Re: Example economic rent calculation
- From: jim_bowery@xxxxxxxxxxx
- Date: 24 Oct 2005 16:47:37 -0700
So how would you rewrite the following Wikipedia article?
http://en.wikipedia.org/wiki/Economic_rent
In economic theory, economic rent is an analytic term employed to
distinguish the difference between the income earned by an input or
factor of production, and the cost of the factor of production. A
factor of production can be put to various and alternative economic
uses; the income earned by (or price paid for) a factor in its current
use may be more than what is minimally necessary to draw the factor
into its current use; one can imagine the price paid for the factor
falling to a level at which the factor would be transferred to its next
best use -- that price, the income earned in its next best use, is the
opportunity cost of the factor. The difference between the opportunity
cost and the income earned in its present use is a rent.
Economic rent is distinct from economic profit, which is the difference
between the firm's costs -- what the firms pays for all the inputs it
uses -- and the firm's revenues. While the definition of "economic
profit" is a strict one, which excludes rents, the commonsense idea of
profit often confounds rents with profits. Real business enterprises
typically own some of the factors of production, which they use to
produce goods and services for sale, meaning that the business
enterprise receives the income due to those factors of production, in
addition to whatever economic profit the enterprise might earn. The
commonsense idea of a highly profitable firm is typically a firm, which
owns factors of production, which earn a high rent in the use to which
the firm puts them -- a farm, which owns highly productive farmland or
a merchant, who owns a highly productive retail location, might be
thought "profitable" in the common sense of the term, profit, because
the firm is receiving a large rent on the factor of production, which
it owns.
In classical economics, analysis focused on three factors of production
-- land, labor and capital -- each of which earned a distinct type of
income -- rent, wages and interest, respectively. These three
categories or types were used to explore what determined the
distribution of income. It was observed that higher wages or higher
interest rates might be expected to draw additional labor or capital to
market, but higher rents did not induce God to make any more land; the
owners of land rented or made useful all the land they had, regardless
of the going rent. Still, some land commanded considerably higher rents
than other land. Since only a minimal rent was necessary to bring land
into some kind of productive use, almost all of any rent earned must be
attributed to market competition to determine how land was to be
allocated to particular uses.
Virtually all of rent -- the income earned by land -- could be assigned
to the allocative function of market prices, while only a portion of
wages (the income earned by labor) or interest (the income earned by
capital) could be attributed to allocation, since wages and interest
also serve to draw these factors into productive use. 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 high rents, which determined that land in
a central city, for example, would not be allocated to farming, but
would be allocated instead to high-value residential or commercial
uses.
Special attributes of a particular piece of land, which made it
especially productive for a particular use, might also drive up the
rent. Highly productive agricultural land might be highly productive
because of its fertility, or special suitability to a particular crop,
as well as being well-situated in relation to transportation and access
to markets. Rent attributable to special variations in resource quality
are sometimes called Ricardian rents.
One implication of the classical analysis is that while a tax on wages
or interest income would affect the quantity of labor or capital
offered to productive use, almost the whole of land rent could be taxed
away without affecting the quantity of land on offer. Henry George,
seeing that a properly designed tax on land rent would have none of the
efficiency-reducing distortive effects of other taxes, advocated a
single-tax on land, as a way of financing government.
To Karl Marx, this land-rent was seen as a form of exploitation.
Land-owners were able to get "something for nothing" just because they
controlled such important natural resources. To Marx, the land-owners
received a part of capitalist society's surplus-value that was
redistributed from the industrial sector, where workers produced it.
Returns to sunk cost investments in specialized capital equipment have
some of the same qualities as land rent, in that, once the sunk cost
investment in specialized equipment is made, the price necessary to
bring the captital equipment into the use for which it was designed may
be much less than would be necessary to repay the original cost of
investment. The difference between the amount necessary to bring a sunk
cost investment into productive use and the amount actually earned has
been termed a quasi-rent. It is not a true rent, because there would
have to be an expectation of earning back the original investment in
order to induce the original investment, and, if the original
investment was not repaid, the specialized asset may be allowed to wear
out, without repair or replenishment, in such use as could be obtained.
