Download Chapter 16 Rent, Interests and Profit

Chapter 16
Rent, interest and profits
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-1
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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-2
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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-3
Determination of land rent
Land rent (dollars)
S
R1
R2
D1
R3
D2
D4
0
D3
S
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Acres of land
Q
16-4
Land rent
• Supply of land is perfectly inelastic
• Changes in 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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-5
Perfectly inelastic supply of land
• Why?
– No production costs associated with land
– Economy has a finite supply of land
– Variability in the useability of land affects
a very small fraction of the total amount
of land
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-6
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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-7
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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-8
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
Two important aspects of interest:
1. Measured as a percentage
2. Money is not a resource
– Money is not in itself useful
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-9
Determining interest rate
• Demand and the supply of money determine
interest rate
Demand for money
• Total demand for money is made of:
– Transaction demand for money — the demand
for money as a medium of exchange
– Asset demand — money acts as a financial asset
and store of wealth
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-10
Determining interest rate (cont.)
• Money supply
– The money supply curve is a vertical line
and is independent of the interest rate
• The intersection of the demand-for-money
curve and the money supply curve determines
the equilibrium interest rate
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-11
Rate of interest (per cent)
Interest rate determination (cont.)
Sm
10
8
6
Ie
4
2
Dm
0
50 100 150 200 250 300
Amount of money demanded and supplied ($billion)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-12
Determining interest rate (cont.)
Investment decision
• The investment demand curve shows
the amount of investment the business sector
will undertake at various real rate of interest
• Nominal interest rate is the rate of interest
expressed in terms of dollars of current value
• Real interest rate is interest rate adjusted
for inflation
– Important in making investment decisions
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-13
Sm1 Sm2 Sm3
10
8
6
Dm
0
Real Rate of interest (%)
Real rate of interest (%)
The interest rate and investment
$125 $150 $175
Amount of money demand
and supplied
(a) The money market
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
10
8
6
0
$15
$20
$25
Amount of Investment, I
(b) Investment demand
16-14
Range 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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-15
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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-16
Economic profits
• Economists define profit more narrowly
than accountants
• Profit from the viewpoint of accountants
only considers explicit cost
– Payment by firms to outsiders
• They ignore implicit costs
– Payments for similar resources that are owned
and self-employed by a firm
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-17
Economic profits (cont.)
• Economic or pure profits are what remain
after all opportunity costs — explicit and
implicit wage, rent, and interest costs and
a normal profit — have been subtracted
from a firm’s total revenue
• Economic profit can be either positive
or negative
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-18
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  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-19
Sources of economic profits
• Economic profits
– Are not a cost
– Accrue to the entrepreneur
Sources of economic profits
• Uncertainty, risk and profits
– Bearing of uninsurable risk
• Uncertainty, innovation and profits
• Monopoly profits
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-20
Functions of profits
•
•
•
•
Energise the economy
Stimulate innovation and output
Encourage investment
Allocate resources among alternatives
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-21
Income shares
• Largest share of national income accrues
to labour. It receives currently about 54 per
cent of the national income
• Labour’s relative share has declined in
Australia since the 1980s
• Capitalist share less than 25 per cent
of national income
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-22
Relative share of GDP at factor cost:
Australia
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-23
Income shares
Historical trends
• Defining labour’s share as ‘wages and salaries’,
it increased from around 50 per cent in the
post-war period to a high of around 61 per cent
in the 1970s
• Changing output mix and industry mix have
contributed to the rise in labour’s share
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-24
Next chapter:
Market failure and
resource allocation
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
16-25