Rent: In Context
Understanding
Rent, Interest
and
d
Profits
Rent: Understanding the Lingo
• Classical Factor Rent:
Rent: (in economics) The return on a
productive factor whose supply is fixed. The factor exists in a
certain supply, no matter what the owner might receive for it (i.e.
land).
Short--term economic rent arising from a temporary
• Quasi Rent:
Rent: Short
inelasticity of supply; income earned by factors that are fixed in
supply
l only
l iin th
the short
h t run.
run. (In
(I the
th long
l
run more resources will
ill b
be
attracted to this area because of the economic rent.)
Factors of Production:
Payments for Factors:
•land
•rent
•labour
•wages
•capital
•Interest (Interest is the income
paid for the use of capital. Interest is
in fact what is foregone when capital
is purchased. Thus, we often refer to
the “implicit
“implicit rental rate of capital.”
capital.”
This refers to the interest that could
have been earned on the money that
was spent on capital, plus the
depreciation cost of the capital.)
Rent: Understanding the Lingo
• Transfer Earnings:
Earnings: The amount of money that a factor of
production could earn in its next best opportunity; the portion of
total earnings required to keep a resource in its current use. (i.e. If
you could earn $500.00 doing something else, then you need to be
paid at least $500.00 to keep you doing whatever you’re doing
now.) Another way of looking at it: How much money would it take
to entice a factor of production away from one use to another.
Example: How much money would it take to attract an electrician
toward
t
d th
the plumbing
l bi vocation?
ti ?
• Economic Rent:
Rent: The amount a factor of production is earning
over and above what it could be earning in its next best
alternative use (its “transfer earnings”).
While some
could also be
electricians,
others could
only do
manual
labour if their
plumbing gig
fell through.
S
Wage
e
After all, not
all of these
plumbers
have equal
alternative
opportunities.
Supply and Demand for Plumbers
W
Economic
Rent
Transfer
Earnings
D
Q
Employment
Illustrating Economic Rent in a Model
The more
inelastic
supply is (i.e.
the less able it
is to respond
or adapt to
price changes
in the
market)…
… the less
opportunities it
will have to
switch over to
other areas of
production.
Thus, its
transfer
earnings are
reduced, and
it’s economic
rent is
increased!
Supply and Demand for Plumbers
S
Wage
e
Illustrating Economic Rent in a Model
Economic
Rent is equal
to the
producer
surplus.
W
Economic
Rent
D
Transfer
Earnings
Q
Employment
1
Classical Factor Rent Determination
R2
Rentt
More Rent (AKA
Economic Rent)
R1
D2
D1
Q
Quantity of Land
Supply and Demand for Land
Rentt
2
SLR
R2
R1
D1
Q
Quantity of Land
The supply of
land for a
specific
ifi
purpose, ie.
agriculture, is
variable in
the long-run.
This is
because land
can always
be switched
from one use
to another.
R1
D1
Q
Quantity of Land
“Classical Factor” Rent and “Economic” Rent are Completely Different!
Classical Factor Rent:
Rent: Applies
only to resources that are fixed in
supply (i.e. land)
Economic Rent:
Rent: Can apply to any
resource. (i.e. land, labour
labour,, or
capital)
Denotes total payment received
for use of resource.
Denotes only that part of a
payment received that is in
excess of the payment a resource
could receive in its next best
application.
Supply and Demand for Land
 The Economic Irony: Rent
Rent--seeking
Monopoly with Rent Seeking
12
MC
ATC
Cost / Revenue (Dollars)
10
8
6
4
D
2
0
0
1
2
3
4
5
6
7
MR
Output (Units Produced)
8
9
is pursued in the hopes of earning
monopoly
p yp
profits ((aka “economic rent),
),
yet the costs incurred in “seeking” the
rent exhausts any of the “monopoly”
profits that could have been earned. As
long as monopoly profits exist, rentrentseekers will exist, yet the rent seeking
costs will drive up the ATC curve until
the monopoly earns zero (i.e. normal)
profits. Thus, the longlong-run equilibrium
for a monopoly with rentrent-seeking looks
just like a monopolistically competitive
equilibrium in the long run.)
