomeration Benefits
Input Sharing:
- An apparel manufacturer buys buttons from a local
company (within its market) that specializes in the
manufacture of buttons
- Studies have found that innovations are highly
concentrated spatially and that innovative industries are
more likely to be geographically concentrated.
- An innovator is 5-10 times more likely to cite a patent
from a firm in the same metropolitan area than from
another firm elsewhere in the country.
September 22, 2014 Class 3 Slides 49
Agglomeration Benefits
Labor-Market Pooling
- Silicon Valley company can quickly fill a position by
hiring one of the many skilled programmers already
present in the market.
- Reduces risks for both employer and employee by
reducing search costs and enhancing the match quality
between workers and jobs.
Knowledge Spillovers:
– Software programmer learns “tricks of the trade”
through random interactions with other programmers.
September 22, 2014 Class 3 Slides 50
Convenience Goods vs. Shopping Goods
Convenience Goods – grocery stores, drug stores, dentists*, video stores.
Shopping Goods – Goods for which the customer invests time comparison
shopping, comparing goods and prices.
September 22, 2014 Class 3 Slides 51
Book Example – Shopping Goods – car dealerships
The special arrangement facilitates comparison-shopping that the
consumers are going to do.
This clustering saves advertising and promotional costs for the firms.
Saves transportation-to-markets costs (time and money) for consumers and
encourages comparison shopping.
September 22, 2014 Class 3 Slides 52
Localization Economies for Input Specific Industries
• Firms cluster where a high density of trained workers are based.
• Silicon Valley and Bangalore, India
• Knowledge “in-the-air ” – saves on training costs and down-time for the
firm.
• Provides a degree of security of employment to workers at market
wages.
• Localized Economies breed industry specific specialization in the service
sector.
– Lawyers, Accountants, Agents, etc.
September 22, 2014 Class 3 Slides 53
Silicon Valley is cited as a good example of a Localized Economy that
potentially lacks industry diversity to the detriment of the localized
workforce and economy.
The Companion Book describes the disadvantages of “iron districts” –
localized economies that only employed strong men to the detriment of the
family ’s overall earning potential.
Supplemental industries (Textile Mills) tend to sprout up in these locations
(mining and engineering industry towns) where women and children have
a comparative advantage and are available as an underutilized labor force.
September 22, 2014 Class 3 Slides 54
Urbanization Economies
• External to the Local Industry
• Arise from the size of the local economy
• Book Example – size and diversity of transportation linkages to
larger cities
Railways, Interstate Highways, Airports, etc. with more
convenient service.
• Availability of Interindustry Linkages
Greater availability of specialized tertiary firm needs
Patent Attorneys, Architects, etc.
September 22, 2014 Class 3 Slides 55
The Companion book cites Los Angeles as a good example of an
Urbanization Economy. It does not have a single dominant industry. Film
and television production are prevalent but they are a small part of a diverse
local economy which includes high tech, aerospace and textile
manufacturing.
Urban Economies like Los Angeles and New York possess broad
employment bases which contribute to what Jane Jacobs called “new work.”
Broad innovation in multiple industries which smooth out the cyclical
economic cycles of more localized economies (like Silicon Valley, Detroit or
Pittsburgh.)
September 22, 2014 Class 3 Slides 56
Other Positive Urbanization Effects:
Urban wages are higher in larger cities. This urban wage premium is larger
the longer a worker has stayed in a large city and remains with them even
when they move to a smaller city.
This suggests that cities foster knowledge spillovers.
September 22, 2014 Class 3 Slides 57
Negative Outcomes of Urbanization Economies
• Congestion
• Pollution
• Crime
• Competition increases rents
September 29, 2014 Class 4 1
REAL ESTATE INSTITUTE
NEW YORK UNIVERSITY
SCPS
REAL ESTATE ECONOMICS
&
Market Analysis
REAL1-GC1045
Fall 2014
September 29, 2014 Class 4 2
• Monocentric City Model
• Role of Transportation
• Early Theories of Land Rent
• Bid Rent Function
• Bid Rent Function for Households
• Bid Rent Function for Firms
• Bid Rent Function for Firms w/ Substitution
September 29, 2014 Class 4 3
The standard urban spatial model is known as the Monocentric City Model.
• The model is based on the assumption that the city revolves
around a single center.
