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abstract
This article revisits
economic notions of
On Price, Cost, and Value
by Ünsal Özdilek, PhD
price, cost, and value
as they are applied in
real estate economics
and in particular
appraisal practice.
It also reviews the
traditional sales
comparison, cost, and
income capitalization
approaches based on
these notions. Human
economic conduct
is reconsidered
using a time-space
reference that
improves objectively
our conventional
understanding of
price, cost, and value
and the traditional
valuation approaches.
C
learly understanding and differentiating price, cost, and value is fundamental in real estate economics as well as in general economic theory. In their
practical assignments, appraisal professionals usually analyze and advance an
opinion on the market value of real property through the application of three
traditional approaches: the sales comparison approach, the cost approach, and
the income capitalization approach. Although the application of one or more
of these approaches may be more appropriate for the purpose of a valuation
and the type of property, theoretical foundations recommend that they should
converge. However, appraisers often face differences in their market value
estimations that are sometimes very significant. When this occurs, the variance becomes an important test, requiring additional attention to the true
essence of the price, cost, and value. Unfortunately, appraisal professionals
do not take these opportunities to consider the essential nature of price, cost,
and value, instead relying on the prevailing valuation approach and existing
mechanical definitions.
Definitions of price, cost, and value in real estate practice are historically
borrowed from the science of economics, which has its origins in the debates
about these notions between different schools of thought. It is hard to blame
professionals for not discerning the true essence of these notions in their market
value estimates because economists themselves have not resolved the distinction between price, cost, and value. In fact, the extensive related literature is
more confusing than enlightening about the definitions of these concepts.1
There is a preference among economists to use price as a substitute for
value and cost. This preference started in the mid-twentieth century when
the neoclassical school of economics combined supply and demand utility law
into a unified price theory. Before that, there were very substantial debates
on value theory as well as on cost theory. 2 Today, value theory has become
1. See for example, Peter F. Colwell, “A Statistically Oriented Definition of Market Value,” The Appraisal Journal
(January 1979): 53–58; Harold D. Albritton, “A Critique of the Prevailing Definition of Market Value,” The
Appraisal Journal (April 1980):199–205; R. T. M. Whipple, Property Valuation and Analysis (Sydney: Law Book
Company, 1996); Max Kummerow, “Thinking Statistically about Valuations,” The Appraisal Journal (July 2000):
318–327; and Hans Lind, “A Statistical Definition of Value: A Critical Comment,” letter to the editor, The
Appraisal Journal (July 2003): 274–277.
2. Cost theory had its glory days during the nineteenth century in the classical school of economics with the idea
of the distribution of wealth between the cost agents of production.
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The Appraisal Journal, Winter 2010
On Price, Cost, and Value
a short, symbolic explanation within economic
handbooks, while cost theory survives as an ordinary summation variable in the equations, often
used with multiple descriptive modifiers such as
production cost.
Real estate appraisal practice and economic
theory in general suffer from the absence of a clear
distinction between the notions of price, cost, and
value caused by the imprecision of language, plurality of definitions, and divergence of conceptions
within areas of study.3 This leads to difficulties in
implementing the different approaches of market
value estimation based on these notions. This
article focuses on these concepts and tries to distinguish them clearly and objectively through the
use of a psychological time-space reference as it is
felt and applied in real estate practice. It aims as
well to improve our understanding of the valuation
approaches that they support.
The Concept of Time in Economics
Literature
Economists recognize the role and importance
of time, but the concept of time has not been specifically examined except by Keynes, Hayek, Hicks,
and von Mises.4 John Maynard Keynes recognized
the role of time, especially with regard to the difficulty of valuing things based on future uncertainty.
Hayek and von Mises noted that current economic
theory could not incorporate the time dimension
correctly, specifically with regard to the process
of individual decision making, which takes place
in time. Hicks distinguished two kinds of economic
models: models that include time as a parametric
variable (causal or logical time) and models where
economic activity takes place in time (real or historical time).5
Time has the characteristics of a mathematical
variable in its causal form, represented sometimes
by a t subscript in equations. This abstract representation of time is sometimes criticized because
authors, in order to permit the equilibrium state,
approximate real time by supposing that everything happens simultaneously.6
While causal time is essentially a mechanical
concept, historical time is seen as being naturally
social and behavioral. Hicks, Samuelson, and
Schumpeter are considered as the first economists
who emphasized the importance of historical time.7
The historical passage of time is envisioned as
a unidirectional sequence of irreversible events
that leads toward the growth of uncertainty. In
this version, the role of time in economic theory is
represented as biological in nature, not a derivative
of or parallel to Newtonian physics.
