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
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 = MPP * 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 and a more inelastic supply. The supply of office space will depend upon the current turnover of existing stock, the creation of new space and changes of use.
It can be seen in the short term that supply of new development stock is inelastic because of planning and the time delay (such as construction times) and in the longer term supply becomes more elastic. However this is controlled by planning restrictions and commercial uncertainties. Any real rent rises is a sign of an inability to fully supply to the expanding demand.
Explain how innovation and mechanisation in the construction sector of your economy could influence productivity.
In this answer machinery is referred to as capital.
Productivity in the construction sector can be influenced by innovation and mechanisation.
Mechanisation can be defined as the condition of having a highly technical implementation or the act of implementing the control of equipment with advanced technology, usually involving electronic hardware, and automation which replaces human workers with machines.
Mechanisation looks into factors which determine the substitution of capital for labour; for example providing workers with machinery to enable them to do a specific job more efficiently. By using mechanisation in the construction industry work can be achieved more speedily and finished on time and to schedule. Larger amounts of materials can be handled so the size of the project can be increased, more complex projects can be completed, and it can optimise the use of labour, capital and materials and cover shortages in areas of skilled labour.
There are various factors that will influence the level a company will use mechanisation. For example, if competition requires the company to be more efficient, the cost effectiveness of capital compared to labour, restricted markets and imperfect knowledge. Therefore it is necessary to inspect when comparing relative prices and productivity. Capital and labour will exist at equilibrium where there are combined.
MPP capital = Price capital
MPP labour Price labour
When a rise in productivity of capital machinery occurs or it becomes more cost effective, this tends to lead to substitution of capital for labour providing it is a suitable substitution. The improvement and price is relative. Reasons for this could be due to the nature of capital been used for a specific task where as labour can be used in different areas. Furthermore it cannot replace the need or use of skilled workers that are required upon a building site,
There are areas which have led to improved efficiency on site with the introduction of machinery such as mini-diggers. For example it may take three men a day to prepare a plot of land, whereas one man with a mini-digger can perform the same task in one day, providing the machinery is cost effective it can show how capital can improve efficiency. Due to the nature of the construction industry in the UK the need for labour is high because of the labour intensive jobs involved within developments therefore the substitution of capital for labour is low. Mechanisation with capital equipment is greater where developments of high-rise buildings require specialist equipment such as tower cranes. This is where unskilled labour is not suitable. With low-rise developments there is lower use of mechanisation and specialist machinery because the productivity of using unskilled labour can perform a different task which outweighs the need to use specialist machinery. Machinery used at low-rise sites tends to be for foundation preparation, the movement of materials and the use of power tools.
There are various factors to increasing mechanisation within the construction industry could happen. These include an increase in the cost of labour or a reduction in the cost of machinery, the need for greater use of specialist machinery such as cranes used in high-rise developments.
The definition of Innovation is development of new standards through solutions that meet new requirements and needs in value added new ways. Innovation can cover numerous aspects within the construction industry ranging from new incentive schemes, organisational improvements, new equipment, standardising components and reducing time of labour intensive processes. In the construction industry innovation can have many obstacles at lower level where differences in location and design make it difficult as to whether newer methods are cost-effective and therefore the knowledge is not used quickly.
In construction projects the use of standardised components such as doors, windows etc is now fairly main stream and by using off site techniques it can help reduce labour intensive work onsite. This will reduce costs because they can be mass-produced and to standard sizes for projects. By standardising measurements and sizes of materials allows for dimensional co-ordination for a systematic method to be used. This will reduce the amount of components, eliminate waste and produce greater levels productivity because of offsite production which allows more speedy assembly on-site. Through the use of off site assembly it reduces on site work. Because of this the offsite work can be produced in a controlled environment and will minimise potential issues as well as help with more complex projects.
It can be seen that productivity in the construction industry has improved with the use of new techniques through mechanisation and innovation. With the introduction of new equipment and machinery allowing greater scaled projects however, it can still be seen that there are limitations to the full effectiveness because of cost or local policies.
