15. Markets for the Factors of Production
Other Factors of Production: Land and Capital
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In microeconomics, how are lenders compensated for the opportunity cost of giving up current consumption when they loan funds?
A
By receiving interest payments, which are the price of borrowing funds over time
B
By receiving economic rent, which is the payment to land in excess of its opportunity cost
C
By receiving dividends, which are payments tied to ownership of equity rather than lending
D
By receiving depreciation allowances, which compensate owners of physical capital for wear and tear
Verified step by step guidance1
Understand the concept of opportunity cost in microeconomics: it refers to the value of the next best alternative foregone when making a decision. Here, lenders give up current consumption to lend funds, so their opportunity cost is the value of what they could have consumed now instead of lending.
Identify how lenders are compensated for this opportunity cost. Since they are postponing their consumption, they require some form of payment that makes lending worthwhile compared to consuming immediately.
Recall that interest payments represent the cost of borrowing money over time. For lenders, interest is the return they receive for deferring consumption and taking on the risk of lending.
Differentiate interest payments from other forms of payments: economic rent relates to land, dividends relate to equity ownership, and depreciation allowances relate to physical capital wear and tear. These do not compensate lenders for opportunity cost in lending.
Conclude that lenders are compensated by receiving interest payments, which serve as the price of borrowing funds over time and cover the opportunity cost of giving up current consumption.
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