Ch 27 Rent, Interest, & Profit

A.Economic Rent Price paid for land or other resources that are completely fixed in supply (perfectly inelasticity supply) Changes in Demand Land Rent is a Surplus Payment due to same amount of land available in society –No ‘Incentive Function’ for rent because supply is fixed (next slide)

Economic Rent The Determination of Land Rent Acres of Land Land Rent (Dollars) L0L0 D1D1 D2D2 D3D3 D4D4 S R1R1 R2R2 R3R3 0 a b -- What is the value of land at each Demand curve? -- The supply of land is perfectly inelastic

B.Henry George Proposed a Single-Tax on land Progress and Poverty (1879) Economic rent could be heavily taxed without diminishing the available supply of land or economy as a whole Land performs no incentive function Critics cite many problems w/ this: -- Current Gov’t spending wouldn’t be covered by a single tax. The supply of land is perfectly inelastic

C.Interest Stated as a Percentage Money is Not an Economic Resource Loanable Funds Theory of Interest Supply of Loanable Funds Demand for Loanable Funds -- Loanable Funds Theory: S&D for funds available for lending (and borrowing).

Interest The Market for Loanable Funds Quantity of Loanable Funds Interest Rate (Percent) 0 D S i= 8% F0F0 *** Be familiar with this Graph***

Interest, cont’d Extending the Model –Financial Institutions –Changes in Supply –Changes in Demand –Other Participants

Interest, cont’d Range of Interest Rates –Risk –Maturity –Loan Size –Taxability Pure Rate of Interest -- Pure rate of Interest is best approximated by the interest paid on a long-term, virtually riskless securities such as long-term bonds or of the U.S. Gov’t (20 year Treasury Bonds).

Interest, cont’d Role of the Interest Rate –Interest and Total Output –Interest and the Allocation of Capital –Interest and R&D Spending –Nominal and Real Interest Rates Application: Usury Laws (next slide) –Nonmarket Rationing –Gainers and Losers –Inefficiency -- Nominal rates: interest expressed in dollars of current value. -- Real rates: interest expressed in purchasing power (dollars of inflation adjusted value).

Usury Laws Quantity of Loanable Funds Interest Rate (Percent) 0 D S i= 8% F0F0 Usury Laws specify a max interest rate for loans (price ceiling).

D.Economic Profit Explicit Costs - $ to outsiders Implicit Costs - $ sacrifices when using own resources instead of selling on the market (aka opportunity costs) Economic (Pure) Profit - $ after all costs are subtracted from a firm’s total revenue Role of the Entrepreneur –Normal Profit: min return to stay in business

Economic Profit, cont’d Sources of Economic Profit –Static Economy: forces are constant –Risk and Profit Insurable Risks: insurance for fire, etc Uninsurable Risks: unknown changes in supply and demand conditions: - Changes in General Economic Environment - Changes in the Structure of the Economy - Changes in Gov’t Policy

Economic Profit, cont’d Innovations and Profit Monopoly and Profit Functions of Profit –Profit and Total Output –Profit and Resource Allocation

Income Shares