• The center is referred to as the Central Business District
or “CBD”
• The CBD is the center of the city’s economic life.
• All jobs are located at the CBD and people commute from
the surrounding residential areas to their jobs in the center.
September 29, 2014 Class 4 4
Urban areas contains a collection of such centers of
economic activity and depends upon its economic history
and its functions in the modern economy.
Except for a few cities that began as railroad junctions,
most of today’s major urban areas began as ports.
Shipping – importing and exporting goods – was the
economic driver and remains so today.
All of the major urban areas in the United States were
founded prior to the 1920s.
September 29, 2014 Class 4 5
Initially there were ports focused on trade but soon, wholesale
trading, banking interests, insurance companies and manufactures
chose to locate around these ports.
Later in the 19
th
century rail lines grew around existing ports
servicing existing concentration of economic activity.
September 29, 2014 Class 4 6
Many urban areas in the late nineteenth and early twentieth
centuries can be considered to be monocentric . In most urban
areas, the traditional CBD continues to be the single largest
concentration of economic activity today.
There are important exceptions – New York, Philadelphia and
Chicago outgrew their original downtown districts well before
1900. Important parts of their economies were located in other
locations.
September 29, 2014 Class 4 7
The book discusses the Chicago Union Stockyard as an example of
planned relocation of a CBD.
Up until the 1860s there were many stockyards and meatpacking
plants located in and around downtown Chicago.
In 1865 the Union Stockyards – a consortium of meat packers and
railroad companies – decided to move 5 miles southwest of
downtown to a single location. The site was given railway and
water access and instantly became a huge agglomeration of
industrial activity.
September 29, 2014 Class 4 8
This is an important example but very rare.
Most cities today follow the traditional monocentric model.
September 29, 2014 Class 4 9
The Role of Transportation and Infrastructure
Historians usually emphasize the importance of the technical
changes in long distance transportation.
How and where cities develop is most influenced by the
transportation linkages serving the area.
September 29, 2014 Class 4 10
By the 1850s and 60s the streets were wider, straighter and paved.
By the 1890s a major change in technology occurred when
Commuter services – initially horse drawn trolleys and steam
driven street cars – were converted to electric power which quickly
led to Subway systems.
At the same time beltway rail lines were being developed and rail
yards for the assembly and disassembly of trains took place. Now
a factory could be located anywhere near a beltway rail line – often
building their own “spur” to transport its rail cars to the rail yard.
September 29, 2014 Class 4 11
By the 1920s the development of the internal combustion engine
and the automobile led to firms having even more choices for
location decisions.
People were no longer tied to the fixed routes of existing rail lines.
Truck shipping provided efficient vehicle movement for freight
within urban areas which was not possible before.
Streets and bridges improved. Urban highway and interstate
highways were developed. Circumferential and radial freeways
enabled travelers, commuters and shippers to avoid city centers.
All this by 1960.
September 29, 2014 Class 4 12
The modern urban area contains several types of economic CBDs
with their associated agglomerations:
• The downtown CBD
• Major airports and other transportation and
distribution centers
• Industrial areas
• Large shopping centers
• hospitals and related medical facilities
• educational institutions
• government offices and facilities
September 29, 2014 Class 4 13
Early Theories of Land Rent
September 29, 2014 Class 4 14
Land is an important input into the production of all goods and
services.
The market for urban land is of central importance to the theory of
urban location patterns.
The urban land market is highly regulated.
September 29, 2014 Class 4 15
David Ricardo (1821)
Had the first modern theory of urban land rent.
He defined land rent as “that compensation which is paid to the owner of land
for the use of its original and indestructible powers. ”
Ricardo was referring to the fertility of agricultural land.
His fundamental insight was to realize that agricultural land is not all of the
same utility.
He supposed that there is a fixed supply of land with the best fertility – what he
called “No. 1 Land” “No. 2 Land” and “No. 3 Land”.
September 29, 2014 Class 4 16
Ricardo assumed that with equal employment of capital and labor,
No. 1, No. 2 and No. 3 land would yield a net produce of 100, 90,
and 80 units of food per acre.
Therefore land rent exists because land varies in fertility and
because land of a given fertility level is in fixed supply.
