Tuesday, March 30, 2021

Making sense of property as a monopoly

Let us start by assuming that the property system is competitive and see how far that gets us in making sense of property pricing. After all, there are many different owners of different locations. That seems like what the textbooks describe.

The competitive market of economic theory has a few quirks. At the firm level, the demand curve is flat. Varying your own supply has no price effect. Yet, at the market level, varying supply does have a price effect. The problem of adding up a bunch of zero effects from firm quantity variation to a positive effect at the market level is an issue. It is resolved by assuming free entry at the market price; if a firm decreases its output while all others retain the same output, a new firm will enter the market and sell exactly that amount necessary to get back to the market equilibrium.

Neat, huh?

So let’s get back to it. We have a bunch of property-owning firms that can redevelop their space into housing. Each property owner sees a flat demand curve at the market price (because of our neat assumption) and has a cost curve that looks like...

Well, what does it look like exactly?

In strictly economic terms, the only input to the property right over a location is the existence of a property system. There are no input costs. To develop housing there are of course costs involved, such as fees, construction, and selling costs. But you can net these costs out of both demand and supply to look at the market for “empty” locations, or property rights to locations. After all, new housing supply is merely the subdivision of space—the subdivision of property rights into smaller pieces. The demand curve is still downward-sloping for that property rights market, but the supply curve must sit at zero.

Here we hit our first problem. If we assume perfect competition, we can only have land (location) prices of zero.

This “zero cost of location” view is what Ed Glaeser argues is the right way to think about housing.
…housing is expensive because of artificial limits on construction created by the regulation of new housing. It argues that there is plenty of land in high-cost areas, and in principle, new construction might be able to push the cost of houses down to physical construction costs.
In other words, land prices should be zero everywhere. Any deviation from this is due to regulatory intrusions in the market. Indeed, this implies that the very existence of a land market with trades at non-zero prices indicates it is not competitive. This is a bizarre conclusion in my view.

Maybe we will have more luck making sense of the property system by assuming it is a monopoly despite the many different owners. This has some intuitive appeal. First, you can’t choose to have your locations supplied by a competing property titles system. You can’t run more than one property system in parallel. Can you imagine the conflicts over who owns what space with multiple property systems? Second, the ownership of monopolies is often carved up (subdivided) and owned by many different people who each own constituent parts. Though we usually call these company shares or stocks. 

So what then of the economic theory of monopoly?

As a starting point, a monopoly model avoids the assumption of free entry as the reason individual firms cannot observe their own-supply effect on price. This matches the reality of the private property system as it does not allow free entry. You can only compete in the property market by first buying property from the property market. This seems sensible.

The property market for any use, like housing, therefore looks this at a point in time.

Since costs are all sunk, we can simplify a bit by ignoring the stock of existing housing and look forward in time only. Think about redrawing the axes with the origin at the equilibrium current price and stock.

A change in the housing stock is the supply of new housing. The question of interest is how the stock of housing evolves over time in a property monopoly to determine an equilibrium rate of new supply?

In this model, if demand stays fixed and existing housing does not depreciate, then no new housing is built.

As demand shifts, new supply is added at a rate that maximises the revenue gain from selling those new properties rather than keeping them undeveloped in your balance sheet. It is the same monopoly maximisation principle applied at the margin. In other words, you sell new housing lots at a rate that maximises the present value of that flow of sales.

This logic is shown below. From the t=0 equilibrium, demand shift upwards. The green line shows the marginal revenue from the new supply (i.e. the change in the housing stock, Q, over that period). The new equilibrium is where the revenue from that flow of new property put to housing uses is maximised (i.e. where marginal revenue from that flow is zero).

This equates to a rate of supply that I explain in my absorption rate theory of housing supply (assuming a zero interest rate to simplify the inter-temporal trade-off).

The steeper (more price sensitive) the demand, the less supply responds to the same vertical demand shift. That’s because each property owner is sensitive to their bigger own-supply effect on the market price. Thin markets mean less supply.

Under this monopoly logic, the supply curve for property is not an independently-determined cost curve, but a derived curve based on the slope of the market demand curve.

But how do you get to the monopoly outcome? Is a conspiracy needed?

Not at all. All that is needed is trial and error. Remember, unlike the competitive market assumption of free entry, in the monopoly model, changes in firm output affect market output. If firms start near the competitive rate of supply per period in the face of a sloping (and rising) market demand curve, they will quickly learn to get to the monopoly rate of supply independently.

All that is needed is a learning rule of “win-stay, lose-shift”. This rule says that if the increasing the rate of supply last period increased your marginal revenue, then increase next period, otherwise decrease the rate of supply. If decreasing the rate of supply last period increased your marginal revenue, continue to decrease, otherwise increase.

When I simulate this learning rule with three firms, they quickly converge to the monopoly rate of supply, and hence the monopoly price. This convergence will occur even with 1,000 firms in the market. Property markets have been around for a while now. It seems likely that the current set of property owners has learnt this maximising equilibrium.