In their recent compilation of papers related to
the time element in economics, Zamagni and Agliardi
studied methodological concerns of integration
of time in causal models.8 Godet and Pfeife both
brought attention to different methodologies of
forecasting the future in strategic management.9
Morgenstern, Knorr, and Heiss analyzed classical
forecasting methodology under judgmental analysis
(subjective or qualitative models such as Delphi
or scenario analysis), causal analysis (basically
regression analysis), and time-series analysis
3. Appraisal Standards Committee, Market Value Initiative White Paper (Chicago: Appraisal Institute, December 7, 1999).
4. John Maynard Keynes, A Treatise on Probability (London: Macmillan and Co., 1921); Friedrich A. Hayek, “Das intertemporal gleichgewichtssystem der
preise und die bewegungen des geldwerts,” Weltwirtschaftliches Archive 28 (1928), 33–76, translated in English as “Intertemporal Price Equilibrium
and Movements in the Value of Money,” in Money, Capital and Fluctuations: Early Essays, ed. R. McCloughry, 71–117 (Chicago: Chicago University
Press, 1984); John R. Hicks, “Gleichgewicht und konjunktur,” Zeitschrift für Nationallökonomie 4 (1933), translated in English as “Equilibrium and
the Trade Cycle,” in vol. II, Money, Interest, and Wages: Collected Essays in Economic Theory, 28–41 (Oxford: Basil Blackwell, 1982); and Ludwig von
Mises, Human Action: A Treatise on Economics (New Haven: Yale University Press, 1949).
5. John R. Hicks, “Some Questions of Time in Economics,” in Evolution, Welfare, and Time in Economics, ed. Anthony M. Tang, Fred M. Westfield, and James
S. Worley (Toronto: Heath 1976), 135–151. In economics, the orthodox neoclassical models work with causal time, while political economists usually
assume historical time.
6. Graeme D. Snooks, Economics Without Time: A Science Blind to the Forces of Historical Change (Ann Arbor, MI: University of Michigan Press, 1993);
Gerald P. O’Driscoll, Jr., and Mario J. Rizzo, The Economics of Time and Ignorance (New York: Routledge, 1996); and David L. Prychitko, ed., Why
Economists Disagree: An Introduction to the Alternative Schools of Thought (Albany, NY: SUNY Press, 1998). The literature distinguishes two types
of analysis in causal time models: static and dynamic. If all the variables are seen at the same moment of time, then a static analysis is used. A
dynamic analysis is a version of a static general-equilibrium model except that the number of goods and equilibrium equations has been multiplied
by the number of points in time being considered. A good example is found in Kenneth J. Arrow and Gerard Debreau, “Existence of an Equilibrium
for a Competitive Economy,” Econometrica 22 (1954): 265–90.
7. John R. Hicks, Value and Capital (Oxford: Clarendon Press, 1946); Paul A. Samuelson, Foundations of Economic Analysis (Cambridge, MA: Harvard
University Press, 1947); and Joseph A. Schumpeter, History of Economic Analysis (London: Oxford University Press, 1954).
8. Stefano Zamagni and Elettra Agliardi, eds., Time in Economic Theory (Cheltenham: Edward Elgar, 2004).
9. Michel Godet, From Anticipation to Action: A Handbook of Strategic Prospective (Paris: UNESCO Publishing, 1994); and Sanja Pfeifer, “A Question
of Time: Do Economists and Strategic Managers Manage Time or Do They Even Care?” Contemporary Management Issues 6, no. 1-2 (2001):
89–105.
On Price, Cost, and Value
The Appraisal Journal, Winter 2010
71
(basically trend analysis).10 Earlier, RosensteinRodan recognized methodological problems of the
time element (1) in the economic period of activities,
(2) as consumable goods or a service (scarcity of time),
and (3) in the velocities of adjustments between supply
and demand.11
Discussions related to scarcity of time, time
allocation, or time preference cover a good-sized
corpus of the economic literature. Scarcity of time
as a resource means that it should be economized
in order to decrease the cost of production.12 These
concerns have been well known in industry and considered by Henry Ford, John Kenneth Galbraith, and
Frederick Winslow Taylor,13 with the management of
time being a vital source of competitive advantage in
cost optimization, e.g., faster and newer products, time
budgeting and forecasting, and time-series analysis.