Nevertheless, the existence of quasi-rents can create paradoxical
situations. A railroad, for example, consists of large, sunk cost
investments in right-of-way, rail and rolling stock, with the objective
of being able to transport people or goods at a very low variable cost.
The alternative uses of the specialized capital stock of a railroad,
for other than railroading, are, typically, few and poor. Once the sunk
cost investment is made, it is in the interest of the railroad to
accept shipments at rates, which cover the low variable cost, even when
the rate does not offer an adequate return on the sunk cost investment
in right-of-way, rail and rolling stock.
Modern neoclassical economics has generalized the concept of rent to
suggest that the owner of any kind of input can receive income for that
input, in excess of what is necessary to put the factor into a
particular productive use. The rent, in this conception, is the
difference between what is paid and the opportunity cost, represented
by the income available in the next, best use of the factor.
Rent can be viewed as an estimate of how much market prices for an
input would have to change, before the allocation of that particular
input would change. How much would the price of maize have to fall
relative other crops, before a given field would be planted in rice or
potatoes or alfalfa or some other crop instead of maize? A field
particularly well-suited to maize, but not other crops, could be said
to be earning a rent as a maize field, to the extent that the amount
actually earned as a maize field exceeded the absolute minimum amount
necessary to allocate the field to maize, as opposed to its next best
use, i.e. its opportunity cost.
As another example, an excellent professional basketball player
typically earns much more income than is necessary to compensate him or
her for the training, effort, practice, and the like needed to become a
player. In the presence of the productivity enhancing effects of large
arenas and television broadcasting, which allow team owners to sell the
right to view games to very large numbers of customers, a few highly
talented basketball players compete for a relatively few, highly
compensated slots on pro teams. The difference between the amount of
money putatively needed to get a Michael Jordan to play basketball at
all, and the amount actually paid Michael Jordan to play for the
Chicago Bulls, may be termed a rent.
The generalization of the concept of rent to include quasi-rents and
returns above opportunity cost has served to highlight the role of
barriers to competition in determining and creating rents. A person
seeking to become a medical doctor makes a huge sunk cost investment in
medical training and education, which has limited potential application
outside of medical practice. In a competitive market for medical
services, a doctor's wages would be bid down, until the expected net
return on the sunk cost investment in training would be near zero, that
is, barely enough to justify making the investment. In a sense, the
required investment becomes a barrier to entry, discouraging would-be
doctors from making the necessary investment in training to enter the
competitive market for medical services, when the return on the
necessary sunk cost investment is competed away. Restrictions on the
numbers of people entering into the competitive market for medical
services, however, would have the effect of raising the return on
investments in medical training, without increasing the number of
entrants to the market. Associations of doctors have been known to
lobby government to limit, in various ways, the number of medical
schools training medical doctors and the number of medical students at
those institutions. This kind of political activity is sometimes
termed, rent-seeking, though the returns realized from such political
activities might be more akin to monopoly profits than rents, as
generally conceived. Monopoly profits are sometimes called monopoly
rents.
[edit]
Two types of factor rent
* Classical factor rent -- This is the return to a factor above and
beyond the amount necessary to induce the supplier to offer the input
to the market. This corresponds to the notion of a producers' surplus
or "scarcity rent." This type of economic rent arises because of
scarcity in the supply of inputs. If factor supply is perfectly
elastic, there would be no producers' surplus and no economic rents.
* Paretian factor rent - This is the return to a factor above and
beyond the amount that the factor supplier would receive in its
next-best alternative use. This type of economic rent draws on the
notion of opportunity costs. For example, if someone is earning $20,000
for a job, and the next best job pays $15,000, then the economic rent
is the difference between the two: $5,000.
[edit]
See Also
* list of economics topics
* Quasi-rent
* Rent-seeking
* Hotelling rent
* Ricardian rent
* von Thünen rent
.
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