ECONOMICS UNIQUENESS

26 ■ THE ECONOMICS OF UNIQUENESS
and heritage values of the neighborhood, ΔV and ΔH, as given. In doing so, they
neglect the impact of their own investment and demolition decisions on other
properties around theirs. Th is coordination failure implies that, in general, the
combination of all private investment decisions will not maximize the sum of
private profi ts.
Under relatively general assumptions, it can be shown that decentralized decisions
result in both an insuffi cient volume of investment and an excessive amount
of demolition. Th e word “insuffi cient” has a precise interpretation here. It means
that if a single investor had to decide about the aggregate level of private spending
I in the intervention area, he or she would go for a larger fi gure than the sum of
all spending I i by local residents and outside developers. Similarly, if the intervention
area includes n properties with architectural value, a single investor who
owned the entire area would possibly choose to renovate and preserve k of them
(with k ≤ n). But decentralized decisions by local residents and outside developers
would result in fewer (and possibly none) of the properties surviving.
First Externality: Insuffi cient Investment
Ignore for a moment the fact that some properties in the intervention area have
architectural value, and assume that all of them are generic buildings. Th e value
of each of those properties increases by f' I units for each unit of investment in the
property itself, and by f' V units when the average value of properties in the area
goes up by one unit (the notation f' X is used to indicate the partial derivate of
the hedonic price function f(.) with respect to argument X). Because decentralized
investors take the average value of properties in the area as given, they only
expect the value of their property to increase by f' I units if they invest one unit.
But a single investor spending a unit on all properties in the area would internalize
the fact that property prices are bound to increase by (1 + f' V ) × f' I . Because
the expected monetary gain is bigger in the single investor’s case, he or she can be
expected to spend more on each property.
Th is point is made diagrammatically in fi gure 2.2. Th e assumptions made on
the fi rst and second derivatives of the hedonic price function f(.) imply that ΔV i
can be represented as a concave function of private investment spending I i . Each
individual investor, taking the decisions of others as given, spends so as to maximize
the net gain ΔV i − I i . In fi gure 2.2, this net gain is represented by the verti-
cal distance between the function ΔV i and the 45 o line. Th e optimal spending,
1 from a decentralized point of view, is therefore I . Th is spending yields a profi t
i
P i
1 , represented by the solid bold line. It is assumed that project spending U on
infrastructure makes this profi t strictly positive.
However, with all individual investors making a similar decision, property
prices increase not just by ΔV i but by (1 + f’ V ) × ΔV i . Once all private decisions are