Time economization in the economic process is recognized through Böhm-Bawerk’s great contribution
in the theory of capital and interest.14 He emphasized
that people rate present goods more highly than future
goods with similar characteristics, other things being
equal. This principle of time preference underlies the
requirement that future marginal value products be
discounted to their present values.
Perception of Time and Economic
Conduct
Time is the central concern of physics just as value is
in economics. Any attempt to establish a conclusive
definition of the concept of time leads to confusion.
There are two essential ways of considering time:
cosmological and mental/psychological. The first,
cosmological time, is something independent from
human perception, used essentially to study, for
instance, the total increase in the entropy of the universe or experiments on relativity by physicists. This
definition is less relevant for the everyday life in which
the economy operates. But, the second—mental time—
relates to human perception, and it is more appropriate
to use for the study of the economic world.
The most explicit recognition and description of
the role of mental time in economic theory is found
in the writings of the Austrian school of economics,
especially in von Mises’s Human Action treatise.15 In
its view, time profoundly shapes human economic
conduct. From a tacit knowledge of time fleeting by,
and a succession of ideas and actions, humans are
intensely aware of their life’s irreversibility. This
state of “chronesthesia” (a term used by Tulving)16
allows one to be constantly aware of the permanent
pursuit of self-interest in everyday existence, from
the unconscious to the most planned activities.
Since humans cannot do or have everything they
want, all their natural conduct involves judgments
and evaluations. This is a process of comparison and
rating among the possible choices. Choice implies
change, and it can be defined as an uncertain outcome of evaluation, manifesting itself by action or
inaction. Decisions to choose an alternative and
carry out an action in order to do or have something
with less uncertainty require personal knowledge or
experience. Economic chronesthesia—awareness of
the economic past and potential future—comes ultimately from experience. According to Korzybski, the
consciousness of time with the occurrence of actions
(change) is bound in time.17 In his explanation, and
according to the discussions in Canonne about the
value and the notion of property,18 the human brain
is seen as a “chronofactorized” organ, having the
10.Oskar Morgenstern, Klaus Knorr, and Klaus P. Heiss, Long Term Projections of Power: Political, Economic, and Military Forecasting (Cambridge, MA: Gallinger Publishing Company, 1973).
11.Paul N. Rosenstein-Rodan, “The Role of Time in Economic Theory,” Economica 1, no. 1 (1934): 77–97. Some authors also have brought attention to
the difficulties of comparing time conception across different cultures and age groups, for example differences in saving rates between young and old
people; see Pitirin A. Sorokin, Sociocultural Causality, Space, Time: A Study of Referential Principles of Sociology and Social Science (New York: Russell &
Russell, 1964); Richard H. Thaler, The Winner’s Curse: Paradoxes and Anomalies of Economic Life (New York: Free Press, 1992); and Richard B. McKenzie,
“The Nature of Time in Economics” (paper presented at the Virginia Political Economy Lecture Series at George Mason University, Fairfax, VA, 1997).
12.Gary S. Becker, “A Theory of the Allocation of Time,” Economic Journal 75, no. 299 (Sept. 1965): 493–517; and George Lakoff and Mark Johnson,
Philosophy in the Flesh (New York: Basic Books, 1999).
13.Samuel Crowther, “Henry Ford: Why I Favor Five Days’ Work With Six Days’ Pay,” World’s Work (October 1926); John Kenneth Galbraith, The New Industrial
State (Boston: Houghton Mifflin, 1967); and Frederick Winslow Taylor, The Principles of Scientific Management (New York: Harper Bros., 1911), 5–29.
14.Eugen von Böhm-Bawerk, Positive Theory of Capital, trans. William A. Smart (New York: Stechert, 1889).
15.Von Mises, Human Action.
16.Endel Tulving, “Chronesthesia: Conscious Awareness of Subjective Time,” in Principles of Frontal Lobe Function, ed. Donald T. Stuss and Robert T. Knight,
311–325 (Oxford: Oxford University Press, 2002).
17.Alfred Korzybski, Time-Binding: The General Theory (Lakeville, CT: Institute of General Semantics, 1954). In his classification of life, he defined vegetation as energy-binders through their awareness and control of energy, animals as space-binders through their awareness and control of space, and we
humans as time- and space-binders through our awareness and control of time.
18.Jean Canonne, “La pensée de valeur économique. Ses histoires: revue critique. Ses origines: contributions” (dissertation, Union Institute Graduate
School, Cincinnati, OH, 1996).
