Appunti di Economic Assessment of Urban Transformations (Primo + Secondo Parziale)

1. Basic elements of public economics

• Welfare Economics

A classical field in Public Economics

Objective of this field: The analysis of the reasons why welfare is so different across a given unit (countries/regions/cities)

The context when this field emerged (time of 1900) was really owing to philosophical theories called:

Utilitarianism Utilitarist Theory

Based on 3 principles:

Are principles that guide the evaluation of welfare

1. Welfarism

Says that we evaluate things/actions on the basis of the level

of happiness and satisfaction that people get from doing what they prefer

2. CONSEQUENTIALIST Says that we evaluate actions on the basis of the consequences they generate

3. SUMMING Says that the correct criteria to evaluate aggregate welfare is given by the sum of individual welfare levels

But

a final fundamental criteria of this theory is the principle of PARETO-EFFICIENCY

A resource allocation is Pareto efficient if and only if that resource allocation cannot be modified so that the level of welfare of everyone is improved => A welfare state is Pareto optimal if and only if there is no alternative state of the world in which an individual is better off and worse off

• To improve the Pareto efficiency of a system you have always at least maintain for all the people the same level of welfare and at least for some people you have to increase the welfare level.

➔ The 2 fundamental theorems of Welfare Economics are based on the concept of Pareto-efficiency

• 1° FUNDAMENTAL THEOREM OF WELFARE ECONOMICS States that a competitive equilibrium is Pareto-efficient

This provides the foundation for the universal preference that we use private markets to systems where allocation of resources takes place on the bases of prices rather than a centralized/ socialized planning

PRICETAKING BEHAVIOUR

• Monopolistic competition: similar to perfect competition but there is a degree of differentiation of the products (example: give people the perception that goods are different) (condition in which the good is good)

2. The theory of land rent

• LAND RENT
• Most of us prefer to access locations they believe bring benefits (high accessibility, beautiful places, with little crime, services, etc.)

In other cases, the evaluation process that takes place diverges indirectly from what we call the SHADOW PRICE OF A GIVEN LOCATION.

Usually - the evaluation process is reflected in the HIGHER WILLINGNESS TO PAY for a space IN A CITY^*1

• OPTIMIZATION PROCESS:

We formalize the behaviour of consumers/firms setting a target in terms of utility/profit and we reach this goal subjected to the fact that resources are limited.

And what we do is to optimize a function (among the many possible choices we can make, we pick up the choice that maximizes our utility)

Rent is the result of an optimization process^*2

Remember - Rent is not the result of a financial action - The price system we find in Real Estate operates only the result of relatively free actions - Rent is not Speculation

Ricardian Model

The mechanism that drives income distribution

• You have landlords, entrepreneurs who make use of the land to produce goods and services, workers
• Wage = unit price of work
• Profits
• Unitary land rent = price that the owner pays for a given unit of land
• You can rank lands according to their marginal productivity (we think land as a piece of agricultural production). This is what represents the negatively sloping convex curve.
• And the market goes from the most productive piece of land to the least one

1. We start with a land demand = TMT

   We can calculate how much income goes to workers, how much goes to entrepreneurs, and how much goes to landlords.

   • Survival wage is an assumption in our model.
   • Total wage = OWAT
   • Unit price of rent (marginal rent) = rs
   • Total land rent = the integral of the curve rb
   • The remaining rectangle is the total profit = SWAb

2. Exogenous shock moves the demand to TMT* (demand increases)

   Ex: income increase, technological snow.

We stop in TMT* because we cannot pay lower wages

• It's a supply driven type of rent

• Driven by the accessibility to the central location (Von Thünen) or to the productive location (Ricardo)

B1

• Some pieces of land come with limited supply due to inherent economic reasons

Ex cities are limited (naturally scarce) not man cities

Ex European agriculture production competes against non-European agricult. production (low prices) so it's difficult to keep people to grow vegetables in their fields. But we like our landscape intact

In Europe there is a policy that is subsidizing agriculture (so that the prices of our products are low) to keep farmers in competition.

Ex-some agriculture products come in limited supply generating scarcity rent.

B2

• Absolute rent due to pure agglomeration effect - driven by demand

Most of us prefer to live in a urban location & cities grow up

(and cities are sources in increasing the utility level) - this is translated into prices

A2

• It's a microterritorial type of rent that emerges any time some portions of space are committed to a specific use

• Driven by a demand that increases the price up.

Ex In agriculture → there are hypothetical wines that are produced only in some specific places using some specific grapes

(You cannot produce Barolo everywhere you couldn’t produce it other than with Nebbiolo grapes) - Their land is expensive

disbursment: Immediately or at a certain point in time.

Ex. In America, money that you get as private pension from insurance companies.

Perpetuity with a constant growth rate equal to g: Cash flows grow by g over time so that the loss of real value that they get because of inflation process is compensated by this growth rate.

[g < k] -> because if g ≥ k the numerators grow exponentially wrt the denominators. And the NPV tends to ∞.

5. Investment appraisal III

EVA: ECONOMIC VALUE ADDED

• WACC -> It is an indicator that weighs the cost of relative sources of financing depending the way you get money to fund an investment.

Ways of financing:

• EQUITY -> cost of equity (as interest rate)
• DEBT -> cost of debt (as interest rate)

So a weighted average of different costs of different sources of financing within the company.

In EVA depreciation enters differently with respect to NPV.

• Subtract before calc GROSS INCOME =
• After NOPLAT, add the invested capital at time t with a declining share that is due to the amount depreciated over time + heading over time the utility that we associate to the good in which we invest is gradually declining.

• Subtract before calc GROSS INCOME
• Adding after calc NET INCOME

that we find in statistic textbooks

Pro

• a convenient way to model the probabilities of given in or analysis, because pick up from data concerning our investment.

• Read data are standardized by the standardized distribution
• On the statistic textbook we find data corresponding to a given threshold or exceed (Behaviour model)
• We transform the corresponding numbers into the normal unit of measurement

Cons

• If you use this model to assess the probability to get a given level of risk and exposure you fail to meet events that are rare and come with substantial losses

• Because when starting from 5σ and moving towards smaller levels of σ in the Gaussian distribution we may quickly run in much larger losses (that of course are associated to lower probabilities level but can become very large)

5 Real options

(financial options models)

• "Option is a form of contract that grants the buyer the right to sell or grants the buyer the right to buy a given asset at a given date for a given price
• Options are complex contracts and there are ways to assess these options:
  • Binomial method
  • Black & Scholes formula