Microeconomics chapter 16 (Rent, Interest, and Profit)

How is the supply curve on the graph of land rent?

perfectly inelastic (vertical)

What are uninsurable risks the result of?

uncontrollable and unpredictable changes in demand and supply that either reduce revenues or increase costs

What do losses signal for a business?

that society desires for the afflicted entities to contract

What do profits signal for a business?

that they should expand

What can profit be thought of as for entrepreneurs?

the "price" that allocates the scarce resource of entrepreneurship toward different possible economic activities

Future value

the amount to which some current amount of money will grow as interest compounds over time

A decision on how much to spend on R&D depends on what?

the cost of borrowing funds in relationship to the expected rate of return

Pure rate of interest

the hypothetical interest rate that would serve purely and solely to compensate lenders for their willingness to patiently forgo alternative consumption and investment opportunities until their money is repaid (most likely over a long period of time)

What does the interest rate on money loans determine?

the interest income earned by households for providing capital to firms

What determines the demand for land?

-the price of the products produced on the land -the prices of the other resources that are combined with land

Effects where equilibrium interest rate is 8% but a usury law says that lenders cannot charge more than 6%

-Nonmarket rationing -Gainers and losers (Lenders = losers b/c they receive 6%) -Inefficiency

What are the 4 main categories of uninsurable risks?

-changes in the general economic environment -changes in the structure of the economy -changes in government policy new products or production methods pioneered by rivals

What are the three main ways in which entrepreneurs can generate economic profits (that is, accounting profits that exceed normal profits)?

-create popular new products -reduce production costs below rivals' costs -create and maintain a profitable monopoly (they can generate economic rent by restricting their outputs and raising their prices)

Entrepreneurs' nonroutine decisions

-decide their firm's strategy for combining land, labor, and capital to produce a G or S -decide whether and how to develop new products and new production processes -personally bear the financial risks associated with the success or failure of their respective firms

What are the 5 "functional" income categories tracked by the U.S. government? **See graph on page 376!

1) wages and salaries 2) rents 3) interest 4) corporate profits 5) proprietors' income (income received by doctors, lawyers, farmers, small business owners, and other unincorporated enterprises) - it is a combo of wages and profit, but mostly wages, which is compensation for labor, while profit is compensation for entrepreneurship

What receives 80% of all income earned by Americans in a typical year?

Labor (70% without proprietors' income)

Free good

a good for which demand is so weak relative to supply that an excess supply of it occurs even if the market price is zero

Incentive function

a high price provides an incentive to offer more of the resource, whereas a low price prompts resource suppliers to offer less

Proposition by Henry George

a tax on rental income should be the only tax levied by government

What do governments use to impede monopolies from forming or, if they arise, break them up to restrict their business behaviors?

anti-trust laws

Private land ownership and having to pay market-determined land rents also economic growth and development how?

as consumer tastes change and as new technologies are developed, the best uses to which particular pieces of land can be put also change

For people to delay consumption and increase their saving, they must be what?

bribed, or compensated by an interest payment

How do financial institutions profit?

by charging borrowers higher interest rates than the interest rates they pay savers

What is the easiest way to express interest and why?

by percentage, because we can compare interest payments easier this way

Economic rents do what?

cause land to be directed - they do not cause land to be supplied

What receives 20% of all income earned by Americans in a typical year?

capitalists

Policyholders

individuals and firms who purchase insurance policies (contracts) from an insurance company

As with all economic resources, what type of demand is the demand for land?

derived demand

What causes demand curve to downslope?

diminishing returns (MP declines)

Economic profit flows to individuals to motivate them to provide the economic resource known as?

entrepreneurs

Residual claimants

entrepreneurs only receive whatever residual revenue - if any - remains after all the other factors of production have been paid (they face financial risks)

What does demand curve shifting right increase?

equilibrium interest rate

Loanable funds theory of interest

explains the interest rate on any particular type of loan in terms of the supply of and demand for funds available for lending in the loanable funds market that exists for that particular type of loan

