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Rent, Interest, & Profit Economic Rent The price paid for the use of land or other natural resources that are completely fixed in total supply (perfectly inelastic) Demand determines the price of rent Demand is derived, as in labor markets Product Price Productivity of the Resource Price of Complimentary Resources Rent as a Surplus Payment Although capital is fixed in the short run, in the long run it is not Capital is relatively elastic, thus upward sloping Unlike capital, land supply is always fixed, thus economic rent is a surplus payment (it is not necessary to ensure the supply of land) Not a cost to society, but a cost to firms because they compete with alternative uses for the land Economic Rent in Action How does economic rent explain suburban sprawl? Why is land in Lake Oswego so expensive? Why is land in Western Oregon worth more than land in Eastern Oregon? Complete Student Workbook Activity 50 Pages 245-246 Interest The price paid for the use of money Stated as a percentage (ex. APR) Money is not a resource It is a means of purchasing resources/capital If a stranger wanted you to give them $5, would you? What if they paid you $6 dollars the next day? $10? $20? $50? $100? Loanable Funds Interest is determined by the supply of and demand for funds available for lending and borrowing A supply & demand graph with interest on the y-axis and loanable funds on the x-axis Households rarely lend, but do put money in banks, which in turn lend money Changes in Loanable Funds Supply Increasing thriftiness will decrease the supply of loanable funds Decreasing thriftiness will increase the supply of loanable funds What causes changes in household thriftiness? Demand Higher rates of return increase demand for loanable funds Lower rates of return increase demand for loanable funds What causes changing rates of return? Other Reasons Interest Varies Risk—how likely it is to be paid back Maturity—length of time to pay it back Loan Size—typically the larger it is, the higher the interest rate Taxability—exemptions lead to greater willingness to lend and borrow The Pure Rate of Interest A single, general rate of interest used to simplify economic discussion of interest rates Usually closest to long-term, near riskless securities and bonds Role of the Interest Rate Rationing the supply of loanable funds Low interest rates promote R&D Government banks manipulate interest rates to expand or contract the economy Take Macroeconomics to learn more about this Two Types of Interest Rates Nominal Interest Rate The rate of interest expressed in dollars of current value Real Interest Rate The rate of interest expressed in purchasing power Adjusted for inflation Government Regulation of Interest Rates Although many interest rates are influenced by the Federal Reserve’s rates for borrowing money from Uncle Sam, private lenders can set rates at whatever price they like…should government limit private lenders’ interest rates (usury laws)? Explain. Profit Total revenue minus implicit costs and explicit costs Payment to the entrepreneur Normal profit—payment necessary to retain the entrepreneur (what could be made elsewhere) Residual profit—remaining profit after all costs are paid Sources of Profit Innovation E.g. Apple Monopoly Power E.g. cell phone network providers Risk Insurable vs. uninsurable Changes in economic environment (e.g. recession) Changes in structure of the economy (e.g. s/d changes) Changes in government policy (e.g. taxes) The Role of Profit Encourages innovation Encourages efficient use of resources Allocative and productive efficiency Homework Textbook Chapter 27 #2, 5, 6, 8, 10