Principles of Economics 2nd edition by Fred M Gottheil PowerPoint Slides prepared by Ken Long ©1999 South-Western College Publishing

Chapter 17 Interest, Rent, & Profit 5/28/2018 ©1999 South-Western College Publishing

This chapter discusses principles associated with Marginal Physical Product of Capital & Marginal Revenue Product of Capital Loanable Funds & Equipment of Capital The Ethics of Earning Interest-Based Income Pure Rent, Differential Rent, & Location Rent Wage-related Rents Profit Interest Rate Determination The Present Value of Property ©1999 South-Western College Publishing

What is the Economic Problem? We live in a world of scarce resources, yet people have unlimited wants, so how do we meet people’s wants and needs in a world of scarcity? ©1999 South-Western College Publishing

What are resources? Entrepreneurship - an innovative person who takes risks, sees opportunity, and builds a business Capital - a machine or tool used in the productive process Land - anything from the earth is a land resource Labor - directed and productive effort

What is a resource market? Involves the demand and supply of resources, that is, land, labor, capital and entrepreneurship ©1999 South-Western College Publishing

How is the Resource Market different than the Product Market? In the resource market, firms are demanders and households are suppliers ©1999 South-Western College Publishing

The factor incomes discussed in this chapter are: Wages Rent Profit ©1999 South-Western College Publishing

What is the Marginal Revenue Product of Capital? The change in total revenue that results from adding one more dollar of loanable funds to production ©1999 South-Western College Publishing

What are Loanable Funds? Money that a firm employs to purchase the physical plant, equipment, and raw materials used in production ©1999 South-Western College Publishing

What is Capital Equipment? The machinery a firm uses in production ©1999 South-Western College Publishing

What is Interest Rate? The price of loanable funds, expressed as an annual percentage return on a dollar of loanable funds ©1999 South-Western College Publishing

Why is the Marginal Revenue Product of Capital Curve negative? Because the law of diminishing returns applies to capital ©1999 South-Western College Publishing

Marginal Revenue Product of Capital Interest Rate Loanable Funds 1414 ©1999 South-Western College Publishing

What two factors determine the MRP of Capital? Marginal Physical product of capital Price of the good MRP=MPP x P ©1999 South-Western College Publishing

What is Marginal Factor Cost? MFC is the change in a firm’s total cost that results from adding one more unit of a factor to production ©1999 South-Western College Publishing

What is the MRP = MFC Rule? ©1999 South-Western College Publishing

A firm will continue adding loanable funds to production as long as its MRP is greater than or equal to the marginal cost of employing loanable funds, MFC ©1999 South-Western College Publishing

What is the Loanable Funds Market? The market in which the demand for and supply of loanable funds determines the rate of interest ©1999 South-Western College Publishing

S D (MRP) Surplus Shortage Interest Rate Loanable Funds 20 ©1999 South-Western College Publishing

D S2 S1 P2 P1 Q2 Q1 Decrease in Supply 2121 ©1999 South-Western College Publishing

D S1 S2 P1 P2 Q1 Q2 Increase in Supply 2222 ©1999 South-Western College Publishing

What is Present Value? The value today of the stream of expected future annual income a property generates ©1999 South-Western College Publishing

How is Present Value Computed? Divide the annual income generated, R, by the rate of interest, r ©1999 South-Western College Publishing

PV = R/r 2525 ©1999 South-Western College Publishing

Why does a decrease in the interest rate increase the present value of property? Because the lower the interest the more money is needed in savings to generate the same income ©1999 South-Western College Publishing

For a simple Loan Payment Calculator check out - http://www.interest.com/hugh/calc/simple.cgi ©1999 South-Western College Publishing

Why does the value of property increase with a Price Floor? Because of the guaranteed price the product will receive ©1999 South-Western College Publishing

A Price Floor S Surplus P D 29 ©1999 South-Western College Publishing

What is Rent? The difference between what a resource receives and the cost of bringing the resource into being ©1999 South-Western College Publishing

What is Differential Land Rent? Rent arising from differences in the cost of providing land ©1999 South-Western College Publishing

What is Location Rent? Rent arising from differences in land distances from the marketplace ©1999 South-Western College Publishing

For an historical prospective concerning land and property rights, check out - http://www.systemics.com/docs/ricardo/david.html http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/ricardo/index.html ©1999 South-Western College Publishing

What is a Wage-Related Rent? The difference between what a worker receives and what it takes to bring the worker into production ©1999 South-Western College Publishing

What is Opportunity Cost? That which is given up in the best alternative endeavor ©1999 South-Western College Publishing

What is Economic Rent? That portion of a resource’s earnings above its opportunity cost ©1999 South-Western College Publishing

If your wage rate is $10 but you would work for $8, what is your wage-related rent? $2 ©1999 South-Western College Publishing

Economic Rent & Opportunity Cost Wage $10 Economic Rent Opportunity Cost D $4 Hours of labor 100

Who is an Entrepreneur? A profit-seeking decision maker who organizes an enterprise and assumes the risk of its operation ©1999 South-Western College Publishing

What is Profit? Income earned by entrepreneurs ©1999 South-Western College Publishing

For an example of entrepreneurship, check out - http://www.rentertainment.com http://www.parasol.com ©1999 South-Western College Publishing

What is a resource market? What is the Marginal Revenue Product of Capital? What are Loanable Funds? What is Capital Equipment? What is Interest Rate? What is Marginal Factor Cost? What is the Loanable Funds Market?

What is Present Value? What is Economic Rent? What is Differential Rent? What is Location Rent? What is a Wage Related Rent? What is Opportunity Cost? Who is an Entrepreneur? What is Profit?

END ©1999 South-Western College Publishing