Land is completely fixed in total supply. As population expands and the demand for land increases rent first appears and then grows. From society's 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 which must be covered by the revenue gained through the sale of the commodities produced on that land.

Supply is upsloping because households prefer present consumption to future consumption and must be enticed through higher interest rates to save more (consume less) now. The higher the interest rate the greater the saving and the amount of money made available to the loanable funds market. Demand is downsloping because more business investment projects become profitable as the cost of borrowing (the interest rate) falls. The equilibrium interest rate is the rate at which the quantities of funds supplied and demanded in the loanable funds market are equal. Anything that changes the supply of loanable funds or the demand for loanable funds will change the equilibrium interest rate. Two examples: Higher taxes on interest income would reduce the supply of loanable funds and increase the equilibrium interest rate; a decrease in business optimism would reduce the expected return on investment decrease the demand for loanable funds and reduce the equilibrium interest rate.

The nominal interest rate is the interest rate stated in dollars of current value (unadjusted for inflation). The real interest rate is the nominal interest rate adjusted for inflation (or deflation). The real interest rate is more relevant for making investment decisions -- it reflects the true cost of borrowing money. It is compared to the expected return on the investment in the decision process. Real interest rate = 4 percent (= 12 percent - 8 percent).

Accounting profit is what remains of a firm's total revenues after it has paid for all the factors of production employed by the firm (its explicit costs) but not for the use of the resources owned by the business itself. Economists also take into consideration implicit costs -- the payment the owners could have received by using the resources they own in some other way. The economist adds these implicit costs to the accountant's explicit costs to arrive at total cost. Subtracting the total cost from total revenue results in a smaller profit (the economic profit) than the accountant's profit.

Sources of economic profit: (1) uninsurable risks; (2) innovations; and (3) monopoly.

(a) Profit from assuming uncertainties of innovation as well as monopoly profit from the patent. (b) Monopoly profit arising from its locational advantage. (c) Profit from bearing the uninsurable risk of a change in demand (the change could have been unfavorable).