Objectives for todays lecture lecture 9 October 4

Objectives for today’s lecture (lecture 9, October 4) By the end of today, we will: • • better understand the role of land in regional economic activity be able to describe how land use, without intervention, tends to be determined by its “highest” and “best” use. develop a fertility-based metric of land value (land rent) that explains how land is rationally applied as a factor input. define land’s extensive margin

Defining land • Importance of standardized measures – allows specification of ownership and defines extent of rights – allows transfer of real estate from person to person • Areal – land is measured in square units – – – • 1 acre = 43, 560 square feet (based on 66 feet/chain … 10 chains X 1 chain) 1 hectare = 10, 000 square metres (100 m X 100 m) roughly 2. 4 acres per hectare 1 section = 640 acres 36 sections = 1 township Historical development of land surveys – metes and bounds system – early surveying (1800 s: 1 township = 9 X 12 miles, 1800 acre sections) – contemporary land surveys in the United States: • based on original rectangular survey system (started in the mid-1850’s throughout the United States and Canada) • 640 acres per section, 36 sections per town/township • identification of town/townships based on location relative to meridians (north-south lines) and baselines (east-west lines)

Land as a factor of production • Individuals who employ land in production of commodities must also provide additional inputs – their own labor – machinery or implements – fertilizer and technology (both physical and mental) • Other types of land use also requires a combination of other inputs to produce output – residential, commercial, and industrial use of land requires capital investment in improvements – recreational use of land requires site developments and related retail and service sector activity • Management decisions that direct the combination of inputs characterize the manner in which land is used. – intensively used land versus extensively used land – often, these decisions are dictated by the relative prices of inputs

The capacity to use land is determined by: Accessibility: 1. Accessibility 2. Resource Quality 3. Economic Considerations – convenience, time, and transport costs savings associated with specific locations – typically a function of distance to market but can also reflect distance to other raw materials – efficiency is often concerned with optimizing transportation and communication costs and timedistance considerations

The capacity to use land (continued) Economic considerations: a. The private supply of land is voluntary Resource Quality: a. Biological limits on agricultural lands ability of land to respond to inputs what limits this land response? will we ever run out of food or fiber? b. Physical limits on non-agricultural lands land’s ability to concentrate human settlement how do we affect land’s physical finiteness? how does relative compatibility play a role? c. Ability of land to regenerate itself natural processes can renew resource quality what examples of this exist in Wisconsin? can physical finiteness be dealt with? what drives landowners to supply land? b. Demand for land as input is a firm choice what dictates the demand for land? c. Supply and demand for land interact determines the private market price for land economic elements of land are highly variable elastic: change in price brings about a more than proportionate change in quantity demanded/supplied inelastic: price change has less than proportionate change in quantity demanded/supplied d. Importance of economic considerations how does competition for land affect supply? how do opportunity costs dictate land uses how does technology affect supply of land? how does technology affect demand of land?

Generalized profile of land uses showing the overlapping ranges within which selected uses may be regarded as the “highest” and “best” use. • Why do we NOT see skyscrapers in Pine River? … or conversely • Why do we NOT see cattle grazing on the capital lawn … … or a chairlift on Bascom Hill?

The Economics of Land • Economic principles affecting land use – proportionality (there exists an optimal mix of inputs) – law of diminishing returns (returns to inputs increase to a point and then diminish in their ability to produce further output) – return can follow several paths (functional forms) … our presentation will be graphical and use a simple (& typical) cubic production function • Concept of land rent – net return (or surplus) of the total value of a product above the factor costs used in its production. – provides a basis for explaining value of real estate and the incentives for owning and using land. – helps explain how land is combined with other inputs to produce output – also helps in explaining leasing arrangements, taxation policies, land development and land management.

