The Value Problem

Economists believe they have solved the old Water-Diamond Paradox by showing how prices are determined at the margins. But how then do we value a large stock of resources when we only know the value of a marginal unit?

Consider this problem. A river catchment has 1,200 megalitres of tradeable water rights. The last trade occurred at a price of $2,000/megalitre. Essentially this means that the last megalitre (the marginal unit), out of the 1,200 megalitre stock of water in the catchment, is worth about $2,000. But are all the other 1,199 megalitres therefore worth $2,000 a pop? Quite simply no. If the government compulsorily acquired half of the water in the catchment, the 600th megalitre would be worth more than the 1200th megalitre – an example of declining marginal value.

Whether the weather increases volatility of markets

I recently read, and thoroughly enjoyed, the book Rigged. In one scene a young trader is asked what factor contributes most to changes in the price of oil - to which he responds, the weather. For example, a cold winter in North America or Europe signals an increased demand for oil and sends the price up. 

So my question is this. Given how weather dependent our agricultural industry, our energy industry, and other essential primaries industries can be, how much less volatile would financial markets be if we had predictable or constant weather?

UPDATE - Turning points

Recently I posted about the spike in population growth experienced in Australia over 2008, and how we cannot simply extrapolate the trend, or we will miss important turning points. I predicted that the rate of population growth will fall from this level over the next few years as a result of

1) reduced migration, and
2) a decline in birth rates due to the ‘bringing forward’ of births encouraged by the baby bonus.

I didn’t have to wait long for some supporting evidence. The ABS today released overseas arrivals and departures data showing a significant increase in departures, and decline in arrivals, since April 2009.  It looks like migration is on its way back down.  When the June 2009 release of the population statistics is published on 3rd December we might just see the turning point in population growth I forecast back in September. 

iTunes v Foxtel

I know; there is no battle between iTunes and Foxtel (yet) but it seems like a good attention grabbing headline. The relevant point here is that Foxtel is releasing a new service where subscribers can download movies and TV programs. Although the service has its drawbacks, it sounds like the next big thing to me.

Whenever I see innovation like this, I can’t help but see it as another example of economics in action. It also makes me wonder what industries will be next to leap into the downloadable marketplace. Given that music and books have taken the leap, probably in response to pirated downloads, movies were an obvious candidate to jump soon. But what next?

Rebound effect in action

The image below is from an email sent by the Queensland Government Climate Smart program.  What an odd prize for a program designed to reduce energy consumption!

Move over horoscopes, forget cold reading, here is… economics!

Derren Brown, famous British magician, mind reader, and all round deceptive yet entertaining fellow, has often discussed the tricks used by psychics and fortune tellers. One particular method, cold reading, involves suggesting non-specific messages, and letting the subject of the reading provide the meaning to the message.

For example, a psychic using cold reading techniques might suggest that there is an old male, or a dog, or another such subject of emotional connection, and let the subject say something like, “yes, my dog Spot died recently”, to which the psychic replies with something like, “I can feel you have a strong bond with those, human or otherwise, that you share your life with”. Essentially, the psychic says nothing except that you are close to the people you are close to. But the delivery of the message makes it appear that the psychic knows something about you that they couldn’t have – unless they have psychic ability.

I will get to economists under the fold.

The value of food security?

Food security, energy security, job security - all political terms that conjure up emotion, deliver electoral support, all the while remaining devoid of meaning.

I have been asked impossible questions in my job. But one comment recently sticks in my mind. It goes:

..there must be some data that they could have used to address the “value” of having future food security.

What value might that be? Do you want a dollar figure that represents the present value of all future value streams from having food security? And do you imply that food security means that Australia remains a net exporter of food?

Wikipedia provides a fairly detailed, but useless, entry on food security. It does not mention national self-sufficiency at all, but merely one’s access to nutrition, and the link with poverty. No surprises there.

I’m all for national pride, but arbitrarily deciding that a country must be self-sufficient in one particular good is a poor philosophical position. If we replaced food security with toilet paper security, or car security, or hat security, we would immediately reveal the absurdity of the argument.

