Land and Capital

ch14

Economic rent

• Economic rent is the return paid to an input which is available in fixed supply.

• Economic rent is the simplest input price to analyze because it is characterized by perfectly inelastic supply.

Fixed Land Must Work for Whatever It Can Earn

Chapter 14 Figure 14-1

market equilibrium

• The market equilibrium price of land is determined mainly by the demand for it, relative to the fixed supply available.

• We call the price of using a piece of land for a period of time rent.

Using of rent concept

• Rents are critical to the accurate calculation of the economic and social costs of production.

• They also provide a convenient benchmark against which to measure the relative inefficiency or efficiency of various taxation schemes.

Why efficient taxation

• Efficient taxation occurs in markets for land due to the presence of the perfectly inelastic supply curve.

• So no distortion in either the quantity supplied or the price paid by the employer.

• only the supplier bears the burden.

Tax on Fixed Land Is Shifted Back to Landowners, with Government Skimming Off Pure Economic

Rent

Chapter 14 Figure 14-2

Physical capital

• Physical capital consists of structures, equipment, and inventories of inputs and outputs that are in turn used as productive inputs for further production.

• Payments for the temporary use of capital goods are called rentals.

return to capital

• Market determination of the return to capital is, by way of contrast, an extremely complicated process.

return to capital factors

• The return to capital depends upon many factors, economic and psychological, that lie well beyond the straightforward intersection of a derived demand curve and a simple supply curve.

• It depends upon the willingness of people to forgo present consumption to finance increased consumption in the future.

• It depends upon the uncertainties inherent in forecasting the future, and the aversion of people to the risks that those uncertainties create.

• It even depends upon policies enacted on a macroeconomic and sometimes international level.

rate of return to capital

• The rate of return to capital is a percentage computed from the ratio of net annual receipts and the dollar value of capital.

• Ex: buying an ounce of gold today for $350 and sell it a year from now for $400. The rate of return is $50/$350 = 14%.

interest rates

• interest rates are annual returns on borrowed funds.

• The real rate of interest is equal to the nominal rate reduced by the rate of inflation.

• Present value is the value today of a stream of future returns.

• PV = N1/(1 +i)+ N2/(1+ i)^2 + ... + Nt (1 + i)^t

Present Value of an Asset

Chapter 14 Figure 14-3

profits

• profits are revenues less costs.• They accrue to many owned, nonlabor

factors of production in the form of implicit rents. (return to the owner for capital and land provided by him)

• They can also represent rewards for risk taking and monopoly rents derived from continued scarcity.

• Also as reward for innovation.

Empirical

• studies show that over the past 30 years, U.S. corporations have earned a modest rate of return on their investments—only about 6 percent after taxes.

Trends in Wages and Profits in the United States

Chapter 14 Figure 14-7

Saving

Investment in capital goods today leads indirectly to even greater investment and consumption in the future.

Investments Today Yield Consumption Tomorrow

Chapter 14 Figure 14-4

interest rates and PV

• High interest rates reduce the number of capital investment projects with positive present values and thus the demand for (new) capital.

• Low interest rates do the opposite, thereby encouraging capital-intensive investment.

demand for capital is downward-sloping.

• The derived demand for capital comes from its marginal product.

• The law of diminishing returns applies to capital .

• That is, as a firm continues to invest in capital, the rate of return on marginal dollars will eventually fall.

short-run equilibrium

• In short-run equilibrium, a fixed amount of capital is rationed such that the rate of return on capital exactly equals the market interest rate.

• In the short run, the supply of capital is fixed, based on past investments; thus, its price is determined by the position of the demand curve.

Short-Run Determination of Interest and Returns

Chapter 14 Figure 14-5

long-run equilibrium

• In LR equilibrium, the supply of capital is upward-sloping, which means that as interest rates rise, savers are willing to supply more funds to the market.

Long-Run Equilibration of the Supply and Demand for Capital

Chapter 14 Figure 14-6

classical capital theory qualifications

• technological change, uncertainty and risk, inflation, and macroeconomic fluctuations.

• Taxes and inflation can alter the behavior of investors because they lower the real return on investments.

• Technological changes usually increase the return on investments by increasing the productivity of resources.

all investments carry risk and uncertainty

• Any decision is based upon best estimates of the future.

• Since the future is rarely certain, there are few absolute guarantees that the return for a given investment will be as predicted

Chapter 14 Table 14-1