Monday, May 3, 2010

How much is this island worth?

I would appreciate some feedback on a little conundrum I face at work.  The following analogy is close enough for our purpose, and what I want to know is how much the island is worth?

Imagine a large island was discovered in Australian waters in the 1960s.  The government takes ownership of the mostly desert island.  It has little environmental value, with a surprising lack of biodiversity, some small mineral deposits that are uneconomical to extract, and otherwise is of little use. 

The government decides that they may as well put the island to some use, and offer people a licence to inhabit the island, and the rights to the minerals and any vegetation they find.  The licence is offered for free with the condition that the licence holder make use of it within 3 years (by inhabiting the island or making use of its resources in some way).  By 2010 a dozen people have licences and inhabit the island.  The government estimates that they could offer 100 more licences before the islands land is fully ‘developed’.

The government changes its licensing policy and decides that licences will be converted in title of the land in the island - much like it is on the mainland.    It now has 12 blocks of land in private hands, and 100 in government hands.

The government then decides to sell its remaining blocks of land to the market.  At what price could they sell these 100 blocks?

I see two drivers of price:
1. The previously free and seemingly non-scarce licence is replaced with a scarce piece of land, therefore people will be willing to pay something simply out of speculation of future value (because they now don’t have to inhabit the island to keep the block).
2. The price is still worth nothing if people weren’t willing to take the licences for free for 50 years.

How do we estimate the market price, if any, of these blocks of land?


  1. Hi Cameron.

    Thanks for commenting on my blog. By all means jump in with both feet to help Steve Keen with his ingenious model.

    Does the govt in you problem have to unload these parcels by a certain date? If so, an auction or, better yet, a call for sealed bids would bring the best prices. Some advertising in flush markets would also bring the price up.

  2. That is the question Warren. We are happy to auction the land but face the problem that the supply is so enormous. If we decide to sell it all, the price will decline towards zero. We can either decide a quantity to sell (which may be a political call) and see what the price ends up being, or decide on a reserve price, and sell as much as we can above that price.

    Any perceived value of land to existing owners, and the ones that buy the first parcels at a reasonable price, will be destroyed by releasing too many parcels.

    My impression is that potential buyers would realise this and all offer near zero prices anyway. But we then face the problem that our government has promised not to just 'give things away' anymore.