Understanding Economic Rent, Interest, and Profit in Economics

1. Ch 27Rent, Interest, & Profit

2. A. Economic Rent • Price paid for land or other resources that are completely fixed in supply (perfectly inelasticity supply) • Changes in Demand • Land Rent is a Surplus Payment due to same amount of land available in society • No ‘Incentive Function’ for rent because supply is fixed (next slide)

3. The Determination of Land Rent Economic Rent S R1 D1 Land Rent (Dollars) R2 D2 R3 D3 b a 0 L0 Acres of Land D4 -- What is the value of land at each Demand curve? -- The supply of land is perfectly inelastic

4. The supply of land is perfectly inelastic Henry George • Proposed a Single-Tax on land • Progress and Poverty (1879) • Economic rent could be heavily taxed without diminishing the available supply of land or economy as a whole • Land performs no incentive function • Critics cite many problems w/ this: -- Current Gov’t spending wouldn’t be covered by a single tax.

5. C. Interest • Stated as a Percentage • Money is Not an Economic Resource • Loanable Funds Theory of Interest • Supply of Loanable Funds • Demand for Loanable Funds -- Loanable Funds Theory: S&D for funds available for lending (and borrowing).

6. *** Be familiar with this Graph*** The Market for Loanable Funds Interest S Interest Rate (Percent) i= 8% D 0 F0 Quantity of Loanable Funds

7. Interest, cont’d • Extending the Model • Financial Institutions • Changes in Supply • Changes in Demand • Other Participants

8. Interest, cont’d • Range of Interest Rates • Risk • Maturity • Loan Size • Taxability • Pure Rate of Interest -- Pure rate of Interest is best approximated by the interest paid on a long-term, virtually riskless securities such as long-term bonds or of the U.S. Gov’t (20 year Treasury Bonds).

9. Interest, cont’d • Role of the Interest Rate • Interest and Total Output • Interest and the Allocation of Capital • Interest and R&D Spending • Nominal and Real Interest Rates • Application: Usury Laws (next slide) • Nonmarket Rationing • Gainers and Losers • Inefficiency -- Nominal rates: interest expressed in dollars of current value. -- Real rates: interest expressed in purchasing power (dollars of inflation adjusted value).

10. Usury Laws S • Usury Laws specify a max interest rate for loans (price ceiling). Interest Rate (Percent) i= 8% D 0 F0 Quantity of Loanable Funds

11. D. Economic Profit • Explicit Costs - $ to outsiders • Implicit Costs - $ sacrifices when using own resources instead of selling on the market (aka opportunity costs) • Economic (Pure) Profit - $ after all costs are subtracted from a firm’s total revenue • Role of the Entrepreneur • Normal Profit: min return to stay in business

12. Economic Profit, cont’d • Sources of Economic Profit • Static Economy: forces are constant • Risk and Profit • Insurable Risks: insurance for fire, etc • Uninsurable Risks: unknown changes in supply and demand conditions: - Changes in General Economic Environment - Changes in the Structure of the Economy - Changes in Gov’t Policy

13. Economic Profit, cont’d • Innovations and Profit • Monopoly and Profit • Functions of Profit • Profit and Total Output • Profit and Resource Allocation

14. Income Shares