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Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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Page 1: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Rent, Interest, and Profit

Chapter 14

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter Objectives

• Economic rent• The loanable funds theory • Interest rate variation• Economic profits• Distribution of U.S. earnings

14-2

Page 3: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Rent

• Price paid for land and other natural resources

• Perfectly inelasticity supply

• Changes in demand

• A surplus payment

14-3

Page 4: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Determination of Land Rent

Acres of Land

Lan

d R

ent

(Do

llar

s)

L0

D1

D2

D3

D4

S

R1

R2

R3

0a b

14-4

Page 5: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Rent

• Application: a single tax on land–Henry George’s proposal–Single tax movement–Criticisms

• Productivity differences• Alternative uses of land

14-5

Page 6: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Interest

• Price paid for use of money• Stated as a percentage• Money is not a resource• Loanable funds theory

–Supply of loanable funds–Demand for loanable funds

14-6

Page 7: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Market For Loanable Funds

Quantity of Loanable Funds

Inte

rest

Rat

e (P

erce

nt)

0

D

S

i=8%

F0

The equilibrium interest rate

14-7

Page 8: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Loanable Funds Theory

• Extending the model• Financial institutions• Changes in supply

–Household thrift

• Changes in demand–Rate of return on investment

• Other participants14-8

Page 9: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Time-Value of Money

• Money more valuable the sooner it is obtained–Ability to earn interest

–Compound interest

• Future value

• Present value

14-9

Page 10: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Range of Interest Rates

• There are many interest rates• Why do interest rates differ?

–Risk–Maturity–Loan size–Taxability

• Pure rate of interest

14-10

Page 11: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Role of the Interest Rate

• Relationship to–Total output–Allocation of capital–R&D spending

• Nominal and real rates• Application: Usury Laws

–Nonmarket rationing–Gainers and losers–Inefficiency

14-11

Page 12: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Nominal Interest Rates

Short-Term Interest Rate, 2007

New ZealandHungary

MexicoAustralia

United KingdomUnited StatesSouth Korea

CanadaSweden

SwitzerlandJapan

0 2 4 6 8 10

Source: Organization for Economic Cooperation and Development 14-12

Page 13: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Profit

• Explicit costs• Implicit costs• Pure profit• Total revenue less explicit and

implicit costs• Role of the entrepreneur

–Normal profit14-13

Page 14: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Sources of Economic Profit

• Static economy• Risk and profit

–Insurable and uninsurable risks–Changes in economic environment,

structure of economy, government policy

• Innovations and profit• Monopoly and profit

14-14

Page 15: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Profit

• Functions of profit–Profit and total output–Profit and resource allocation

• Income shares• Labor receives 70-80%• Rest is rent, interest, profit

14-15

Page 16: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

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

14-16

Page 17: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Key Terms

• economic rent• incentive function• single-tax movement• loanable funds theory

of interest• time-value of money• future value• present value• pure rate of interest• nominal interest rate• real interest rate

• usury laws• explicit costs• implicit costs• economic or pure

profit• normal profit• static economy• insurable risks• uninsurable risks

14-17

Page 18: Rent, Interest, and Profit Chapter 14 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Next Chapter Preview…

Natural Resourceand Energy Economics

14-18


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