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14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Economic Rent Acres of Land Land Rent (Dollars) L0L0 D1D1 D2D2 D3D3 D4D4 S R1R1 R2R2 R3R3 0 a b LO1 14-3

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Page 1: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

14

Rent, Interest, and Profit

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Rent

• Price paid for land and other natural resources

• Perfectly inelasticity supply• Changes in demand• A surplus payment

LO1 14-2

Page 3: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Rent

Acres of Land

Land

Ren

t (D

olla

rs)

L0

D1

D2

D3

D4

S

R1

R2

R3

0a b

LO1 14-3

Page 4: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Rent

• Land ownership: fairness vs. allocative efficiency

• Application: a single tax on land• Henry George’s proposal• Single tax movement• Criticisms

LO1 14-4

Page 5: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

Page 6: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

Page 7: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Loanable Funds Theory

Quantity of Loanable Funds

Inte

rest

Rat

e (P

erce

nt)

0

D

S

i =8%

F0

The equilibrium interest rate

LO2 14-7

Page 8: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Time-Value of Money

• Money is more valuable the sooner it is obtained• Ability to earn interest• Compound interest

• Future value• Present value

LO3 14-8

Page 9: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

Page 10: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Profit

• Explicit costs• Implicit costs• Pure profit• Total revenue less explicit and

implicit costs• Role of the entrepreneur

• Normal profit

LO4 14-10

Page 11: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Profit

• Insurable risks• Uninsurable risks

• Changes in economic environment• Structure of economy• Government policy• New products of production

methods

LO4 14-11

Page 12: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Profit

• Profit is compensation for bearing uninsurable risks

• Sources of economic profit• Create new products• Reduce production costs• Create and maintain a profitable

monopoly

LO4 14-12

Page 13: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Profit

• Profit rations entrepreneurship• Profit aids in resource allocation• Profit and corporate stockholders

LO4 14-13

Page 14: 14 Rent, Interest, and Profit McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Income Shares

LO5

Distribution of U.S. Income

Rents$268 (2% )

Interest$788 (7% )

Corporate Profits$1309 (12% )

Proprietors' Income$1041 (9% )Wages and

Salaries$7792 (70% )

14-14


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