Rent, Interest, and Profit Rent, Interest, and Profit

Wages are dominant type, if proprietor’s income is added, the percentage rises even higher. Wages are dominant type, if proprietor’s income is added, the percentage rises even higher. Historically, corporate profit has grown as a share over time as that form of business organization grows. Industry has changed from land-capital intensive to labor-capital intensive to labor-service intensive.

ECONOMIC RENT …price paid for the use of land and other natural resources, which are completely fixed in supply.

Fixed Supply … land and natural resources have limits … perfectly inelastic supply curve ECONOMIC RENT

Perfectly inelastic supply Perfectly inelastic supply …since land has no production costs … “free and nonproductive gift of nature” … “free and nonproductive gift of nature” … quantity does not change with price ECONOMIC RENT

Changes in demand will determine the amount of rent Changes in demand will determine the amount of rent … price of the product grown on the land … the productivity of the land … the prices of other resources combined with the land ECONOMIC RENT

Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT Changes in the demand for land... Inelastic Supply...

Changes in the demand for land... Inelastic Supply... combines with demand... D1D1 Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT

R1R1 Changes in the demand for land... Inelastic Supply... combines with demand... to determine rent D1D1 Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT

R1R1 D2D2 D1D1 R2R2 0 If demand decreases... rent decreases Changes in the demand for land... Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT

D3D3 R1R1 D2D2 D1D1 R2R2 R3R3 If demand decreases... rent decreases....and decreases...and decreases Changes in the demand for land... Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT

D3D3 R1R1 D4D4 D2D2 D1D1 R2R2 R3R3 If demand decreases... rent decreases....and decreases...and decreases Changes in the demand for land... Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT

D3D3 R1R1 D4D4 D2D2 D1D1 R2R2 R3R3 If there is no demand for land, then it is a free good. Changes in the demand for land... Land Rent (dollars) Acres of Land S 0 DETERMINATION OF LAND RENT

Economic rent is a surplus payment not necessary to ensure that land is available to all society. Economic rent is a surplus payment not necessary to ensure that land is available to all society. … individual firms do need to pay rent to attract land resources away from alternative uses, … so rent is a cost for firms.

InterestInterest price paid for the use of money … the money that must be paid for the use of one dollar for one year. price paid for the use of money to obtain capital … the return to capital

InterestInterest Interest is stated as a percentage amount to be paid for use of money …required by the Truth in Lending Act of 1968.

Money itself is NOT a Resource. InterestInterest … used to acquire capital goods √ by borrowing money or using money, businesses are buying the use of real capital goods.

Loanable Funds Theory Of Interest Interest Rate, (percent) Quantity of Loanable Funds i = 8% D F0F0 S Supply is upsloping because at higher interest rates, consumers will be induced to save more and spend less.

Loanable Funds Theory Of Interest Interest Rate, (percent) Quantity of Loanable Funds i = 8% D F0F0 S Demand is downsloping because at lower interest rates, businesses and consumers are willing to borrow more.

Interest Rate, (percent) Quantity of Loanable Funds Loanable Funds Theory Of Interest i = 8% D F0F0 S Equilibrium occurs where the Supply (savings) intersects the demand (investment, consumption).

…A change in investment or consumption decisions moves the demand curve. Rates of return or tax policy Rates of return or tax policy …A change in savings decisions moves the supply curve. …A change in government spending policies Deficits shift the demand curve, as the gov’t demands loanable funds. Deficits shift the demand curve, as the gov’t demands loanable funds. Changes in the real interest rate

Range Of Interest Rates Varying degrees of risk (riskier loans carry higher rates) …Differing maturity dates (longer-term loans carry higher rates) …Size of loan (larger amount of loan have lower rates) …Taxability (some interest earned is tax-free, so interest paid would be lower) …Market imperfections (monopoly power in market may raise rate)

… affects both levels and the types of investment undertaken. √ Level of investment is inversely related to the rate of interest. √ Adds to capital formation … rations money capital to those who are willing to pay for it, … rations money capital to those who are willing to pay for it, √ so…capital is allocated to its more productive and profitable uses. Role of the Interest Rate

Nominal Interest Rates Short-Term Interest Rate, 2007 New Zealand Hungary Mexico Australia United Kingdom United States South Korea Canada Sweden Switzerland Japan Source: Organization for Economic Cooperation and Development 14-24

Economic Profit …what remains of a firm’s total revenue after the explicit and implicit costs are subtracted.

Economic Profit Profit is the reward for the entrepreneur- for risk-taking, for innovation, for creative ways of combining resources. Profit is the reward for the entrepreneur- for risk-taking, for innovation, for creative ways of combining resources. √ Normal profit is the minimum required to retain the entrepreneur. √ Economic profits are above the normal and act as the incentive to take risks.

Economic profits occur in a dynamic, ever-changing economy as the reward to the entrepreneur, but they also accrue to those with monopoly power in the market. Economic profits occur in a dynamic, ever-changing economy as the reward to the entrepreneur, but they also accrue to those with monopoly power in the market. Expectation of profit encourages firms to invest and expand output and production. They allocate resources to those ventures that are profitable—a signal that society’s needs and wants for being met. Expectation of profit encourages firms to invest and expand output and production. They allocate resources to those ventures that are profitable—a signal that society’s needs and wants for being met. Economic Profit