Following this weeks theme of economics 101, today’s posting addresses three topics of interest to most readers of personal finance blogs. These topics are rent, interest and profits.
Rent: – No I’m not talking about the musical – I’m talking about defining rent as the price for the use of land or natural resources that are given and fixed in total supply. Rent is determined by the intersection between supply and demand. Since most land is in fixed supply – they aren’t making any more of it – rent values is often largely determined by demand.
Why does it make sense to think about rents? Well, if you are like us DINKs you might have a piece of investment property that you are renting out. Conversely, if you are a renter, it makes sense to know what’s impacting your payments. So, factors impacting rents, at least around the Washington DC area, are: interest rates, employment trends, neighborhood location and housing stock quality.
Interest: What is interest? Its batted around a lot in the media, but its often poorly defined. Interest is the price paid for the use of money or loanable funds. So, if the interest rate is 2.5% a year, for a $100 borrowed today, $102.5 will have to be repaid tomorrow.
A couple of interesting things about interest rates. First, they are impacted by supply and demand. Demand for loanable funds rises when people and firms need to borrow for housing, or to invest in inventory, etc. Supply, however is heavily determined by monetary policy – in the US by the Federal Reserve bureaucracy. The great thing about interest rates is they provide a market mechanism for money to be allocated to the most productive uses. Firms or individuals will usually only borrow if the return on investment exceeds the rate of interest of borrowed funds.
Profits: Profits are the excess of total revenues over total costs. In this case, costs are everything that goes into generating the profit, staffing time, labor, insurance, as well as environmental externalities, etc.
Where does profit come from? Sources of profit include the introduction of successful innovation, rewards for risk taking, monopoly power or undue collusion with government (think Halliburton no bid contracts). Generally speaking profit serves as incentive for innovation and shifts resources to commodities that society wants most.
Just to end this posting, supply and demand for rent, interest and profits don’t often operate as economists theorize. The real world is messy and involves layers of politics, psychology and sociology that can greatly impacts on market trends. This aside, a basic knowledge of these core concepts can help you better understand how markets – and accordingly how your personal situation is effected.
Best,
James
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