02 Microeconomic Concepts 202305

Economic Context of Property
Development:
Microeconomic Concepts
U E B Q 4 5 5 3 P R O P E R T Y D E V E LO P M E N T
Where are we going?
When you have completed study of this chapter, you will
be able to:
▪Explain the key microeconomic concepts and theories that
have a bearing on urban property markets.
▪Introduce the inter-related economic concepts concerning
the rent, land uses and land use intensity.
▪Explain how the location of each site influences the way it
is used and its profit-making potential.
▪Explain why property exchange prices and their associated
valuations are largely explained by demand-side factors.
What economists study?
The Property Market and Price Determination
Chapter Type and Density of Development

Contents
Location and Land Use
The Timing of Redevelopment


Contents

Introduction
Is it Is it about
business?
about
money? Is it about
How people
government
make money
and jobs?
and spend
it?
Why some Why some

people are rich nations are
and others rich and others
poor? poor?
What economists
study?
Economics is
study of choices
and their
consequences.
What economists
study?
All economic questions
arise because we want
more than we can get.
Urbanisation
Scarcity Choices Incentives

Want › Resources = Scarcity
Unlimited Limited
Choice
Benefit
Cost (Losses)
(Gains)
Driven by
Incentives
Go for greater benefits Give up another alternative
Trade off/ exchange

Want › Resources = Scarcity
Unlimited Limited
Choice
i) Individual
ii) Households
iii) Firms Benefit
iv) Government Cost (Losses)
(Gains)
Driven by
Property developer?
Incentives
Property Investor? Go for greater benefits Give up another alternative
Trade off/ exchange

Economics is the social science that studies
the choices that individuals, businesses,
governments, and entire societies make as
they cope with scarcity and the
incentives that influence and reconcile
those choices.
Microeconomics Macroeconomics
Microeconomics Macroeconomics
What will happen to the demand How the weak Ringgit is affecting
of high-rise properties if there is a the construction industry?
drop of price on the landed
properties?
What, how, and for whom Do choices made in the

goods and services get pursuit of self-interest also
produced? promote the social
interest?
Goods
What
Services
Economic Problems
Land
Labour
How
Capital
Entrepreneurship
Self Interest
For whom Efficiency
Social Interest
Equity
Land - Rents
Labours - Wages
Factor of
Capital - Interest
Production
Entrepreneurship - Profit
Now read:
Section 1.1 Supply and demand, markets and
equilibrium price determination in Chapter 1
Microeconomic Concepts of Wyatt P. (2013)
Property Valuation. Second Edition. Wiley.

Contents

The Property Market and Price
Determination
Payment for use of land (rent)
The price of land falls,

demand will increase.
Quantity of land
Determination
S
The higher the price that

can be obtained,
the greater the quantity
of property that will be
supplied.
D
Quantity of land
Determination
S
Equilibrium price P* is
Excess supply where demand for
P1 property equals
P*
P2
supply at quantity Q*
Excess demand D
Q*
Quantity of land
Determination
Property has two components:
1. The land itself and
2. Improvements - in the form of buildings and
other man-made additions.
The Property Market and
Price Determination
Property is unique and heterogeneous
▪Geographical position
▪Accessibility
▪Visibility
▪Physical attributes
▪Legal restrictions
▪External influences e.g. government intervention
Determination
Large, indivisible and expensive
▪financing plays a significant role in market
activity.
Durable
▪a big market for existing property
Determination
Price determination focus on

rental values.
S
Price Determination
P2
Rent
Classical economists regards the

P1 supply of all land is completely
(perfectly) inelastic and cannot be
P
increased in response to higher
demand)
D
O Q
Quantity of land
S
Price Determination
The opportunity cost of using land
Rent
is zero and all earnings from the land

(represented by the area OPEQ) is
P E economic rent.
Economic
D
Rent
O Q
Quantity of land
S
Price Determination
If the productivity of land or the
Rent
price of the commodity produced

