Download Chapter 1 Economic Principles and Cycles

Chapter 1
Economic Principles and Cycles
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I. Economics
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Economics

Economics is primarily concerned with the efficient
allocation of scarce resources

In economics, we are concerned with :
1.
2.
3.
Production
Distribution
Consumption of goods and services
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A. Real Estate Economics

Real estate economics is used to analyze national,
regional, city and neighborhood trends in an effort to
interpret what effect these trends will have on the real
estate market
National Trends
State Trends
County Trends
City Trends
Neighborhood Trends
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B. Real Estate Economics

Real estate economics deals with the mechanisms that
society creates to allocate different types of land among
individuals.
Real Estate Trends are interwoven and dependant on
the other trends in the local economic situation as well
as the national trends in economics.
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C. Real Estate Economics

The value of real estate in any market is dependent on the
four elements of value;
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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Demand
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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C. Real Estate Economics

The value of real estate in any market is dependent on the
four elements of value;
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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C. Real Estate Economics

The value of real estate in any market is dependent on the
four elements of value;
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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C. Real Estate Economics

The value of real estate in any market is dependent on the
four elements of value;
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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C. Real Estate Economics

The value of real estate in any market is dependent on the
four elements of value;
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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C. Purchasability

The value of real estate in any market is dependent on the
four elements of value;
1.
2.
3.
4.
Demand
Utility
Scarcity
Transferability.
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1. PurWhy Study Real Estate
Economics?

In economics, our goal is to determine how the
market system prices and distributes goods and
services throughout the economy.

REAL ESTATE ECONOMICS is the application of
economic principles to the real estate
marketplace.

In economics, we study what has happened in the
past in order to explain and predict what will
happen in the future.
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B. Real Property

There are 2 types of property:



REAL PROPERTY (immovable)
PERSONAL PROPERTY (movable)
Real Property is the land and buildings or
improvements attached to the land.





Land
Anything permanently attached to the land
Anything incidental or appurtenant to the land
That which is immovable by law
Any property that is NOT real property is considered
personal property
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C. America’s Economic
History

America’s early economic growth was fueled by an
unlimited supply of free or low-cost land.

Early economic growth was stimulated by what the
land could support





Crops
Fur
Game
Domestic animals
Mineral wealth
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cont.

Gradually, after the industrial revolution, our
nation’s economic base changed to
manufacturing, technology, and service related
industries.

The days of wide-open land are long gone.

The larger the population, the scarcer and more
valuable the land becomes.
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D. National and Local
Economies

Local economies may be based upon an industry
or even a single employer.

A local economy can be very different from
regional or national economies.
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E. Real Estate Economics

Real estate economics is inductive in nature.

It is a logical process that begins by looking at the
neighborhood and the site itself.

The analysis looks at the economy on the
following 4 levels:




National
Regional
City
Neighborhood
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II. Supply and Demand
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A. Law of Supply

Producers will increase production (supply) when prices
rise in order to maximize their profits.

However, in a free market, the entry of additional suppliers
creates an upward shift in the supply curve.

A SUPPLY CURVE indicates the number of units that will
be available on the market at a given price

As supply increases, exceeding demand, prices start to
decline

In real estate, when prices are high, more owners are
willing to place their homes on the market for sale and
developers will be encouraged to produce more units.
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B. Law of Demand

The amount consumers purchase varies inversely
with price.

A DEMAND CURVE indicates the number of units
consumers purchase or are willing to purchase at
a given price.
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C. Equilibrium
(Point and Price)

EQUILIBRIUM is the point where demand and
supply curves cross, establishing the market price

Since the marketplace is constantly changing with
new sellers and buyers, the equilibrium point does
NOT remain constant
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D. The Real Estate Market is
an Imperfect Market

Real estate does NOT lend itself to perfect
economic supply and demand models.

Demand is meaningless unless it is coupled with
purchasing power and/or financing ability.

In a market system, items will NOT be produced if
there is no market. If there is a demand, there will
be production.
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E. Elasticity of Supply and
Demand

ELASTICITY is the size or magnitude of a reaction
to a change in price.

ELASTIC SUPPLY means that a small change in price will
greatly affect the quantity supplied.

INELASTIC SUPPY means that a change in price will
have little effect on the quantity supplied.

ELASTIC DEMAND means that a small change in price
will greatly affect the quantity demanded.

INELASTIC DEMAND means that a change in price will
have little effect on the quantity demanded.
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1.
Available alternatives. Where 2 similarly
desirable houses are available, the lower
priced house will lower the demand of the
other.
2.
Relative high price of real estate
3.
Long time dimension of the purchase decision.
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F. Real Estate Supply &
Demand in the Market

A neighborhood is the basic market unit of supply and
demand in real estate.

From an economist’s point of view, the real estate market is
primarily a local market.

SELLER’S MARKET exists when there are few sellers and
many buyers who keep prices up

BUYER’S MARKET exists when there are many sellers but
few buyers and prices go down.
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G. Supply Side Economics
 SUPPLY
SIDE ECONOMICS is the economic theory that
the most effective way to stimulate growth is to provide
incentives for people who produce or supply the goods by
lowering taxes and reducing governmental regulations
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III. Inflation and
Deflation
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A. Deflation and Inflation in
Real Estate

In a deflationary period, the dollar buys more.

