Thursday, September 01, 2005

Economics of Katrina

I am sort of confused about the economics of city building, maybe on of you could help me out.

Let's say a city is worth X. X is probably a pretty big number considering all the infrastructure and revenue a city produces. Then Y is the amount of money it would cost to rebuild that city. Y can also be seen as "how bad do you really want it?" Obviously if Y is greater than X you just scrap the city and start over somewhere else. It also seems to indicate (to me, at least) that the value of the city is X+Y or the "actual" value of the city plus "how much do you really want it?" As it appears that no one is really talking about scrapping New Orleans just yet, which would indicate that cities are hugely undervalued. If there is enough capital to rebuild the entire city from scratch (almost) then the New Orleans market was hugely undervalued for all those years that it was not underwater (and thus every other major city). Is the "market" on N.O. that off-base or has it really been accounting for this risk all along?

16 comments:

NoFreeLunch said...

I don't understand why you're adding those two costs from different time periods to get the value. The value of the city is the price + whatever other profits you are foregoing by investing at that moment in time.
The rebuilding is based on the demand for New Orleans. People want one New Orleans, not two, so when New Orleans disappears we build one New Orleans back. That doesn't mean that New Orleans was twice as valuable or that twice as much capital should have been invested originally.

Anonymous said...

Especially when the market gets flooded.

miriam said...

'Then Y is the amount of money it would cost to rebuild that city. Y can also be seen as "how bad do you really want it?" '

zev, i am going to swallow my general distaste for this sort of everything-has-a-simple-number business for just long enough to point out that, as far as i can see, "how much do you really want it" is part of X, not of Y. if the whole point of setting a number of these two is to compare them and see if X > Y, then how much people want the city should be on the X side (mitigating for building), no?

good shabbos.

kaspit said...

"Let's say a city is worth X."

Sure, Jerusalem is worth X and I'll build my homeland in Uganda, given the right financing package, of course.

Actually, there is speculation about scrapping N.O. but maybe not folks who feel it's home.

For more economics, check out the Business Week editorial at my site. good shabbes,

Sam said...

I am sort of confused about your entire post. "Let's say a city is worth X." Stop right there! What do you mean? You can neither buy nor sell a city. Do you mean the aggregate of all the property values? The value of one factory, or one house, or one office building makes sense when everything else remains more-or-less constant, but at the scale of the city I think this number only relates to taxes.

Your city-building calculus is too confusing for me. I don't think anyone will decide whether to rebuild or abandon New Orleans. Many actors will make small decisions instead: they will rebuild the ports and the oil industry. Who knows about anything else?

kaspit said...

Against my better judgment, look at:

Should New Orleans be rebuilt?

Your welcome (?), ;>

K

Zev said...

Thanks Kaspit, Rachel Soloveichik also blogs about the same issue.

I guess my question is, where does the money come from to rebuild? Has there just been a surplus of cash lying around waiting to rebuild after a disaster?

Sarah, in deference to Sam I will just talk about one house for the moment. If you buy a house for $100, but are willing to pay another 100 to rebuild doesn't that mean that your house was undervalued (i.e. you were willing to pay more)?

NoFreeLunch said...

No! If you are going to buy a candy bar, and you drop $1 and lose it on the way there, and then buy a candy bar for $1, does that mean that you would have paid $2 had you not lost any money? You would have spent the other dollar on something else. It is the same if you exchanged the first dollar for something else and then lost the something else, be it a candy bar or a house.

Zev said...

But if you lose the candy bar before you eat it and buy another, then you would have been willing to pay $2 at the onset.

NoFreeLunch said...

Then you should be willing to pay $2 for the second candy bar - and the candy bar is really worth $3!
Why does it matter whether you lose a candy bar, or a dollar before it is changed into a candy bar? They are worth the same!

NoFreeLunch said...

Zev, here is a problem for you: You buy a candy bar for a dollar, lose it, and then buy a house for 100 dollars. How much was the house worth?

Sam said...

I am not an economist but here's what I remember from ECON 200. First off, your reservation price for a good (the maximum you are willing to pay for it) usually does not equal its price. This is only possible if the supplier can engage in price discrimination. You might be willing to pay $10 for a candy bar, but if candy bars are priced competitively you will pay less. If CVS charged you $10, but they only cost $1 to make, I could start up a candy bar business selling them for $9 and make a killing, until Oren starts selling them for $8, etc.

Second, you are comparing two different goods. You aren't buying two candy bars at the same time and then losing one of them. The above comment makes this clear: the fact that your house might burn down several times does not mean that you are willing to pay anything for the first house!

If you wanted, you could cook up a textbook model to figure out how the risk of the loss affects your initial decision.

miriam said...

ummm... in my infinite ignorance on all things economical, i believe the phrase we are all dancing around is "sunk costs are sunk."
anyhow, zev:
if you lose the candy bar/house/whatever, it doesn't turn out that you were willing to pay $2 for the candy bar. rather, somehow you were tricked by fate to spend $1 on nothing, you feel like an idiot about it for a few seconds, and now you are faced with exactly the same initial decision: to buy a candy bar for $1 or not. the only difference is that you are now $1 poorer.

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