Lecture Economics (18th edition): Chapter 14 - McConnell, Brue, Flynn''s

Chapter 14 - Rent, interest, and profit. 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.

Rent, Interest, and Profit

Chapter 14

Chapter Objectives

• Economic rent

• The loanable funds theory

• Interest rate variation

• Economic profits

• Distribution of U.S earnings

Economic Rent

• Price paid for land and other

natural resources

• Perfectly inelasticity supply

• Changes in demand

• A surplus payment

Determination of Land Rent

Acres of Land

L 0

D 1

D 2

D 3

S

R 1

R 2

R 3

Economic Rent

• Application: a single tax on land

–Henry George’s proposal

–Single tax movement

–Criticisms

• Productivity differences

• Alternative uses of land

• Price paid for use of money

• Stated as a percentage

• Money is not a resource

• Loanable funds theory

–Supply of loanable funds

–Demand for loanable funds

Market For Loanable Funds

Quantity of Loanable Funds

0

D

S

i=

8%

F 0

The equilibrium interest rate

Loanable Funds Theory

• Extending the model

• Financial institutions

• Changes in supply

–Household thrift

• Changes in demand

–Rate of return on investment

• Other participants

Time-Value of Money

• Money more valuable the sooner

it is obtained

–Ability to earn interest

–Compound interest

• Future value

• Present value

Range of Interest Rates

• There are many interest rates

• Why do interest rates differ?

–Risk

–Maturity

–Loan size

–Taxability

• Pure rate of interest

Role of the Interest Rate

• Relationship to

–Total output

–Allocation of capital

–R&D spending

• Nominal and real rates

• Application: Usury Laws

–Nonmarket rationing

–Gainers and losers

–Inefficiency

Nominal Interest Rates

Short-Term Interest Rate, 2007

New Zealand

Hungary Mexico Australia United Kingdom

United States South Korea

Canada Sweden Switzerland

0 2 4 6 8 10

Economic Profit

• Explicit costs

• Implicit costs

• Pure profit

• Total revenue less explicit and implicit costs

• Role of the entrepreneur

–Normal profit

Sources of Economic Profit

• Static economy

• Risk and profit

–Insurable and uninsurable risks

–Changes in economic environment, structure of economy, government policy

• Innovations and profit

• Monopoly and profit

Economic Profit

• Functions of profit

–Profit and total output

–Profit and resource allocation

• Income shares

• Labor receives 70-80%

• Rest is rent, interest, profit

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 beware

Key Terms

• economic rent

• incentive function

• single-tax movement

• loanable funds theory

of interest

• time-value of money

• future value

• present value

• pure rate of interest

• nominal interest rate

• real interest rate

• usury laws

• explicit costs

• implicit costs

• economic or pure profit

• normal profit

• static economy

• insurable risks

• uninsurable risks

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Natural Resource

and Energy

Economics