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The Appraisal Journal, Winter 2010
On Price, Cost, and Value
Figure 1 Time-Space Representation of Price, Cost, and Value
Past
Present
Future
Price
Cost
Value
capacity for stocking knowledge and passing it on
to future generations.
As a conception of the mind, time is subjectively
experienced by each individual through the flow of
events, which are sooner, present (instantaneous),
and later. The needs of the individual imply the
possibility of satisfaction, and the aggregate of these
possibilities leads to one’s concept of the future. A
feeling of duration and “chronoconnection” of time is
experienced whenever the present situation causes
one to relate it either to past experiences by memory
or to desired future situations by expectation. The
present is essentially fleeting, being represented
as an ongoing point separating the past from the
future. The moment one consciously examines it,
it is already in the past. It is impossible to conceive
the present without putting it into relation with the
past that precedes it. In this mental conception, the
passing of time and its duration are not measured
by the mechanical ticking of a clock in a linear progress, but in the intensity and density of individual
life experiences. Furthermore, individual economic
conduct is influenced by aggregate conduct in society.19 This implies that there is both an individual
and a collective dimension of mental time, each
influencing the other.
Distinctions between Price, Cost,
and Value
The neoclassical school of economics claims that
subjective motivations of individuals are shaped by
their “universal anticipation of future satisfactions.”
This recognition of time in the future also embraces,
in some way, the role of time in the past and present.
But, since the dominance of price theory, economics
has envisaged a unilateral position of time where
everything happens simultaneously. This article,
however, considers a coexisting trilateral dimension of time—past, present, and future—that shapes
human economic conduct, and presupposes not
only the idea of price, but also that of cost and value
occupying different regions of mental time.
According to von Mises, an economic agent
experiences time as an infinite number of moments
that are linked together. The economic agent lives
and acts in the present, at a given place, by remembering moments that have passed and anticipating
moments that are going to come. This is the basic set
of concepts for the dynamic understanding of mental
time that is past (before), present (simultaneous),
and future (after). This chronological aspect of economic conduct will be used here to help distinguish
the different natures of price, cost, and value.
Figure 1 uses an adaptation of the time-space
representation of Stephen Hawking to show that
price, cost, and value coexist, but occupy different mental space-time regions: past, present, and
future.20 In Figure 1, the limits of the conical regions
between present and future or between present and
past represent the limits of human action in a particular market for a given product. More specifically,
the region outside those limits is not in the consciousness of the economic conduct in this market.
In a given space and at a precise moment of time in
the individual economic conduct, there is only one
possible action that can be observed, followed by
9.William Faulkner, Light in August (New York: Vintage, 1985); and Ken Kesey, One Flew Over the Cuckoo’s Nest (New York: Signet, 1995).
1
20.Stephen W. Hawking, A Brief History of Time: From the Big Bang to Black Holes (New York: Bantam Books, 1998).
On Price, Cost, and Value
The Appraisal Journal, Winter 2010
73
other more or less planned actions. The result of the
action is at the present moment, in connection with
the regions of the past and future actions. Enlarging
the time and space cone through the future (or the
past) of this market will signify more possible actions
or events. The continuous time arrow line from
past through future describes its irreversibility and
the utility judgments of each economic agent, from
both the demand and supply sides. In space, we can
move either way, or any way; but real time just goes
forward, never backward.
Abstracting from this representation, it is possible to use the terms past price, present price, or
future price. It is often possible to hear spoken or see
written the use of price and value together in formulations such “price is the value of …” or, even more,
“price is the cost of the value of …” But, because of its
objective and empirical content, price falls only into
the past region of the market. Price is an observed
phenomenon that has to do with practical transactions in the market. One characteristic of price is
that it comes from the interactions and exchange
process between the agents of supply and demand.
Price evolves from value; it is neither value nor cost,
each having individual content. The role of time in
price appears in the principle of retrospection of
economic conduct via the consultation of prices as
references. For economic agents, prices are fairly
reliable indications or past references to judge cost
at present and expect value in the future.
Just as for price, many terms are used for value.
Value also can be seen in the past, present, or future
regions, with multiple qualifications. However, it is
clear that all economic calculations deal with the
future anticipation of enjoyment or profit, and value
is the future. To want is always to want a future. If
we did not expect anything from the future, then
the future would not have any sense. Usually, the
economic literature defines value in the sense of the
importance and worth of things. Contrary to price,
value is accepted as taking the form of an individual
opinion rather than a past or observed fact. Value is
the source of cost and price, and it is not numerable.
As the future contains in itself the dimension of a
projection, the role of time in value appears in the
principle of prospection of economic conduct.
