Interest and its types



Generally, interest refers to the payment made by a borrower of the fund to the lender for the use of the fund in a specific time period. In economics, interest is the price paid for the use of the borrowed fund to spend on the purchase of capital assets used in production.

According to J. M. Keynes, “Interest is the reward for parting with liquidity for a specific period of time.”

According to Seligman, “Interest is the return from the fund of capital.”

There are two concepts of interest which are explained as follows:-

1. Gross interest:-

Gross interest is the total amount paid by a borrower to the moneylender in return of the capital borrowed for a period of time. It is also known as total interest. The gross interest that a lender receives is the aggregate of net interest and other charges. Net interest is the price paid by a borrower to the lender only for the use of capital. Other charges include the returns for risk, returns for management and inconvenience charges. Thus, the addition of net interest, return for risk, return for management and the return for inconvenience is gross profit.

2. Net interest:-

The term interest in economics does not refer to the gross interest but to the net interest. Net interest is also known as pure interest. It is the price paid only for the use of capital or money. Net interest is that part of the gross interest which is exclusively paid for the use of capital. Net interest is normally the same during a period of time in a different market. In order to calculate the net interest, the payments for risk, management, and inconvenience are to be deducted from the gross interest.

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