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CHAPTER FOUR LITERATURE REVIEW 4.1 Introduction

A review of the literature is undertaken in this section. In addition, the theoretical and conceptual basis for the study is provided. The study of residential preferences and choice behaviour has received considerable attention for many years in various disciplines of humanities such as environmental psychology, geography, urban and regional planning, urban sociology, civil and building engineering, estate management and environmental economics. The two major approaches which have received attention in studying the housing choice in the housing literature are: revealed and stated modelling approaches. Revealed models are based on observational data of households‘ actual housing choices in real markets.

In contrast, stated preference and choice models are based on people‘s reactions to hypothetical houses.

The problem of housing choice is, therefore, strongly related to the identification of the factors associated with the dwelling and environmental context that may determine the attractiveness of a place. Numerous studies have been carried out in the international literature on housing choice models (see, e.g., Cooper, Ryley and Smith, 2001; Earnhart, 2002; Gayda, 1998; Ortuzar, Martinez and Varela,2000; Perez,Martinez and Ortuzar, 2003;

Walker, Marsh,Wardman and Niner,2002), and a wide variety of explanatory variables has been considered: price, rent, dwelling size, accessibility, natural features, etc.

In addition, empirical and methodological reviews of residential housing choice are undertaken in this section. Lastly, a review of hedonic pricing methodology which is central to the study of housing choice decistion is also dwelt upon.

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Ecological Residential Theory

Studies on residential choice stem originally from the ecological tradition of Burgess (1926), Hoyt (1939) and others in the 1920s and 1930s, collectively known as the ‗‘Chicago School‘‘

(UN-HABITAT, 2003). The Chicago school saw residential choice as an outcome of

‗‘ecological‘‘ competition for niches among social classes who behaved like different species in terms of endowments and want, and who would compete for different house types, with the strongest groups taking the most desirable houses and the weaker groups occupying residual ones. Park, Burgess and Mckenzie (1925) note the concentration of low-income houses within particular sections of the city. These zones are those designated as ‗working men‘s housing and zones in transition‘. Earlier generations of working men‘s housing were slowly taken over by warehouses, immigrants and the urban poor, as better households moved to the suburbs. The zones in transitions were the ghettos, slums and ‗bright light areas‘ (UN-HABITAT,2003). Slums do not occur in a vacuum. They result from a combination of poverty or low incomes with inadequacies in the housing provision system (UN-HABITAT,2003).

Residential Location Theory

This is one of the urban microeconomic models which explains household location behaviour and also offers valuable insight into the city structure. The earliest contributors to this model include: Wingo(1961); Kain(1962); Alonso(1964); Muth(1969); and Beckmann(1969). The core of this theory is that a major determinant of people‘s residential choice behaviour is the accessibility to their residential locations or place of residence. In essence, the model emphasises journey-to-work phenomenon as a basic factor in people‘s residential choice behaviour. Simple models of residential location theory are essentially based on the concepts of cost minimisation. For instance, a worker surveys the housing market from his/her workplace and he/she typically observes that housing prices, P declines with distance, d, from the Central Business District (CBD) in at least one direction. The theory, however, assumes that travel costs, t, increase with distance from his/her workplace. For any given amount of housing, H, he faces a total expenditure on housing, Z, composed of a housing expenditure plus transport expenditure.

( ). ( )

j j j

ZR d Ht d ………..(1)

For quantity H0, the worker can solve for the least cost distance by taking derivatives.

' ' '

( ). 0 ( ) 0

j j j

ZR d Ht d  ………...(2)

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and solving the expression for dj*, the optimal distance or location for quantity H0 and workplace j. This least cost distance can be substituted back into equation (1) to calculate the minimum total expenditure for quantity H0, as

* *

( ). 0 ( )

j j j j j

ZR d Ht d ……….(3)

The decline of housing prices with distance Rj(d), will differ systematically across workplace, very likely showing steep rates of decline with distance for centrally located workplaces and gradual rates of decline for peripheral workplaces. The major drawbacks that beset the theory has to do with the assumptions of monocentricity, which implies that the locations of all employment and residential housing are located around central business districts, each household has only one worker and that workplace choice is predetermined and exogenous to residential location choice.

