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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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