Chapter 6 Urban Land Rent

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Chapter 6 Urban Land Rent
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Rent

• Rent is the payment for the use of land.
• When we talk about the cost of land in urban
  econ., we are actually talking about rent.
• When you purchase land, you are actually
  purchasing an expected flow of servicesthis is
  essentially the same as saying you are paying the
  current value of the flow of future services.
• In any case, when you hear cost of land, think
  RENT!!!

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Deriving the simple bid-rent curve (Agri.)
X X

- -

OR
The idea here is that more fertile (or
productive) land commands a higher rent In
farming, productivity is based primarily on soil
quality, but this is location specific, not all
places are equally productive. In other
industries, productivity may be based on access
to transportation or other companies in a similar
business.
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Access to Bottom Land
Prior to mass production of fertilizers, the most
fertile land was bottom-land. It offered both
rich soil because nutrients from soil up-hill
eroded down into the bottom-land, and It offered
access to water. The cost of bottom-land was
often much higher than the less productive
hillier terrain.
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Describing the Leftover Principle

• Competition among producers leads to a bidding
  process for the land.
• Producers bid more for land that can produce
  more.
• This drives economic profits to 0i.e., all
  costs are covered, along with the wages of the
  producer.
• This means, the land owner gets whatever is left
  over once all other factors of production are
  paidsometimes, this is a lot!

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Deriving the simple bid-rent curve (Manuf.) No
Factor Sub.
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/ / / /
We simplify the model by assuming every
manufacturer uses the same amount of land
Similar principles applyLand that has lower
freight costs (i.e., better access to land, air
or water transportation) commands higher rents.
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Deriving the simple bid-rent curve (Manuf.)
If we look only at ground transportation for
manufacturing, we can develop a bid-rent curve
that declines with distance from a major
highway. At each location, rents adjust for the
manufacturer to generate 0 economic
profit. According to the graph, what is the
maximum distance away from a major highway that
a manufacturer will locate?
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Central Place The bid-rent curve for office
space (the info. sector)
In the info. sector, access to other firms in the
sector is important, and access is determined by
travel distance. Firms located at the center of a
region travel less than those at the edge. Firms
located away from the center see costs of travel
increasing at geometric ratei.e., not a linear
rate.
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If we ignore the possibility of factor
substitution between land and capital, the bid
rent curve for offices looks like this.
Fixed building config., and land used
So, differences in the costs of travel for info
exchange are completely offset by differences in
land rent... again, economic profit0.
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The trade-offs between Land and Capital Factor
Sub.
Before, we assumed the amount of land used by
firms was fixed at .25 hectares. Now, lets think
about the factor substitution. A firm will use
less land as land becomes more expensive. They
will substitute capital, which is the same price
everywherebecause its easily movable. What does
this mean about building configuration? The same
floor space can be achieved on smaller plots of
land by building UPWARDS!!! Why does a taller
building require more capital? Elevators,
reinforcement, engineering
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The trade-offs between Land and Capital
Firms can substitute between land and capital, to
increase revenue but, according to the Leftover
Principle, who gets everything after all other
factors are paid? The land owner Factor
substitution allows for even higher rents for
office space in the center of cities. The ability
to substitute capital for land also changes the
shape of the bid rent curve from concave to
convex
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What Does a Convex Bid Rent Curve Mean?

• As we approach the center of a city, the price of
  land rises at an increasing rate.
• The rapidly increasing land price is the result
  of factor substitutionfrom landto capital.
• In turn, current factor substitution leads to
  MORE factor substitution as the city grows.

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Office Bid Rent
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Manufacturing Bid Rent
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Bid Rent
Peachtree Street/Hwy 75-85
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Bid RentWithout Major Complications
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Deriving the Residential Bid Rent Curve

• Assumptions
• Cost of commuting is only in
• Only one person per HH commutes
• Other travel is insignificant
• Public services are the same everywhere, and
• So are public amenities

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Residential Bid Rent (no factor sub)
A standard house is 1,000 SF. An average HH has
800 allocated to rent Commuting costs are 50
per mile per month At a distance of 4 miles, a
house will rent for 600 and commute costs will
be 4 x 50 or 200 for a total of 800. At a
distance of 10 miles, a house will rent for 300
and commute costs will be 10 x 50 or 500 for a
total of 800. There is no utility difference
between locationseq.
However, consumers are free to substitute a
smaller house as they move toward the employment
centernext slide
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Residential Bid Rent (with factor sub)
As the price of housing (i.e., land) per SF
rises, people can consume fewer SFhousing size
is not perfectly inelastic. This means people
near employment centers consume fewer SF and
substitute toward other consumer goods with lower
(opportunity) costs. The leftover principle still
applies here. Because people use fewer SF, they
can now afford to pay more per SF. So, with
factor substitution, price of housing rises more
quickly as you approach the employment center.
At a distance of 10 miles, a house will rent for
300 (.3 x 1000 SF) and commute costs will be 10
x 50 or 500 for a total of 800. At a distance
of 5 miles, a house will rent for 550 (.8 x
approx 687.5 SF) and commute costs will be 5 x
50 or 250 for a total of 800.
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Question to ponder

• What does factor substitution in residential
  housing mean for people locating far from
  employment center?
• SF consumed?
• Price per SF?
• This would make a good discussion question on an
  examwink, wink, nudge, nudge, say-no-more

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Residential Bid Rent (with MORE factor sub)
Remember that not only can consumers substitute
the amount of square feet consumed in
housing Builders can also substitute capital for
land as land becomes relatively more
expensive. What happens to the shape of
housing??? As builders substitute capital for
land, housing gets taller. The convex residential
bid rent curve gets MORE convex.
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Residential Bid Rent (with MORE factor sub)
Consumer factor substitution
Builder factor substitution
Both, lead to a substantial reduction in land
used for housing.
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Utility maximization and housing People maximize
utility subject to a budget constraint of 1,500
(or 2,000 less the 500 commute costs). Panel A
indicates that at 10 miles out, this consumer
chooses 1,200 or all other goods and 1,000 SF of
housing at the price .30 per SF (300). Moving
from 10 miles to 5 miles out reduces commute
costs to 250. Thus, the new budget moves up to
1,750, which can now be allocated between
housing and all else. If the price is .55 per SF
(i.e., no factor substitution), the consumer can
increase utility by moving to point z. However,
to maintain locational equilibrium, prices rise.
At a price of .80 per SF the consumer can
achieve exactly the same level of utility at
point f as before at point i.