Social Area Analysis and Factorial Ecology Theory

Ecological and classical micro-economic studies on urban housing choice were later ‗brought together, in the form of social area analysis and through the methodology of factorial ecology, to provide a more comprehensive view of urban residential choice. In every city that was studied in widely different parts of the developed world, residential choice was due, in part, to three factors, usually known as socio-economic status, familism and ethnicity (Shevky and Bell, 1955; Berry and Kassada, 1975). As perceived by these authors, socio-economic status was an ‗index of advantage‘ that combined factors such as income, education and occupation. Familism according to them, is concerned with the effect of family type:

households with children and non-working wives in the 1970s tended to seek suburban bungalows, while single persons were more inclined to live in apartments in the central city.

Ethnicity usually measured the proportion of those born outside the country, but could also represent the separation of particular ethnic or religious groups. The three factors were of different strengths in different cities and cultures and had different weightings on the variables; but they were invariably, the three major factors determining urban residential choice.

Maximum Housing Expenditure Theory

This theory states that income and the availability and conditions of mortgage finance determine residential location behaviour. Their choice is fairly restricted and the point on the housing cost curve will be determined largely by mortgage availability. This theory is based on the assumption that the house-buyers will attempt to acquire a house as expensive as they can afford with the maximum mortgage which they can raise in the area of their choice,

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although house-buyers may seek a property over a wide area, transport costs may be a relatively minor consideration and may vary in relation to the distribution of houses within a specific price range. Environmental and social factors are likely to be a much greater influence over choice. This hypothesis evolved by Ellis (1967) and Stegman (1969), implies there is no overall relationship between income, travel cost/time and place of work, and that there is no effective trade off.

The Tiebout Model

The Tiebout Model specifically dwells on the relationship between local government programmes, taxes and housing prices. This theory relies on the existence of four postulates.

These are:

 A house purchased or rented in a particular area embodies a bundle of services that vary depending on government activity;

 Individuals form preferences for an area based on the public services and other features of the external environment together with the private services of the house;

 Different levels of service provisions will often result in different tax burdens among municipalities; and

 Individuals differ in their preference and willingness to pay for private housing services and also for the goods associated with housing in a particular neighbourhood (Blair, 1995: 251).

Thus, the theory places strong emphasis on differences in preferences resulting from government policies and programmes. The theory recognises that individuals in the same position might not make the same decisions. If they are not satisfied with the way things are, they will not necessarily bear it, individuals ―vote with their feet‖ for the combination of amenities and disamenities they prefer.

The early work of Tiebout (1956) continues to prompt research based on his market model for explaining the behaviour of both individuals and local government units operating within spatially defined political jurisdictions located in urban areas. Since Tiebout‘s article, many economists have viewed the decision of families to reside in a particular community as a conscious choice of one particular package of local public services over others (Friedman, 1981). Tiebout suggests that under certain conditions, consumers might reveal their preferences for locally provided public goods. Tiebout proposes that a market-like mechanism might exist for local public goods because the taxes used to finance those goods are specific to each jurisdiction. He further suggests that households would sort themselves

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such that all families in a given jurisdiction would derive the same marginal benefit from the local public goods, and marginal benefit would be equal to marginal cost.

The Cultural Agglomeration Model

This model states that cultural factors are important in taking residential choice decisions.

According to this theory, people often believe they will find congenial friends (or friends for their children) if they live near people like themselves. Thus, neighbourhood where individuals with similar social characteristics are found, will form based on social desires and agglomeration economies. Balchin and Kieve (1982) based this on households with similar incomes and presume they will, in the long run, be willing to incur the same price for travelling and housing. If travelling costs increase, certain groups will migrate to areas where the cost of housing is relatively cheaper, while people will tend to move to more expensive housing if travelling costs decrease. The actual direction of change, if any, will depend upon the relative strength of these two opposing forces. It should, however, be noted that even if there was an inverse correlation between house prices and travel costs, it is unlikely that all households would trade off. Harvey (1996: 206) also posits that environmental characteristics are important in the location decisions of a household.

