What is Economic Rent?
Economic Rent is the difference between the actual payment to a factor and its supply price or transfer earning. In the words, Economic Rent may be defined as any payment to a factor of production which is in excess of the minimum amount necessary to keep the factor in its present. occupation. Modern theory of rent defines rent as economic rent which is the payment to a factor over and above what is required to keep the factor in its current employment.
This concept was developed by Joan Robinson. It defines rent as the payment for the hire of a factor over and above the minimum amount needed to bring forth its supply. Economic rent can accrue to all factors of production. According to modern economists rent is the difference between the actual earning of a factor unit and its transfer earning. Economic Rent = Actual Earnings — Transfer Earning What is the factor of production is earning in its present occupation is called Actual Earning.
Transfer earning can also be called opportunity cost of the factor. Transfer earning is the expected earning of the factor from his next best occupation.
There is an implicit assumption in the theory of rent. The rent is calculated on the basis of equilibrium price of the factor. The equilibrium price of the factor is determined when its supply equals demand.
In above Figure
Actul Earning = OLE W
Transfer Earning = OLEK
Economic Rent = OLEW — OLEK
Elasticity of supply of Factor and Economic Rent : Assuming that demand curve of factor is downward sloping, there is distinct relation between price elasticity of supply (Es) of factor and economic rent of that factor. Higher the Es of factor lower the economic rent of that factor.
Rent is closely linked up with specificity. Greater the element of specificity lower the transfer earnings and greater is the element of rent in the real income. Non -specificity of a factor of production increases the element of transfer earnings in the real income. Economic rent is closely related to the elasticity of the factor of production. When the supply of the factor is completely inelastic, then entire earnings of a factor will be economic rent. This is possible only when the factor is completely specific. When this is the case, the factor has only one use and the supply is fixed. As a result, the transfer earnings or the opportunity cost is zero and the entire earnings accruing to a factor are economic rent.
The demand curve for the factor is DB and its supply curve is a vertical straight line ST, it indicates that whatever the price, the supply will remain the same i.e. supply is fixed. Demand. and supply curves intersect at point R which is the point of equilibrium. The equilibrium price is OP and the quantity of the factor demanded and ‘supplied is OT.
If the price is reduced, the supply remains the same and not a single unit of the factor will leave the production activity i.e. no unit will transfer, to an alternative use. Thus, the transfer earnings are zero in this case and the entire earnings amounting to OPRT will be economic rent. Here, economic rent is called pure economic rent. Therefore, the return to a factor whose supply is completely fixed is known as pure economic rent.