What Is Economic Rent?
Economic rent is any additional payment made to a factor of production, over and above the amount needed for bringing that factor into production. Classical economic theory dictates that any payments made for non-production related items, such as the location of a business (land) or assets received by those with political power (e.g., patents), are considered economic rent.
Economic rent is the difference between the amount of money paid to a factor of production and the amount of money that would have to be paid to keep that factor in its current position. In other words, it is the cost of using a resource beyond the amount necessary to keep that resource in its present state.
Economic rent can be found in both the labor market and the housing market. In the labor market, economic rent is the difference between what a worker is paid and what that worker would be willing to accept in order to do the same job. In the housing market, economic rent is the difference between the amount of money paid for a home and the amount of money that would be necessary to keep that home in its current state.
Let’s have a look at some of the definitions of economic rent given by economists
According to neoclassical economists
Economic rent is income in excess of opportunity cost or competitive price.
As per Robert Tollison’s (1982) Definition
Economic rents are “excess returns” above the “normal levels” that are generated in competitive markets. More specifically, a rent is “a return in excess of the resource owner’s opportunity cost.
Best known for his idea of a single tax on land, Henry George said
Economic rent is the part of the produce that accrues to the owners of land (or other natural capabilities) by virtue of ownership” and as “the share of wealth given to landowners because they have an exclusive right to the use of those natural capabilities.
Lucian Bebchuk and Jesse Fried, law professors, define the term as
Extra returns that firms or individuals obtain due to their positional advantages.
Understanding Economic Rent
The owner’s economic rent is the difference between the amount of money paid to the owner of a good or service and the opportunity costs incurred by the payer. Economic rent is also sometimes called “unearned income. In his book Progress and Poverty, Henry George, an American political economist argued that rent was the key to understanding economic inequality.
George believed that rent was the result of market forces, and that it was unfair because it represented an unearned income for the owner of land or other resources. George’s ideas influenced the development of the Henry George Foundation, a non-profit organization dedicated to promoting his economic theories.
Rent-seeking is another term for economic activity that is aimed at capturing economic rent. This activity can take many forms, but it typically involves attempts to influence the price paid for a good or service or to change the regulatory environment in a way that benefits the rent-seeker at the expense of others. Economic rent plays a significant role in many industries, and rent-seeking is a major source of economic inequality.
Economic Rent Formula
Economic Rent = Agreed Price – Free Market Price
By subtracting the free market price from the agreed cost of a factor of production, according to the formula, one can calculate economic rent. The price that is negotiated between the buyer and producer is known as the agreed price. In addition, the free market rate is defined as being equal to the producer’s supply in a competitive market.
- Economic Rent and Salaries: Economic rent can be generated in the labor market by employees who have specialized skills or knowledge that are not easily replicated. For example, a software engineer with experience coding in a specific programming language may be able to command a salary that is higher than the free-market price for her services because her skills are in high demand and not easy to replace.
- Economic Rent and Labor: Economic rent can also be generated by workers who are able to sell their labor for more than the free-market price. For example, a construction worker who is willing to work for $10 per hour may be able to find a job that pays $15 per hour because there is a shortage of workers with his skills.
- Economic Rent and Facilities: Economic rent can be generated by businesses that are able to use their facilities to produce goods or services at a lower cost than their competitors. For example, a factory that is located near a port may have an advantage over other factories that are located further away from the port because it can receive raw materials and ship finished products more quickly and cheaply.
Economic rent can also be generated by businesses that have unique access to scarce resources. For example, a company that has the only gold mine in a country may be able to charge higher prices for its gold than companies that must purchase gold on the open market.
How is Economic Rent Used?
Economic rent is often used as a measure of market power. For example, if a company is able to charge higher prices for its products than its competitors, it may be said to have market power.
Economic rent can also be used as a measure of monopoly power. For example, if a company has a monopoly on the production of a good or service, it may be able to charge higher prices than companies that compete in a market with multiple producers.
Economic rent can also be used to measure the success of a company in exploiting its position in the market. For example, if a company can generate economic rent by selling its products for more than the free-market price, it may be said to have been successful in exploiting its market power.
Economic rent can be used to determine how effective a market is. If economic rent exists in a market, it means that the market isn’t perfectly competitive. It can also help in measuring the welfare of society. For example, if economic rent exists in a market, it may be said that the market is not entirely efficient and that there are potential benefits to be had from trade.
Different forms of Economic Rent
- Contract rent: Economic rent arises due to a contract between two or more parties is contract rent. Contract rent is an umbrella term for a situation in which two parties agree to mutually beneficial terms, but over time, outside conditions change and grant one party an unequal advantage, often to the detriment of the other party. The most common examples are employment contracts, leases, and athlete-team contracts.