A DEFLATIONARY ECONOMY exists when there
are more goods than there is purchasing power.

The dollar buys less in an inflationary period.
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B. Stagflation

STAGFLATION is the name given to the
phenomenon of inflation during a recessionary or
no-growth period.

During a recession, the increase in unemployment
should reduce the purchasing power for goods
and stem inflation.
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IV. Basic Real
Estate Economic
Theories and
Principles
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A. Leverage

LEVERAGE is obtained by using other people’s
money to purchase real estate.

The advantage of leverage is that, for relatively
low capital outlay, a person can control real estate
of high value.
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B. Multiplier Effects

A MULTIPLIER EFFECT measures the outcome of an
economic event as a multiple of the amount of the initial
change.

A large change in a variable results from only a small initial
change in another variable.
1.
2.
Manufacturing and Service
Dollar Multiplier
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C. Marginal Propensity To
Save
 The
marginal propensity to save is affected by
expectations
 If
a person has negative expectations of the
future, he might save more money
 If
the future is expected to be good, savings could
be reduced
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D. Marginal Propensity to
Consume
 Increases
in the propensity to consume will mean
less money saved and a greater demand for
goods
 This
increase in demand could be inflationary
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E. Theory of Filtering
Down

FILTERING DOWN is the principle by which housing tends
to be passed on to lower economic groups

People tend to “move up” leaving more marginal housing
units available for people on the lower economic scale

This process can be halted or even reversed by
GENTRIFICATION, the return of the affluent into
neighborhoods that had become home to lower income
households
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F. Economies of Scale

ECONOMIES OF SCALE are obtained by
producing more and spreading fixed costs over a
larger number of units, and results in savings to
the producer
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G. Law of Diminishing
Returns

The LAW OF DIMINISHING RETURNS states
that at some point, as production is increased,
additional units will result in increasing costs, so
that as units are added, profits may decrease.
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H. Economics of Subdividing

There are more buyers for smaller parcels than
there are large parcels.

Lower prices for smaller parcels make smaller
properties more affordable.

The increased demand and an economy of scale
allow a subdivider to make more money on
individual, subdivided parcels than on larger
parcels.
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I. Economics of
Assemblage

ASSEMBLAGE is the concept of assembling a
group of smaller lots to form one large lot, which
can net a larger profit.

The shortage of larger parcels within a highly
developed area allows an owner or assembler to
get a higher price for the group of properties than
the total value of each of the individual properties.

PLOTTAGE INCREMENT
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J. Economic Obsolescence and
Economic Life

More buildings are torn down than wear out.

ECONOMIC or EXTERNAL OBSOLESCENCE
occurs when the value of a property decreases
because of negative factors affecting the
neighborhood.


Economic Life
Highest and Best Use
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K. Principle of First Choice

PRINCIPLE OF FIRST CHOICE states that a business that
needs a particular type of location for a specific use will pay
the most.
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L. Principle of Competition

PRINCIPLE OF COMPETITION states that when
extraordinary profits are made in a field, then
competition will enter the field and profits will
decline.
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M. Principle of Substitution

This appraisal principle is also a basic economic
principle.

The PRINCIPLE OF SUBSTITUTION affirms that
the maximum value of a property tends to be set
by the cost of acquiring an equally desirable
alternative property.
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N. Principle of Change

Property is NOT static; it is always changing.

The PRINCIPLE OF CHANGE states that real
estate values do not remain constant but are
always in a state of flux.
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O. Principle of Real Estate
Cycles

Development stage (Integration)

Maturity (Equilibrium Stage)

Decline (Disintegration)
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P. Business Cycles

There are recurring patterns or business cycles in
the economy

Cycles are not precise, but vary in length and
intensity

Cycles are waves that have a high point or peak
and a bottom point with a trough
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Q. Forecasting Real Estate
Cycles

The downward swing of the real estate cycle tends
to lead a general business recession

A real estate recovery tends to lag behind a
general business recovery

Sales of family housing are generally strongest in
the spring until September, when the market slows
down
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R. Recessions and
Depressions

RECESSION is defined as a minimum of two quarters in
which the growth of real Gross Domestic Product (GDP) is
negative

A DEPRESSION is nothing more than a severe recession,
during which the economy shrinks considerably.
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S. Government and Cycles

Government fiscal policy affects the business
cycle.

FISCAL POLICY is the responsibility of our
federal government to tax its citizens and wisely
spend our money to benefit the nation.

The Federal Reserve controls the money supply
and usually short-term interest rates through
monetary policy.
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Chapter Summary

Economics



Real Estate Economics
Real Property
America’s Economic History

Basic Theories &
Principles






Supply and Demand





Law of Supply
Law of Demand
Equilibrium
Elasticity
Real Estate Supply & Demand in
the Market











Inflation and Deflation

Stagflation



Leverage
Multiplier Effects
Marginal Propensity to Save
Marginal Propensity to Consume
Theory of Filtering Down
Economies of Scale
Law of Diminishing Return
Economics of Subdividing
Economic Obsolescence and
Economic Life
Principle of First Choice
Principle of Competition
Principle of Substitution
Principle of Change
Principle of Real Estate Cycles
Business Cycles
Forecasting Real Estate Cycles
Recessions and Depressions
Government and Cycles
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