good/service increased, then
P E D1 demand for all quantities of land and
Economic hence the rent offered would rise.
D
Rent
The demand curve would shift from
O Q D to D1.
S
Price Determination
The only response is higher price of
Rent
P1.
P1
Price therefore is solely demand-
P E D1 determined.
Economic
D
Rent
O Q
Quantity of land
Determination
▪Different businesses will demand land in different locations for
different uses.
▪Businesses able to pay a price for land that depends on the revenue
they can generate and the costs they will incur in the process.
Determination
▪Users compete for land in the form of rent.
▪Now the supply of land for a particular use
is not perfectly inelastic since land can be
used for alternative uses – it has an
opportunity cost.
Determination
Because supply is not perfectly inelastic (supply curve is now
upward-sloping), some of the rent is transfer earnings and the
rest is economic rent.
Opportunity Cost and Economic Rent
D S
Rent
Economic rent – excess
payment/surplus profit
earned by factor of
production
Economic
Transfer earning - Rent
minimum sum to retain
factor of production
in its current use Opportunity
Cost
Quantity of land
Economic rent - a payment S
in excess of transfer earnings
that reflect the scarcity
value of the land. Demand for
development
land is derived
Rent
P* demand
Economic
Rent
D
Transfer earning - A minimum sum or opportunity
Transfer cost to retain land in its current use, which must be
earnings at least equal to the amount that could be
obtained from the most profitable alternative use.
O Q* Quantity of land
Perfectly inelastic Inelastic Elastic
S S
ER ER
D D D
Economic
Rent (ER)
OC/ TR OC/ TR
- Land supply is fixed. - Land supply is not fixed.

- Land can only use for one/single use - Reason: additional supply will be added – HOW?
(e.g. farming) - Land has multiple/alternative uses.
- Land components: No opportunity - Land components: opportunity cost (OC), & economic
cost (OC), only economic rent (ER) rent (ER)
Determination
Elasticity of supply of land
The amount of price shift in response to a change in demand will
depend on elasticity of supply
– the more inelastic, the greater the change in price.
S City centre
Price Determination
P2
P1
The lands in the city central are
Rent
D2
almost entirely made up of
economic rent because of the
D1 scarcity of this type of space in
these locations
O Q1Q2 Quantity of land
City fringe
Price Determination
S The supply of the land on the edge
P2
of urban area are more elastic.
Rent
P1 D2
D1 The supply curve has a more gentle
slope.
O Q1 Q2
Quantity of land
Determination
The proportion of transfer earnings and economic rent depends on
the elasticity of supply of land:
▪the more inelastic the supply, the higher the economic rent
▪the more elastic the supply, the higher the transfer earnings.
City centre
City fringe
S
• the more inelastic the supply, the higher the

economic rent
P2 • the more elastic the supply, the higher the
transfer earnings.
P1
Rent
S
P2
Rent
P1 D2
D1
O O Q1 Q2
Q1Q2 Quantity of land
Quantity of land
S
Short-run: Supply curve is
unlikely to be very sensitive The Property Market and
to rent levels; tends to be
inelastic. Price Determination
r1
r*
Effect of time
In the short-run, supply will be
Rent
D1
inelastic (S) and demand (D) will
D
be elastic, producing an equilibrium
rent, r*
If demand increases to D1,
O
Office floor-space
rent will rise to r1
S

r1
S1 Price Determination
r* Effect of time
Rent
D1 In the long-run, supply adjusts

Long-run: Supply curve D
because the increase in rent
become more elastic - improves the profitability of
businesses change
production methods, space property development activity.
utilisation and location.
O
Office floor-space
S

r1
S1 Price Determination
r2
r* Effect of time
Rent
D1 The supply of land will increase to

D
say S1, settling rents back to r2,
assuming no further change in
demand.
O
Office floor-space
Determination
Effect of time
Even if supply was not fixed/perfectly inelastic in the long-run, the
longevity of property means that new stock is a very small proportion
of total stock and therefore new supply has negligible influence on
price. Therefore, r1 rarely falls back to r2.

Contents

Price Determination
Land use intensity
Land can be used more intensively through the
addition of capital (e.g. more floor-space) to
improve the productivity of land.
Price Determination
Land use intensity
As more capital (floor-space) is added to the
fixed amount of land, initially the marginal
revenue product (MRP) of the land might
increase because of economies of scale but
the principle of diminishing returns means
that eventually it will fall
350
300
250
Labour Cost TC MC Output MP Price TR MRP
200
0 30 0 0 - 5 0 -
150
1 30 30 30 10 10 5 50 50
2 30 60 30 24 14 5 120 70 100
3 30 90 30 39 15 5 195 75
50
4 30 120 30 50 11 5 250 55
5 30 150 30 58 8 5 290 40 0
6 30 180 30 62 4 5 310 20 1 2 3 4 5 6
MP TR MRP MC
Wind loading
Engineering services
Fire protection
Structural frame
Vertical transportation
Foundation
High cost associated with tall buildings
•Vertical transport – hoists and cranes, problem with material storage, the delays in waiting
for the construction to set.
•Engineering services – lifts, refuse disposal installation, pumping requirement for sewerage
disposal
•High cost for foundation
•The necessity of structural frame, more stringent requirement for staircase, more fittings
and furnishing for convenience – need wider stairways, larger landing area, area for access
•Improvements fire-resistance precautions, particularly insulation between floors.
•Wind loading factors: increase constructional difficulty and increase cost – withstand wind
blow.
Optimal combination of land and capital (Fraser, 1993)
Economies Principle of When OX unit of capital employed,

of scale diminishing return profit is maximised i.e. the MRP of
Cost of capital/value of output (unit)
a unit of capital equals the (MC) of

a unit of capital.
Q Land (economic) rent

Y
MC
P
MRP
Total cost of capital
O
X
Units of capital
Price Determination
Land (economic) rent
Q
Y Profit is maximized, MRP = MC, when OX
MC
P units of capital are employed.
MRP If capital < OX, MR > MC
If capital > OX, MR < MC
OX is the optimum amount of capital to
combine with the land.
O Total revenue = QYXO

