Resource Markets: Land and Capital

1
Resource Markets Land and Capital
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Two Other Factors of Production

• Capital
• Machines/Buildings used to produce goods
• Interest used to describe the annual cost of
  money used to buy capital, and the annual returns
  to capital.
• Land
• Rent used to describe the annual returns to
  this factor of production.
• Crop rents paid to landowners.

3
What is Interest

• Can refer to the price for credit or loanable
  funds.
• The amount that you pay for the right to borrow
  money.
• Can refer to the return earned by capital as an
  input in the production process.
• The amount you get when you invest in something
  that provides a market return.

4
Loanable Funds Market Looks like any other
market.
Savings, newly created Money, bonds, etc.
Demand for loans, Consumer credit, Business
credit, Government demand etc.
Exhibit 4
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Loanable Funds

• Loanable Funds funds that someone borrows and
  another person lends, for which the borrower pays
  an interest rate to the lender.
• Loanable Funds Markets
• Your savings
• Business investments
• Credit cards
• School loans

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Risk, Loan Terms, and Cost of Making the Loan

• Risk positive relationship with interest rate.
• Credit reports provide information on risk based
  on past credit history.
• Term Length positive relationship with interest
  rate.
• If you agree to pay off the loan earlier, and
  hence accept a higher payment, you can get a
  lower interest rate
• Home mortgage ARM (3 7 year fixed)
• Cost of Making the Loan higher the cost per
  dollar of loan, the higher the interest rate.

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Nominal and Real Interest Rates

• Nominal interest rate
• Not adjusted for inflation
• determined by supply and demand
• equals real rate plus expected inflation.
• Real interest rate
• adjusted for expected inflation
• nominal rate minus expected inflation
• matters most to borrowers and lenders
• Inflationary expectations can shift the supply
  and demand for loanable funds

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Exhibit 2 Expected Inflation and Interest Rates
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Economic Rent payment in excess of opportunity
costs.
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Example of Delaware County
Predicted Days to Development
Average time to Conversion 12.3 years
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Whats the value of this land?
Development Value for Ag Land in DE

• Analyze 4800 house
• sales 1996 1998.
• Estimate the value of
• land for houses
• Project the value onto
• undeveloped sites

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Developed Land Supply Curve for Delaware County (
2000)
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How can we use this data?The Cost of
Preservation
Category Acres Millions All Agricultural
Land 178,566 849.9 Predicted Years to Devel.
lt 4 41,989 276.2 Within 0.1 mile of
stream 15,808 69.2 Within 0.1 mile of stream
and less than 4 years predicted Time to
Development 3,863 25.1
2
3
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Other applications Farms or Forests?
Olson, 1981 Prentice and Haxeltine, 1996
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Projecting Future TrendsAnalysis with Global
Land Use Model
Forest Loss (2005 2105) 430 Million ha (358
495 M ha) Carbon Loss (2005 2105) 64 Pg
(54 71 Pg)
Sohngen and Sedjo (2005) Sohngen and Mendelsohn
(2005)
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Comparison of Forestland Supply Functions.
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Economic Rent and Other Factors

• The concept of economic rent applies to economic
  factors besides land. An example is labor.
• Economic rent differs depending on the
  perspective from which the factor is being viewed.

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Profit

• The profits that appear in newspaper headlines
  are accounting profits, not economic profits.
• Economic Profit the difference between total
  revenue and total cost, where both explicit and
  implicit costs are included in total cost.

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Theories of Profit Profit and Uncertainty

• Uncertainty when a potential event is so
  unpredictable that a probability cannot be
  estimated.
• Risk when the probability of a given event can
  be estimated.
• Risks can be insured against, while uncertainties
  cannot.
• The investor-decision maker who is adept at
  making business decisions under conditions of
  uncertainty makes a profit.

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Theories of Profit

• Profit and Arbitrage Opportunities Buy Low,
  Sell High. Profit is the return to taking
  advantage of arbitrage opportunities.
• Profit and Innovation Profit is the return to
  the entrepreneur as innovator.

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Profit and Loss as Signals

• Profit and loss signal
• how a market may be changing.
• entrepreneurs to move resources into a product or
  service which earns profits.
• entrepreneurs to move resources out of a product
  or service which generates losses.

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Present Value

• Present Value refers to the current worth of some
  future dollar amount.
• PV An / (1i)n

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Deciding Whether to Purchase A Capital Good

• Business firms often compute present values for
  investment decisions.
• At lower interest rates, present values increase
  and firms buy more capital goods
• At higher interest rates, present values decrease
  and firms will buy fewer capital goods