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Ch 27 Rent, Interest, & Profit 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) Economic Rent The Determination of Land Rent Land Rent (Dollars) S R1 D1 R2 D2 R3 D3 0 a b L0 Acres of Land D4 -- What is the value of land at each Demand curve? -- The supply of land is perfectly inelastic The supply of land is perfectly inelastic B. 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. 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). *** Be familiar with this Graph*** Interest The Market for Loanable Funds Interest Rate (Percent) S i= 8% D 0 F0 Quantity of Loanable Funds Interest, cont’d • Extending the Model – Financial Institutions – Changes in Supply – Changes in Demand – Other Participants 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). 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). Usury Laws Interest Rate (Percent) S i= 8% D 0 F0 Quantity of Loanable Funds • Usury Laws specify a max interest rate for loans (price ceiling). 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 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 Economic Profit, cont’d • Innovations and Profit • Monopoly and Profit • Functions of Profit – Profit and Total Output – Profit and Resource Allocation • Income Shares