X
Units of capital Total cost = PYXO
Surplus revenue = QYP
Price Determination
Land use intensity
If land is expensive, a large amount of
building may take place before building costs
increase to a level where it pays to acquire
more land to provide extra accommodation.
If the land is expensive,
large amount of building
need to generate higher
revenues (MRP’) to pays

for the land cost.

Y
MC
P
MRP
MRP’
O
Units of capital X X1
The price obtained from goods and

Cost of capital/value of output (unit) services produced from the land falls
the MRP curve will drop from MRP
to MRP’.

Y
MC
P
MRP
MRP’
O
Units of capital X1 X
The production cost falls due to an
improvement in construction technology or
Cost of capital/value of output (unit) a fall in the cost of borrowing capital would
shift the MC of capital line downwards to
MC’.

Y
MC
P MC’
MRP
O
Units of capital X X2
Demand and its effect on rent and intensity of land use in different locations
Revenue and cost per unit of output
Revenue and cost per unit of output

Rent Rent
Cost of capital Cost of capital
MRP MRP
Capital Capital
(a) Intensive use of land (b) Extensive use of land

Now read:
Section 1.2 The property market and price
determination in Chapter 1 Microeconomic Concepts
of Wyatt P. (2013) Property Valuation. Second
Edition. Wiley.

Contents

Location and land use
Where the land is?
Land close to a market or a supply of
labour will yield the same output as land
that is further away but would incur lower
labour and capital costs due to
accessibility advantages.
Where the land is?
Assuming the price of the output
remains the same regardless of where it
was produced, the utility value of the
prime site is greater and this value is
reflected in the rent.
Von Thunen’s single use revenue and cost model
Distant land suffers greater diminishing return

Total cost (including transport)
The rent decreases as the distance to
the market increases.
Revenue/costs
Total
R revenue
Difference between
revenue and cost
(surplus profit)
For a single land use, transport costs

Costs will increase as distance from the Beyond distance Y this use is no
(excluding central market increases. longer profitable as costs exceed
revenue.
transport)
O Y
Market location Distance from market
Total cost
for use B
Total cost
for use A
Where the land is?
Revenue/costs
R Assuming revenue is the same from both

Revenue products. Land use B has the greatest
from both
uses
surplus available to bid as rent (BR > AR).
Land use B is able to outbid land use A but
A only up to distance X from the market,
B after which, because A’s total production
costs do not rise so steeply, it is able to
O X Y outbid B.
Distance from market
R
D
C
B
A
O X Y Z Distance from market
R
D
C
B
A
A O X Y Z Distance from market
B
C
D
Land use and bid-rent theory A M
Rent earning capacity

B
N
Z Y X A B C D
Distance from market
Bid-rent curves
Bid-rent curves (indifference curves)
Rent
Businesses will endeavour to
locate on the bid-rent curve
nearest the origin.
Market rent
o
(CBD) Distance from CBD
Bid-rent curves
Bid-rent curves (indifference curves)
Lines join equilibrium locations where access and

rent are traded off against each other. It indicates
the maximum rent that can be paid at different
locations and still enable the business to earn normal
Rent
profit.
Businesses will endeavour to

Increasing
locate on the bid-rent curve
profit
nearest the origin.
Market rent
o X
(CBD) Equilibrium location is at X, as this is the most
Distance from CBD profitable location at current rents
Alonso’s bid-rent concept
Retailers are particularly dependent on a central location where

Retail the market is located, accessibility is maximised and transport
costs are minimised. The availability of such sites is very limited
Rent
and therefore supply is almost perfectly inelastic.
Office
Office occupiers outbid industrial occupiers.
Industrial
o
Retail
Distance from CBD
Office greater accessibility leads to higher demand,

which, in turn, causes rents to rise and land use
intensity to increase.
Industrial
Now read:
Section 1.3 Location and land use in Chapter 1
Microeconomic Concepts of Wyatt P. (2013)
Property Valuation. Second Edition. Wiley.

