Economic rent
Encyclopedia
Economic rent is typically defined by economists as payment
for goods and services
beyond the amount needed to bring the required factors of production
into a production process and sustain supply
. A recipient of economic rent is a rentier.
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 natural economic rent on resources (such as land and minerals) for the purpose of public finance
without risking the adverse effects caused by taxes on production
or consumption
. Alternatively, economic rent can be collected as royalties
, or extraction fees in the case of minerals and oil and gas. Economic rent is closely related to producer surplus but is measured in input units rather than output units
.
".
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."
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.
, and other schools of economic thought excepting neoclassical economics
, land is recognized as an inelastic factor of production. Rent is the distribution paid to freehold
ers for "allowing" production on the land they control.
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 deregulation.
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 practising, 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.
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.
Distribution (economics)
Distribution in economics refers to the way total output, income, or wealth is distributed among individuals or among the factors of production .. In general theory and the national income and product accounts, each unit of output corresponds to a unit of income...
for goods and services
Goods and services
In economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility. It is often used when referring to a Goods and Services Tax....
beyond the amount needed to bring the required factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
into a production process and sustain supply
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
. A recipient of economic rent is a rentier.
Economic rent is different from other unearned
Unearned income
Unearned income is a term in economics that has different meanings and implications depending on the theoretical frame. To classical economists, with their emphasis on dynamic competition, income not subject to competition are “rents” or unearned income, such as incomes attributable to...
and passive
Passive income
Passive income is an income received on a regular basis, with little effort required to maintain it.The American Internal Revenue Service categorizes income into three broad types, active income, passive income, and portfolio income...
income, including contract rent
Renting
Renting is an agreement where a payment is made for the temporary use of a good, service or property owned by another. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from landowners...
. This distinction has important implications for public revenue and tax policy.
As long as there is sufficient accounting profit
Profit (accounting)
In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
, governments can collect natural economic rent on resources (such as land and minerals) for the purpose of public finance
Public finance
Public finance is the revenue and expenditure of public authoritiesThe purview of public finance is considered to be threefold: governmental effects on efficient allocation of resources, distribution of income, and macroeconomic stabilization.-Overview:The proper role of government provides a...
without risking the adverse effects caused by taxes on production
Production (economics)
In economics, production is the act of creating 'use' value or 'utility' that can satisfy a want or need. The act may or may not include factors of production other than labor...
or consumption
Consumption (economics)
Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...
. Alternatively, economic rent can be collected as royalties
Royalties
Royalties are usage-based payments made by one party to another for the right to ongoing use of an asset, sometimes an intellectual property...
, or extraction fees in the case of minerals and oil and gas. Economic rent is closely related to producer surplus but is measured in input units rather than output units
Output (economics)
Output in economics is the "quantity of goods or services produced in a given time period, by a firm, industry, or country," whether consumed or used for further production.The concept of national output is absolutely essential in the field of macroeconomics...
.
Definitions
According to 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 costOpportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
".
Henry George
Henry George
Henry George was an American writer, politician and political economist, who was the most influential proponent of the land value tax, also known as the "single tax" on land...
, best known for his proposal for a single tax on land
Land value tax
A land value tax is a levy on the unimproved value of land. It is an ad valorem tax on land that disregards the value of buildings, personal property and other improvements...
, 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."
Classical factor rent
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.- "A payment for the services of an economic resource which is not necessary as an incentive for its production"
- "Any payment that does not affect the supply of the input"
- "A payment to any factor in perfectly inelastic supply"
Neoclassical Paretian rent
Neoclassical economicsNeoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
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
Vilfredo Pareto
Vilfredo Federico Damaso Pareto , born Wilfried Fritz Pareto, was an Italian engineer, sociologist, economist, political scientist and philosopher. He made several important contributions to economics, particularly in the study of income distribution and in the analysis of individuals' choices....
, the economist for whom this kind of rent was named, may or may not have proffered any conceptual formulation of rent.
