Economic rent

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In economics, economic rent is any payment to a factor of production in excess of its opportunity cost. Economic rent should not be confounded or confused with opportunity cost, producer surplus, or normal profit in that all of these other terms involve productive human action. Economic rent is the cost of non-produced inputs or advantages; the result of natural or contrived exclusivity.

In regard to labor, economic rent could be created by the existence of guilds or labor unions (e.g., higher pay for workers, where political action creates a scarcity of such workers); for a produced commodity, economic rent may also be due to the legal ownership of a patent (a politically enforced right to the use of a process or ingredient); for operating licenses, it is the cost of permits and licenses that are politically controlled as to their number regardless of competence and willingness of those who wish to compete in the area being licensed; for most other production including agriculture, and extractions, economic rent is due to scarcity of natural resources (e.g., land or minerals). When economic rent is privatized, the recipient of economic rent is referred to as a rentier.

By contrast, in production theory, if there is no exclusivity and there is perfect competition, there are no economic rents, as competition drives prices down to their floor.[1][2]

Economic rent is different from other unearned and passive income, including contract rent. This distinction has important implications for public revenue and tax policy.[3] [4][5] As long as there is sufficient accounting profit, governments can collect a portion of economic rent for the purpose of public finance. For example, economic rent can be collected by a government as royalties or extraction fees in the case of resources such as minerals and oil and gas. Historically, theories of rent have always applied to rent received by different factor owners within a single economy. Hossein Mahdavy was the first to introduce the concept of "External rent" whereby one economy received rent from other economies.[6]

Definitions[edit]

According to Robert Tollison (1982), economic rents are "excess returns" above "normal levels" that take place in competitive markets. More specifically, it is "a return in excess of the resource owner's opportunity cost".[7]

Henry George, best known for his proposal for a single tax on land, defined rent as "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."[8]

Professors of law Lucian Bebchuk and Jesse Fried define the term "to refer to extra returns that firms or individuals obtain due to their positional advantages."[9]

Economic rent simplified, is an excess where there is no enterprise or costs of production.

Classical factor rent[edit]

Classical factor rent is primarily concerned with the fee paid for the use of fixed (e.g. natural) resources. The classical definition is expressed as any excess payment above that required to induce or provide for production.

  1. "A payment for the services of an economic resource which is not necessary as an incentive for its production"[10] This can be simplified to when there is no enterprise given by the receiver of the economic rent.
  2. "Any payment that does not affect the supply of the input"[11] This can be simplified to when there are no costs of production by the receiver of the economic rent.
  3. "A payment to any factor in perfectly inelastic supply"[11]

Neoclassical Paretian rent[edit]

Neoclassical economics extends the concept of rent to include factors other than natural resource rents. But the labeling of this version of "rent" may be somewhat opportunistic or simply incorrect in that Vilfredo Pareto, the economist for whom this kind of rent was named, may or may not have proffered any conceptual formulation of rent.[12][13]

  • "The excess earnings over the amount necessary to keep the factor in its current occupation"[14]
  • "The difference between what a factor of production is paid and how much it would need to be paid to remain in its current use"[15]
  • "A return over and above opportunity costs, or the normal return necessary to keep a resource in its current use"[16]

Monopoly rent[edit]

Some returns are associated with legally enforced monopolies like patents or copyrights. In addition, companies like Microsoft and Intel have important de facto monopolies that can be quite valuable. The American Medical Association has traditionally regulated the number of students each US medical school can graduate, and has been accused of maintaining the high income of doctors by restricting the supply of new doctors.[17] Some businesses like public utilities are by their very nature monopolies. George Stigler estimated the impact of rents from non-labor monopolies on the US economy to be fairly low.[citation needed]

Land rent[edit]

In political economy including physiocracy, classical economics, and other schools of economic thought, land is recognized as an inelastic factor of production. Rent is the distribution paid to freeholders for "allowing" production on the land they control.

"As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land ...."

David Ricardo is credited with the first clear and comprehensive analysis of differential land rent and the associated economic relationships (Law of Rent).

Johann Heinrich von Thünen was especially influential in developing the spatial analysis of rents, which highlighted the importance of centrality and transport. Simply put, it was density of population increasing the profitability of commerce and providing for the division and specialization of labor that commanded higher municipal rents. And the high rents determined that land in a central city would not be allocated to farming, but would be allocated instead to more profitable residential or commercial uses.

Observing that a tax on the unearned rent of land would not distort economic activities, Henry George proposed that publicly collected land rents (land value taxation) should be the primary (or only) source of public revenue; though he also advocated public ownership, taxation and regulation of natural monopolies and monopolies of scale that cannot be eliminated by regulation.

Hypothetical example[edit]

The generalization of the concept of rent to include opportunity cost has served to highlight the role of political barriers in creating and privatizing rents. For example, a person seeking to become a member of a medieval guild makes a huge investment in training and education, which has limited potential application outside of that guild. In a competitive market, the wages of a member of the guild would be set where the expected net return on the investment in training would be just enough to justify making the investment. In a sense, the required investment is a natural barrier to entry, discouraging some would-be members from making the necessary investment in training to enter the competitive market for the services of the guild. This is a natural "free market" self-limiting control on the number of guild members and/or the cost of training necessitated by certification. Some of those who would have opted for a particular guild may well decide to choose a different guild or occupation.

