Chapter 2 Economic Theories and Measurements
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Transcript Chapter 2 Economic Theories and Measurements
Chapter 2
Economic Theories and
Measurements
I. Economists
A. Adam Smith (1723 – 1790)
Adam Smith is the father of modern capitalist theories
LAISSEZ-FAIRE (“Let people do as they please”) is a
governmental policy allowing an economy to grow without
government interference or direction
The “invisible hand”
Smith never proved his doctrine, but enumerated
countless cases of governmental follies. He understood
how markets worked and established the foundation of
the supply and demand theory.
B. Thomas Malthus (1766 – 1834)
The Malthusian theory was set forth by Thomas Malthus in
An Essay on the Principle of Population
Malthus believed that population growth was bound to
reduce worker wages
Population increases would mean higher rents and prices,
thus resulting in a lower standard of living
C. John Maynard Keynes
(1883- 1946)
Keynes believed an economy reaches a balance
at less than full employment
Keynesian economics advocated governmental
intervention in the economy to fight unemployment
and inflation
Keynes is considered the founder of modern
“macroeconomics,” which is the study of the entire
economic system as a whole, rather than its
individual parts
D. Milton Friedman (1912 – 2006)
Nobel
prize winner and influential member of the School of
Economics at the University of Chicago
Friedman
was associated with MONETARISM, which is
the belief that we need a careful and steady increase in
the money supply and that by increasing the money
supply we increase production
E. Ben Bernanke (1955 - )
Chairperson
of the Federal Reserve
Bernanke
wrote extensively on the causes of the
Great Depression
He
believes that the Federal Reserve was largely
responsible for the depression by reducing the
money supply and has stated that it won’t happen
again
II. Economic
Systems
Economic Systems
The major economic systems used today in the
Western world are:
CAPITALISM which is when the majority of decisions
are made by private individuals demanding land,
goods, or services in competitive markets
SOCIALISM which occurs when the government
makes the majority of decisions
A. Capitalism
Capitalist markets answer the questions:
What?
How?
For Whom?
1. Basic Principles of Pure Capitalism
Private Property
Private Enterprise
Competitive Markets
Profit Motive
Laissez-Faire
2. Mixed Capitalism
The U.S. is a “mixed economy” in which both public
(government) and private (individual) institutions
exercise economic control
3. How Capitalism Works
A CAPITALIST SOCIETY exercises private control over
production and distribution through individuals working
for individual gain
Sources of production under capitalism are:
Land
Labor
Capital
Management
ENTREPRENEUR
=
=
=
=
Rent
Wages
Interest
Profit
B. Socialism
Under Socialism, major industries are owned by the
government
Karl Marx is the father of socialism
1. Karl Marx (1818-1883)
Marx believed that economic change was possible only
through revolution
Under socialism, private ownership of the means of
production is replaced by state ownership
Socialism requires a COMMAND ECONOMY rather than a
MARKET ECONOMY
III. Land and the
Real Estate Market
A. The Broker in the
Marketplace
Informed buyers and sellers make for a narrower range
of sales prices
Boards of Realtors® provide a Multiple Listing Service
(MLS)
Real estate agents stabilize local markets by providing
information about current selling prices as part of their
service
B. The Internet and the Real
Estate Marketplace
The Internet is a significant real estate marketing tool
It provides for a marketplace with informed buyers and
sellers
More than 87% of buyers used the Internet to shop for
a home according to the National Association of
Realtors®
Seller Internet Services
IV. Types of
Competition
A. Perfect Competition
PERFECT COMPETITION is an economic situation in
which no single seller or buyer can influence prices
Real estate does NOT fit into the perfect competition
category because the product is NOT homogeneous
B. Imperfect Competition
IMPERFECT COMPETITION is an economic situation in
which many sellers and buyers have some degree of
control over prices
1. Oligopoly
The market is controlled by a small number of
firms such that the production and pricing of one
will affect all.
DUOPOLY
2. Monopoly
In a monopoly there is NO competition to act as a curb
against higher prices and excess profits
A MONOPOLY occurs where there is only one producer in
a market
3. Monopsony
A MONOPSONY is a market situation in which there is only
one buyer
The right of governmental agents to acquire property
through eminent domain is an example of monopsony
4. Oligopsony
OLIGOPSONY is a market situation in which there are only
a few buyers
V. Understanding
Value
A. Highest and Best Use
The HIGHEST AND BEST USE of land is that use which
will provide the greatest net value
B. Value
There are 4 forces influencing value of land:
Physical
Social
Economic
Political
Values are NOT static
C. Price
Price is NOT necessarily the same as value
A PRICE is the amount obtained when an item or service is
actually sold
EQUILIBRIUM PRICE
D. Rent
RENT is the economic return from use of land or
improvements
TENANT CONCESSIONS
E. Profit
PROFIT is a return beyond the value of the land, labor,
material, and management that goes into a project
Without profit as a motivation, decisions would be based on
non-economic considerations
Unearned Profit
VI. Economic
Measurements
Economic Measurements
There are a great number of indicators used to measure
the health of our economy in general
By studying changes in these indicators, economists
attempt to predict future economic changes
A. Governmental Agencies
A number of government agencies provide
information on measures of our national economy
1.
