Economic Analysis for Property and Business

Marcus Warren

• Publisher: Routledge
• Year: 2007
• eBook ISBN: 9781136408922
• Edition: 1
• Topic: Architecture
• Subtopic: Architecture General

Marcus Warren's book provides a broad coverage of economic theory, analysis and policy relevant to most undergraduate students studying economics as part of their degree. Specifically it is designed for students studying for property and business related courses and is a vital purchase for all first year students and some second year students involved in these disciplines. It is also relevant for accountancy, business and marketing students studying economics as one or two of their modules. The main feature of this book is the inclusion of an application for students on property surveying courses, building surveying courses and rural land management students as well as some pure business examples for the business students. These applications will cover the main markets for this book at the end of each theory section. The text is clear, concise and includes real life examples and case studies to back up the theory presented. It is global in its appeal, especially relevant for the UK, Europe and the Commonwealth.

Part 1

Market analysis for the property analyst

1 Applied property market analysis: the theory of demand and supply

This first chapter is designed to give a thorough, yet easily understandable, working knowledge of market analysis. After a brief introduction, the fundamental theory of demand and supply is examined. This foundation is then built upon in an applied manner for a range of markets in the property arena in Chapters 2 to 7. A sound comprehension of market analysis should enable one to explain a whole host of property-related issues such as:

• variances in house prices or commercial rents over time and between location

• the design of buildings and their location globally as well as at the local level

• the volume of new building taking place

• the relationship between the price of development land and the completed building

• the impact of changes in technology on buildings

• the impact of government legislation on property markets.

The list above is by no means exhaustive and is merely a flavour of what is to follow, but in each instance it is hoped that the reader will appreciate how economic theory can be successfully applied to real-world issues.

The essentials of the market system

The concept of a market is far from new both in terms of economic theory and in practice. For centuries, people all around the world have traded goods and services in formal marketplaces. Indeed, many of the urban areas that can be seen today have developed around areas originally designated to sell agricultural produce from the surrounding rural areas. In such locations traders initially set up stalls to sell goods to the general public that visited that market. Today, some of these market areas still remain although much of the activity has dissipated into a variety of retail outlets. On the theoretical side, perhaps the best known advocate of the market system was Adam Smith who described the workings of the market as an ‘invisible hand’ in his famous text An Enquiry into the Nature and Causes of the Wealth of Nations written in 1776.

By looking back at the origins of markets it can be seen that farmers grew crops and reared livestock that were then sold on to market traders who would then, in turn, sell them on to the consumer perhaps in a modified form. The type of output that the farms produced would be largely governed by what people wished to buy. It was obviously illogical to supply products that nobody wanted as they would remain unsold, although occasionally errors inevitably occurred, i.e. too much or too little of a particular good could be supplied as fashions and tastes changed over time.

For example, imagine if a particular type of vegetable was very popular with consumers one year, farmers would be enticed to plant more of it in the next growing season. However, because of the length of time involved between planting, harvesting and distribution, by the time the new crop reached the market, the product's popularity may have dwindled. Such difficulties of time lags would be even more pronounced when looking at the commercial rearing of animals.

Moreover, supply could also be affected by variables beyond the farmer's control. Poor weather, or an unanticipated infestation of crops by pests or disease, could lead to a bad harvest. Conversely, better than expected weather conditions could produce a bumper crop. Thus, the farmers and the stall holders were a source of supply aimed at satisfying public demand although situations were likely to arise whereby the market was over-supplied or there were shortages of some items.

Those that visited the market were the source of demand for the goods on sale. The public attended the market to purchase directly for themselves and shopkeepers could purchase in bulk. Shopkeepers would then sell the produce on to the consumer through their shop or outlet, perhaps after modifying or improving the good in some way. The bargaining process that ensued between supplier and consumer dictated that if there was a lack of demand, the selling price of the good was likely to be driven down. This was especially the case if the good was readily perishable and needed to be disposed of quickly. Conversely, prices would be driven up if shortages occurred as people competed for the limited supply.

In this way we can see that markets are basically an interaction between the two forces of demand and supply. As a consequence the term ‘market analysis’ may be interchanged with the phrase ‘demand and supply analysis’ as they both refer to exactly the same process. The benefits of such a system are that it should operate in the consumer's interest by providing products that are desired by the public. Moreover, if there is sufficient competition the goods should be sold at reasonable prices. However, although the mechanics of the market system are automatic and should need little regulation, there are instances whereby the state may intervene on the grounds of health and safety and ensuring that there is fair competition amongst traders, for example.

In many countries, traditional markets such as that described above continue in existence. However, developments in international communications, trade and technology have enabled us to continue the market process of the interaction between supplier and consumer without the need for both parties to meet at a formal location. For example, the prices of products at a modern supermarket are determined by the availability of supply and the level of demand. However, systems exist that enable the consumer to order products through the Internet and have them delivered to their home without necessitating a trip to the physical retail outlet itself. Moreover, continuing with the agriculturally-based example of above, fluctuations in supply are more easily brought under control as we plant more disease-resistant crops, are able to preserve food for a longer period of time or make up shortages via imports from abroad.

As economies grew and became more developed through international trade and technology, the market system naturally encompassed a whole host of other goods and services. As such the subject of market economics was developed to enable analysts to focus upon how demand and supply theory could be used to investigate the operation of a diverse range of markets in the modern economy. By means of example and application this textbook examines a range of markets related to property such as those for housing, offices, retail outlets and development land as well as those for building labour and construction components. By reading on, it will be demonstrated that the fundamental principles of market analysis are the same in each instance and that a knowledge base in this area will provide an understanding of how markets have behaved in the past and how they are likely to behave in the future. Moreover, if you wish to investigate non-property-related markets your analysis should follow the same logical progression.

