December 11, 2011

Capital, Interest and Profits - Review Notes

Capital


Capital consists of those durable produced goods that are in turn used as productive inputs for further production.

There are three major categories of capital goods: structures (factories), equipment (machine tools) and inventories(goods on the shelfs of retails stores).

Investing in capital goods involves indirect or roundabout production. An item to catch fish can be made by spending time which can be used to catch fish with hands. There is an opportunity cost here. But investment of time or the opportunity cost is made in a capital good because it allows more consumption in the future than the opportunity cost.

Interest


The rate of return on capital is the annual net income (rentals less expenses) per dollar of invested capital.

In a world free or risk, inflation and monopopy, the competitive rate of return on capital would be equal to the market interest rate.

Profit



Profits are defined as the difference between total revenues and total costs.

From the total revenue all expenses (wages, salaries, rents, materials, interest, excise taxes, and the rest are deducted. The residual amount is termed as profit. The profits go the enterpreneur.

1. Profits are implicit returns

If the enterpreneur does not charge the business for his labor, his capital and land and profit will be an implicit return to his factors of production.

2. Profits as a reward for risk taking

If the revenues of the business are charged with the implicit returns - what remains is a reward for risk taking.

3. Profit as monopoly returns




References

Paul Samuelson and William D. Nordhaus, Economics, 13th Edition, McGraw-Hill, 1989

Knols - 237 profit

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