Rent,
Interest,
and Profit
29 - 1
Functional Distribution of Income
Interest
7%
Corporate Profit
12%
Rent
2%
Proprietor's
Income
8%
29 - 2
Wages are dominant type, if
proprietor’s income is added,
the percentage rises even
higher.
Historically, corporate profit
has grown as a share over
time as that form of business
organization grows.
Industry has changed from
land-capital intensive to
Wages & Salaries labor-capital intensive to
labor-service intensive.
71%
ECONOMIC RENT
…price paid for the use of
land and other natural
resources, which are
completely fixed in supply.
29 - 3
ECONOMIC RENT
Fixed Supply
… land and natural
resources have limits
… perfectly inelastic
supply curve
29 - 4
ECONOMIC RENT
Perfectly inelastic supply
…since land has no production
costs
… “free and nonproductive gift
of nature”
… quantity does not change
with price
29 - 5
ECONOMIC RENT
Changes in demand will determine
the amount of rent
… price of the product grown on
the land
… the productivity of the land
… the prices of other resources
combined with the land
29 - 6
Land Rent (dollars)
DETERMINATION OF LAND RENT
Changes in the demand for land...
S Inelastic Supply...
0
Acres of Land
29 - 7
DETERMINATION OF LAND RENT
Changes in the demand for land...
S
Inelastic Supply...
Land Rent (dollars)
combines with
demand...
D1
0
Acres of Land
29 - 8
DETERMINATION OF LAND RENT
Changes in the demand for land...
S
Inelastic Supply...
Land Rent (dollars)
R1
combines with
demand... to
determine rent
D1
0
Acres of Land
29 - 9
DETERMINATION OF LAND RENT
Changes in the demand for land...
S If demand decreases...
Land Rent (dollars)
rent decreases
R1
R2
D1
D2
0
Acres of Land
29 - 10
DETERMINATION OF LAND RENT
Changes in the demand for land...
S If demand decreases...
Land Rent (dollars)
R1
R2
R3
rent decreases.
...and decreases
D1
D2
D3
0
Acres of Land
29 - 11
Land Rent (dollars)
DETERMINATION OF LAND RENT
Changes in the demand for land...
S
If demand decreases...
rent decreases.
...and decreases
...and decreases
...and
decreases
D
R1
R2
1
R3
D2
D3
0
D4
29 - 12
Acres of Land
Land Rent (dollars)
DETERMINATION OF LAND RENT
Changes in the demand for land...
S
If there is no demand
for land, then it is a
free good.
R1
R2
D1
R3
D2
D3
0
D4
29 - 13
Acres of Land
Economic rent is a surplus
payment not necessary to ensure
that land is available to all society.
… individual firms do need to
pay rent to attract land resources
away from alternative uses,
… so rent is a cost for firms.
29 - 14
Interest
price paid for the use of money to
obtain capital
… the return to capital
price paid for the use of money
… the money that must
be paid for the use of one dollar
for one year.
29 - 15
Interest
Interest is stated as a
percentage amount to be
paid for use of money
…required by the
Truth in Lending Act of
1968.
29 - 16
Interest
Money itself is NOT a Resource.
… used to acquire capital goods
√ by borrowing money or
using money, businesses are
buying the use of real capital
goods.
29 - 17
Loanable Funds Theory Of Interest
Interest Rate, (percent)
S
i=
8%
D
F0
29 - 18
Supply is
upsloping
because at
higher interest
rates, consumers
will be induced
to save more
and spend less.
Quantity of Loanable Funds
Interest Rate, (percent)
Loanable Funds Theory Of Interest
Demand is
S downsloping
because at lower
interest rates,
businesses and
consumers are
willing to borrow
D more.
i=
8%
F0
29 - 19
Quantity of Loanable Funds
Loanable Funds Theory Of Interest
Interest Rate, (percent)
S Equilibrium
occurs where
the Supply
(savings)
intersects the
demand
(investment,
consumption).
i=
8%
D
F0
29 - 20
Quantity of Loanable Funds
Changes in the real interest rate
…A change in investment or consumption
decisions moves the demand curve.
• Rates of return or tax policy
…A change in savings decisions moves the
supply curve.
…A change in government spending
policies
• Deficits shift the demand curve,
as the gov’t demands loanable funds.
29 - 21
Range Of Interest Rates
Varying degrees of risk (riskier loans carry
higher rates)
…Differing maturity dates (longer-term
loans carry higher rates)
…Size of loan (larger amount of loan
have lower rates)
…Taxability (some interest earned is
tax-free, so interest paid would be lower)
…Market imperfections (monopoly
power in market may raise rate)
29 - 22
Role of the Interest Rate
… affects both levels and the types of
investment undertaken.
√ Level of investment is inversely
related to the rate of interest.
√ Adds to capital formation
… rations money capital to those who
are willing to pay for it,
√ so…capital is allocated to its
more productive and profitable uses.
29 - 23
Nominal Interest Rates
Short-Term Interest Rate, 2007
0
2
4
6
8
10
New Zealand
Hungary
Mexico
Australia
United Kingdom
United States
South Korea
Canada
Sweden
Switzerland
Japan
29 - 24
Source: Organization for Economic Cooperation and Development
14-24
Economic Profit
…what remains of a
firm’s total revenue after
the explicit and implicit
costs are subtracted.
29 - 25
Economic Profit
Profit is the reward for the entrepreneurfor risk-taking, for innovation, for
creative ways of combining resources.
√ Normal profit is the minimum
required to retain the entrepreneur.
√ Economic profits are above the
normal and act as the incentive to take
risks.
29 - 26
Economic Profit
Economic profits occur in a dynamic,
ever-changing economy as the reward to
the entrepreneur, but they also accrue to
those with monopoly power in the market.
Expectation of profit encourages
firms to invest and expand output and
production. They allocate resources to
those ventures that are profitable—a
signal that society’s needs and wants for
being met.
29 - 27