Economic Rent and Return for Other Factors of Production

Unit 4 : Microeconomics National Council on Economic Education The Determination of Economic Rent

Why is the supply curve for land vertical?

What determines the amount of rent if the supply of land is perfectly inelastic (vertical)?

What effect will an increase in the demand for land have on the amount of land available?

The Unique Aspect of Economic Rent O Determination of rent, like wages, occurs within context of supply & demand factors and institutional circumstances O Economic rent: The price paid for the use of land and other natural resources, the supply of which is fixed (perfectly inelastic)

The Unique Aspect of Economic Rent O Rent usually accorded special treatment because of inelasticity of supply of land and other natural resources

The Unique Aspect of Economic Rent O This aspect of natural resources has attracted attention of economists since days of the Physiocrats, has led to controversial issues in economic theory and public policy O Physiocrats believed wealth of nations came solely from agriculture and land development, agricultural goods should be highly priced O Other examples: Henry George’s single-tax movement, urban-renewal programs, “obscene profits” of landlords and oil industry

The Unique Aspect of Economic Rent O MAJOR THEORITCAL POINT TO UNDERSTAND: when the supply of a factor is perfectly inelastic, price paid to that factor cannot provide incentive to produce more O Economists refer to such a factor as a surplus or as economic rent. O Amount of economic rent received by owners of land and other factors fixed in supply is determined by productivity of each factor

Unique Aspect of Economic Rent O Henry George and others argued that, since a tax on land or any other factor with fixed supply doesn’t affect amount of that factor available to society, all economic rent could be taxed away with no cost to society

Unique Aspect of Economic Rent O Critics of this theory point out that rent is a cost to individuals because the supply of land for any one use is not perfectly inelastic. O Users of land, just as with other factors of production, must bid the land away from alternative uses O Therefore, rent is merely a cost of production

Let’s talk about it… O Scenario 1: Agricultural land near a large city was selling for $3,000 an acre last year. Now a subdivision is being developed on this land, and it is selling for $50,000 an acre. Why did the price rise so dramatically? Do you think it is fair that the owners of this land reaped such a large and sudden return for no effort on their part?

Let’s talk about it… O Scenario 2: A professional basketball player earns $850,000 a year. The next-best alternative for this player might be as a high school coach for $40,000 a year. Should $810,000 of his current salary be considered wages or rent (an economic surplus)? If a large part of the wages and salaries of many highly paid athletes, entertainers and others is considered as economic-surplus payments (not necessary to attract people into a particular line of work), does this suggest that such incomes should be taxed heavily?

Interest Rates in Market Economies O The interest rate is the price paid for the use of money (loanable funds). O Like other prices, the price of money (an interest rate) is determined by the supply of and demand for loanable funds. O A real interest rate is the nominal rate of interest minus inflation. O Real interest rates influence investment decisions.