jmherbenerEvery exchange of present money for future money commands the pure rate of interest. Whether its a consumer loan, the a corporate bond, or the buying of inputs to produce outputs.
An entrepreneur’s Net Income, which is the difference between the cost of buying his inputs and the revenue from selling his outputs includes (but is not limited to) a rate of return that conforms to the rate of interest. The capitalist earns the same rate of interest for lending his present money regardless of what use the borrower has for the funds, e.g., buy a house, build a factory, purchase inputs. This is no different than a steel producer who gets the same price for steel regardless of the use the buyer has for it, e.g., building a building, making a car, producing precision medical instruments. Now there are different prices for different types and qualities of steel, but each unit of a particular type that has a particular quality sells for the same price. Likewise, each unit of present money for the same maturity and same uncertainty (e.g., the uncertainty concerning the likelihood of the payoff) will receive the same rate of interest.
Suppose the production of cotton in America in 1830 is in a maturity and uncertainty class of investments that earns a rate of return of 7%. Also, different land areas (e.g., Louisiana, South Carolina) and different organizational structures (e.g., large plantations with slaves, small farms without slaves) have different physical productivity. If one alternative earned 10% and another 5%, then capitalists would shift their investment funds to the 10% return alternatives and out of the 5% return alternatives. By doing so, they would push up the prices of inputs (in particular, land) in the higher return areas and push down the prices of inputs in the lower return areas. They would continue to shift their investments until the rate of return was a uniform 7% of all investments in that class.
But just as credit card interest rates are permanently above mortgage rates, the rate of return on some investments in production will be higher than the rate of return on other investments. This occurs because investors do not find it advantageous to arbitrage across this difference. They don’t find it advantageous because there are different classes of investments, some with investments have longer time horizons and greater uncertainty than others.