Interest versus Profit

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  • Post category:Economics

Suppose Jane spends $10,000 in January on a plot of land containing young Christmas trees. She doesn’t need to spend any more money, she just has to wait until December when she will sell 100 mature trees for an average of $30 apiece. She will then sell the land for $7,300, meaning she would turn her original investment into $10,300. Can we say that the Chrismas tree venture was profitable?

Before answering the question, we need to consider interest payments. If she originally borrowed the $10,000 from someone at a 5% annual interest rate, then she actually lost all the money and owes the lender $200.

Even if she used her own funds, most economists would still say she lost money on the deal, if alternative investments yielded a rate of return higher than the implicit 3% return in the Christmas tree business. For example, if she could have invested her savings into a 12-month corporate bond yielding 5% and the investment was at least as safe as investing into a crop of Christmas trees, then she would be $200 poorer if she invested the money in the land with the Christmas trees.