The strength and durability of the market system has been demonstrated by the success of those economies that have allowed it to proliferate, subject to sensible checks by the state in areas where it may fail. Indeed, the market system has been exported throughout the world as economies become increasingly interrelated through international trade. As such many countries that formally tried to control the price and output of goods and services through a state-controlled centrally planned system have now embraced the market system in many areas. However, it has to be said that no economy is a purely free market economy as there is always a degree of state intervention and provision. As such one may imagine a spectrum with the two extremes being the free market at one end and the completely centrally planned economy at the other. All countries will obviously fall within this spectrum, some closer to one end than the other.

Applied demand theory

As ordinary consumers we all demand a variety of goods and services on a daily basis. We require food, clothing and shelter to name the most fundamental of our basic needs. However, our demands will normally only be met if we have the purchasing power to back them up. Thus, economics is interested in measuring ‘effective demand’. That is demand that results in an actual transaction taking place rather than simply examining people's desires or wants which are by definition less quantifiable, but may be of interest to other disciplines such as sociology. For example, many of us may dream of owning a large mansion house set in large secluded grounds. Such a dream is a desire or want that most cannot bring into fruition because of a lack of sufficient income to purchase such a property or to service a mortgage upon it. The reality is that we demand shelter, and the type of accommodation that we actually purchase or rent is our real, effective demand. Obviously real transactions can be measured so that people's behaviour can be analysed for a variety of purposes, as we shall see in the forthcoming chapters of this section.

In addition to consumers demanding goods and services, firms at home and abroad also have effective demands. Development companies, surveying firms or financial institutions have a demand for employees, office space, transport and materials, for example. In addition, one must not exclude an often significantly large government sector from the analysis, which, just in their provision of services at both the local and national level, is a substantial source of demand in the economy.

All of these sources of demand if summed together are referred to in economics as aggregate demand although it is normally more useful to break down the analysis into its smaller constituent parts. In conclusion, as economics is only concerned with effective demand rather than demands in general it is acceptable practice just to write or say the word ‘demand’ as effective demand is assumed.

Demand variables

Before undertaking any purchase of a good or service you are normally likely to assess a large number of variables that will help you in the decision-making process. Such assessment may be done automatically by your brain at a very high speed as you have become used to frequently making similar decisions. As a consequence you may not be consciously aware of computing and quantifying a range of issues before you come to a conclusion as to whether or not to buy. However, where such computation becomes more apparent is when either an unusual purchase is made or when one is dealing with the purchase of an expensive item such as a computer, car or house.

There are many variables that we are likely to consider. Economics attempts to both identify and quantify these so that interested parties can predict the purchasing behaviour of both individuals and firms. In this way, producers can hope to meet consumers’ needs and thus make a profit. As a starting point in this exercise, a demand function can be drawn up which is essentially a measurable list of the most appropriate variables that largely explain the purchasing behaviour of the consumer, or group of consumers, in question.

In its simplest form the demand function can be written in notation form in the following way:

D = f (P, Y, S, T)

The letters designated for each variable are the normal abbreviations used in economics texts:

D	=	demand
f	=	is a function of
P	=	price
Y	=	income
S	=	substitute goods
T	=	tastes

Note that the letter ‘Y’ is used to denote income. This is due to the fact that the letter ‘I’ is used for investment.

A consideration of these variables would go a long way in helping to explain the purchasing behaviour of individuals and firms. Indeed, the variable ‘tastes’ encompasses a wide range of issues such as people's perception of quality, the importance of status, the potential for brand loyalty and even the impact of time. This simple function is easy to remember as the four chosen variables form a pronounceable word ‘PYST’. Remembering the word enables one to break it down again to reveal the initial for each variable.

However, more detailed analysis may require an examination of a wider range of variables in an attempt to explain more fully the reasons for demand and any potential changes in such demand. Thus, to extend the function, one could attempt to measure the importance of other influencing factors such as expectations, the impact of government policy, demographic issues, to name just a few examples. Which variables are the most important will depend upon the market in question. In order to isolate the impact of each variable they are examined in turn coupled with the assumption that all other variables are held temporarily constant. If this was not done the analyst may believe that a change in the market is due to the variable currently being investigated. However, this variable may be influenced by changes in other variables that are occurring at the same time. The term used for holding all other variables constant is ceteris paribus.

This chapter now goes on to discuss the influence of these variables in some detail so as to provide an insight into their relative importance. The discussion below will hold for the purchase or rent of any good or service. Examples of each type of transaction are used to demonstrate such flexibility.

Price

When considering the purchase of a service, such as a structural survey from a building surveyor for example, most consumers will initially investigate its price. Sensitivity to price is important, as the consumer first needs to know whether or not he or she can afford to undertake the transaction. In addition, few will want to pay more for a service than is required, and therefore cheaper options or providers are typically sought. In other words, quantity demanded is highly related to price. The more expensive something becomes the less of it is demanded as people switch to substitutes or make do without the service. Thus, the ‘law of demand’ is often quoted as being: ‘quantity d...

Table of contents

• Front Cover
• Half Title
• Title Page
• Copyright
• Contents
• Acknowledgements
• Introduction
• The methodology of economics
• Part 1: Market analysis for the property analyst
• Part 2: Applied theory of the firm
• Part 3: The economy and its management
• Index