The place that cost occupies in this representation is the precise point of time and space separating
price from value. Its place refers to the availability
of cost information in the present state of the market
74
The Appraisal Journal, Winter 2010
and at the precise moment of decision in the human
economic conduct. The cost of a product or service
is an objective phenomenon that is fixed at a present
moment and available in the market in terms of its
acquisition sum or in units of resource input necessary to produce it. Before the exchange between
the agents of supply and demand in which price is
decided, the cost of a product will be confronted, in
the present, according to the agents’ personal values
and the observed prices of similar products. Cost also
has an individual content, which is the idea of pain
or sacrifice or the giving up of something in return
for an object. The role of time in cost appears within
the principle of “synchronisation” at a precise place
and moment in the present where both the knowledge of past prices and the anticipation of future
benefits for the same product are confronted in the
economic conduct.
The notion of market value (MV), described in
the following section, is not an isolated price, cost,
or value. Market value is estimated based on data
related to each one of these notions. Variations in the
estimations of market value converge to zero when
they are closely related and perfectly acknowledged.
They always coexist in each transaction and are typically present in different proportions. In the case of
newly built properties, these proportions may sometimes be close or even equivalent; however, there is
no empirical evidence of that.
Approaches to Value Estimation
It is clear that personal evaluations do not necessarily
comply with those of the market and sometimes they
can be very far apart. However, active participation
in a free exchange process generally follows market
standards. It is important to understand individual
economic conduct as it operates in real time, but
taken in isolation individual economic conduct is
not enough to describe and accurately measure
the market value of goods because the conduct
is individually subjective and chaotic. This is the
basic problem of measurement in economics, which
must deal with an aggregation of the values of all
the individuals, defined previously as the “universal
anticipation of their future satisfaction.” Market
value estimation is by default imperfect because it
approximates the real sum of the total subjective
values of individuals in the market, which can be
defined here as universal value (UV). Economics,
and in particular appraisal practice, should not be
On Price, Cost, and Value
blamed for this measurement approximation—all
it tries to do is make a reliable reading of values as
expressed in the market. Market value thus may be
the best demonstration of universal value, based
not on isolated individual price, cost, and value, but
ideally on all of them for the individuals participating
in a given market.
The idealistic market described here is not an
outcome or a culmination of only past prices but
also related current costs, and both are guided by
the future expectations of values. Obviously, the
reality is more complex and uncertain. According to
a recent study by the U.S. Securities and Exchange
Commission, when markets are inactive—including
situations where reliable prices are not so reliable
and available—a need arises to reassess existing
concepts and approaches in order to make them
more pragmatic. 21 But, the currently troubled
situation requires neither the removal of basic concepts, nor the prescribing of what markets should
do or be; maybe we should rehash and readjust
some of the fundamental philosophical and even
political questions.
Figure 2 helps to explain market value and its
estimation, which is central in economic theory,
especially in real estate. As a practical example,
consider here the market of a real property and two
participants, the buyer and the seller, in its exchange
process. Before negotiation, they have opinions on
the price, cost, and value of the subject property,
which are related to that of the market. The negotiation will be based on the multiple positive and
negative characteristics of the property that are
considered important in the market, and will depend
on each participant’s personality, skills, and quantity
and quality of information. The buyer’s and seller’s
personal motivations, while being the essence of the
exchange, are not revealed to each other and consequently remain out of the negotiation process. If the
buyer and seller agree rationally and consciously at
a given place and on a given date, their particular
values become an objective price through a cost
judgment. The market value is not an isolated price,
cost, or value, but it is the best expression of them
in the market.
The market value of the subject property can
be estimated through the study of observed prices
of similar properties or comparables in the market. This is the process of market value estimation
through the sales comparison approach (SCA).
Among the three traditional approaches in appraisal
practice, the sales comparison approach is the
most frequently used and direct value estimation
approach. This approach estimates the market value
of a subject property by comparing its characteristics
to those of comparable properties, preferably sold
Figure 2 Market Value Definition and Estimation by the Sales Comparison Approach (SCA)
P
Demand
V
C
Exchange
Transaction
price (P)
SCA
C
P
Supply
Market
Value (MV)
V
21.SEC Office of the Chief Accountant, Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study
on Mark-To-Market Accounting (Washington, DC: Securities and Exchange Commission, 2008).
