Saturday, August 11, 2012

Class XI, Principles of Economics, "Interest, Gross Interest and Net Interest"


In ordinary language, interest refers to the excess amount, which is paid by the borrower above the amount borrowed after a given period of time usually a year to the lender at an agreed percentage. In economics the term interest refers to a return on capital only. Samuelson defines interest as

“The market rate of interest is that percentage return per year which has to be paid on any safe lone of money, which has to be yielded by any safe bond or other type of security, and which has to be earned on the value of any capital asset in any competitive market where are there are no risks or where all risks have already been taken care by special premium payments to protect against risk”.

It therefore can be said that interest in the price of services of capital in the production of wealth.

Gross Interest

The total amount which a creditor charges from a debtor by way of interest is really Gross interest. It includes the services payments of the capital and the cost of capital. The gross interest means the total amount which a debtor pays to the creditor and their Interest includes certain costs and expanses. Gross interest is composed of certain elements such as insurance against risk, return for inconvenience, wages of management etc.

Net Interest

Net interest is the amount, which is paid for the use of capital only as a factor of production. Net interest is rather the price of the productivity of capital. It is equal to the gross interest minus the cost of lending. Net interest is generally equals to the channels of lending.

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