Download Chapter 16 Rent, Interests and Profit

Chapter 16
Rent, Interest and Profits
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
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Learning Objectives
• Extend our analysis of resource pricing to
include each of the non-wage income
sources: rent, interest and profits.
• Develop an understanding of the pattern of
all income shares in Australia, including
wages, and their current and historical
significance.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
2
Economic Rent
• Economic rent is a term used by economists
• Narrower than the common meaning of the
term ‘rent’
• Economic rent is the price paid for the use
of land and other natural resources that are
completely fixed in total supply
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
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Determination of Land Rent
Land Rent (dollars)
S
R1
R2
D1
R3
D2
D4
0
D3
S
Acres of Land
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
Q
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Land Rent
• Supply of land is perfectly inelastic
• Demand
–
sole active determinant of land rent
–
‘derived demand’
–
down-sloping


Law of diminishing returns
Product price must be decreased to sell additional
units
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
5
Perfectly Inelastic Supply
• Why?
–
No production costs associated with land
–
Economy has a finite supply of land
–
Variability in the usability of land affects a very
small fraction of the total amount of land
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
6
Land Rent is a Surplus
• Does not serve as an incentive
• A payment that is not necessary to
ensure that land will be available to
the economy as a whole
• The case against land rent
–
Henry George’s proposal: single tax on land
–
Advantages and disadvantages
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
7
Productivity of Land
• Different properties will differ in their
productivities




Soil fertility
Mineral wealth
Climatic factors
Environmental degradation
• Different grades of land can be
represented by differing demand
curves
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
8
Interest
• The price paid for the use of money.
Typically the amount that must be
paid for the use of one dollar for one
year
• Measured as a percentage
• Money is not a resource
• Money is not in itself useful
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
9
Determining Interest Rate
• Money demand
–
transactions demand + assets demand
• Money supply
• Nominal interest rate: current dollars
• Real interest rate: adjusted for
inflation
–
important in making investment decisions
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
10
Rate of interest (per cent)
Interest Rate Determination (cont.)
10
Sm
8
6
Ie
4
2
Dm
0
50 100 150 200 250 300
Amount of money demanded and supplied ($billion)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
11
Types of Interest Rates
• Commercial rates, mortgage rates, etc.
• Reasons for interest rate differentials
–
Risk
–
Maturity or length of loan
–
Size of loan
• Pure rate of interest
–
Overall interest rate in the economy
–
Best approximated by interest paid on long-term Federal
Government bonds
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
12
Role of Interest Rates
• Affect level of production of investment
goods
–
Change in interest rates results in change in investment
demand
• Affect composition of production of
investment goods
–
Interest rates allocate the available supply of money to
those projects which are expected to result in the highest
levels of profit
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
13
Economic Profits
• Various terms
–
Economic profits or pure profits
–
Accounting profits
–
Explicit costs
–
Implicit costs
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
14
Role of the Entrepreneur
• Recall from Chapter 2
–
entrepreneurs take initiative to combine other resources
in production
–
entrepreneurs make non-routine decisions
–
entrepreneurs introduce innovation
–
entrepreneurs take economic risks
• Normal profit
–
the minimum return necessary to retain the entrepreneur
in a production line
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
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Sources of Economic
Profits
• Economic profits
–
are not a cost
–
accrue to the entrepreneur
• Potential sources
–
uninsured risks (dynamic and uncertain)
–
innovations
–
monopoly power and profits
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
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Functions of Profits
• Energise the economy
• Stimulate innovation and output
• Encourage investment
• Allocate resources amongst
alternatives
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
17
Income Shares
• Largest share of national income
accrues to labour
• Labour’s relative share has declined in
Australia since the 1980s
• Capitalist share less than 25 per cent
of national income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
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Next Chapter:
Market Failure and
Resource Allocation
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia.
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