In economics, economic rent is any payment to a factor of production in
excess of the cost needed to bring that factor into production. In classical
economics, economic rent is any payment made or benefit received for
non-produced inputs such as location and for assets formed by creating official
privilege over natural opportunities. In neoclassical economics, economic rent
also includes income gained by beneficiaries of other contrived
exclusivity, such as labor guilds and unofficial corruption.
Economic rent should not be confused with producer surplus, or normal profit,
both of which involve productive human action. Economic rent is also
independent of opportunity cost, unlike economic profit, where opportunity cost
is an essential component. Economic rent should be viewed as unearned revenue,
whereas economic profit is a narrower term describing surplus income greater
than the next best risk-adjusted alternative. Unlike economic profit,
economic rent cannot be eliminated by competition, since all value from
natural resources and locations yields economic rent.
In regard to labor, economic rent can be created by the existence of guilds or
labor unions. For a produced commodity, economic rent may also be due to the
legal ownership of a patent. For operating licenses, it is the cost of
permits and licenses that are politically controlled as to their
number, regardless of the competence and willingness of those who wish to compete
in the area being licensed. For most other production, including agriculture
and extraction, economic rent is due to a scarcity of natural resources. 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.
Economic rent is different from other unearned and passive income, including
contract rent. This distinction has important implications for public
revenue and tax policy. 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
typically 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.
Definitions According to Robert Tollison, 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". Henry George, best known for his
proposal for a single tax on land, defines rent as "the part of the produce
that accrues to the owners of land 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." The law professors Lucian Bebchuk and
Jesse Fried define the term as "extra returns that firms or individuals obtain
due to their positional advantages." In simple terms, economic rent is an
excess where there is no enterprise or costs of production.
Classical factor rent Classical factor rent is primarily
concerned with the fee paid for the use of fixed resources. The classical
definition is expressed as any excess payment above that required to induce or
provide for production. "A payment for the services of an
economic resource which is not necessary as an incentive for its production";
this can be simplified to when there is no enterprise given by the receiver of
the economic rent "Any payment that does not affect the
supply of the input"; this can be simplified to when there are no costs of
production by the receiver of the economic rent
"A payment to any factor in perfectly inelastic supply"
Neoclassical Paretian rent 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 opportunistic or 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. The neoclassical
understanding of "economic rent" is synonymous with the more appropriately
named term "economic profit". "The excess earnings over the amount
necessary to keep the factor in its current occupation"
"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"
"A return over and above opportunity costs, or the normal return necessary to
keep a resource in its current use" Monopoly rent
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 that each US
medical school can graduate and has been accused of maintaining the high incomes
of doctors by restricting the supply of new doctors. Some businesses, like
public utilities, are by their nature monopolies. George Stigler estimated the
impact of rents from non-labor monopolies on the US economy to be
fairly low. Land rent
In political economy, including physiocracy, classical economics,
Georgism, and other schools of economic thought, land is recognized as an
inelastic factor of production. Rent is the share 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.
Johann Heinrich von Thünen was 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. These high rents determined that land in
a central city would not be allocated to farming but 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 should be
the primary 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.
Labour 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 so that 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
decide to join a different guild or occupation.
However, a political restriction on the number of people entering into the
competitive market for services of the guild has the effect of raising the
return on investments in the guild's training, especially for those already
practicing, by creating an artificial scarcity of guild members. To the extent
that a constraint on entrants to the guild actually increases the returns to
guild members as opposed to ensuring competence, then 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.
The same model explains the high wages in some modern professions that have
been able to both obtain legal protection from competition and limit
their membership, notably medical doctors, actuaries, and lawyers. In
countries where the creation of new universities is limited by legal
charter, such as the UK, it also applies to professors. It may also apply to
careers that are inherently competitive in the sense that there is a fixed
number of slots, such as football league positions, music charts, or urban
territory for illegal drug selling. These jobs are characterised by the
existence of a small number of rich members of the guild, along with a much
larger surrounding of poor people competing against each other under very
poor conditions as they "pay their dues" to try to join the guild..
Terminology relating to rent 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 the risk taken by the landlord in investing
his or her capital. Scarcity rent
Scarcity rent refers to the price paid for the use of homogeneous land when its
supply is limited in relation to demand. If all units of land are homogeneous but
demand exceeds supply, all land will earn economic rent by virtue of its
scarcity. Differential rent
Differential rent refers to the rent that 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 generally
accrued under conditions of extensive land cultivation. The term was first
proposed by David Ricardo. Contract rent
Contract rent refers to rent that is mutually agreed upon between the
landowner and the user. It may be equal to the economic rent of the factor.
Information rent Information rent is rent an agent
derives from having information not provided to the principal.
See also Georgism
Ground rent land
List of economics topics Quasi-rent
Rent seeking FIRE economy
Rentier state Hotelling rent
Ricardian rent Schumpeterian rent
Johann Heinrich von Thünen Differential and absolute ground rent
Property income Unearned income
References External links
Definition of economic rent at Economist.com
The Art of Rent, a series of seminars at Queen Mary University of London.
Rent-Seeking Network Rent-Seeking papers by Behrooz Hassani
Agricultural economic rent