Trade-Off Model

Trade off model, according to Muth (1969), explains the predominance of high-quality housing on the city perimeters in terms of the trade-off between access to central locations and household demand for space. The model is based on the assumption that as incomes rise the rate at which household are willing to substitute access for cheaper land changes. The model deals with two categories of changes namely: space versus access within a central city and trade offs in a multiple nuclear city.

(i) Space Versus Access/Travel Cost Minimisation Theory

According to Balchin, Bull and Kieve (1995: 84), if travel costs to work are nil or very low, households will be prepared to pay the highest rents or prices for accommodation. Through the working of the price mechanism, this would imply that the rich live very close to the central business district and the poor live in less expensive outer area. The opposite is however generally true, low income earners live close to their work places (usually within the inner area of cities) to minimise their cost of travelling, rents are mainly regulated, and housing densities are high. As incomes rise, there is the tendency for people to live farther

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away from their work in areas of lower density and more expensive housing. Balchin, Bull and Kieve (1995) also argue that the outward spread of cities would only be compatible with travel cost minimisation if employment was simultaneously decentralised, but that this decentralisation of employment opportunities usually do not take place which implies that travelling cost remains important.

According to Blair (1995: 249), the increased distance from the Central Business District (CBD) also increases the opportunity cost of commuting. The increased opportunity cost of commuting tends to orient the optimal location toward the city‘s centre where access is best. Which pull will dominate cannot be determined theoretically and may be illustrated with the help of a simple diagram. Initially, the household is in equilibrium at point M, as income increases, the household will relocate because the desire for more space between the cheaper land near the fringe is for better access. A relocation to M‘ would reflect the stronger space pull caused by the income increase. The contrast suggests that the trade off is affected by attitude regarding the value of non-work time and preferred living accommodation.

Fig 4.1: Space versus Access as Income Increases

Source: Blair, 1995 Critics point out that a trade off model of the above sort is least satisfactory in explaining residential location choice behaviour within a conurbation where there may be several CBDs and a complex pattern of commuting. Patterns and relationships will also be distorted by the decentralisation of employment. A further step was taken by Blair to expand the theory by making provision for the Multiple Nuclear City.

(ii) Trade offs in the Multiple Nuclear City

The structure of cities has however changed in recent years and locations other than the CBD have become very popular for commercial use. There are increasingly multiple points within a metropolitan area that represent points of substantial access in most major metropolitan

Central Busines s District

Urban Fringe

Access Pull

Space Pull

M M

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areas. During the past few years, jobs have shifted from the central city to suburban locations, so the assumption of minimum transportation costs at the CBD are unrealistic for most families. The CBD remains the site of the plurality of jobs, but many large business agglomerations exist throughout most metropolitan areas. Within limited areas, land costs may actually decline, moving towards the central city.

Evans (1985) also expands the trade off hypothesis by suggesting that a household might move further out from the city centre if their demand for space increases, but if their income increases and their demand for space remain constant, they will probably move closer to the city centre. Evans further suggests that following a general increase in pay, higher income household out-bid income groups both in the periphery of urban areas and in the inner cities, in the latter case often by means of gentrification. High income groups can bid for land or residential houses in any location because they can afford high transportation cost and expensive housing, which implies that increases/decreases in transportation cost will not have an impact on their residential location behaviour. High income commuters do not have to trade off travel and housing cost, they can afford both.