Supply and Demand for Plumbers
S
S
W
Economic
Rent
R
1
Transfer
Earnings
Rent
D
Q
Quantity of Land
Rent--Seeking: The Untold Story of Monopoly
Rent
• Rent
Rent--seeking
seeking:: The act of obtaining special consideration that would
allow a firm to operate within a competitively restricted market. (Examples:
Buying an existing monopoly, buying a restricted taxicab medallion within
New York city, or lobbying the government to restrict competition from
foreign markets.)
The supply of
land for a
specific
purpose, ie.
agriculture, is
fixed in the
short-run.
SSR
The quantity of
land
demanded,
dictated by the
human
population and
a variety of
socio-political
factors, cannot
change the
actual supply
of land,
therefore price
must change.
Classical Factor Rent Determination
SLR
Supply and Demand for Land
Wage
S
Rentt
Supply and Demand for Land
ALL Economic
Rent
(AKA “Classical
Factor” Rent)
Classical Factor Rent Determination
The
“overall”
supply of
land,
dictated by
the planet,
is fixed.
Rent
If we are
looking at
the
overall
supply of
land, it is
perfectly
inelastic.
Thus, it
has no
transfer
earnings
(it can’t
do
anything
else other
than just
be land),
and all its
revenue
is
economic
rent.
D
Q
1
Employment
Interest: In Context
Factors of Production:
Payments for Factors:
•land
•rent
•labour
•wages
•capital
•Interest (Interest is the income
paid for the use of capital. Interest is
in fact what is foregone when capital
is purchased. Thus, we often refer to
the “implicit
“implicit rental rate of capital.”
capital.”
This refers to the interest that could
have been earned on the money that
was spent on capital, plus the
depreciation cost of the capital.)
2
Interest: Understanding the Lingo
Interest Rates
• interest: the price of borrowing money
• bank rate
• nominal rate of interest (aka stated, explicit): a rate of
interest that does not take the effect of inflation into
account. Comparatively speaking, it can be calculated
as: (NR = RR + e)
• prime rate
• real rate of interest: a rate of interest that takes the
effects of inflation into account. (RR = NR – e)
• quoted rate
The real rate of interest is the difference between the
nominal rate of interest and the expected rate of
inflation. For example, with a nominal interest rate of
6% and a rate of inflation of 2%, the real rate of
interest is 4 per cent.
Rate of Interest
S
r1
D
Q
Quantity of Loanable Funds
Accounting Perspective
Income Statement
Revenue:
$ 20,000.00
The supply of
loanable
funds comes
from firms,
consumers,
and gov’t
savings.
The demand
for loanable
funds comes
from firms,
consumers,
and gov’t
seeking loans
to cover
deficits.
(Excess
spending
over income.)
Economic Perspective
Income Statement
Revenue:
Products
• mortgages
• consumer loans
• credit cards
• car loans
• business loans
• retail credit
Profit: Understanding the Lingo
Loanable Funds Theory of Interest
Supply and Demand for Funds
• discretionary rate
$ 20,000.00
Operating Expenses:
12,000.00
Operating Expenses:
12,000.00
Net Income:
$8 000 00
$8,000.
Net Income:
$8 000 00
$8,000.
• Profit: revenue minus expenses
• Net Income: technical term for profit
Accounting Perspective
Economic Perspective
only operating expenses are
taken into consideration
operating expenses and
opportunity costs are taken into
consideration
• Normal Profits: returns that just equal the
opportunity costs of the resources
Economic roles that profits play within a free market
system include:
• a signal to resource owners,
• incentive for efficiency, and
• a reward for innovation.
Justifications for profits include:
If opportunity cost =
$8,000.00
Accounting Profit:
$8,000.00
• reward for innovation,
• return on risk, and
• encourages competition.
Karl Marx: Profit result from extracting labour value from
the working class. (Left
(Left--winger)
Economic Profit:
$0.00
Adam Smith: Profits resulting from imperfect
competition. ((Right
Right--winger)
3