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The present value of an asset is the discounted value today of the income stream associated with<br />

the asset. One factor that affects the present value of future income is the interest rate. The<br />

higher the interest rate that could be earned, the lower the present value of future income.<br />

Another factor that affects the present value of future income is the number of years until the<br />

future income is received. The greater the number of years, the lower the present value of the<br />

future income. In evaluating an investment opportunity, the present value of expected future<br />

returns is compared to the current cost.<br />

Economic rent is payment to a factor in excess of opportunity costs. If economic rent for a factor<br />

is high, it is because the demand for what the factor produces is high. Economic rent allocates<br />

resources to their most valuable use and provides incentive for resource owners to develop the<br />

productivity of their resources.<br />

Economic profit is the difference between total revenue and total costs, including both explicit and<br />

implicit costs. The sources of economic profit are arbitrage, uncertainty, innovation, and<br />

monopoly profits. Profit attracts entrepreneurs and resources into markets of growing consumer<br />

demand.<br />

Questions for Chapter 26<br />

Fill-in-the-blanks:<br />

1. ______________________ is the payment for the use of loanable funds.<br />

2. The ______________________ interest rate is the nominal interest rate minus the rate of<br />

inflation.<br />

3. ______________________ ______________________ is payment to a factor in excess of<br />

opportunity costs.<br />

4. ______________________ refers to buying at a low price in one market and selling at a<br />

higher price in another market.<br />

Multiple Choice:<br />

___ 1. The supply of loanable funds:<br />

a. comes from households that save part of their income<br />

b. results from the desire to accumulate wealth for retirement or for major future<br />

expenditures<br />

c. is directly related to the interest rate<br />

d. All of the above<br />

___ 2. Positive rate of time preference means that:<br />

a. consumers prefer to postpone consumption until the future<br />

b. consumers will be willing to borrow (and pay interest) in order to consume now rather<br />

than later<br />

c. Both of the above<br />

d. Neither of the above<br />

___ 3. Both consumer demand and investment demand for loanable funds will be:<br />

a. inversely related to the interest rate<br />

b. directly related to the interest rate<br />

c. unrelated to the interest rate<br />

FOR REVIEW ONLY - NOT FOR DISTRIBUTION<br />

Interest, Present Value, Rent, and Profit 26 - 10

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