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14
Rent, Interest, and Profit
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Economic Rent
• Price paid for land and other natural
•
•
•
LO1
resources
Perfectly inelasticity supply
Changes in demand
A surplus payment
14-2
Economic Rent
Land Rent (Dollars)
S
R1
D1
R2
D2
R3
D3
a
0
b
L0
Acres of Land
D4
LO1
14-3
Economic Rent
• Land ownership: fairness vs.
•
LO1
allocative efficiency
Application: a single tax on land
• Henry George’s proposal
• Single tax movement
• Criticisms
14-4
Interest
• Price paid for use of money
• Stated as a percentage
• Money is not a resource
• Interest rates and interest income
• Range of interest rates
• Risk
• Maturity
• Loan size
• Taxability
LO2
14-5
Loanable Funds Theory
• Extending the model
• Financial institutions
• Changes in supply
• Household thrift
• Changes in demand
• Rate of return on investment
• Other participants
LO2
14-6
Loanable Funds Theory
The equilibrium interest rate
Interest Rate (Percent)
S
i=
8%
D
0
F0
Quantity of Loanable Funds
LO2
14-7
Time-Value of Money
• Money is more valuable the sooner it
•
•
LO3
is obtained
• Ability to earn interest
• Compound interest
Future value
Present value
14-8
Time-Value of Money
(1)
(2)
(3)
(4)
Beginning
Period Value
Computation
Total Interest
End Period Value
$1000 (Year 1)
$1000 X 1.10 = $1100
$100
$1100 (=$1000 + $100)
$1100 (Year 2)
$1100 X 1.10 = $1210
$210 (=$100 +$110)
$1210(=$1000 + $210)
$1210 x 1.10 = $1331
$331 (= $100 + $110+
$121)
$1331(=$1000 + $331)
$1210 (Year 3)
LO3
14-9
Role of Interest Rates
• Relationship to:
• Total output
• Allocation of capital
• R&D spending
• Nominal and real rates
• Application: Usury Laws
• Nonmarket rationing
• Gainers and losers
• Inefficiency
LO3
14-10
Global Perspective
LO3
14-11
Economic Profit
• Explicit costs
• Implicit costs
• Pure profit
• Total revenue less explicit and
•
LO4
implicit costs
Role of the entrepreneur
• Normal profit
14-12
Economic Profit
• Insurable risks
• Uninsurable risks
• Changes in economic environment
• Structure of economy
• Government policy
• New products of production
methods
LO4
14-13
Economic Profit
• Profit is compensation for bearing
•
LO4
uninsurable risks
Sources of economic profit
• Create new products
• Reduce production costs
• Create and maintain a profitable
monopoly
14-14
Economic Profit
• Profit rations entrepreneurship
• Profit aids in resource allocation
• Profit and corporate stockholders
LO4
14-15
Income Shares
Distribution of U.S. Income
Proprietors'
Income
$1041
(9%)
Wages and
Salaries
$7792
(70%)
Corporate
Profits
$1309
(12%)
Interest
$788
(7%)
Rents
$268
(2%)
LO5
14-16
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
LO5
14-17