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Rent, Interest, and Profit

Chapter 14. Rent, Interest, and Profit. Chapter Objectives. Economic rent The loanable funds theory Interest rate variation Economic profits Distribution of U.S. earnings. 14- 2. Economic Rent. Price paid for land and other natural resources Perfectly inelasticity supply

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Rent, Interest, and Profit

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  1. Chapter 14 Rent, Interest, and Profit

  2. Chapter Objectives • Economic rent • The loanable funds theory • Interest rate variation • Economic profits • Distribution of U.S. earnings 14-2

  3. Economic Rent • Price paid for land and other natural resources • Perfectly inelasticity supply • Changes in demand • A surplus payment 14-3

  4. Determination of Land Rent S R1 D1 Land Rent (Dollars) R2 D2 R3 D3 a b 0 L0 Acres of Land D4 14-4

  5. Economic Rent • Application: a single tax on land • Henry George’s proposal • Single tax movement • Criticisms • Productivity differences • Alternative uses of land 14-5

  6. Interest • Price paid for use of money • Stated as a percentage • Money is not a resource • Loanable funds theory • Supply of loanable funds • Demand for loanable funds 14-6

  7. Market For Loanable Funds The equilibrium interest rate S Interest Rate (Percent) i= 8% D 0 F0 Quantity of Loanable Funds 14-7

  8. Loanable Funds Theory • Extending the model • Financial institutions • Changes in supply • Household thrift • Changes in demand • Rate of return on investment • Other participants 14-8

  9. Time-Value of Money • Money more valuable the sooner it is obtained • Ability to earn interest • Compound interest • Future value • Present value 14-9

  10. Range of Interest Rates • There are many interest rates • Why do interest rates differ? • Risk • Maturity • Loan size • Taxability • Pure rate of interest 14-10

  11. Role of the Interest Rate • Relationship to • Total output • Allocation of capital • R&D spending • Nominal and real rates • Application: Usury Laws • Nonmarket rationing • Gainers and losers • Inefficiency 14-11

  12. Nominal Interest Rates Short-Term Interest Rate, 2007 0 2 4 6 8 10 New Zealand Hungary Mexico Australia United Kingdom United States South Korea Canada Sweden Switzerland Japan Source: Organization for Economic Cooperation and Development 14-12

  13. Economic Profit • Explicit costs • Implicit costs • Pure profit • Total revenue less explicit and implicit costs • Role of the entrepreneur • Normal profit 14-13

  14. Sources of Economic Profit • Static economy • Risk and profit • Insurable and uninsurable risks • Changes in economic environment, structure of economy, government policy • Innovations and profit • Monopoly and profit 14-14

  15. Economic Profit • Functions of profit • Profit and total output • Profit and resource allocation • Income shares • Labor receives 70-80% • Rest is rent, interest, profit 14-15

  16. 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 14-16

  17. Key Terms • economic rent • incentive function • single-tax movement • loanable funds theory of interest • time-value of money • future value • present value • pure rate of interest • nominal interest rate • real interest rate • usury laws • explicit costs • implicit costs • economic or pure profit • normal profit • static economy • insurable risks • uninsurable risks 14-17

  18. Next Chapter Preview… Natural Resource and Energy Economics 14-18

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