Explain, with examples, how urban planning policies can reduce the adverse effects of the following property market inefficiencies:
- seller power
The seller will have power if the demand is there but not the supply. The seller can increase the price which will cause price inflation. In order to reduce this, planning policies need to be used to either increase supply or manage the demand.
Seller power or a monopolist owner of land can be prevented from having the right to demand an extortionate selling price for that which is required to access a new potential and comprehensive development by that of the Local Authority and with the power of the compulsory purchase provision. Once planning has been established and recognised then the planning authority can implement the powers of compulsory purchase to gain access to the needed land.
Planning policies can also be used where there is underdevelopment of a site. For example it may be more profitable for a developer to produce more substantial properties however the local need for the land and development of a more intensive but with smaller units to help with demand of the local area.
It can be seen by the graph below that where thedevelopment would end if the development were pursued to a position of perfect competition where the price is equal to the marginal social cost.
- Imperfect information.
Imperfect information will occur where the incomplete, uncertain, misunderstood or inaccurate data from which the wrong decisions can be potentially made. The use of planning policies and Government intervention can help minimise the potential issues and problems that occur from imperfect information. For example the planning authority can refuse planning based on the lack of knowledge for a plot where a nuisance has been underestimated. Planning policies can allow for future needs of a development which may have been overlooked or to allow for the preservation of specialist buildings
If uncertainty arises from imperfect information, this can affect any land use decisions due to a lack of knowing the objectives of people in a similar position. For example should one owner spend money to improve a property when there is a possibility that it might not have a positive effect on his property because other owners won’t do the same causing any improvements to get wasted. As the planning authority is not aware of owners’ plans, by announcing any renovation plans to the area it can create more certainty and this can stimulate renovations to properties independently and allow others to be brought into line.
Allocations of land resources can be affected by inaccurate forecasts. For example a developer has to foresee the need for the building as if the future demand is underestimated then the site is not an intensive enough development. However if it is overestimated then it may be challenging to obtain a realistic rent. As the planners have better information in which to make these decisions they can avoid the mistakes. Schemes can also be used to co-ordinate the plans of developers to ensure that there is not an oversupply to the market.
Regulations are in place to cover building requirements and plans to remove the uncertainty and provide a framework so that developers can be part of schemes.
- External benefits.
Externalities are effects of a third party which arise from the consumption and production of services and goods for which no suitable compensation is rewarded. These fall outside of the market, for example they will affect people who are not directly involved in the consumption or production of a service or good, it can also be known as the spill-over effect.
When external costs occur on third parties outside the market because of the consumption or production these are known as negative externalities. For example this could be where air pollution has occurred from the building of a new road. This is where the social cost of production is greater than the private cost.
Where there are external benefits from the consumption or production of goods or services that occur from this it is known as positive externalities. For example the installation of flood defence systems will help prevent damage to a property. This is where the social benefits are greater than the private benefits.
Planning policies can help deal with both positive and negative by the way of the uses of subsidies, helping to reduce the private cost of consumption or reduce the cost of supply which should cause an expansion of demand. Planning authorities can command and control certain rules and procedures to ensure the full use of land is realised and help improve information to potential developers.
CEM (2006) ‘Factor market theory applied to property space ’, Paper 3297. Reading; The College of Estate Management.
CEM (2007) ‘Problems of urban areas’, Paper 0552. Reading; The College of Estate Management.
CEM (2007) ‘The construction industry’, Paper 4015. Reading; The College of Estate Management.
CEM (2007) ‘The economics of planned intervention’, Paper 0550. Reading; The College of Estate Management.
CEM (2010) ‘Strathgammon Estate Group Ltd’, Paper 1968. Reading; The College of Estate Management.
CEM (2011) ‘The Economics of Property and Construction: Preview’, Paper 8284. Reading; The College of Estate Management.
CEM (2011) ‘The real property market’, Paper 0334. Reading; The College of Estate Management.
http://www.tutor2u.net/blog/index.php/economics/ (Last accessed 14 Apr 2013).
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