However, a political restriction on the numbers of people entering into the competitive market for services of the guild has the effect of raising the return on investments in the guilds training, especially for those already practicing, by creating an artificial scarcity of guild members. To the extent that a constraint on entrants to the medieval guild actually increases the returns to guild members as opposed to ensuring competence, then to that extent the practice of limiting entrants to the field is a rent seeking activity, and the excess return realized by the guild members is economic rent as defined.

Terminology relating to rent[edit]

Gross rent
Gross rent refers to the rent paid for the services of land and the capital invested on it. It consists of economic rent, interest on capital invested for improvement of land and reward for risk taken by the landlord in investing his capital.
Scarcity rent
Scarcity rent refers to the price paid for the use of the homogeneous land when its supply is limited in relation to demand. If all units of land are homogeneous, but demand exceeds supply, the entire land will earn economic rent by virtue of its scarcity.
Differential rent
Differential rent refers to that rent, which arises owing to differences in fertility of land. The surplus that arises due to difference between the marginal and intra-marginal land is the differential rent. It is accrued generally under extensive cultivation of land. The term was first stated by David Ricardo.
Contract rent
Contract rent refers to that rent which is mutually agreed upon between the land-owner and the user. It may be equal to the economic rent of the factor.
Information Rent
The Rent an agent derives from having information not provided to the principal.

See also[edit]

References[edit]

  1. ^ "Economics A-Z terms beginning with R". The Economist. 
  2. ^ What is Economic Rent?
  3. ^ Kittrell, Edward R. (1957). "Ricardo and the Taxation of Economic Rents". The American Journal of Economics and Sociology 16 (4): 379–390. doi:10.1111/j.1536-7150.1957.tb00200.x. JSTOR 3484887. 
  4. ^ Goode, Richard B. (1984). Government finance in developing countries. Brookings Institution Press. ISBN 978-0-8157-3195-5. Retrieved 2010-05-27. 
  5. ^ Hammes, John K (1985). "Chapter 6 - Economic Rent Considerations In International Mineral Development Finance". Finance For The Minerals Industry. AIME. ISBN 0-89520-435-5. Retrieved 2010-07-18. 
  6. ^ Hossein Mahdavy, "The Pattern and Problems of Economic Development in Rentier States: The Case of Iran", in Studies in the Economic History of the Middle East, ed. M.A. Cook (Oxford University Press, Oxford, 1970)
  7. ^ Tollison, Robert D (1982). "Rent seeking: A Survey". Kyklos 35 (4): 575–602. doi:10.1111/j.1467-6435.1982.tb00174.x. Retrieved 2010-07-21. 
  8. ^ George, Henry (1880). "Chapter 11 The Law of Rent". Progress and Poverty (4 ed.). Robert Schalkenbach Foundation 2006. ISBN 0-665-09522-8. 
  9. ^ Pay Without Performance — the Unfulfilled Promise of Executive Compensation, by Lucian Bebchuk and Jesse Fried, Harvard University Press, 2004, (p.62)
  10. ^ "Definition of economic rent". HighBeam.com: Online Dictionary (www.highbeam.com). 2001-01-01. Retrieved 2010-05-27. 
  11. ^ a b Wessels, Walter J. (2000). "Chapter 27 Economic Rents". Economics (3 ed.). Barrons Educational Series Inc. p. 479. ISBN 0-7641-1274-0. 
  12. ^ Bird, Ronald; Tarascio, Vincent J (1999). "Paretian Rent versus Pareto's Rent Theory : A Clarification and Correction". In John Cunningham Wood and Michael McLure. Vilfredo Pareto: critical assessments of leading economists 2. Routledge (Taylor & Francis Group). p. 474. ISBN 0-415-18501-7. 
  13. ^ Foldvary, Fred E. (Jan 2008). "The marginalists who confronted land". The American Journal of Economics and Sociology. 
  14. ^ Shepherd, A. Ross (1970). "Economic Rent and the Industry Supply Curve". Southern Economic Journal 37 (2): 209–211. doi:10.2307/1056131. JSTOR 1056131. 
  15. ^ "Definition: economic rent". Research Tools Economics A–Z (The Economist (economist.com)). Retrieved 2010-05-27. 
  16. ^ Morton, John S.; Goodman, Rae Jean B. (2003). "The Story of Economic Rent: What do Land, Athletics and Government have in Common". Advanced Placement Economics (3 ed.). National Council on Economic Education. p. 266. ISBN 1-56183-566-8. 
  17. ^ Berlant, Jeffrey (1975). Profession and Monopoly: a study of medicine in the United States and Great Britain. University of California Press. ISBN 0-520-02734-5. 
  18. ^ "Wealth of Nations B.I, Ch.6, Of the Component Parts of the Price of Commodities"

External links[edit]