Tom’s Tips

Can You Solve This Austrian Economics Puzzle?

Posted by: By Tom Woods | August 15, 2018

For background: the Austrian School of economics speaks of time preference: we prefer a good in the present to the same quantity of that good in the future.

Now here’s the puzzle.

(If it goes over your head, just skip to the end. But try.)

How does the existence of finite prices for land help demonstrate the existence of time preference?

I’ll give you a hint, in the form of a question:

Why aren’t land prices infinite? Land yields a return year after year in perpetuity, so why isn’t its price the sum of these returns, stretched out across its useful life (which in this case is infinity)?

OK, go think about it.

Here’s the answer.

Let’s say the land yields a $10,000 return every year, starting with its first yield tomorrow. You’d be willing to pay just about $10,000 for the yield in that time period. But would you pay $10,000 for its $10,000 yield a year from now?

No. You’d pay maybe $9000 or $9500, because a $10,000 yield a year from now involves waiting, and is therefore worth less to you.

What would you pay for a $10,000 yield coming two years from now? Maybe $8700?

So when you sum up all the yields, you’re adding smaller and smaller numbers for each succeeding year until you get so far out in time that you value the yield for that year at virtually zero, and the land price therefore settles on a finite number.

If you didn’t have time preference, you’d value all the time periods equally, at $10,000, so the price would be the infinite sum of those yields.

But you do have time preference, so land has a finite price.

Why this matters:

Suppose you have a website that earns $1000 per month. You may think that’s small potatoes. But you can often sell a site like that for 30X monthly earnings — which means you have a $30,000 asset on your hands.

No, it won’t be an infinite price — investors don’t value every succeeding month of revenue equally, as our puzzle reminded us — but it sure makes that $1K/mo site seem a lot nicer.

How to build a site like that, around a subject you love (so it’ll be like a fun hobby rather than drudgery)?

Like this:
http://www.happyearner.com/hobbysite

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