In a mythical world of zero interest, the perpetual $100 rents from this land-site would no longer need to be discounted for interest, so that the value of the site would become (if such a thing were possible) infinite. Land-sites, in other words, would be valued more highly than anything else in reality by human beings. This conclusion obviously clashes with common sense—but then, so does the notion of a zero interest rate. This hypothetical example merely reinforces our previous conclusion (p. 4.7:2) that time preferences, which give rise to interest rates, are inherent in our understanding of human action.

What determines the price of a durable consumers' good, such as a house? On the one hand, the price of a house, like any consumers' good (in a risk-free market), approaches its marginal cost of production. If the monetary value of the use of the house for a fixed period is its rent, then its market value will also tend to equate to the sum of its discounted rents over the life of the house, together with rents on the lot on which it stands to perpetuity. Thus prevailing market rents are not set arbitrarily by landlords or anyone else, but stand in a natural mathematical relationship to the capital values of rental houses. If market rents vary temporarily above or below the point determined by this relationship, then investors will maximize their utility by bringing new property into the rental market or withdrawing such property, until equilibrium is restored. Because the capital value of a house approaches the sum of its discounted rents, real estate values are highly sensitive to interest-rate fluctuations. If interest rates rise, market values are discounted to a greater degree and hence become significantly lower.