Federal Reserve
2.
Bureau of Economic Analysis
3.
Energy Information Administration
4.
Bureau of Labor Statistics
5.
U.S. Census Bureau
B. SMSAs
The Standard Metropolitan Statistical Areas consists
of at least 50,000 people
There are about 286 SMSAs in the U.S.
C. Indexes and Statistics
17.
Consumer Leverage Ratio
18.
Big Mac Index
19.
Misery Index
Prime Rate
20.
Bankruptcies
5.
Retail Sales
21.
Poverty Rate
6.
Stock Market Indexes
22.
Capital Expenditure
7.
Wholesale Price Index
23.
Help Wanted Advertising
8.
Consumer Price Index (CPI)
24.
Unemployment
9.
Balance of Trade
25.
Inventories
10.
Personal Income
26.
Collection Account Billings
11.
Median Household Income
27.
Unused Plant Capacity
12.
Savings
28.
Machine Tool Orders
13.
Consumer Credit
29.
Fiberboard Orders
14.
Federal Deficit
30.
Ratio of Corporate Debt to Corporate Inventory
15.
National Debt
31.
National Defense Spending
16.
Currency Valuation
32.
Vendor Performance
33.
Property Value Indexes
1.
Gross Domestic Product (GDP)
2.
M¹
3.
M²
4.
D. Leading and Lagging
Indicators
LEADING INDICATORS indicate changes in the
economy that should or will happen while LAGGING
INDICATORS show us what has happened in the
economy
1. Composite Index
(Lagging Indicators)
Average duration of unemployment
Ratio of manufacturer and trade inventories to sales
Change in labor costs per unit
Average prime rate
Commercial and industrial loans
Ratio of consumer installment credit to personal income
Change in consumer price index
2. Leading Indicators
Average weekly hours
Average weekly claims for unemployment
New orders for consumer goods and services
Vendor performance
Contracts and orders for plants and equipment
Building permits
Change in unfilled orders of durable goods
Changes in the price of sensitive materials
Stock prices
Money supply
Index of consumer expectations
E. Real Estate Oriented
Indicators
Some of the tools listed below are used to measure the
local real estate economy in your area:
Housing Affordability Index
2. Median Multiple
3. Housing Opportunity Index (HOI)
4. Occupancy Rate
5. Vacancy Rate
6. New Building Permits
7. Home Resales
8. Time to Sell
9. Rental Growth Rate
10.Mortgage Default Rate and Foreclosures
1.
VII. Real Estate
Bubble and the
Economic Bubble
Real Estate Bubble ?
A bubble occurs when investors put so much demand on a
product that the price is driven up beyond any rational
explanation of value
A bubble bursts when a great many owners try to unload
the product and realize their gain, only to discover that
there are fewer buyers than sellers at the high prices
Some sellers begin to panic and will sell at any price, which
threatens the entire market.
VIII. The Bubble
Burst
Burst Bubble
In 2006, we began to see a moderate drop in prices in
some real estate markets
By 2010, almost every area in the nation has experienced a
sharp decline in real estate values
Many factors played a role in the rapid escalation of real
estate prices and the subsequent fall in values
A. Exuberance
EXUBERANCE is the belief that values can only go up and
no matter what you paid, someone will pay more
This is often referred to as the Bigger Fool Theory
B. Speculators
Speculators entered the market in droves and developers
were willing to sell to speculators who planned to resell at a
profit
Speculators purchased multiple units in hopes of flipping for
a profit
FLIPPING is a purchase and a quick resale of a property
When speculators became net sellers rather than net
buyers, the lessening demand affected the entire real
estate marketplace
C. Developers
Because of demand, there was a rush to complete new
housing units
Builder demand led to shortages and higher prices of many
materials
Developers raised prices with each new phase of a
development
Developers encouraged speculators to purchase multiple
units
As the market softened, developers found themselves in
competition with the speculators to sell units
D. New Loan Products
Loan originators pushed products that lowered and even
eliminated down payment requirements for buyers
Many buyers were encouraged to take loan products with
escalating payments in the belief that loans could be
refinanced later
When buyers have no equity in a property, they are less
likely to maintain it and more likely to default on their loan
E. Subprime Loans
When Freddie Mac or Fannie Mae will not purchase a loan
because the borrower either has poor credit or has
insufficient income, it is considered a SUBPRIME LOAN
Because a market developed for subprime loans, lenders
rushed to make them
In many cases they were considered, PREATORY
LENDING in that loans were made without regard as to the
likelihood of the borrower being able to make the payments
F. Refinancing
Because loan originators could readily resale loans, home
owners were encouraged to refinance and spend the
money
Homes were regarded as piggy banks
When real estate values declined, many owners discovered
that their homes were upside down…they owned more than
their home was worth
G. Optimistic Appraisals
The 1989 FIRREA requires licensing and certification for
appraisers in federally related transactions
Unfortunately, appraisal standards did not protect lenders
from appraisals where the lenders encouraged higher
valuations
In many areas, over 95% of appraisals were at or more
than the sales price
H. Stock Market Drop
While the stock market drop in 2008 did not cause the real
estate market to collapse, it has been a factor in further
depressing values.