On Price, Cost, and Value
The Appraisal Journal, Winter 2010
75
recently in the same market. Basically, this approach
provides a way of forming an opinion on the market
value of the subject property by price adjustments
of comparables, considering their differences in
characteristics. Its application requires, however,
a sufficient number of comparables, with a good
quantity and quality of information on the prices
considered and the properties’ characteristics. As
illustrated in Figure 3, the estimation process with
SCA is a backward-oriented approach—an approach
of the past—because the universal value inference
with market value is based on the observed price
adjustments from past individual transactions.
A second approach to market value estimation, the
cost approach (CA), when applicable can provide an
additional opinion on the market value of the same
property. Its application is based on the theory that
land is always valued at its highest and best use, as if
vacant, and the building is valued according to how it
contributes to or detracts from the market value of the
land. This approach is more useful when properties
are special or unique, such as stadiums or churches.
The tricky part in the cost approach is the
depreciation of the building or improvements and
the estimation of the land’s market value with
other approaches. Suppose the subject property is
new and the land market value is known, the cost
approach estimates the market value of the building
or improvements by summing up all the production
cost elements. Cost availability in the present market
and the sacrifice by both the supply and demand
sides (cost of acquisition for the buyer and cost of giving up something for the seller) at a precise moment
in time make the cost approach a simultaneous
approach, i.e., an approach of the present.
A third estimation of the market value, through
the use of income capitalization approach (ICA), is
more advisory and supportive. This approach is
based on the assumption that future income is less
valuable than present income, the market value of
the subject property being equal to the present worth
of its future benefits (in terms of money or services).
The investor in real property estimates the duration
of the income stream and its risk and expenses, and
selects an appropriate capitalization rate from the
market. Then, the net yearly income during the
economic life of the property is actualized with a
chosen rate of capitalization from the market, allowing the market value of the subject property to be
estimated. Thus, the income capitalization approach
is a forward-oriented approach—an approach of the
future—because it is based on the assumptions of
future income and expense expectations.
The basic representation of the three approaches
in different times may get complex if we delve more
into each one, as we realize that they can also be
intertwined. For instance, as with the income capitalization approach, the cost approach may use past
data for future anticipation. The sales comparison
approach may also rely on future anticipation with
not-yet-observed prices. Depending on client needs,
appraisers can use approaches at a specific date, now
or going back several years in the past, to evaluate
the market value of a given property. There is also
a revitalization process in the market, with prices,
costs, and values following and determining each
other continuously. But, even with the approaches
using some collateral and interrelated data, they are
essentially looking in different directions in time.
It is important to notice that there is a chronological time link between price, cost, and value because
of the human faculty of comparisons of past, present,
and future utilities. This comparison process at the
individual level expresses the role of time in its social
Figure 3 Approaches of Value Estimation in Time-Space Representation
Future
Present
Past
CA
SCA
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The Appraisal Journal, Winter 2010
Cost
Market
Value
ICA
On Price, Cost, and Value
and behavioral form (historical time). Approaches
to value follow this faculty of comparison, which is
their common point when price, cost, and value are
confronted and weighted. Even if the founders of the
appraisal system did not state it plainly, it is clear
that this social and behavioral dimension of the time
element is brilliantly addressed throughout the use
of the three concurrent approaches of appraisal.
The role of time in its causal form is more comprehensible in the appraisal practice that considers
the instantaneous state of the market. The effect of
the time element as a cause is considered through
the adjustment process. The adjustment process is
necessary when the market is dynamic during a given
period of time. For instance, if comparable properties
have been sold in different periods of time, appraisers
need to make an adjustment to take into account the
time factor. It is also possible to use a regression model
that integrates the effect of time as an additional variable among other variables of the properties.
Economic Surplus
Even if individuals have perfect knowledge of
the market and the approaches to valuation are
applied correctly, there will still be variations
in the estimates of market value. There are two
essential levels in valuations during which errors
might cause these variations. The first level is the
personal valuation done by individuals who possess
or desire the good. At this level, price, cost, and value
estimations vary from one individual to another
because of their subjective economic utilities and
their attitudes towards extra-economic factors
such as regulations, protectionism, free trade, and
sociocultural conditions.22
The second level is valuation done by someone
other than the participants in the exchange process.
This level uses information extrinsic to the good
and might be done by someone who is an expert.
More specifically, this is a later process of economic
valuation of the personal valuations using different
approaches. At this level, errors in the estimations
have different origins, e.g., treatment of data; differences in the approaches and methods; bias; and
ability of the expert. However, error factors at both
levels of valuation contribute to forming the basis of
market imperfection.