That bloody housing shortage

It seems that the RBA's Anthony Richards may have been reading my blog. His comment today from a national housing market forum includes the following

I said in a talk earlier this year that most calculations available then put underlying demand at something like 180,000 to 200,000 dwellings per year. However, I noted that such figuring was based on simply extrapolating earlier trends in household size and ignored the likely impact of prices on the demand for housing. At some point, the overall demand for housing will be affected by the higher cost of housing. For example, with housing – both owner-occupied and renter – more expensive than in
the past, we might expect to see some young adults choosing to live with their parents for longer. We might expect some households to look for an extra flatmate rather than leaving a bedroom vacant. Some owners of holiday homes or second homes might have become more inclined to sell them, with those houses then occupied full-time.

Hence the ‘undersupply’ of housing might not be as large as sometimes thought. But this is not necessarily something that should reassure us – it may be because the higher cost of housing – partly reflecting supply side problems – has choked off some of the demand that might otherwise have existed.

However, by the end of his statement, fingers are squarely pointed at the pet issue for housing analysts, supply side constraints.  That bloody housing shortage gets a good run in his statement as well. 

I also wonder how we are meant to know the counterfactual demand that might otherwise have existed.  Isn't he just saying that demand for housing follows the law of demand?
 
His remarks are reported as evidence that the housing market is ready to 'take off'. But only time will tell whether the inverse correlation between change in housing shortage and change in price proves reliable in the longer term, or whether the RBA really can forecast market behaviour.

----------UPDATE----------

It looks like I'm not the only one who has interepreted the housing market exactly the opposite way to the RBA and other property bulls.

Roads for nobody

Friday's local rag suggests that the State government here in Queensland is keeping their employees busy by investigating a possible new tunnel from Toowong to Everton Park.  This is to alleviate traffic congestion (of course).

Let me make some predictions.
1. This tunnel will not start construction within a decade.
2.  If 1 comes true, expect the tunnel never to be built.

The reasons are equally as obvious as the predictions.
1. The State government has no money for ridiculous projects like this.
2. The Federal government will tighten its belt before they are asked to fund this project.
3. The private sector will not fund it - they wouldn't fund a little $250million bridge because of good alternative routes, why would they fund this. 

If you want to head north on the Bruce highway from Toowong, wouldn't you take the other tunnel they plan to build to the Inner City Bypass, then get on the other new tunnel to the airport, then get on the Gateway motorway heading north?  I would.

It appears that the transport planning community has looked to cities around the world that have similar traffic problems to Brisbane (Los Angeles, Sydney etc), and adopted similar approaches to alleviating traffic congestion.  One wonders why transport planners don't instead look to cities that actually don't have severe traffic problems, and instead adopt some of the approaches used in these cities.  It is a lot like asking a chronic alcoholic which intervention worked best for him when he still drinks like a fish. 

I await a more diversified transport plan for South East Queensland.

Property bulls take note

The main problem with the housing shortage proponents is that they neglect the existing 8.5million or so existing residential dwellings as a supply of housing. Currently, the average dwelling occupancy rate across the country is 2.53 persons/dwelling. This rate has varied between 2.48 and 2.60 over the last 27 years. In fact, it peaked at 2.6 in 1982 (soon after the second oil crisis). The graph below shows that we are currently heading back to level of occupancy last seen in the 1980s.

But surely, with such a small variation, this issue is minor compared to the 17,000 homes we are currently short of! On the contrary, it is the crux of the whole debate. You see, a change in the occupancy rate occurs for all dwellings, including the 8.5million existing homes. The 43,000 people apparently in need of the 17,000 dwellings can be accommodated in existing dwellings, and the result would be a shift in the occupancy rate of 0.005. If you look at the y-axis scale you can see how small an increment this is (one quarter of one notch), and how quickly we are heading that way.

In fact it only requires 1 in 200 households to welcome another person. Seems realistic to me, considering how popular this trend is amongst my peer group. Also, considering that the average dwelling is much larger now than when the occupancy rate was 2.6 back in 1982, such a shift would barely be noticable. 

I have mentioned before how this adjustment in occupancy rate occurs, for example:

• youths stay home with parents longer
• group households rent spare rooms
• elderly parents move in with children’s families
• other lone relatives move in
• when families relocate they choose smaller houses… and so on

This is happening and there is plenty of scope for it to continue. In 2003-4, 35% of households reported one spare bedroom, while 42% reported more than one spare bedroom. That’s at least 9.4million spare rooms in existing dwellings.

So I caution the property bulls to be realistic with their investments. Don’t expect a boom of 6 years to be followed by a six month bust. If you want to get into the market now, buy on the high rental yield and find good tenants. And of course, don’t forget about location.