Economic Rent

• Economic rent is the price paid for use of land and other natural resources which are completely fixed in supply

• Perfectly inelastic supply of the resource is one unique feature of the supply side of the market that determines rent.  Land has no production cost; it is a "free and nonreproducible gift of nature."  It's quantity does not change with price

Changes in demand therefore determine the amount of rent.  This will be determined by several factors:

• The price of the product grown on the land

• The productivity of the land

• The prices of other resources combined with the land for production

Land rent is viewed as a surplus because it performs no incentive function to provide more supply; it is not necessary to ensure the availability of land

Some argue that rent should be taxed away, since it is unearned, or that land should be nationalized and owned by the state.

Henry George's proposal for a single tax of up to 99 percent of land rent asserted that this tax could eliminate other taxes.  This was popular in the 1880s

Critics of the single-tax idea make several points

1. Current levels of government spending are too great to be supported by rent taxes

2. It is difficult to separate the rent component from other income resulting from the combined use of land with other resources

3. Unearned income goes beyond land and land ownership; capital gains and interest income might also be considered unearned

4. It is unfair to tax current owners, who  may have paid a steep market price for the land and therefore find that the rent return is not high relative to that price.

Differences in land productivity result from differences among the parcels of land.  These differences justify different amounts of rent to allocate land to its most productive use.

Land has alternative uses and costs.  Without rent to allocate land among its various users, there would be no market mechanism to make sure each piece of land was being utilized in its most valuable fashion.  Therefore, rent does provide an important function to the economic system.

Interest Rates

Interest is the price paid for the use of money.  It is usually viewed as the money that must be paid for the use of one dollar for one year.

• The interest rate is determined in the "money market" (recall the supply + demand of money graph - see 'Macroeconomics: Chapter VII)

• Real interest rates are used by businesses to consider investment decisions

• There are many different interest rates with different names and they vary for many reasons

1. Varying degrees of risk (riskier loans carry higher rates)

2. Differing maturities on the loan (higher rates usually on longer-term loans)

3. The size of the loan (larger loans have lower rates)

4. Taxability (interest on some local and state bonds is tax-free; the interest would be lower, since lenders don't have to pay federal taxes on that interest income)

5. Market imperfections play a role, because some banks in smaller towns have more market power than banks that have a lot of competition

• To circumvent the difficulties in discussing the whole structure of interest rates, economists talk of "the" interest rate, or the pure rate of interest.  This is best approximated by the interest paid on long-term, riskless bonds such as the long-term bonds of the U.S. government.

•   Recall the effects of changing interest rates on GDP

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