Economic Principles
What the exam tests
Economic principles underlie every adjustment and every highest and best use conclusion. Expect questions that name a principle and describe a situation - identify the principle, or the direction of its effect.
The principles
- Supply and demand: price responds to the balance; supply is relatively fixed in the short run.
- Substitution: a buyer pays no more than the cost of an equally desirable substitute; the basis of the sales comparison and cost approaches.
- Anticipation: value is created by the expectation of future benefits.
- Change: value is never static, which is why every opinion carries an effective date.
- Competition and balance: excess profit attracts competition that erodes it; balance concerns the mix of land, labor, capital, and coordination.
- Conformity: maximum value occurs with reasonable homogeneity.
- Contribution: an item is worth what it adds to the whole, not what it cost.
- Diminishing returns and surplus productivity: added inputs eventually add less than they cost.
- Externalities: outside forces add or subtract value (progression and regression).
- Opportunity cost: the return foregone on the next-best alternative.
Worked example
A three-bedroom, two-bath home sits in a neighborhood of three-bedroom, two-bath homes. The owner adds a third bath. Cost new is $25,000; matched pairs show the market pays about $12,000 for the extra bath here. Contribution is $12,000, not cost. The extra bath may be an over-improvement, and diminishing returns has already set in.
Traps
Treating cost as value. Reversing progression (a lesser property benefits from better neighbors) and regression (a better property is dragged down by lesser neighbors). Citing substitution without market support for the substitute's cost.