Investors felt less secure because of the drop in value of
their holdings
Because the stock market is based more on expectations
of the future than what is happening right now…the stock
market is expected by many economists to rebound prior to
a general economic recovery
I. Spike in Oil Prices
From 2007 to 2008, oil prices went from $50 a barrel to
$140 a barrel before falling back
Higher gas prices made it difficult for many prospective
buyers to be able to afford a new home
K. Rising Unemployment
Most households have to rely on two incomes to qualify for
a home loan
The loss of one income results in prospective buyers no
longer being in the marketplace
IX. Recession 2007
Recession 2007
According to the National Bureau of Economics Research,
December 2007 was the beginning of the worst recession
we have seen since the collapse of the stock market in
1929
Many economists underestimated the depth of the
recession thinking it would be “short and shallow”
There are a number of factors that worked together to bring
on this recession in our economy
A. Change From Production to
Service Economy
Some economists believe that the loss of much of our
heavy industrial base has had a negative effect on our
overall economy and affects the length and severity of the
recession
Loss of manufacturing jobs means loss of high paid jobs
that are often replace by lower paid service positions
Loss of production means greater imports and a negative
balance of trade
B. Collapse in Home Prices
The collapse in the housing market resulted in the
following:
Loss of Jobs
Less Commodity Demand
C. Commercial Real Estate
Market
Rising vacancies in office, retail, and industrial properties
has resulted in a slow down in development
REIT’s showed significant decline in value in 2007 and
2008
D. Deregulation and Bank
Failure
The Graham-Leach Bliley Act of 1999 removed barriers
between traditional banks, investment banks, and insurance
companies
In 2004, the SEC released the major investment bankers from
the net capitalization rule that had required that they maintain
reserves which minimized risk
Banks failed
Other casualties:
Lehman Brothers
AIG
Merrill Lynch sold to B of A
Washington Mutual
Wachovia sold to Citigroup
Security Pacific
bank
PFF Bank and
Trust
Downey Savings
and Loan
E. Mortgage-Backed
Securities
Packages of loans were collateralized and sold as
mortgage-back securities
They had high yields and lots of ready buyers
Many were equal to “junk bonds” based on subprime loans
The losses suffered by investors made them cautious and
lenders reluctant to make loans both of which had serious
negative affect on our economy
F. Shadow Banking
Hedge funds and investment banks are relatively free of
government regulation
Mortgage-backed security transactions led to the failure of
some hedge funds and a number of investment banks as
the value of their securities began to evaporate
G. Tight Credit
Lenders tightened credit to consumers and businesses as
the recession set it
Excess of greed changed to excess of caution
Without credit, the auto industry stumbled
Businesses that were doing well, could not borrow on their
accounts receivable or inventory
Without credit, the recession continued
C. Private Action
Some lenders took action to keep loans performing and
avoid foreclosures
Wells Fargo took over $107 billion in option adjustable rate
mortgages when it rescued Wachovia
Wells Fargo has rewritten loans at low interest rates for terms of 6 – 10
years
Wells Fargo has also significantly reduced balances on loans
X. Economic
Stimulus 2008
2008 Stimulus
In an effort to turn the economy around, the government
under both Presidents Bush and Obama realized that
action was necessary
The belief was that we could NOT afford to wait for the
economy to correct itself
A. President George W. Bush
$168 Billion Economic Stimulus Act of 2008
Tax rebates, for low to moderate income taxpayers, to encourage consumer spending
Tax incentives to stimulate business investments
Raise loan limits that could be purchased by Fannie Mae and Freddie Mac
$700 Billion Financial Reserve to Bail Out Financial
Institutions
No restrictions were put on “how” to use the bailout money resulting in AIG paying for
executive junkets and bonuses
B. President Barack H.
Obama
$787 Billion American Recovery and Reinvestment Act
of 2009
Purpose was to preserve and create jobs, invest in infrastructure,
provide assistance to unemployed, and tax relief
MAKING HOMES AFFORDABLE PLAN
CASH FOR CLUNKERS
FIRST TIME HOME BUYER CREDIT
Helping Families Save Their Home Act of 2009
$750 Billion Bank Rescue Plan
Chapter Summary
Early Economists
◦
◦
◦
◦
Economic Systems
◦ Capitalism
◦ Socialism
Gov’t Agencies
Indexes and Statistics
Leading/Lagging Indicators
Real Estate Oriented Indicators
Real Estate/Economic
Bubble
The Bubble Burst
◦ Perfect
◦ Imperfect
Recession 2007
Understanding Value
Economic Stimulus
Land and the Real
Estate Market
◦ The Broker
◦ The Internet
Economic Measurements
Types of Competition
◦ 2008 to present