The psychological theory of interest was propounded by John Rae in 1834. But credit goes to Bohm Bawerk an Austrian School economist who has given final shape to the theory. The American economist Irving Fisher modified and gave a new theory viz Time Preference theory. According to this theory, people prefer present goods rather than future goods. Because the present goods are more certain than future goods, just" as a bird in the hand is worth two in the bush". There are many countries where no one knows what will happen next day. ASEAN crisis of 1996 and American crisis of 2007-08 were not predicted even for economists, including Nobel Laureats. So, when people save they have to postpone their present enjoyment or satisfaction. If one postpones one's present satisfaction, one has to be paid an 'Agio' or 'Premium'. This premium is 'interest'. People prefer present consumption than future consumption due to the risk increasing and uncertainties of the present world.

This theory was first propounded by Adam Smith. But the credit goes to J.S.Mill who perfected this theory.
According to Mill "every employer will keep a given amount of capital for payment to the workers". It is known as 'Wage Fund'. It is fixed and constant. Wages depend directly upon the fund and inversely with number of labourers employed.
The average wage of a worker can be calculated by using the formula.
Average wage per worker =\(\frac{Total \ Wage \ Fund}{Number \ of \ Workers}\)
If the number of workers increases, the wage per worker would fall and vice versa.
Criticisms:
(i) It does not explain the difference in wages in different occupations.
(ii) It ignores the role of trade unions.
(iii) Actually the capitalists will take away a large sum before making payment of wages.

1. The transaction Motive
2. The precautionary Motive
3. The speculative Motive

(i) According to Hawley profit is the reward for risk taking in business.
(ii) Every business involves some risks. Since the entrepreneur undertakes the risks, he receives profit.
(iii) If the entrepreneur does not receive the reward, he will not be prepared to undertake the risks
(iv) Thus higher the risks, the greater are the profit.
(v) Every entrepreneur produces goods in anticipation of demand.
(vi) If his anticipation of demand is correct, then there will be profit.
(vii) It is the profit that induces the entrepreneur to undertake such risks.

(i) According to Schumpeter profit is the reward for innovation.
(ii) Innovation means invention put into commercial practice.
(iii) Innovation may consist of introduction of a new product or a new method of production or opening a new market or discovery of new raw materials or reorganisation of an industry.
(iv) The cost of production decreases and so profit increases.
(v) Innovation should be done continuously.

(i) According to Clark profit is the difference between price and cost of production.
(ii) Profit is the reward for dynamic changes in society-like increase in population, increase in volume of capital, improvement in methods of production, change in forms of industrial organisation and increase in wants of consumers.

(i) Wage is equal to the subsistence level of the labourer ie the minimum amount of food, clothing & shelter which workers & their family require for existence
(ii) If workers are paid higher wages than the subsistence level, the workers would be better off & so population increases.
(iii) So wages come down & vice versa.
(iv) So wages should not be above or below the subsistence level of the labourer.

SI.No	Rent	Quasi Rent
1	Rent accrues to land	Quasi - Rent accrues to man made appliances
2	The supply of land is fixed forever.	The supply of man made appliances is fixed for a short period only.
3	It enters into price.	It does not enter into price.
4		It is temporary.

Nominal wage or money wage:
It is paid in terms of money.
Real wage:
The wages are paid in terms of goods & services
Piece wage:
The wages are paid on the basis of quantum of work done.
Time wage:
The wages are paid on the basis of the amount of time that the worker works.

Transaction motive:
(i) The desire of the people to hold cash for the current transactions.
(ii) The amount kept for this motive depends on the income. M_t = f(y)
Precautionary motive:
(i) The desire of the people to hold cash to meet unexpected expenditure such as sickness, accidents.
(ii) The amount for this purpose depends on income. M_p = f(y)
Speculative motive:
(i) The desire of the people to hold cash in order to take advantage of the future changes in price of bonds and securities.
(ii) The amount for this purpose depends on the rate of interest. M_s = f(i)