- Monopoly rent: A monopoly is an enterprise that is the only seller of a good or service. Economic rent arises due to monopoly power is monopoly rent. In a monopoly market, the firm faces no competition and can charge any price it likes for its product. The firm will continue to produce and sell its product as long as the price charged covers the marginal cost of production. Monopoly rent is the difference between the price charged by a monopoly firm and the marginal cost of production.
- Differential rent: Differential rent arises due to differences in the quality or location of a good or service is differential rent. Differential rent arises because some goods or services are more desirable than others. For example, a prime piece of real estate in a major city will fetch a higher price than a similar piece of property in a rural area. Differential rent also arises because some goods or services are more difficult to produce than others. For example, a diamond is more difficult to produce than a piece of coal, and thus it will sell for a higher price.
- Scarcity rent: Economic rent that arises due to the scarcity of a good or service is scarcity rent. Scarcity rent arises because there are not enough a good or services to meet the demand from consumers. For example, if there are only 10 diamonds in the world and 100 people want to buy them, then the price of each diamond will be very high. Scarcity rent can also arise due to government restrictions on the production or sale of a good or service. For example, if the government imposes a quota on the number of cars that can be produced in a year, then the price of cars will be higher than it would be if there were no such restriction.
- Gross rent: Gross rent is the total amount of money paid by a tenant to a landlord for the use of a property. It includes any payments made for utilities, insurance, or other services that are provided by the landlord. Gross rent is usually calculated every month. Its example can be given as follows: Suppose a tenant pays $1,000 per month in rent, and the landlord charges an additional $100 per month for utilities. The gross rent would be $1,100 per month.
- Information rent: Economic rent that arises due to the possession of information is information rent. Information rent arises because some people have information that others do not have. For example, if I know that a particular stock is about to go up in value, I can buy it and sell it for a profit. The person who sold me the stock will have paid me the information rent.
- Classical rent (land rent): Economic rent that arises due to the ownership of land is classical rent or land rent. Land rent arises because the land is a fixed resource. This means that there is a limited supply of land, and it cannot be produced by human effort. As a result, the price of land is determined by the laws of supply and demand. If there is more demand for land than there is supply, then the price of land will go up. The owner of the land can then charge a higher rent to tenants.
- Neoclassical Paretian Rent: Economic rent that arises due to the presence of imperfect competition in a market is neoclassical Paretian rent. Neoclassical Paretian rent arises because imperfectly competitive firms can charge prices that are higher than the marginal cost of production. The extra profit that a firm makes due to its market power is called economic rent. Neoclassical Paretian rent is also sometimes called monopoly rent.
- Personal Economic Rent: Economic rent that arises due to the possession of personal skills or talent is personal economic rent. Personal economic rent arises because some people have skills or talents that others do not have. For example, I may be able to speak French fluently, while you may not be able to speak French at all. As a result, I can charge a higher price for my services as a translator. Personal economic rent can also arise due to luck or chance. For example, if I win the lottery, I will receive a large sum of money that I would not have otherwise had.
Economic Rent vs. Profit
Economic rent is different from profit. Profit is the difference between the total revenue of a firm and the total cost of production. Economic rent, on the other hand, is the difference between the price charged by a firm and the marginal cost of production. Thus, a firm can earn economic rent even if it is not making a profit.
Economic Rent and Economic Efficiency
Economic efficiency is the allocation of resources in such a way that maximizes the production of goods and services. Economic rent can be a source of economic inefficiency. This is because economic rent represents a transfer of income from one group to another.
For example, if I can charge a higher price for my services due to my possession of information, then I will earn more income than someone who does not have this information. This transfer of income from the person who does not have the information to the person who does have the information is inefficient.
Economic Rent and Equity
Economic rent can also be a source of inequity. This is because economic rent represents a transfer of income from one group to another. For example, if I can charge a higher price for my services due to my possession of information, then I will earn more income than someone who does not have this information. This transfer of income from the person who does not have the information to the person who does have the information is inequitable.
How Does Economic Rent Differ From Producer Surplus?
Producer surplus is the difference between the price of a good and the marginal cost of production. Economic rent, on the other hand, is the difference between the price of a good and the opportunity cost of production. The opportunity cost of production is the value of the next best alternative use of resources. Thus, economic rent includes producer surplus, but it also includes the opportunity cost of production.
Economic rent is a payment to a factor of production in excess of the amount needed to keep it employed. Economic rent arises when there is imperfect competition in the market for a good or service.
When there is perfect competition, all economic rent goes to the owners of the factors of production. When there is imperfect competition, some of the economic rent may be captured by the firm that has market power. Economic rent can also arise due to the possession of personal skills or talent.