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Economics U$A: 21st Century Edition

Profits and Interest (Microeconomics)

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In response to rising interest rates in the 1970s, the Maryland legislature raised usury ceilings so that more home loans would be available. In December of 1980 Apple Computers went public, affirming four years of hard work with substantial compensation for its founders. Pharmaceutical companies invest millions in bringing new drugs to market. How much profit do they get in return? These stories exhibit economic reasons for interest payments and how investments in facilities and equipment are related to interest rates and expected profits on investment.

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Unit Overview

Purpose:

To show the economic reasons for payments of interest and normal profits, the causes of “windfall” profits, and how the decision to invest in plant and equipment is related to the interest rate and expected returns on the investment.

Objectives:

  1. Interest rates are determined by the supply and demand for loanable funds, and both the supply and the demand for funds are affected by the level of interest rates. If the interest rate is lower in one market than another, the supply of funds to that market will be reduced.
  2. Factory buildings and equipment help in the production of output; they have marginal physical product. The demand for new fixed investment depends on the expected returns on investment; if the expected return exceeds the prevailing interest rate, the firm would be willing to borrow in order to invest in plant and equipment.
  3. Entrepreneurs and others who hold equity stakes often earn a return in excess of the normal return to an investment.
    • Such returns are called pure economic profit; they are due to the temporary monopoly or “windfall” profits that may occur because of the innovative or risk-taking activity of the entrepreneur.
    • “Windfall” profits encourage other firms or entrepreneurs to enter the industry; ultimately this drives prices and profits down.

Meet the Series Experts

Laurence Levitan

Senator in the Maryland Legislature for nearly twenty years, specializing in fiscal affairs and government operations. He chaired the Budget and Taxation Committee for fifteen years, chaired the Fiscal Affairs and Government Operations Committee, and served on many other committees, including: Pensions, Spending and Affordability, Joint Committee on Income Tax Reform, Rules, Legislative Policy, Joint Budget and Audit, Joint Committee on Management of Public Funds, Special Joint Committee on Legislative Data Systems, and Fiscal Affairs and Oversight. Mr. Levitan received his B.S. from Washington and Lee University and J.D. from George Washington Law School.

Ian Spatz

Public policy expert and Senior Advisor in the national health care practices of Manatt, Phelps & Phillips and Manatt Health Solutions, where he provides insights into health-reform efforts. He develops strategies affecting health-care providers and insurers, pharmaceuticals, consumers, and U.S. healthcare initiatives, as well as federal and state development and implementation of communication and advocacy efforts. He worked for 15 years at Merck & Co., one of the world’s leading research-based pharmaceutical and vaccine companies. As Merck’s Vice President for Global Health Policy, he directed U.S. policy and represented Merck before Congress, the Administration, and the media. Mr. Spatz received his B.A. from Brandeis University, J.D. from New York University, and M.P.P. from the Woodrow Wilson School of Public and International Affairs.

Steve Jobs

Late American business magnate, inventor, and Co-Founder and Chief Executive Officer of Apple Computer. In the late 1970s, Jobs, in association with Apple Co-Founder Steve Wozniak, Mike Markkula, and others, designed, developed, and marketed one of the first commercially successful lines of personal computers, the Apple II series. In the early 1980s, he was among the first to see the commercial potential of the mouse-driven graphical user interface, which led to the creation of the Macintosh computer. During high school in Cupertino, California, he frequented after-school lectures at the Hewlett-Packard Company in Palo Alto, California, where he was soon hired, and he worked with Steve Wozniak as a summer employee. In 1972, Jobs enrolled at Reed College in Portland, Oregon, then dropped out to pursue his entrepreneurial activities.

Stephen Wozniak

Computer engineer and Co-Founder of Apple Computer, Inc., where his inventions and machines contributed significantly to the personal computer revolution of the 1970s; he created the Apple I and Apple II computers. Wozniak received the National Medal of Technology in 1985 (along with Steve Jobs), was inducted into the National Inventors Hall of Fame, and in 2001 was awarded the 7th Annual Heinz Award for Technology, the Economy, and Employment. Wozniak has been given honorary degrees by the University of Colorado at Boulder, Kettering University, North Carolina State University, and Nova Southeastern University. Mr. Wozniak studied engineering at the University of California, Berkeley, then dropped out to take a job at Hewlett Packard.

What's your Economics IQ?

Take the Economics USA: Profits and Interest Quiz.

Quiz addendum:

1. Answer explanation: $25,000. 1500 = .06 X. 1500 / .06 = 25,000

2. Answer explanation: The degree of risk involved. All other factors may have some bearing as well, but the primary determining factor will usually be degree of risk.

4. We can conclude from this diagram that the input is…

 

 

 

 

Answer: 

 

 

 

 

 

Land. We know by the vertical supply curve that this is a fixed input which, by the economist’s definition, is land.

5. The price of this input is called…

Answer:

Rent. The fixed supply curve tells us that this is land, a fixed input, so income derived from this input is rent.

Glossary

  • anti-usury laws
    Laws that regulate the maximum interest rates that can be set for loans, in order to protect borrowers.
  • economic profits
    The excess of a firm’s profits over what it could make in other industries.
  • interest rate
    The annual amount that a borrower must pay for the use of a dollar for a year.
  • marginal value product of capital
    Measure of a firm’s revenue contributed by the last unit of a productive factor employed.
  • present value of an investment
    Future value of resources minus the value of those resources when initially put toward a certain production.
  • return on a fixed investment
    When money put into capital goods yields either a profit or a loss.
  • supply and demand for loanable funds
    The amount available for lending in the general money market vs. the interest rates that consumers are willing to pay to borrow money.

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Economics U$A: 21st Century Edition

Credits

Produced by the Educational Film Center. 2012.
  • Closed Captioning
  • ISBN: 1-57680-895-5