It seems logical to conclude that the monopoly model of property makes more sense than a competitive model. Indeed, monopoly was the traditional economic way of understanding property markets. In terms of understanding housing markets and effective policies to reduce prices, I think the following points are key.
  1. That the property system is a monopoly shows that the rate of new housing development is mostly a product of demand. Property owners don’t want to build faster. This is because supply is not independent of demand. Supply is merely a reflection of demand.
  2. Rezoning and changing planning rules might change where development happens (as it should—they are location regulations after all) but probably won’t change the rate of new supply. The rate is the one the market wants. Developers don’t want to flood the housing market.
  3. Making housing cheaper should be understood the same way we understand other monopolies. We regulate prices. We create public options. Pretending that we can somehow capitalise on competitive market forces that don’t exist won’t change things.


  1. You are misrepresenting Glaeser. No where in that link does he say what you state he does.

    You are also conflating the property title system,the market for land and the market for housing. This is nonsensical. The fact that there is only one property title system implies nothing about whether the market is competitive or monopolistic.

    1. The quote comes from the top of p23 of the link. I can't be more clear about his views than him. He has repeated similar claims elsewhere.

      "The fact that there is only one property title system implies nothing about whether the market is competitive or monopolistic."

      I disagree. It exactly does imply that. Just like a taxi license system. creates a monopoly, or a radio spectrum license system creates a spectrum monopoly. The market of land and house are just both trades of part of the three-dimensional space that is regulated by the property title's system. Sometimes there are buildings in that space, Sometimes not.

    2. His quotation is not the part I have a problem with. Nowhere does Glaeser say that "....prices should be zero." You are strawmanning him with the model of perfect competition, which he never states exists in practice.

      Monopolies are defined by a lack of competition. There is no difference between what you are describing with the title system and other forms of property rights. Your comment on the property title system could be extended to the legal system and property rights generally. Your example of a taxi licensing service illustrates thus perfectly. Multiple licensing systems where only one operator could be granted a license at one time would be a monopoly. A single system where as many people who wanted could get a taxi license at minimal cost would not be. It is the effect on suppliers in the market that is relevant, not the number of systems in operation.

  2. Your comparison of land ownership with stock ownership also makes no sense. Stock owners of a single firm in a monopoly position by definition don't compete with each other supplying the same good in a market. There is still one demand curve for the firm which will equal the market demand curve in that situation. You haven't made any case for why land ownership should be thought of in the same way where landowners profits are not pooled the way stocks are.

    1. I think the linked article explains quite well the commonalities. If a single entity owns all the three-dimensional space defined in the property titles system, it is a monopoly. Whether you carve up ownership of this entity into parts with percentage shares or location shares does't change the optimal production choices.

    2. Land owners are not a single entity. This is exactly why the comparison with stock owners is spurious. Pretending they are is disingenuous.

    3. I do not pretend that landowners are a single entity. The comparison with stock owners is useful.

    4. I am genuinely not getting you here. If the actual landowners are not the entity that "owns all the three-dimensional space defined in the property titles system", then who is? The title system itself?

      This doesn't appear to make any sense when talking about how competitive the market for housing is. To take your example of a taxi license system, sure, the state could theoretically have a monopoly on issuing taxi licenses in a market. But that implies nothing about whether the market for taxi services itself is competitive or not. A licensing system that issued huge numbers of taxi licenses and imposed almost no barrier to entry could still end up with a highly competitive market for taxi services, but the licensing system itself would be a monopoly.

      There seems to be no logical reason you couldn't extend this line of reasoning to the property rights system in general and say that every market is a monopoly! States typically only have one legal system after all.

      That issue with the stock ownership I have is that if you and I both own stock in Amazon, sure we can compete in the market for Amazon stock. But we cannot and would not be able to compete in the market for the services Amazon provides to the firm's' customers. The property title system cannot compete with itself, but that does not imply individual landowners in the system cannot!

      Anyway I enjoyed the exchange.

    5. “ A licensing system that issued huge numbers of taxi licenses and imposed almost no barrier to entry could still end up with a highly competitive market for taxi services, but the licensing system itself would be a monopoly. ”

      You noted the exact issue that I wrote about - free entry. Sure, if the government gave out more pieces of 3D space for free to anyone who wants it (free entry), like they can with a taxi license system, then the property market could be competitive. But you cannot do this with finite locations.

  3. I agree with Unknown. Yours is a bizarre misinterpretation of Glaeser that no-one else shares.

    1. Thanks for the constructive comment. I'm pretty familiar with Glaeser's work. I have published the most comprehensive critique and replication of his approach that incorporates the theoretical interpretation that I describe.

      When Glaeser's paper was first presented in 2003, the discussant at the conference explained why it was nonsense. Later in 2005, another review article came to similar conclusions. That and other critiques have been ignored.

      A reviewer of my own recent paper critiquing Glaeser noted that "The main point of this paper is both correct and important: the popular hedonic price method of calculating a "regulatory tax" initiated by Glaeser and Gyourko (2003) (henceforth G&G) has little or no scientific merit, and should not be used."

      So I guess I beg to differ that my interpretation is bizarre.