September 29, 2014 Class 4 17
Ricardo introduced several crucial concepts:
Land varies in its natural endowment or advantage for the user
Land of a given level of natural endowment or advantage is fixed in supply
The land market is governed by perfect competition
Land rent is determined by the natural endowment or advantage of land
Ricardo’s theory ignored location .
September 29, 2014 Class 4 18
Von Thunen (1826)
Flipped Ricardo’s theory around and said that Land Varies in location but
fertility is the same everywhere – to show how land rent varies by distance to a
central marketplace.
If the quality of the farmer ’s product is the same then all farmers will receive
the same price for their product at market – therefore the farmer bears the entire
cost of shipping their product to marketplace.
The land closest to market is the most valuable. As you get farther from the
market transportation cost eat up the entire profit of food production therefore at
some point out from the market the land has not agricultural value.
Von Thunen ’s fundamental insight is that competition among the farmers for
the sites with low shipping costs means that land rent will be higher closer to the
marketplace, even when fertility of soil does not vary.
September 29, 2014 Class 4 19
Bid Rent Function
September 29, 2014 Class 4 20
Firm Location Choice (Real Estate Site Selection) is
fundamentally about competition for a scarce resource .
Land is an important input into the production of all goods and
services.
The Bid Rent Function is a way of graphically capturing the
financial and proximal choices firms and households make when
selecting a location in relation to the Central Business District
(CBD).
September 29, 2014 Class 4 21
Bid Rent for Households
September 29, 2014 Class 4 22
Bid Rent for a particular household for a particular site is the maximum rent per
unit of land that the household can pay to reside at location x and maintain some
given level of utility .
September 29, 2014 Class 4 23
Suppose that the only attribute of land that matters to a household is distance to
the downtown workplace.
Greater distance to the workplace means that the household must spend more
money and time to get to and from work.
The household therefore bids less for land at greater distances to maintain its
utility level.
September 29, 2014 Class 4 24
Draw the Bid Rent Function for Households
What happens if commuting costs decrease?
September 29, 2014 Class 4 25
Bid Rent Function for Firms
September 29, 2014 Class 4 26
Bid Rent Function for Firms assumes:
Firm produces a particular good that is sold for export at the port/CBD.
Firm occupies 1 acre of land
Firm produces the same amount regardless of location.
Firm uses labor, capital and land to produce output.
Firm shipping costs rise with distance from CBD.
(This closely matches Von Thunen ’s model for farmers.)
September 29, 2014 Class 4 27
Standard bid rent for firms assumes that the firm produces a given amount of
output on an acre of land and this quality does not vary with distance from the
port.
This assumption is unrealistic because it means that land cannot be substituted
for other inputs – there is always a fixed ratio of output to land.
September 29, 2014 Class 4 28
Bid Rent Function for Firms with Substitution:
September 29, 2014 Class 4 29
Bid Rent Function for Firms with Substitution:
A more realistic model would assume that land and other inputs can vary.
Firms can change the amount of capital and labor per unit of land by building a
taller building.
Firms that face a higher land rent substitute away from land and use more of
their inputs (capital/labor) to produce a given level of output.
As land rent rises closer to the port, firms substitute away from land and toward
capital.
As land rent falls farther from the port, firms substitute toward land and away
from capital.
September 29, 2014 Class 4 30
Bid Rent Function with Multiple Land Uses
September 29, 2014 Class 4 31
Bid Rent has an implicit consideration for the concept of
Highest and Best Use.
• Legally Allowable
• Physically Possible
• Financially Feasible
• Maximally Productive
September 29, 2014 Class 4 32
All real estate parcels have the potential * for multiple land uses – as such each
parcel is subject to multiple bidders with a differing utility need. This is
especially true with land in relative proximity to the CBD.
Bidders for the Land Include:
• Commercial
• Manufacturing
• Residential
• Agricultural
September 29, 2014 Class 4 33
Using the Bid Rent Function graph – where would each bidder start on the price
axis? Why?
What is their relative slope and why?
September 29, 2014 Class 4 34
Bid Rent Functions to Review:
Bid Rent of Households
Bid Rent of Households with varying commuting costs
Bid Rent of Firms
Bid Rent of Firms with Substitution
Bid Rent for Multiple Land Uses
Bid Rent with Urban Growth Boundary
Bid Rent High Quality School district
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