Monday, June 8, 2009

Location, Location, Location?

George runs a miniature golf course in Marietta, Ohio. He rents the course and equipment from a large recreational supply company and supplies his own labor. His monthly earnings, net of rental payments, are $800, and he considers working at the golf course just as attractive as his only other alternatives, working as a grocery clerk for $800/month.

Now George learns that his uncle Kramer has died and left him some land in downtown New York City (right next to the Empire State Building). The land has been cleared, and George discovers that a construction company is willing to install and maintain a miniature golf course on it for a payment of $4000/month. George also commissions a market survey, which reveals that he would collect $16,000/month in revenue by operating a miniature golf course there. (After all, there are many more potential golfers in Manhattan that in Marietta.) After deducting the $4000/month payment to the construction company, this would leave him with $12,000/month free and clear. Given these figures, and assuming that the cost of living is the same in New York as in Marietta, should George, a profit maximizer, switch his operation to Manhattan?

Congratulations to Jeremy Jusek for providing the first correct answer. While the revenue estimates clearly indicate that Manhattan is a more lucrative market, it's also likely to be much more costly to operate a mini-golf course in downtown Manhattan given the scarcity of land. As Jeremy points out, the opportunity cost of using the land for a mini-golf course is likely to be extremely high. It's probably better to sell the Manhattan property and stay put in Marietta.


Jeremy Jusek said...

No, George shouldn't. The $12k/month doesn't take into account the implicit costs. If he's renting equipment he doesn't have to worry about capital costs, but there's $1600/month he's losing from:
a) The golf course in Marietta (it said he supplied his own labor)
b) Working on his own as the grocery store clerk.

Then take into account the cost of what money he could make if he rented or sold of the land in Manhattan. Land in downtown New York would go for enormous amounts of money:

That's an estimated 7.5 million dollars per acre in downtown Los Angeles, a town with 9,862,049 (2008 census). Now place acreage in a larger city, 19,490,297 (2008 census), and it's probable that to build anything larger than a putt-putt course, George has more than one acre at his disposal.

This land just needs to rent or sell for more than the $10,400/month profit he'd normally have, which is almost guaranteed. So no, he shouldn't develop the property.

Love the Seinfeld references, hahah.

Megan Born said...

Yes, I believe George should move to downtown New York. His total opportunity cost of living there would have to take his revenue and subtract the explicit and implicit costs. Therefore he would start with $16000/month(revenue)- $4000/month(explicit costs)- $800(implicit costs or the alternative of being in Marietta)= $11200/month opportunity costs in New York. While in Marietta, under the same situation and equation, George has no opportunity costs. His revenue is $800/month- $0(explicit costs)-$800/month (implicit costs)= $0/ month opportunity costs.
George should move to New York because he has a greater chance of financial success there.

Greg Delemeester said...

On behalf of Qi Wu:

"In my point of view that George should switch his operation to Manhattan. However there are more potential golfers in Manhattan."