The universal value of a good is in the future,
which is uncertain. As specified previously, the
economic process of measurement tries to explain
and/or predict an accurate market value of the eventual universal value. But, the presence of natural
variations between price, cost, and value prevents
this. In the absence of this natural mechanism of
variations, price, cost, and value would tend to be
equal and then universal value would be perfectly
predictable. In this case, there would be no need for
economic analyses. The presence of variations and
the continuous disequilibrium between price, cost,
and value actually create an economic surplus that
attracts participants in a free market system. This
chaos is also good for the field of economics whose
role is essentially to ensure a better distribution of
the surplus by explaining and predicting market
value of the universal values.
The system of variations between price, cost,
and value can be reported using the well-known
supply and demand model. This conventional
model has its roots in the early-twentieth-century
work of Alfred Marshall who unified the cost
theory of supply and the price theory of demand.
In his supply-demand framework, the interactions between the supply and demand sides are
expressed through price, as a perfect substitute of
cost and value.
In contrast to this unilateral price representation, the analysis proposed in this article needs a
representation for trilaterally coexisting systems
of price (P ), cost (C ) and value (V ), as illustrated
in Figure 4. On the supply side, as well as the
demand side, agents base their final decision not
only on price but also on cost and value. In each
of the graphics in Figure 4, the demand curve (D),
for residential services for instance, represents the
sum of individual demands based on their marginal
utilities, and the supply curve (S), on the marginal
cost of each supplier.
At the equilibrium point X, for a given quantity
(qe), V expectations in the future (t > 0), C availability
in the present (t = 0), and P knowledge in the past (t
< 0) together satisfy both the demand and supply side
agents. The downward-sloping demand curve represents the relationship between P, C, and V given a
demanded quantity, meaning that when P increases,
22.Daniel F. Spulber, “Market Microstructure and Intermediation,” Journal of Economic Perspectives 10 (Summer 1996): 135–152; and James Harrigan,
“Technology, Factor Supplies, and International Specialization: Estimating the Neoclassical Model,” American Economic Review 87, no. 4 (1997):
475–494.
On Price, Cost, and Value
The Appraisal Journal, Winter 2010
77
Figure 4 Variation between Price, Cost, and Value ($000s)
Variation
P
C
t<0
V
t=0
S
t>0
S
Ve = 130
X
S
Pe = 110
Ce = 100
X
D
X
D
D
qe
qe
in connection with C and V, the quantity demanded
falls (with other factors remaining constant). The
upward-sloping supply curve shows the relationship
between P, C, and V for a supplied quantity (with
other factors remaining constant); as P increases,
in connection with C and V, the quantity supplied
also increases. Supply and demand curves follow the
same patterns for C and V in interrelations, however,
with coexistence in different degrees.
Consider here an example of property that costs
$100,000 to build on average. Participants in the
market will attribute a certain utility on this property
if it has a potential P of more than C, for example
$110,000.23 At the equilibrium point X, the difference
of $10,000 between Pe and Ce depends also on Ve,
which is the subjective real sum of all the utilities of
the agents participating in the market. Again suppose
that the real Ve of the property is $130,000. In this
case, the potential total economic surplus would be
the difference between Ce and Ve ($30,000). However,
as Pe in the market is $110,000, the realized surplus
will then be $10,000; the $20,000 of the surplus to be
recovered will eventually drive C and P to move and
to find new equilibriums. Considering this example
further, it is possible to imagine a situation where the
surplus is negative, i.e., when Ce and Pe are higher
than Ve. In this case, economic production for profit
realization is not justified unless it is necessary for
survival. It is also possible for Pe, Ce, and Ve to all be
equal in the whole market for a given category of
property, i.e., where economic surplus is nil.
As you might notice, the problem with this analysis
is V, which is in a relative and abstract dimension. As
qe
qe
Quantity
explained previously, the closest objective quantification of V is market value, estimated ideally through
the use of three concurrent approaches. However,
there can still be differences, maybe important ones,
between the market value and real V. But even if V is
precisely immeasurable, it exists and directs P and C in
the market. We might estimate the $10,000 difference
between Pe and Ce, as in the example, and suppose this
amount to be the total, or a part of the total, economic
surplus. Furthermore, it is possible to do a historical
analysis of the surplus movements between P and
C. For example, if the surplus of $10,000 increases
continuously, then we can suppose V to be higher,
somewhere above P (or lower if it decreases).
