Input Demand: The Labor and Land Markets
(Part D)
by
Charles Lamson
Land Markets
Unlike labor and capital, land has a special feature that we have not yet considered: it is in strictly fixed (perfectly inelastic) supply in total. The only real questions about land thus center around how much it is worth and to what use it will be put. Because land is fixed in supply, we say that its price is demand determined. In other words, the price of land is determined exclusively by what households and firms are willing to pay for it. The return to any factor of production in fixed supply is called pure rent. Thinking of the price of land as demand determined can be confusing because all land is not the same. Some land is clearly more valuable than other land. What lies behind these differences? As with any other factor of production, land will presumably be sold or rented to the user who is willing to pay the most for it. The value of land to a potential user may depend on the characteristics of the land itself or on its location. For example, more fertile land should produce more farm products per acre and thus command a higher price than less fertile land. A piece of property located at the intersection of two highways may be of great value as a site for a gas station because of the amount of traffic that passes the intersection daily. A numerical example may help to clarify our discussion. Consider the potential uses of a corner lot in a suburb of Kansas City. Alan wants to build a clothing store on the lot. He anticipates that he can earn economic profits of $10,000 per year because of the land's excellent location. Bella, another person interested in buying the corner lot, believes that she can earn $35,000 per year in economic profit if she builds a drugstore there. Bella will be able to outbid Alan, and the land owner will sell (or rent) to the highest bidder.  Because location is often the key to profits, landowners are frequently able to "squeeze" their renters. One of the most popular locations in the Boston area, for example, is Harvard Square. There are dozens of restaurants in and around the square, and most of them are full most of the time. Despite this seeming success, most Harvard Square restaurant owners are not getting rich. Why? Because they must pay very high rents on the location of their restaurants. A substantial portion of each restaurant's revenues goes to rent the land that (by virtue of its scarcity) is the key to unlocking those same revenues. Although Figure 6 shows that the supply of land is perfectly inelastic (a vertical line), the supply of land in a given use may not be perfectly inelastic or fixed. Think, for example, about farmland and land available for housing developments. As a city's population grows, housing developers find themselves willing to pay more and more for land. As land becomes more valuable for development, some farmers sell out, and the supply of land available for development increases. This analysis would lead us to draw an upward-sloping supply curve (not a perfectly inelastic supply curve) for land in the land for development category.  Nonetheless, our major point---that land earns a pure rent is still valid. The supply of land of a given quality at a given location is truly fixed in supply. Its value is determined exclusively by the amount that the highest bidder is willing to pay for it. Because land cannot be reproduced, supply is perfectly inelastic. Rent and the Value of Output Produced on Land Because the price of land is determined, rent depends on what the potential users of the land are willing to pay for it. As we have seen, land will end up being used by whoever is willing to pay the most for it. What determines this willingness to pay? Let us now connect our discussion of land markets with our earlier discussions of factor markets in general.  As our example of two potential users bidding for a plot of land shows, the bids depend on the land's potential for profit. Alan's plan would generate $10,000 a year; Bella's would generate $35,000 a year. Nevertheless, these profits do not just materialize. Land in a popular downtown location is expensive because of what can be produced on it. Note that land is needed as an input into the production of nearly all goods and services. All restaurants located next to a popular theater can charge a premium price because it has a relatively captive clientele. The restaurant must produce a quality product to stay in business, but the location alone provides a substantial profit opportunity. It should come as no surprise that the demand for land follows the same rules as the demand for inputs in general. A profit-maximizing firm will employ an additional factor of production as long as its marginal revenue product exceeds its market price. For example, a profit-maximizing firm will hire labor as long as the revenue earned from selling labor's product is sufficient to cover the cost of hiring additional labor which for perfectly competitive firms equals the wage rate. The same thing is true for land:  Just as the demand curve for labor reflects the value of labor's products as determined in output markets, so the demand for land depends on the value of land's product in output markets. The profitability of the restaurant located next to the theater results from the fact that the meals produced there command a price in the marketplace.  The allocation of a given plot of land among competing uses thus depends on the trade-off between competing products that can be produced there. Agricultural land becomes developed when its value in producing housing or manufactured goods, or providing space for a mini mall, exceeds its value in producing crops. A corner lot in Kansas City becomes the site of a drug store instead of a clothing store because the people in that neighborhood have a greater need for a drug store. One final word about land: because land cannot be moved physically, the value of any one parcel depends to a large extent on the uses to which adjoining parcels are put. A factory belching acrid smoke will probably reduce the volume of adjoining land, while a new highway that increases accessibility may enhance it.  *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 207-209* end |
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