McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved Chapter 6 Urban Land Rent

©2009 The McGraw-Hill Companies, All Rights Reserved6-2 Market value: amount paid to take ownership Land rent: periodic payment from user to owner Introduction to Land Rent

©2009 The McGraw-Hill Companies, All Rights Reserved6-3 WTP for hectare of land = Total revenue - non-land costs Bid rent per hectare = WTP divided by lot size Bid Rent for Farm Land Depends on Fertility

©2009 The McGraw-Hill Companies, All Rights Reserved6-4 WTP: Maximum amount for lot large enough for production facility WTP = Total revenue - non-land costs One part of non-land cost is cost of freight to highway Bid rent per hectare = WTP divided by lot size Bid Rent for Urban Land Depends on Accessibility

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©2009 The McGraw-Hill Companies, All Rights Reserved6-6 Each firm earns zero economic profit after paying for land Variation in freight cost generates variation in land rent Axiom 1: Price of land adjusts for locational equilibrium

©2009 The McGraw-Hill Companies, All Rights Reserved6-7 Office firms gather, process, and distribute information Principle of median location: Travel distance minimized at median location Total travel distance increases at increasing rate as distance to center increases Bid Rent for Office Land Depends on Accessibility

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©2009 The McGraw-Hill Companies, All Rights Reserved6-9 WTP = Total Revenue - non-land costs One part of non-land cost is travel costs of office workers Bid rent per hectare = WTP / size of production site Office Bid Rent without Factor Substitution

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©2009 The McGraw-Hill Companies, All Rights Reserved6-11 Capital and land are input substitutes in production of office space Building up increases capital cost and decreases land cost Capital costs increase with building height Vertical transportation systems Reinforcement for weight bearing Role of Factor Substitution

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©2009 The McGraw-Hill Companies, All Rights Reserved6-13 Low Rent: Short building is least costly Medium Rent: Medium building is least costly High Rent: Tall building is least costly Options for Building Heights

©2009 The McGraw-Hill Companies, All Rights Reserved6-14 WTP = Total Revenue - non-land costs One part of non-land cost is travel costs of office workers Bid rent per hectare = WTP / size of production site Office Bid Rent with Factor Substitution

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©2009 The McGraw-Hill Companies, All Rights Reserved6-16 Move from 5 blocks from center to 1 block from center Savings in travel cost: point e to point a; ∆ Bid = $656 Savings from factor substitution: point a to point j; ∆Bid = $744 Result: ∆ Bid rent exceeds the decrease in travel cost Moving Closer to the Center

©2009 The McGraw-Hill Companies, All Rights Reserved6-17 Move from 5 blocks away from center to site farther away Increase in travel cost decreases bid rent Factor substitution saves cost and increases bid rent Result: ∆ Bid rent is less than the increase in travel cost Moving Farther from the Center

©2009 The McGraw-Hill Companies, All Rights Reserved6-18 Commuting cost is only location factor One member of household commutes to employment area Monetary (not time) cost of commuting Noncommuting travel insignificant Ubiquitous public services, taxes, and amenities Simple Model of Housing Prices

©2009 The McGraw-Hill Companies, All Rights Reserved6-19 Each household occupies standard (1,000 sf) dwelling Each household has $800 per month to spend on housing and commuting Monthly commuting cost is $50 per mile from employment center Model with No Consumer Substitution

©2009 The McGraw-Hill Companies, All Rights Reserved6-20 Price of housing per square foot of living space Axiom 1: Housing price adjusts to offset commuting costs Locational indifference: ∆P h + ∆x t = 0 Slope: ∆P / ∆x = - t / h = - $50 / 1,000 = -$0.05 Housing Price & Locational Indifference

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©2009 The McGraw-Hill Companies, All Rights Reserved6-22 If household that moves closer can afford 1,000 sf, is that the best choice? Higher price: Higher opportunity cost per square foot housing Consumers substitute other goods for housing, decreasing sf of housing Role of Consumer Substitution

©2009 The McGraw-Hill Companies, All Rights Reserved6-23 Slope: ∆P / ∆x = - t / h(x); x = distance to employment area Decrease x => increase in P decreases h, increasing slope (absolute value) Increase x => decrease in P increases h, decreasing slope (absolute value) Consumer Substitution and the Slope of the Housing-Price Curve

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©2009 The McGraw-Hill Companies, All Rights Reserved6-25 Each firm uses 1 hectare of land and $K of capital to produce Q sf of housing Total revenue = P(x) Q is convex because housing-price curve is convex Leftover principle: Willingness to pay = P(x) Q - K = Bid rent for land Residential Bid Rent with Fixed Factor Proportions

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©2009 The McGraw-Hill Companies, All Rights Reserved6-27 Response to higher land rent is taller buildings on smaller lots Cost savings from factor substitution increase bid rent for land Result: bid-rent curve is more convex Role of Factor Substitution in Housing Production

©2009 The McGraw-Hill Companies, All Rights Reserved6-28 Lower price of housing: higher consumption of housing (square feet) Lower price of land: higher consumption of land per sf of housing Larger suburban footprint (land per household) and lower population density Population Density within City

©2009 The McGraw-Hill Companies, All Rights Reserved6-29 Commuting comes at expense of work or leisure Commuting time valued at 1/3 to 1/2 wage Relax Assumptions: Time Cost of Commuting

©2009 The McGraw-Hill Companies, All Rights Reserved6-30 Common workplace: commuting cost double, increasing slope of housing-price curve Different workplaces: two points of orientation Change in residence causes ambiguous change in commute cost Slope of housing-price curve ambiguous Relax Assumptions: Two earners per household

©2009 The McGraw-Hill Companies, All Rights Reserved6-31 Uniform distribution of destinations: offsetting changes in noncommuting travel Concentrated destinations: many points of orientation Change in residence causes ambiguous change in travel cost Slope of housing-price curve ambiguous Relax Assumptions: Noncommuting travel

©2009 The McGraw-Hill Companies, All Rights Reserved6-32 Ceteris paribus, housing and land prices higher in location with Superior public goods Low taxes, ceteris paribus Positive amenities Example: Cleaner air means higher housing and land prices Relax Assumptions: Public service, taxes, amenities

©2009 The McGraw-Hill Companies, All Rights Reserved6-33 Manufactures export output on highways Intercity highway goes through city center Circumferential highway (beltway) Office firms exchange information in central area Workers drive to workplaces Land Use Patterns: Transportation Features of City

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