Economic analysis for property and business

Economic Analysis for Property and Business

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Economic Analysis for

Property and Business

Marcus Warren MA

Principal Lecturer in Land Management at De Montfort University

OXFORD AUCKLAND BOSTON JOHANNESBURG MELBOURNE NEW DELHI

Butterworth-Heinemann

Linacre House, Jordan Hill, Oxford OX2 8DP

225 Wildwood Avenue, Woburn, MA 01801-2041

A division of Reed Educational and Professional Publishing Ltd

A member of the Reed Elsevier plc group

First published 2000

© Reed Educational and Professional Publishing Ltd 2000

All rights reserved. No part of this publication may be reproduced in

any material form (including photocopying or storing in any medium by

electronic means and whether or not transiently or incidentally to some

other use of this publication) without the written permission of the

copyright holder except in accordance with the provisions of the Copyright,

Designs and Patents Act 1988 or under the terms of a licence issued by the

Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London,

England W1P 0LP. Applications for the copyright holder’s written

permission to reproduce any part of this publication should be addressed

to the publishers

British Library Cataloguing in Publication Data

Warren, Marcus

Economic analysis for property and business

1. Real estate business – Economic aspects

2. Construction industry – Economic aspects

I. Title

333.3'3

ISBN 0 7506 4632 2

Library of Congress Cataloguing in Publication Data

Warren, Marcus.

Economic analysis for property and business/Marcus Warren.

p.cm.

Includes bibliographical references and index.

ISBN 0 7506 4632 2

1. Economics. 2. Land use. 3. Real property. I. Title.

HB171.5 . W243

333.33'2 – dc21 00–036024

Composition by Genesis Typesetting, Rochester, Kent

Printed and bound in Great Britain

Contents

Acknowledgements ix

Introduction xi

The methodology of economics xv

Part 1: Market analysis for the property analyst

1 Applied property market analysis: the theory of demand and

supply 3

The essentials of the market system 3

Applied demand theory 5

Applied supply theory 15

The formation of market equilibrium 20

The impact of changing market conditions 21

Conclusion 22

2 Measured market analysis – the concept of elasticity 23

Price elasticity 24

Income elasticity of demand 36

Cross price elasticity of demand 38

3 Dynamic property market analysis 40

Owner-occupied housing 40

Technological change and the location of property 47

4 Market analysis for the factors of production in the assembly

of property 56

The market for land (with specific reference to building land) 56

The market for construction materials and components 61

The market for building labour 64

Entrepreneurship and individual effort 69

Productivity in the construction industry 72

Innovation in the construction industry 77

5 Market forces, the property investor and their role in the

creation of the built environment 83

Conventional investment appraisal techniques 86

Discounting techniques of investment appraisal 90

vi Contents

A critique of investment appraisal techniques 93

The determination of the economic life of a building 94

6 Government intervention in land and construction markets 107

Taxation and subsidization 107

Regulatory policy: health and safety in buildings and land use

control 112

Price control policies 114

7 Market failure in the built environment 124

Externalities in the built environment 125

Urban policy and externalities 132

A conclusion on externalities 135

The case of public goods in the built environment 136

Monopoly situations in the built environment 138

Imperfect information in the urban market 139

Social views and the urban environment 141

A conclusion on market failure and the rationale for public

intervention in the urban market 142

Part 2: Applied theory of the firm

8 Applied cost and revenue theory for construction and property 147

Revenues of the firm 148

Costs facing the firm 153

Normal profit 157

The profit maximizing rule 157

The long-run planning decision: the theory of long-run costs 158

Economies of scale 160

Diseconomies of scale 162

Conclusions on economies and diseconomies of scale 163

9 Market structures in construction and property 165

The theory of perfect competition and its application 166

The theory of monopoly and its application 175

The construction industry 183

Part 3: The economy and its management

10 A simple model of the economy for the property analyst 193

A macro-economic model 193

Demand in the economy 194

Supply in the economy 198

A simple demand and supply model of the macro-economy 199

The multiplier process 202

Contents vii

11 Primary economic objectives and the property sector 208

A steady rate of economic growth 208

A low and steady rate of inflation 215

A low level of unemployment 217

A balance of trade 217

12 Macro-economic management, property markets and the

construction industry 219

Demand management 220

Fiscal policy 220

Monetary policy 231

A general overview of demand management 237

Supply-side economics 238

Local government macro-economic policy and the built

environment 243

Conclusion 244

Index 245

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Acknowledgements

My sincere thanks go to Kerry Marriott, Jane McCormack, Dr John Ebohon

and Sonia Deadman who all contributed greatly to making this book

possible. I would also like to dedicate the text to the memory of Professor

Neil Bowman.

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Introduction

This textbook has been carefully formulated to provide an easy to

understand and highly practical examination of applied economics related

to both property and business. Specifically, its main focus is a compre￾hensive examination of a wide range of property markets against the

backdrop of how businesses can utilize property to its full potential in terms

of both its use and its investment value. The reliance upon the inclusion of

applied examples should enable the reader to appreciate the great scope that

a basic understanding of economics can give them in their future academic

and professional lives.

The fundamental strengths of this book primarily lie in its simplicity and

the way in which it has evolved. With respect to its simplicity, it enables the

reader quickly to gain a workable understanding of economics and

economic analysis so that they can utilize the principles contained within.

Such application can be in the form of enhancing an understanding of

activity in a particular market, or in improving the comprehension of a

report or research in a specific topic area. Moreover, it should also enable the

reader effectively to influence matters themselves by applying the tech￾niques learnt. Importantly, the text has been designed to be of use in any

part of the global economy and its scope is therefore not limited to one

country alone. With respect to its design and content this work has

essentially been developed from a previous text by the same author and

publisher, namely: Economics for the Built Environment. Recognizing that the

primary purpose of the process of evolution is essentially to improve and

adapt, subject to changing criteria, it can be seen that in exactly this way, this

text has been modified to reflect changing economic conditions and thought.

