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Unformatted text preview: Rent, Interest, and Profit ANSWERS TO END-OF-CHAPTER QUESTIONS 27-1 How does the economists use of the term rent differ from everyday usage? Explain: Though rent need not be paid by society to make land available, rental payments are very useful in guiding land into the most productive uses. In everyday usage, rent is the term used to describe the payment that must be paid for the legal borrowing of some good or service. One pays rent for the use of a house or apartment; or one rents a tool from the equipment rental company. When paying this rent one is paying for part of the capital cost of the commodity, plus its maintenance, plus a share of the taxes on it, plus profit to the owner. An economist defines rent much more restrictively: Economic rent is the price paid for the use of land and other natural resources which are completely fixed in total supply. Land is completely fixed in total supply. No matter how high the rent, no more can be brought into use. Thus rent serves no incentive function; the same amount of land will be available no matter how high the rent. But the resulting argument that rent is a surplus that could be eliminated without reducing the supply is to look at it from the viewpoint of society only. The fact is that land has alternative uses. To get land into its most productive use, individuals and firms must compete and the winners are those who will pay the highest rent. It only makes sense to outbid someone else for any particular land if the winner expects to make more profitable use of it than the losers, that is, employ it in its most productive use. 27-2 ( Key Question ) Explain why economic rent is a surplus payment when viewed by the economy as a whole but a cost of production from the standpoint of individual firms and industries. Explain: Land rent performs no incentive function for the overall economy. Land is completely fixed in total supply. As population expands and the demand for land increases, rent first appears and then grows. From societys perspective this rent is a surplus payment unnecessary for ensuring that the land is available to the economy as a whole. If rent declined or disappeared, the same amount of land would be available. If it increased, no more land would be forthcoming. Thus, rent does not function as an incentive for adding land to the economy. But land does have alternative uses. To get it to its most productive use, individuals and firms compete and the winners are those who pay the highest rent. To the high bidders, rent is a cost of production that must be covered by the revenue gained through the sale of the commodities produced on that land. 27-3 In the 1980s land prices in Japan surged upward in a speculative bubble. Land prices then fell for 11 straight years between 1990 and 2001. What can we safely assume happened to land rent in Japan over those 11 years? Use graphical analysis to illustrate your answer....
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This note was uploaded on 03/03/2010 for the course ECON E103 taught by Professor Johnson during the Spring '08 term at Indiana University South Bend.
- Spring '08