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Interest | Meaning and Definitions of Interest

In the general sense interest is the payment to the leader by the borrower for taking the loan. It is Express as rate percent per annum. For example, if a person borrower Rs 100 and plays Rs. 5 per annum is the price of the loan, the rate of interest is 5% per annum. But in economics the meaning of interest is different. Interest is defined as the reward for the use of capital for investment.

Interest


Different economics have to Express different views regarding interest.

According to Prof. Wicksell

Interest is payment made by the borrower of capital by virtue of productivity as a reward for his (capitalist) abstinence.

According to Marshall

Interest is the price for the use of capital in any market.

Gross Interest and Net Interest

1. Gross interest

Interest is the total amount of interest that the lender receives from the borrower. The total payment made by the borrower to the leader on a certain amount of loan received for a period of time is known as gross interest. The payment made by the borrower to the lender is a composite payment. So, gross interest constitutes the following:

a. Net or pure interest: The payment made exclusively for the use of capital is called net or pure interest. It is paid to compensate the leader for allowing the borrower the use of his money for a certain fixed period.

b. Insurance against Risk: When a person lends, it runs the risk or loss of non-payment due to the failure of borrowers. The risk may be personal if the borrowers are dishonest or run away with the money without payment. So, borrowers charge an additional amount which is insurance against risk.

c. Payment of Inconvenience: The money of the lender is locked up for a fixed period. He cannot invest in other areas even if a good opportunity arises. He sir himself may have to borrow from others. He thus compensates himself by charging more than the net.

d. Administrative Cost: When a lender gives any amount of money to a borrower, he has to bear some amount in administrative work. For this, he needs an accountant, other staff, and stationery to keep records. This is the additional cost of the lender. So it is included in gross interest.

To sum up, Gross interest = Net interest + Payment for insurance against risk + payment of inconvenience + Payment for administrative cost.

2. Net Interest

Net interest is the price paid for the use of capital only. It is also known as pure interest. Net interest is only part of gross interest. So, the gross interest minus payment for risk, inconvenience, and management is net interest.

Net interest = gross interest - a payment on insurance agents risk - payment of inconvenience - payment for administrative cost.
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