After reading this chapter, you should be able to: Explain the nature of economic rent and how it is determined; describe the loanable funds theory of interest rates; demonstrate how interest rates relate to the time-value of money and vary based on risk, maturity, loan size, and taxability; relate why economic profits occur, and how profits, along with losses, allocate resources among alternative uses; list the share of U.S. earnings received by each of the factors of production.
14 Rent,Interest,andProfit McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved EconomicRent Price paid for land and other natural • • • LO1 resources Perfectly inelasticity supply Changes in demand A surplus payment 14-2 Economic Rent Land Rent (Dollars) S R1 D1 R2 D2 R3 D3 a b L0 Acres of Land D4 LO1 14-3 Economic Rent • Land ownership: fairness vs • LO1 allocative efficiency Application: a single tax on land • Henry George’s proposal • Single tax movement • Criticisms 14-4 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 LO2 14-5 Loanable Funds Theory • Extending the model • Financial institutions • Changes in supply • Household thrift • Changes in demand • Rate of return on investment • Other participants LO2 14-6 Loanable Funds Theory The equilibrium interest rate Interest Rate (Percent) S i= 8% D F0 Quantity of Loanable Funds LO2 14-7 TimeValue of Money • Money is more valuable the sooner it • • LO3 is obtained • Ability to earn interest • Compound interest Future value Present value 14-8 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 • Inefficiency LO3 14-9 Economic Profit • Explicit costs • Implicit costs • Pure profit • Total revenue less explicit and • LO4 implicit costs Role of the entrepreneur • Normal profit 14-10 Economic Profit • Insurable risks • Uninsurable risks • Changes in economic environment • Structure of economy • Government policy • New products of production methods LO4 14-11 Economic Profit • Profit is compensation for bearing • LO4 uninsurable risks Sources of economic profit • Create new products • Reduce production costs • Create and maintain a profitable monopoly 14-12 Economic Profit • Profit rations entrepreneurship • Profit aids in resource allocation • Profit and corporate stockholders LO4 14-13 Income Shares Distribution of U.S. I ncome Proprietors' I ncome $1041 ( 9% ) W ages and Salaries $7792 ( 70% ) Corporate Profits $1309 ( 12% ) I nterest $788 ( 7% ) Rents $268 ( 2% ) LO5 14-14 ... LO3 1 4-9 Economic Profit • Explicit costs • Implicit costs • Pure profit • Total revenue less explicit and • LO4 implicit costs Role of the entrepreneur • Normal profit 1 4-1 0 Economic Profit. .. maintain a profitable monopoly 1 4-1 2 Economic Profit • Profit rations entrepreneurship • Profit aids in resource allocation • Profit and corporate stockholders LO4 1 4-1 3 Income Shares Distribution of U.S. I... LO4 1 4-1 1 Economic Profit • Profit is compensation for bearing • LO4 uninsurable risks Sources of economic profit • Create new products • Reduce production costs • Create and maintain a profitable