Life Cycle Model

This model states that different age groups with different household characteristics have different desires for their residences, and that these preferences change over the life course (Wenning,1995).So, even if one demographic group focuses on distance to work, others might not and the group‘s preferences might change with time (Masnick,2003). By implication, household changes in the sense that an individual and/or every family evolves through a life-cycle sequence have an important impact on the housing market. Changes in household life-cycle generate mobility either by altering specific housing needs or by creating or eliminating a demand for an independent housing unit. Gayle (2001), identifies six stages in the family life cycle as follows: Stage (i) Pre-family or unattached young adult (ii) Coupling (iii) Child bearing (iv) Child rearing (v) Post family and (vi) Later life. He further grouped these stages into three: (1) Pre-family –stage (i) (2) Active Stage-Stage(ii), (iii) and (iv) i.e coupling, child bearing and child rearing (3) Post-family-Stages (v) and (vi) i.e post family and later life. According to this model there are at least three separate types of housing needed to be satisfied at each stage of the family life cycle. The first type: rental apartment is common in coupling stage. In the second type, the family can write the programme for its castle and make a commitment during the child bearing stage, when the job, geography and gestation must have stabilised. In the third type, the family decides whether to build during

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child rearing stage. This will depend on the family size, composition, aspiration and availability of finance. The Table 4.1 provides the summary of the Life-Cycle Model.

Table 4.1 Summary of the Life Cycle Model.

Stages in Life-Cycle Space requirements/Aspiration Creation of new household (pre-child stage)

1 or 2 persons

Relatively cheap flat or small house.

Child bearing 2-3 persons House with at least 2 bedrooms

Child rearing 3-4or more persons Large house with at least 3 or 4 bedrooms.

Post-child (2 persons). Institution/flat, live with relatives.

Later life (1 person) Relatively cheap flat or small house Source: Adopted from Short (1982).

What is however clear from this brief theoretical review is that most of these studies merely emphasised and focused on the determinants of residential location behaviour without necessarily examining the determinants of residential housing choice which is the main thrust of this study. In addition, majority of these studies have geographers‘, urban planners‘, civil engineers‘, quantity surveyors‘ and estate managers‘ orientations in their approach to the issue of residential location behaviour. Our study, therefore, attempts looking at the problem of residential housing choice from the perspectives of economics based on microeconomic theory of consumer behaviour. Attempt is made therefore to review two basic economics theories relating to the choice namely: Theory of consumer behavior and reveal preference theory.

Theory of Consumer Behaviour

This theory states that consumers‘ purchasing decisions are largely determined by ―rational‖

and conscious economic calculations. Rationality in this context is conceptualised in terms of the consumer seeking to spend his/her income on those commodity bundles that will give him/her the highest level of satisfaction according to his/her tastes and the relative prices. The underlying assumptions implicit in this theory are:

(i) the consumer is fully informed as to the alternatives in the market from which he/she can choose;

(ii) the consideration of price; the lower the price, the higher the quantity consumed and vice versa; and

(iii) consumer always desires more to less.

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Central to this theory is the concept of utility, which according to the neoclassical school of thought was developed around a rational consumer who is faced with a given budget and has a basket of wants to satisfy. This theory holds that the consumer will allocate his/her budget in such a way as to maximise the utility derived from consuming the various commodity bundles. This is mathematically expressed as :

1 2

( , ,..., n)

UU q q q ………..(1)

1 1 2 2 ... n n Mp qp qp q

1 N

n n

i

P Q

……….(2)

Where:

q(q q1, 2,...,qn)is a vector of quantities of goods p(p p1, 2,...pn)is a vector of prices of goods M= the budget constraint

n= the number of commodities consumed i = number of individual households

= summation sign

If the function is continuous and at least twice differentiable, that is, well behaved, we can then derive the condition under which the consumer will maximise utility. An augmented utility function L can then be defined such that:

1 2 1 1 2 2

( , ,... )n ( ,... n n)

L U q qq  Mp qp qp q ………..(3) where L and λ are langrange coefficient and multiplier respectively.

Sufficient conditions for a maximum are satisfied by first order condition which requires that the partial derivatives of equation (3) with respect to q‘s and λ be equal to

1 0

i

u p

q

  

 ………..(4)

and that

i i 0

i

M

p q  ………..(5)

The condition in the first order condition in the equation (4) and (5) can be put as :

1 2

1 2

,... n

n

u

u u

q

q q

P P P

 

 

   ………..(6)

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In other words, the ratio of the marginal utility of a commodity to price is equal for all commodities. Equation (5) implies that the consumer allocates his/her budget amongst the goods in such a way that per unit of money utility of one good is the same with other goods and also the same with the marginal utility of holding a unit of money.

