A buyer could build an equally desirable house, but construction would take 18 months. How does the principle of substitution treat that delay?
Correct Answer
D) It effectively raises the cost of the substitute
When there is a significant delay in acquiring the substitute, the cost of the delay must be considered; a significant delay in effect raises the cost of the substitute.
Why This Is the Correct Answer
Option D is correct because when there is a significant delay in acquiring the substitute, the cost of the delay must be taken into account. An 18-month wait in effect raises the cost of the build-new alternative. That makes the existing, immediately available house relatively more attractive.
Why the Other Options Are Wrong
Option A: It is ignored, because construction cost is what matters
Option A says the delay is ignored because only construction cost matters, which is wrong. The principle of substitution considers the full cost of obtaining the alternative, and a significant delay is part of that cost.
Option B: It lowers the cost of the substitute, so value falls
Option B says the delay lowers the cost of the substitute so value falls, which reverses the effect. A long wait adds to the burden of the substitute, so it raises the effective cost rather than lowering it.
Option C: It means the substitute is excluded from consideration
Option C says the substitute is excluded from consideration, which is wrong. The build-new option remains a substitute; the delay is accounted for as an added cost rather than removing the alternative altogether.
Waiting has a price
A substitute you must wait for costs more than its sticker price, because the delay itself is a cost.
How to use: Use this when a question asks how time to build or acquire affects a substitute's cost.
Exam Tip
In substitution questions, a significant delay increases the effective cost of the alternative.
Common Mistakes to Avoid
- -Ignoring time and considering only construction cost
- -Thinking a delay makes the substitute cheaper
- -Dropping a delayed substitute from the analysis entirely
Concept Deep Dive
Analysis
This question tests how time affects the principle of substitution. A buyer will not pay more for a property than the cost of an equally desirable substitute, but a substitute that takes a long time to obtain is less attractive. A significant delay must be counted, and in effect it raises the cost of the substitute.
Background Knowledge
The principle of substitution holds that a prudent buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. That cost includes time: waiting to build or acquire carries costs such as interim housing, financing and lost use. This principle underlies the sales comparison, cost and income approaches.
Real-World Application
A buyer comparing a move-in-ready home with building a similar one learns that permits and construction would take a year and a half. The buyer pays a premium for the existing home, and an appraiser applying the cost approach recognizes that the delay adds to the effective cost of building new.
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