The total stock of land is Qf. Whatever the price, this
total
stock cannot be changed (aside from minor changes like draining lakes
etc.)
The sellers are signalling a negative demand for the thing
(land
in this case) - the offer curve (Oc) - the higher the price, the
greater the quantity we might expect present owners to be willing to
sell.
By the same token, all present owners who are
not selling are exhibiting
a positive demand for their stock given present prices. This
positve
demand is labelled the reservation demand (RD) in the
above
figure, which is the mirror image of the offer curve (Oc). What
is not being offered for sale by present owners is being retained (held
onto) - that is, it is (in effect) being demanded.
The excess demand curve (XD) shows how much more
land present owners and non owners want to own at each price -
more
is demanded over and above present holdings of land as the
price
falls.
The horizontal sum of the reservation demand (RD) and
the excess demand (XD) is the total demand (TD)
for
land, or stock. It is the intersection of this total demand (TD)with
the fixed supply (Sf) which determines the market price for land
(Pe).
The trades we observe in a stock market are those between people who
no longer want to own the stock, for whatever reason, shown by the
offer
curve (Oc) and those who want to own more than they presently
have
(which might be some or none at all) - shown by the demand for
additional
stock (excess demand) labelled XD
above. Offer and XD intersect
at the trading price (Pe) and Qt of land (or stocks and shares) change
hands between buyers and sellers.
When all these trades have been made, the present owners are now willing to go on owning land at the present price, and are not willing to sell any.
Share Prices and Stock Market price movements.
So, what is a stock or share (or piece of land) worth? The simple
answer first - it is worth whatever someone else will pay for it.
The current market price of the share, or piece of land, or any other
physical
asset, is as good an estimate of what it is worth as you can get.
The current price reflects the total demand (reservation and excess
demand)
matched with the fixed available supply. The price will change,
as
in all markets,
only if demand shifts or supply shifts. For land
and stock markets, the shifts in total supply are usually pretty
trivial
compared with the total stock. So it is shifts in demand which
are
critical in determining prices in these stock markets.
What will shift the demand curve for land (or stocks and shares) and hence change their prices?
Suppose we do not
expect rents to remain constant in the
future.
What might they do? They might be expected to increase (or fall)
by some average and constant amount each year (say plus or minus £A
per year). In this case, the relevant sum for the present value
of
this stream of future rents (annual returns) becomes:
PV = R/i + A/i2 , where R is the basic rent
or annual return (expected this year) and A is the amount by which we
expect
this annual return to change each year in the future, and i is the
discount
rate (the opportunity cost of capital - what we could earn elsewhere,
investing
in something else). So, if we expect returns to fall, the present
value is reduced compared with the simple sum which assumes the return
stays constant. But, if we expect returns to increase, then the
present
value increases, too.
Or, we might expect a continual percentage change in the annual
return,
say plus or minus g% per year. In this case, the PV sum
becomes:
PV = R/(i - g), so that, if the expected growth rate (g) in
the returns on this asset are higher than the opportunity cost of
capital
(i), the present value for this asset goes to infinity: there
is
no price it is not worth paying for such an asset - which is an
explanation
of why share prices shoot upwards for companies expected to do very
well
in the future.
Depreciating assets - ones that wear out.
So, how do we account for the fact that physical plant and equipment
wears out and becomes obsolete? By making an allowance for the
depreciation
of the asset - the continual re-investment necessary to maintain it in
a non-depreciating state. Suppose that this depreciation rate is
d%.
The gross return we need to get from this asset needs to cover this
depreciation
rate, so the net return we need to get on any depreciating asset is the
gross return minus the estimated depreciation rate. So, the gross
return we expect to get should be i = r + p + u + d on these
assets.