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Rent, Interest, and Profit: An Economic Analysis

This chapter explores economic rent, interest rates, and economic profit, discussing their impact on resource allocation and wealth distribution. It also examines the time-value of money and the role of interest rates in the economy. Additionally, it delves into financial risks and the sources of economic profit. The chapter concludes with an examination of the price of credit and the importance of consumer awareness in borrowing.

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Rent, Interest, and Profit: An Economic Analysis

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  1. Chapter 18 Rent, Interest, and Profit

  2. Economic Rent • Economic rent is the price paid for land and other natural resources • Perfectly inelastic supply • Changes in demand • Productivity differences lead to rent differences • A surplus payment • No incentive function LO1

  3. Economic Rent and Demand S R1 D1 Land Rent (Dollars) R2 D2 R3 D3 a b 0 L0 Acres of Land D4 LO1

  4. Land Rent Payment Debate • Is private land ownership fair? • Allocates scarce land resource • A single tax on land • Henry George’s book (1879) • Single-tax movement • Criticisms LO1

  5. Interest • Price paid for use of money • Stated as a percentage • Money is not a resource • Interest rates determine the household’s interest income • Differences in interest rates due to • Risk, maturity, loan size, taxability • Pure rate of interest LO2

  6. Selected Interest Rates, 2016 LO2

  7. Loanable Funds Theory • Loanable funds theory of interest • Financial institutions • Changes in supply • Household thrift • Changes in demand • Rate of return on investment • Other participants LO3

  8. Loanable Funds Market The equilibrium interest rate S Interest Rate (Percent) i = 8% D 0 F0 Quantity of Loanable Funds LO3

  9. Time-Value of Money • Time-value of money • Money is more valuable the sooner it is obtained • Ability to earn interest • Compound interest • Future value • Present value LO4

  10. Compound Interest LO4

  11. Role of Interest Rates • Relationship to total output • Allocates capital and R&D spending • Nominal interest rate • Real interest rate • Usury laws • Nonmarket rationing • Gainers and losers • Inefficiency LO5

  12. Short-Term Nominal Rates LO5

  13. Economic Profit • Explicit costs • Implicit costs • Economic or pure profit • Total revenue less explicit and implicit costs • Role of the entrepreneur • A residual claimant LO6

  14. Financial Risks • Insurable risks • Uninsurable risks • Changes in economic environment • Structure of economy • Government policy • New products or production methods LO6

  15. Sources of Economic Profit • Profit is compensation for bearing uninsurable risks • Sources of economic profit • Create popular new products • Reduce production costs • Create and maintain a profitable monopoly LO6

  16. Normal Profit • Profit rations entrepreneurship • Must make at least a normal profit • Profit aids in resource allocation • Profit and corporate stockholders LO6

  17. Income Shares LO7

  18. The Price of Credit • Effective interest rates • Discounting a loan • Repaying a loan in installments • Effects of compounding • Truth in Lending Act 1968 • Truth in Savings Act 1991 • Fees and teaser rates • “Let the borrower beware”

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