Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 1 Chapter 16 Rent, Interest and Profits

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 2 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 3 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 4 Determination of Land Rent Land Rent (dollars) Acres of Land 0 Q S S D1D1 R1R1 R2R2 D2D2 D3D3 R3R3 D4D4

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 5 Land Rent Supply of land is perfectly inelastic 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 6 Perfectly Inelastic Supply Why? – No production costs associated with land – Economy has a finite supply of land – Variability in the usability of land affects a very small fraction of the total amount of land

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 7 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 8 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 9 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 Measured as a percentage Money is not a resource Money is not in itself useful

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 10 Determining Interest Rate Money demand – transactions demand + assets demand Money supply Nominal interest rate: current dollars Real interest rate: adjusted for inflation – important in making investment decisions

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 11 Interest Rate Determination (cont.) Rate of interest (per cent) Amount of money demanded and supplied ($billion) DmDm SmSm IeIe

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 12 Types 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 13 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 14 Economic Profits Various terms – Economic profits or pure profits – Accounting profits – Explicit costs – Implicit costs

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 15 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  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 16 Sources of Economic Profits Economic profits – are not a cost – accrue to the entrepreneur Potential sources – uninsured risks (dynamic and uncertain) – innovations – monopoly power and profits

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 17 Functions of Profits Energise the economy Stimulate innovation and output Encourage investment Allocate resources amongst alternatives

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 18 Income Shares Largest share of national income accrues to labour Labour’s relative share has declined in Australia since the 1980s Capitalist share less than 25 per cent of national income

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 19 Next Chapter: Market Failure and Resource Allocation