Land and Capital

Chapter 14

Main topics
Land & concept of rent
Land as a factor
Rent defined

Capital & interest

Concept of capital
Valuation
Function of interest

Applications

Land & concept of rent

Land feature of fixed supply
Derived demand based on demand for a
product that uses it as input

Rent price of land or other fixed input

Rent or (pure economic rent): residual left for
owners of fixed inputs

Taxing land no distorting effect

Effect on consumers: none; price constant
Effect on landowners: none; supply constant

Chapter 14
Figure 14-1

Fixed Land Must Work for

Whatever It Can Earn

Chapter 14
Figure 14-2

Tax on Fixed Land Is Shifted Back to Landowners,

with Government Skimming Off Pure Economic
Rent

Capital and interest

Capital produced factor of production
Durable produced goods used to produce
other goods
3 major categories
Structures
Equipment

inventories

Producer durables
Consumer durables

Prices vs rentals of capital goods

Prices for purchase
Rental for use

Capital & interest, contd

Tangible assets real inputs, e.g. land & machines
increase productivity of other factors

Financial assets monetary claims

Solves mismatch between savers & investors

Interest rates price that a borrower pays

for his use of the money
Nominal peso return on pesos invested
Real net of loss of buying power due to
inflation

Chapter 14
Table 14-1

Capital & interest, contd

Present value peso value today of a stream of
income in the future
Nt
N1
N2
V

...
...
2
t
1 i
(1 i )
(1 i )
N

ast
i

Chapter 14
Figure 14-3

Present Value of an Asset

Capital & interest, contd

Maximizing present value calculate
present value for all projects, then rank
projects/assets. Allocate funds
appropriately

Capital & interest, contd

Profits
Business profits: sales less costs
Economic profits: earnings after all costs
both money & implicit/opportunity costs

Determinants:
An implicit return for labor & capital use
Reward for risk bearing

Risk of default
Insurable risks
Systemic risks
Sovereign risk

Reward for innovation

Capital & interest, contd

Theory:
Use of indirect or roundabout production
Payment for forgoing present consumption to increase future
consumption (concept of investment)

Determination of interest & return to capital

Supply of capital: from households
Demand for capital: from businesses

Chapter 14
Figure 14-4

Investments Today Yield

Consumption Tomorrow

Chapter 14
Figure 14-5

Short-Run Determination of
Interest and Returns

Chapter 14
Figure 14-6

Long-Run Equilibration of the

Supply and Demand for Capital

Applications
Taxes & inflation
Technological disturbances
Role of technological innovations in level of
interest & return on capital

Uncertainty & expectations

Empirical findings: returns to labor &
capital

Chapter 14
Figure 14-7

Trends in Wages and Profits in the

United States

Valedictory thoughts
Competitive markets promote efficiency
Capital markets balance saving and
investment
Governments can reduce inequality w/o
impairing efficiency

Appendix 14A
Figure 14A-1

Inputs, Production, Outputs, and

Consumption Form the Circular Flow of
Economic Life

Appendix 14A
Figure 14A-2

Efficient Allocations Are on the

Utility-Possibility Frontier