In analysing the market for property space the important feature about demand is that it is derived and the important feature about supply is that it is inelastic. Critically discuss this statement

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F105ECO Assignment 1                Calum Stringer 0600532


‘In analysing the market for property space the important feature about demand is that it is derived and the important feature about supply is that it is inelastic.’

Critically discuss this statement with reference to theoretical insights into the demand and supply of office space.

The term derived demand is where the demand for an intermediate product.  Labour or good occurs when the demand for a final product increases; this can happen when the intermediate part of production is required for the final product. For example, demand for diesel will lead to the increase of oil extraction, as oil is required to make diesel which is to be consumed, and as demand for diesel increases so will the price. The price increase will lead to an increase demand for resources involved in refining diesel.  It can be seen that Land is different from capital and has a fixed supply, while capital labour and materials can be responded to an increase in demand with an increased supply. As land cannot be created (and additionally a new building plot) then the most effective use of the land is needed.

When looking into demand for services that are produced in an office, the following assumptions have been taken into account, the office space in this example is the only variable and all other costs are fixed.

The table above shows the amount of space that is utilised and the companies output, including the rent that is paid. It shows that the more space that is occupied that its output increases until the point where it starts to decline which could be because the labour has reached capacity for example.  If there is demand for a good increase, the price and MR will lead to an increase and higher demand, however as other factors are fixed this would lead to a point where there are diminishing marginal returns.

The main interest of the company is to identify what additional revenue each unit of space can generate.  This is known as Marginal Revenue Product (MRP) which is worked out by multiplying the Marginal Physical Product (MPP) and the Marginal Revenue (MR).


MRP = Marginal revenue product.

MPP = Marginal physical product.

MR = Marginal Revenue of services sold.

Once the point at which the MRP and Rent is the same then this is the equilibrium and the optimum demand for the rental space: MRP = R.

This is an example of the more general profit maximising condition: MR = MC.

In the example above it can be seen that the maximum output is between 600 and 700m2 of that space. It is assumed that 650m2 is the optimum value because the contribution at 700m2 is zero.  If there are changes in the rent this will cause the MRP curve to move because of the changes in the productivity of the space or in the output of the company as the MPP and MR are factors of the MRP.

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There are various reasons why there may be a change in the physical productivity of the property; these include changes in formerly fixed quantities changing, improvements in factors, and improvements in the office space.  If there were to be a fall in the rental costs then the demand for office space would increase which would allow for more service to be produced. The increase in supply would have a tendency to depress product prices in the market. This would lead to a downward shift in the MRP curve as the service value is reduced, which results in less extra demand ...

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