Chapter 12

• THE THEORY OF RENT

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 Factors of production can earn
different types of ‘income’
• Factor  factor income:
• Labour earns wages
• Land earns rent
• Capital earns  interest

2
Peter is a branch manager of a
bank
---$30,000
Economic rent
of being a branch
manager? $24000 Salary of
a branch
---$6,000 Salary of an manager
accounts clerk
(transfer earning =
opp cost of being
a branch manager) 3
Economic Rent P.27 (Dictation)!!!!!
It is any amount excess over transfer earning
that a factor actually earns. Or
Rent is the an amount in excess of cost, and
cost is defined as that part of payment to
resources which is necessary to keep them at
their present use.
Economic rent = Factor’s actual earning – its
transfer earning
It is not necessary to keep a factor in existence.
Therefore, Economic rent may be zero.
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 Example
• Assume there are 2 jobs (A and B) and Tom
is working for job A for $5000.
Job A
= opp
• What is the transfer earning of job B?
cost
• If salary for job B is $5500, how much is
the economic rent? 5500-5000 = 500
• Will Tom change job from A to B if B also
offers $5000. No, because same opp cost
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REMARKS
1. Rent is part of cost. factor price may include
rent and transfer earning (opp cost)  if transfer of
ownership or outright sale of business both include
rent.
2. Rent denotes stickiness in supply if he or she is
no better alternative elsewhere wage cut stay
in job behaviour may change

3. High rent is a result, not a cause.land is a

derived demand  we should say that high housing
prices cause high land rent by David Ricardo.

4. Function of rent  land become expensive

function of rent is to allocate resources efficiently

5. Rent may be earned by any factor. human or 6

man-made resources e.g. labour or capital goods
 Price, Pf

W1
Economic
rent

D
Transfer earning

Q factor
Qe 7
 Key points
Transfer earning is the __________ of a
factor and is _______ to keep it in
existence.
Economic rent = _______ - __________
Rent may ______ exist and is part of
______.
More elastic the supply of a factor, _______
rent can be earned.

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 SPECIAL CASES

Pf

Transfer
Earning
D
Q factor
9
Pf
S

Economic
Rent
D

Q factor
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EXAMPLE OF RENT

1. Monopoly rent (monopoly power)

2. Ricardian rent  due to same in opp cost in their
existing use.
(same transfer earning)
(same alternative use)
1. Differential rent  due to different in opp cost in
their existing use.
(different in transfer earning)
( different in alternatives use)
1. Quasi-rent  Short run have fixed factor
 the cost we cover the fixed factor
is called economic rent (quasi-rent)
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 RICARDIAN RENT

Factors earn different income presently but

will earn the same transfer earnings
elsewhere.

Factors with more income is earning

Ricardian rent due to their superior ability.

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 Ricardian rent as a payment for
superiority-higher productivity
• Both Paul and Peter are both branch manager of a
bank.
• Peter has ten yrs experience in bank, salary $50,000
• Paul is recent university graduate, salary $15,000
• They both have only alternative as accounts clerks,
salary $6000
• Peter earns economic rent? $50,000 - $6,000 = 44,000
• Paul earns economic rent? $15,000 - $6,000 = 9,000
• The difference in economic rent is Ricardian rent?
$44,000 - $9,000 = $35,000 per month 13
 DIFFERENTIAL RENT

Factors earn same income presently but will

earn different transfer earnings elsewhere.

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 Differential rent due to
Differences in Opp cost
• Peter and May are two experienced bank manager
with identical productivity, salary $50,000.
• Mary can work as piano teacher, salary $20,000
• Peter can work as accounts clerk, salary $6,000
• Economic rent earned by Peter is greater than
Mary’s by?
$20,000 - $6,000 = $14,000

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