Renters will only allocate land to uses that do what?

generate enough revenue to both pay the rent and cover all other costs, including a normal profit

Society will benefit by having R&D spending allocated to projects that have what?

high enough expected rates of return to justify using scarce resources for R&D rather than for other purposes

Time-value of money

idea that a specific amount of money is more valuable to a person the sooner it is obtained (a large amount of money in the future is equivalent to a small amount of money today)

Do accounting profits ignore explicit or implicit costs?

implicit costs

When interest rates are at lower equilibrium, what happens to total spending?

it rises

What do socialists urge?

land should be nationalized (owned by the state) so that payments for its use can be put to work by the government to further the well-being of the entire population

On demand side, anything that increases the rate of return on potential investments will increase demand for what?

loanable funds

What has the ability to affect productivity and rent?

location

Implicit costs

monetary income the firm sacrifices when it uses resources that it owns, rather than supplying those resources to the market

Increases in the usability of land affect what?

only a small fraction of the total amount of land and do not change the basic fact that land and other nonrenewable natural resources are fixed in supply

What does the economist consider implicit costs to be?

opportunity costs that must be accounted for in determining profit

Because the supply of land is fixed, demand is only active determinant of land rant. In this case, supply is what?

passive

Explicit costs

payments made by the firm to outsiders

What to opponents of land nationalization argue?

private land ownership allows Adam Smith's invisible hand to work its magic in terms of allocating scarce land resources to their best possible uses

Single-tax movement

produced by criticism of rental payments - economic rent could be heavily taxed without diminishing the available supply of land or reducing the efficiency with which it is allocated

The higher the rent and demand on a graph determining land rent, the higher the what?

productivity

To whom do banks pay interest to?

savers in order to attract loanable funds and in turn lend those funds to businesses

Usury laws

specify a maximum interest rate at which loans can be made (special case of price ceilings)

Interest rates are the critical prices determining what?

the level and composition of new investments in capital goods as well as the amount of R&D spending in the economy

How is allocative efficiency still achieved even after taxing rental income?

the most profitable use for piece of land before tax remains most profitable use for land after it is taxed

Economic rent

the price paid for the use of land and other natural resources that are completely fixed in total supply

Interest

the price paid for the use of money (aka the amount of money that a borrower must pay a lender for the use of the lender's money over some period of time)

If only land were taxed, why is there no worry about productive efficiency reducing output?

the quantity of land supplied does not change

Nominal interest rate

the rate of interest expressed in dollars of current value

Real interest rate

the rate of interest expressed in purchasing power MINUS dollars of inflation-adjusted value

Normal profit

the typical accounting profit which entrepreneurs want their accounting profit to be (at least as large as the typical accounting profit that their risk taking and decision making could on average be expected to earn in other business ventures)

Why are oligopolistic borrowers better able than competitive borrowers to pass interest costs onto consumers?

they can change prices by controlling output

Uninsurable risks

those risks for which it is not possible to buy insurance from an insurance company

Insurable risks

those risks for which it is possible to buy insurance from an insurance company

How can individuals share profits of corporations?

through investments of their pension funds, or by purchasing stock

What is the purpose of usury laws?

to hold down the interest cost of borrowing, particularly for low-income borrowers

Present value

today's value of some amount of money to be received in the future

Compound interest

total interest that cumulates over time on money that is placed into an interest-bearing account

Entrepreneurs are so successful because of their ability to take on what?

uninsurable risks

How are the supply curve of nonland resources? Why?

upsloping, because when the prices of capital goods rise, entrepreneurs respond by increasing the production of capital goods. Vice versa for when they decrease

If interest earned on savings were to be suddenly exempted from taxation, what would happen?

we would expect the supply of loanable funds to increase and the equilibrium interest rate to decrease

Surplus payments

what economists consider land rents to be ... they are not necessary to ensure that land is made available for economic use

Economic/pure profit

what remains after all costs- both explicit and implicit costs, the latter including normal profit - have been subtracted from a firm's total revenue. This concept can be positive or negative