Types of Land Rent • contract rent – actual payments made by tenants to owners – results from prior contractual agreements – may or may not reflect productive capacity of land • land rent – economic returns to land accruing from its productive use – ground rents vs. site rents – fertility-base land rent versus distance-based land rent • economic rent – surplus of income above the minimum supply price needed to bring a factor into production – short-run economic surplus that can be generated from a factor due to unexpected demand and/or supply conditions – in the long-term, supply and demand equilibrate and economic rent disappears

Classical notions of land rent David Ricardo: • • descended from Iberian Jews who had fled to Holland during a wave of persecutions in the early 18 th Century his father, a stockbroker, emigrated to England shortly before Ricardo's birth in 1772 David Ricardo was the third son (out of seventeen children!) in 1815, Ricardo published his groundbreaking Essay on Profits – – – David Ricardo, 1772 -1823 introduced the differential theory of land rent the "law of diminishing returns" to land cultivation. coincidentally, these principles were “discovered” simultaneously and independently by Robert Malthus, Robert Torrens and Edward West. (more astoundingly, all of them published their treatises within three weeks of each other in February, 1815!)

The manner in which land use contributes to output (production) Returns Function’s maximum output and highest gross (or total) return Function’s maximum average return Function’s maximum marginal return (the “inflection”point) Input of land Point of Diminishing: Marginal Rtn Average Rtn Total Rtn

Value Product Analysis Costs & Returns ($) Maximum TVP (highest “gross” return) Maximum spread between TVP and TFC Aggregate Analysis Total Value Product (TVP) Total Factor Cost (TFC) alternatively … … we can look at this at the margin (marginal analysis) Zone of Rational Action (where efficient operators choose to employ a variable input to produce output) Inputs of land Max AVP Also: MVP=AVP Max TVP

Value Product Analysis Average and marginal costs & returns ($) Zone of Rational Action (where efficient operators choose to employ a variable input to produce output) Average and marginal factor cost Average product Inputs of land Optimal land use where MP = MFC = pland Marginal product Whereas this provides us a perspective of output, we’re still in need of a mechanism to understand land as an input cost … thus, we need to adapt our analysis slightly …

Cost Curve Analysis Costs & Returns Maximum spread between TR and TC Total Cost Aggregate Analysis Total Return alternatively … … we can look at this at the margin (marginal analysis) Zone of Rational Action (where efficient operators choose to employ a variable input in production of some output) Units of Output

Cost Curve Analysis Optimal land use where MC = p Marginal Cost Average and marginal costs & returns ($) Average Cost Value of Ricardian land rent Average and marginal return Zone of Rational Action (where efficient operators choose to employ a variable input in production of some output) Units of Output Profit is maximized when MC = p

Classical notions of land rent • Ricardo worked on land rent with an interest in resource quality – “Ricardian” land rent is fertility-based – application of both value-product analysis and cost curve analysis – assumptions are severe but approach remains useful • Value-product analysis: – – single fixed factor of production (land) homogeneous inputs are added with an interest in the effect on output fixed price per unit of output (fixed product prices) fixed cost per variable input (land price is fixed) • Cost curve analysis: – all of the above assumptions – uniform price for all product units • Land Rent: – residual of production costs from value of product.

Ricardian land rent on lands of three different fertility levels Market Price Land Rent Producer 1 MC Value of Product per Output Unit AC MC MC Units of Output Production on Land of Highest Quality Costs and Returns AC Land Rent Producer 2 Units of Output Production on Land of Medium Quality Land Rent Producer 3 = 0 Units of Output Production on Land at the Extensive Margins What important characteristic of land is overlooked with Ricardian land rent?

Explaining the spatial array of land uses • Ricardian rent provides an explanation of how efficiency in production occurs given heterogeneous land fertility. – recall, though, that land rent explains short-run surplus generated from supply and demand imbalances – in the long-term, differing levels of fertility with sort themselves out into their respective highest/best uses (economic rent = 0). – fails to explain spatial array of alternative land uses beyond agricultural production. • Early understanding that rent advantages are largely driven by location – thus, accessibility leads us to a second conception of land rent. – this advance gave birth to “regional science”

For next Monday (Lecture 10, October 9) Topics of discussion: • • develop a spatial metric of land value use this metric to explain the spatial array of land use from urban rural introduce the concept of exurbanization more fully address the concept of externalities as a primary motivation for land use planning Assignment: • • • Finish reading Chapter 5 of textbook. Assignment #4. Policy memorandum due THIS Friday. Select a topic from page 100; questions 4, 8, 9. Write a response to an angry group of politically influential local real estate developers. Assignment #5 due NEXT Friday … available on the web.