In addition, it has been improved and refined by many years of user

feedback on the original work.

Essentially, the book aims to achieve its goal of being a workable text by

setting itself a range of achievable objectives. These fundamental objectives

are to enable the reader to:

overcome any ‘fear’ of economics

appreciate the practical relevance of ‘theory’

provide a logical framework for analysis

xii Introduction

effectively use the principles of economics to understand a wide range of

applied issues such as:

– activity in property markets

– the behaviour of firms in business

– the implications of government policy

– the importance of changes in the world economy

utilize the principles of economics to their own advantage in their

educational, working and home environments.

Hopefully, this brief work will also go some way towards encouraging the

use of economics to help overcome the many complicated problems facing

the property business. Once a fundamental understanding of the discipline

has been grasped it can be appreciated that it can provide a highly diverse

and flexible analytical framework with which to examine applied issues and

solve problems. In other words, fully informed individuals looking at the

business of property need a thorough grounding in economics just as much

as one in subject areas, which may initially be viewed as being more directly

applied, such as property valuation and building performance to name just

two examples. Moreover, the reader should look for, and appreciate the

linkages between, such related subject areas rather than treat them as

separate entities. To illustrate these points, this text will show, amongst

many other things, that the type of buildings built, the technology and

processes that are used to construct them, the materials that are used, the

clients who occupy them and indeed their location, are all, to a large extent

governed by, or are reactions to, economic decisions or are the result of more

general elements of economic activity.

Who the book is designed for

This book would benefit all those who require a practical understanding of

economics. However, it has been specifically designed for the following

groups:

Students of degree and diploma courses that are tailored to the

requirements of gaining entry into the professions related to property and

construction. Examples of such courses include Building Surveying, Land

(or Estate) Management (both Rural and Urban), Quantity Surveying and

Construction, to name just a few.

Students of business who require an appreciation of land and buildings as

part of an investment portfolio, as well as an understanding of the need

to manage property to enjoy its full use potential.

Students examining property issues in a subsidiary subject on non￾property related courses. For example, many Economics degrees, or

degrees in Combined Studies, have options looking at matters such as

housing, the urban transport problem, the location of business, and

environmental issues, all of which feature in this text.

Introduction xiii

Practising professionals could also benefit from this book. The text clearly

demonstrates that economic theory can be readily and successfully

applied to examine real-world issues. In this way, for example, it shows

why markets behave in the way that they do and suggests how they may

change in the future. Moreover, people in business could obtain an

enhanced appreciation for the reasons for the structure of their own

industry and how such a structure influences matters such as profitability

and output.

Finally, many courses that are not related to property may find this a

useful text simply because of its high degree of application. The level of

application should enable the reader quickly to see the relevance and

flexibility of economic analysis for the study of any industry whether or

not it is in the world of property.

How to use this book

A textbook is essentially a learning tool that is designed to assist an

understanding of a particular subject area. As with all tools, the full

potential of this book can only be realized if it is used properly. As such, it

is strongly recommended that you take great care in reading and absorbing

this introductory section. Therefore, please avoid the temptation of moving

directly to the first chapter, as this is analogous to building the ground floor

of a building without providing it with a firm foundation. Such a building

will be lucky to remain standing, and even if it does it is likely to suffer from

substantial defects! Using the same logic, the book is at its most effective if

the chapters are read in the order that they appear, as although the chapters

are all inter-related and can be used in isolation, there is a logical

progression and reinforcement of principles as the work develops.

It is also important to realize that this text has been developed as a

companion, albeit a very comprehensive one, to additional information that

can be gathered on courses via formal lecture, studio, and tutorial contact.

Furthermore, and most importantly, the structure of the book is designed to

give you an initial understanding, and appreciation for the use, of applied

economic analysis by providing a basic analytical framework. To enhance

your knowledge and understanding of a particular topic in more depth it

may be advisable for you to seek out more detailed theoretical information

from one of the many mainstream economics texts as well as specific

readings in that area. The text is also designed to encourage you to further

the analysis by obtaining data from your own country or area of interest in

order to test the accuracy of its descriptions and predictions. Therefore, there

is additional research to be done in order to expand upon the deliberate

confines of this work. By leaving it to the reader to search for up-to-date and

relevant data it ensures that the principles in the text can be applied over

time and can be used for any case study in any location. In addition, it

encourages you to become aware of the great range of data sources and

information that are now available in the fields of business, property and

construction, especially on the World Wide Web. To continue with the

xiv Introduction

construction-related analogy used above, the book essentially provides a

foundation and frame for a building, but other parts need to be added to the

building in order to make it complete.

To ensure that you have understood and learnt the principles that are

introduced within the book it is recommended that the following guidelines

are observed:

Firstly, read chapters as a whole at your normal reading speed. This

should enable you to get the general gist of the argument, and introduces

you to any new terminology. Then, re-read them at a slower pace, in a

methodological manner, so as to understand their fuller logic and

content.

Make brief notes as you re-read the text.

Re-draw any diagrams and try to understand how they work and how

they could be used or adapted to illustrate different circumstances.

Do not worry if you have to spend long periods of time understanding

any one particular point or section. Never go on without understanding

preceding information. It is important to understand what you read rather

than memorizing it.

Make a glossary of technical terms. This can be useful as a point of

reference, but the exercise will also help you to remember key terms.

In order to gain maximum benefit from this text it firstly has to be

understood what economics is and how its analytical framework can be of

use. For many, the initial task is to overcome any fear of the subject area.