Substituting for equation (4) and solving the (n+1) equations of (4) and (5) will give the demand curves for the n commodities, each appearing as:

1 2

( , ,... , )

i n

qf P P P M ………(7)

Where i=1,2,3,………n.

Thus, the demand for a commodity is a function of all prices of the commodities in the basket of goods and services as well as the consumer income.

The second-order condition for a maximum requires that the bordered Hessian determinants must alternate in sign.

11 12 1 1

11 12 1

11 1

21 22 2

1 2,

1

1 2

1 2

...

; ; ; ;

0, 0,.., ( 1) 0

...

0 0

0

k k

k k kk k

k

U U U P

U U P

U P

U U P

U U U P

P P P

P P P

  

    

        

      

        

…..(8)

Where k =1,2,…………,n

Uij is the principal minor of order K ×K with the characteristic elements

2

i j

q q

U

  ………(9)

Revealed Preference Theory

Revealed preference theory was first expounded by Samuelson (1938) as a consequence of dissatisfactions with the then existing theory of choice, based on ordinal utility and indifference curve analysis. Samuelson's initial reasons for propounding an alternative to the Hicks-Allen synthesis included two important objectives (Wong, 1978). First, Samuelson desires to relate choice theory to behaviour in order to avoid the psychological assumptions that preference and utility were meaningful concepts. That is, Samuelson was striving for the then fashionable objective of attempting to devise a theory of choice which was not based upon particular psychological assumptions. Second, Samuelson stresses the observable nature of choices—that is, behaviour was reflected in terms of observed choices— and it is this aspect of Samuelson's work which has received most attention. Thus, revealed-preference theory represented a marked break with past theories of choice and demand.

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This theory was later extended by others like Houthaker (1950), Hicks (1956) and later by Charas and Cost (1993). It is one of the micro-economic theories of consumer choice;

it permits the nature of the consumer‘s preference to be derived from the observed choices of the consumer when confronted with alternative commodity bundles. A commodity combination is said to be revealed to be preferred to another if the consumer chooses it in preference to another combination which is not more expensive and hence, which to him/her is also affordable. However, if one option or commodity combination is chosen instead of another, then the chosen option is revealed to be preferred to the one not chosen except if the monetary cost of the option is the lowest.

First, the theory assumes choice is the purposive outcome of the interaction of a consumer's utility function and budget constraints and that these are independent of each other. Further, choices are assumed to be revealed for a simple commodity, in a perfectly competitive economy where consumers do not affect prices and there is an infinite range of supply or production possibilities. Then a series of assumptions are made to allow behaviour to be interpreted as a mirror of the underlying preference structure, and to predetermine the existence of a single- valued, continuous, downward-sloping demand curve. The usual assumptions are as follows.

I. The individual makes a rational preference ranking of all potential combinations of goods, whether or not they are available and whether or not the individual has previously consumed the goods. This is the axiom of completeness.

II. The axiom of transitivity states that if A > B and B > C, then A > C.

III. The axiom of greed or satiation, suggests that consumers will always prefer a bundle A to a bundle B, if bundle A contains more of at least one good and less of none of the others. Taken together, assumptions (b) and (c) imply a definition of rational choice.

IV. The axiom of convexity asserts that not only are indifference curves downward- sloping, from left to right (axiom of greed), but also that the curves are convex to the origin.

V. The axiom of continuity implies that consumption points in the choice set are very close to each other (and this is reflected in the continuity of the demand curve).

This is a standard piece of economic analysis, devised to estimate well- behaved demand curves from market data. Further, it is also well established in the literature that violation of the axioms, or pathological cases (see Simmons, 1974), result in peculiar but non unique

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demand curves. This theory has gained widespread acceptability in housing studies on the grounds of its observational superiority over experimental identification of preference rankings or ordinal indifference curves.