Chapter 16Rent, Interest, and Profit

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16-2

Economic Rent

• Price paid for land and other natural resources

• Perfectly inelasticity supply

• Changes in demand

• A surplus payment

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16-3

Economic Rent

Acres of Land

Land

Ren

t (D

olla

rs)

L0

D1

D2

D3

D4

S

R1

R2

R3

0a b

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16-4

Economic Rent

• Land ownership: fairness vs. allocative efficiency• Application: a single tax on land• Henry George’s proposal• Single-tax movement• Criticisms

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16-5

Interest

• Price paid for use of money• Stated as a percentage• Money is not a resource• Interest rates and interest income• Range of interest rates• Risk• Maturity• Loan size• Taxability

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16-6

Loanable Funds Theory

• Extending the model• Financial institutions• Changes in supply• Household thrift

• Changes in demand• Rate of return on investment

• Other participants

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16-7

Loanable Funds Theory

Quantity of Loanable Funds

Inte

rest

Rat

e (P

erce

nt)

0

D

S

i =8%

F0

The equilibrium interest rate

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16-8

Time-Value of Money

• Money is more valuable the sooner it is obtained

• Ability to earn interest

• Compound interest

• Future value

• Present value

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16-9

Time-Value of Money

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16-10

Role of Interest Rates

• Relationship to:

• Total output

• Allocation of capital

• R&D spending

• Nominal and real rates

• Application: Usury Laws

• Nonmarket rationing

• Gainers and losers

• Inefficiency3LO5

16-11

Global Perspective

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16-12

Economic Profit

• Explicit costs

• Implicit costs

• Pure profit

• Total revenue less explicit and implicit costs

• Role of the entrepreneur

• Normal profit

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16-13

Economic Profit

• Insurable risks

• Uninsurable risks

• Changes in economic environment

• Structure of economy

• Government policy

• New products of production methods

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16-14

Economic Profit

• Profit is compensation for bearing uninsurable risks

• Sources of economic profit

• Create new products

• Reduce production costs

• Create and maintain a profitable monopoly

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16-15

Economic Profit

• Profit rations entrepreneurship

• Profit aids in resource allocation

• Profit and corporate stockholders

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16-16

Income Shares

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16-17

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 bewareLO5