- "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 each US medical school can graduate, and by restricting the supply of doctors has been accused of thus increasing the income of doctors. Some businesses like public utilities are by their very nature monopolies. George Stigler estimated the impact of monopoly rent on the US economy to be fairly low, but he specially excluded labor monopolies from his studies.Land rent
In political economy including physiocracy, classical economicsClassical economics
Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....
, and other schools of economic thought excepting neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
, land is recognized as an inelastic factor of production. Rent is the distribution paid to freehold
Fee simple
In English law, a fee simple is an estate in land, a form of freehold ownership. It is the most common way that real estate is owned in common law countries, and is ordinarily the most complete ownership interest that can be had in real property short of allodial title, which is often reserved...
ers for "allowing" production on the land they control.
David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
is credited with the first clear and comprehensive analysis of differential land rent and the associated economic relationships (Law of Rent
Law of Rent
The law of rent was formulated by David Ricardo around 1809, and this is the origin of the term Ricardian rent. Ricardo's formulation of the law was the first clear exposition of the source and magnitude of land rents, and is among the most important and firmly established principles of economics. ...
).
Johann Heinrich von Thünen
Johann Heinrich von Thünen
Johann Heinrich von Thünen was a prominent nineteenth century economist. Von Thünen was a Mecklenburg landowner, who in the first volume of his treatise, The Isolated State , developed the first serious treatment of spatial economics, connecting it with the theory of rent...
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
Land value tax
A land value tax is a levy on the unimproved value of land. It is an ad valorem tax on land that disregards the value of buildings, personal property and other improvements...
would not distort economic activities, Henry George
Henry George
Henry George was an American writer, politician and political economist, who was the most influential proponent of the land value tax, also known as the "single tax" on land...
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 deregulation.
Hypothetical example
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 guildGuild
A guild is an association of craftsmen in a particular trade. The earliest types of guild were formed as confraternities of workers. They were organized in a manner something between a trade union, a cartel, and a secret society...
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 practising, 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
Rent seeking
In economics, rent-seeking is an attempt to derive economic rent by manipulating the social or political environment in which economic activities occur, rather than by adding value...
activity, and the excess return realized by the guild members is economic rent as defined.
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 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.
See also
- List of economics topics
- Quasi-rentQuasi-rentQuasi-rent is an analytical term in economics, for the income earned, in excess of post-investment opportunity cost, by a sunk cost investment...
- Rent seekingRent seekingIn economics, rent-seeking is an attempt to derive economic rent by manipulating the social or political environment in which economic activities occur, rather than by adding value...
- FIRE economyFIRE economyA 'FIRE economy is any economy based primarily on the paper-intensive sectors of Finance, Insurance, and Real Estate . The origins of the term are unclear. Barry Popik describes some early uses as far back as 1982...
- Rentier stateRentier stateA rentier state is a term in political science and international relations theory used to classify those states which derive all or a substantial portion of their national revenues from the rent of indigenous resources to external clients.- Usage :...
- Hotelling rent
- Ricardian rent
- Schumpeterian rentSchumpeterian rentSchumpeterian rents are earned by innovators and occur during the period of time between the introduction of an innovation and its successful diffusion. It is expected that successful innovations, in time, will be imitated, but until that occurs, the innovator will earn Schumpeterian rents. This...
- Johann Heinrich von ThünenJohann Heinrich von ThünenJohann Heinrich von Thünen was a prominent nineteenth century economist. Von Thünen was a Mecklenburg landowner, who in the first volume of his treatise, The Isolated State , developed the first serious treatment of spatial economics, connecting it with the theory of rent...
- Differential and absolute ground rentDifferential and Absolute Ground RentDifferential ground rent and absolute ground rent are concepts used by Karl Marx in the third volume of Das Kapital to explain how the capitalist mode of production would operate in agricultural production, under the condition where most agricultural land was owned by a social class of land-owners...
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