Contents

The Timing of
Redevelopment
The relationships between existing use
value and development value of a
specific site will vary over time.
Two conditions necessary for property
development to be economically viable:
▪Expected development value must exceed
development costs, including the price of the
land and the developer’s profit, and
▪Development site value must be at least the
same as existing use value.
The residual site value for development
purposes will be the highest price which
the most efficient developer would be
willing to pay.
The Timing of
Redevelopment
▪To investigate the relationship between existing use
value and development value of a site in more detail
we need to consider the economic life of a
building.
▪The economic life of a building will be the period
for which the present (capital) value of the existing
use is greater than the present value of the site
cleared and ready for development.
The Economic Life of a Building (after lean and Goodall, 1966)
Capital value
Office space was the most

profitable use at time t = 0
Time (years)
B shows the capital value of the office

building falls over time as depreciation
Capital value
takes hold, maintenance cost increase

relative to rental value and a better
standard of accommodation is expected.
B
O
Time (years)
Capital value
S shows the capital value of the cleared site

assuming no change in supply and demand over
time and that land and construction costs remain
constant over time.
B
O
Time (years)
Not economically viable to

redevelop the site until t = L
Capital value
B
O
L
Time (years)
S may increase to S1 due to

infrastructure improvement
Capital value
S1
…and this will

reduce the economic
life of the building. B
O
L1 L
Time (years)
Capital value
S
B may increase to B1 due
to refurbishment or
conversion to a more
B1
valuable use
…and this will increase B
O the economic life of the
L L2 building.
Time (years)
Capital value
S1
B1
This model can be
used to explain urban B
O structure.
L1 L L2
Time (years)
… at the same time site values may

increase (S to S1).
Capital value
S1
In the central area buildings fall

into disrepair as owners B1
anticipate redevelopment (B1 to
B) B
O
L
Time (years)
… but the infrastructure

usually worsens (S1 to S).
Capital value
S1
Further out from the centre the built

environment is characterised by lots of B1
conversions and refurbishments, increasing
building values (B to B1) B
O
L
Time (years)
… but development
forces are strong (S to
Capital value S1).
S1
S
In the suburbs buildings tend to
be well maintained (B to B1)
B1
B
O
L
Time (years)
Read More at WBLE –
Further Reading
•Landowner's inertia
•Tenure
Factor affecting the •Statutory rights
timing of
redevelopment •Fragmentation of ownership
•Depreciation of property
The relationship between land and property value
Building cost and land value
Building value
Residual land value
Years
Now read:
Section 1.4.2 The timing of redevelopment in
Chapter 1 Microeconomic Concepts of Wyatt P.
(2013) Property Valuation. Second Edition. Wiley.
Key takeaways
1. Land is a scarce resource.
2. Property is unique.
3. Land in different location will have different intensity.
4. Location of land will influence the way in which it is used
and its profit-making potential.
5. Different businesses will demand land in different
locations for different uses.
6. The highest and best use of land is constantly changing
over times.

02 Microeconomic Concepts 202305

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Economic Context of Property

The Property Market and Price Determination

Chapter Type and Density of Development

The Timing of Redevelopment

The Property Market and Price Determination

Chapter Type and Density of Development

The Timing of Redevelopment

Why some Why some

Scarcity Choices Incentives

Trade off/ exchange

Trade off/ exchange

What, how, and for whom Do choices made in the

The Property Market and Price Determination

Chapter Type and Density of Development

The Timing of Redevelopment

The price of land falls,

The higher the price that

Price determination focus on

Classical economists regards the

is zero and all earnings from the land

price of the commodity produced

- Land supply is fixed. - Land supply is not fixed.

• the more inelastic the supply, the higher the

The Property Market and

D1 In the long-run, supply adjusts

The Property Market and

D1 The supply of land will increase to

The Property Market and Price Determination

Chapter Type and Density of Development

The Timing of Redevelopment

Economies Principle of When OX unit of capital employed,

a unit of capital equals the (MC) of

Q Land (economic) rent

O Total revenue = QYXO

revenues (MRP’) to pays

Q Land (economic) rent

The price obtained from goods and

Q Land (economic) rent

Q Land (economic) rent

Revenue and cost per unit of output

(a) Intensive use of land (b) Extensive use of land

The Property Market and Price Determination

Chapter Type and Density of Development

The Timing of Redevelopment

Distant land suffers greater diminishing return

For a single land use, transport costs

R Assuming revenue is the same from both

Rent earning capacity

Lines join equilibrium locations where access and

Businesses will endeavour to

Retailers are particularly dependent on a central location where

Office greater accessibility leads to higher demand,

The Property Market and Price Determination

Chapter Type and Density of Development

The Timing of Redevelopment

Office space was the most

B shows the capital value of the office

takes hold, maintenance cost increase

S shows the capital value of the cleared site

Not economically viable to

S may increase to S1 due to

…and this will

… at the same time site values may