This type of historical analysis is also useful for
finding out about the economic lifecycle of products
on the market. To do such an analysis, professionals need historical information about the price, cost,
and value of a type of property covering a sufficient
horizon of time (e.g., 50 years or more). Historical
data on these parameters might be obtained from the
appraisal division of local governments for instance.
Simple graphical or advanced modeling analyses can
then be carried out to see what the trends are and
the level of correlations between them.
Conclusion
This article examines the meanings and definitions
of the economic notions of price, cost, and value.
Revisiting human, utilitarian, universal economic
conduct within a time-space representation provides an objective way of recognizing the distinct
characteristics of price, cost, and value. This is
23.Many actors and intermediaries can be involved in real estate activities and the share of the potential surplus offered by a subject property: buyers,
sellers, appraisers, brokers, lender institutions, government officials, etc. Each one may have specific individual concerns about the price, cost, and
value of real properties; however, all of these actors are interested in knowing what the potential surplus is.
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The Appraisal Journal, Winter 2010
On Price, Cost, and Value
contrary to the dominant economic approach,
which adopts a unilateral solution with price.
This article presents the idea of trilateral, coexisting economic conduct at the individual level that
transpires not only through price, but also through
cost and value. The discussion suggests that a unilateral proposition will contradict itself, because
such a solution considers price, cost, and value to
be equal and everything perfectly predictable. If this
were the case, then there would be no market or need
for economic analyses. An equation with price as a
dependent variable is restrictive, because it considers only a market of prices and drives aside some
of the variation effects in the whole market of costs
and values. Furthermore, what is unknown and is
of interest is not only in prices, but also in costs, and
much more in values. The trilateral analysis in this
article offers a different approach for understanding
the notions of price, cost, and value and interpreting
the chaotic economic system through examination
of the natural mechanism of variations between
these notions. This new explanation suggests that
the source of total economic surplus originates
essentially from these variations.
The time-space reference turns out to be useful
not only in objectively discerning differences between
price, cost, and value, but also in offering another way
to understand the approaches that they support. In
addition to the problem of defining price, cost, and
value, this article exposes the problem of their economic valuation at two levels: personal and economic.
Economics is certainly interested in understanding
and describing personal valuations, but the technical
process of measurement is ideally based on the valuations of all the participants in the market, i.e., universal value. Although market value is an approximation
of individual approximations, market value appears
to be the best proof of the universal value.
Among the three approaches to market value
estimations, the sales comparison approach is
On Price, Cost, and Value
defined as an approach of the past (based on the
use of observed prices), the cost approach as an
approach of the present (based on the use of cost
elements available on the market), and the income
capitalization approach as an approach of the future
(based on the use of future information on income
and expense streams). The three approaches to value
use available, appropriate information, respectively
on past price, current cost, and future value. Each
one gives an additional independent opinion on the
market value of the universal value. Instead of being
substitutes, these approaches rather are concurrently supportive with different opinions.
Finally, the market value estimation process of a
property involves scientific content that rests on the
three fundamental notions of price, cost, and value
and on the traditional valuation approaches. A routine
with one approach, based on simple computations
and mechanical definitions, is not the real challenge
of the appraisal system. For instance, using only the
sales comparison approach will suppose that price is
a perfect substitute for cost and value, as considered in
the unilateral economic position of time. Adjustments
of causal time as a variable redresses a different nature
of the time factor, related to the dynamics of the market,
and it does not consider the original human behavior
in the historical time that also transpires in cost and
value. The appraisal system offers substantial scientific content, and these notions and methods need to
be used and confronted together, whenever possible,
in a clearer and more analytical manner.
Ünsal Özdilek, PhD, is a professor and the
director of the real estate program in the Business
School at the University of Quebec in Montreal.
His research interests include property valuation,
real estate economics, and spatial analysis,
and he has previously published in real estate
related journals. Contact: [email protected]
The Appraisal Journal, Winter 2010
79
Web Connections
Internet resources suggested by the Lum Library
Alfred Korzybski (Institute of General Semantics)
http://www.generalsemantics.org/
The Austrian School of Economics (Investopedia)
http://www.investopedia.com/articles/economics/09/austrian-school-of-economics.asp?viewed=1
Friedrich Hayek Scholars Page
http://hayekcenter.org/
The History of Economic Thought (The New School for Social Research Economics Department)
http://homepage.newschool.edu/het//home.htm
Ludwig von Mises Institute
http://mises.org/
Neoclassical Economics (Investopedia)
http://www.investopedia.com/terms/n/neoclassical.asp
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The Appraisal Journal, Winter 2010
On Price, Cost, and Value