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Economic rent is defined as an excess distribution to any factor in a production process above the amount required to draw the factor into the process or to sustain the current use of the factor.[1] The disambiguation of economic rent from other unearned and passive increments has important implications for public revenue and tax policy[2][3][4]. True economic rent can be collected by governments for the purpose of public finance without the adverse effect caused by taxes on production or consumption. So long as there is sufficient accounting profit in the production of goods, the rent of naturally occurring input resources such as land and minerals can inure to the benefit of the public purse. 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.

Contents

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"[5]
  • "Any payment that does not affect the supply of the input"[6]
  • "A payment to any factor in perfectly inelastic supply"[7]

Neoclassical Paretian rent

Neoclassical economics 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.[8][9]

  • "The excess earnings over the amount necessary to keep the factor in its current occupation"[1]
  • "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"[10]
  • "A return over and above opportunity costs, or the normal return necessary to keep a resource in its current use" [11]

Land rent

In political economy including physiocracy, classical economics, and other schools of economic thought excepting neoclassical economics, land is recognized as an inelastic factor of production. Rent is the distribution paid to freeholders for "allowing" production on the land they control.

As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land (...) [12].

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 (if not the only) source of public revenue.

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. A person seeking to become a medical doctor makes a huge investment in medical training and education, which has limited potential application outside of medical practice. In a competitive market for medical services, a doctor's wages would be set at 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 doctors from making the necessary investment in training to enter the competitive market for medical services. This is a natural "free market" self-limiting control on the number of physicians and/or the cost of training necessitated by certification. Some of those who would have opted for a medical career may well decide to be lawyers or business people or technologists.

However, restrictions on the numbers of people entering into the competitive market for medical services has the effect of raising the return on investments in medical training especially for those already practicing by creating a politically contrived scarcity of physicians. This kind of political activity to the extent that it exists is termed rent-seeking. To the extent that a constraint on entrants to the medical profession actually increases the returns to physicians as opposed to insuring 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 physicians is economic rent as herein 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

External links

References

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Economic rent is typically defined by economists as an excess distribution to any factor in a production process above the amount required to draw the factor into the process or to sustain the current use of the factor.[1]

The disambiguation of economic rent from other unearned and passive increments has important implications for public revenue and tax policy.[2] [3][4]

Natural economic rent can be collected by governments for the purpose of public finance without the adverse effect caused by taxes on production or consumption. So long as there is sufficient economic profit in the production of goods, the rent of naturally occurring input resources such as land and minerals can inure to the benefit of the public purse. 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.

Economic rents, according to Tollison (1982), are "excess returns" above "normal levels" and they are associated with a lack of competition in markets. Tollison defines economic rents as "a return in excess of the resource owner's opportunity cost".[5]

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".[6]

Contents

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"[7]
  • "Any payment that does not affect the supply of the input"[8]
  • "A payment to any factor in perfectly inelastic supply"[8]

Neoclassical Paretian rent

Neoclassical economics 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.[9][10]

  • "The excess earnings over the amount necessary to keep the factor in its current occupation"[1]
  • "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"[11]
  • "A return over and above opportunity costs, or the normal return necessary to keep a resource in its current use" [12]

Land rent

In political economy including physiocracy, classical economics, and other schools of economic thought excepting neoclassical economics, land is recognized as an inelastic factor of production. Rent is the distribution paid to freeholders for "allowing" production on the land they control.

As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land (...).[13]

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 (if not the only) source of public revenue.

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. A person seeking to become a medical doctor makes a huge investment in medical training and education, which has limited potential application outside of medical practice. In a competitive market for medical services, a doctor's wages would be set at 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 doctors from making the necessary investment in training to enter the competitive market for medical services. This is a natural "free market" self-limiting control on the number of physicians and/or the cost of training necessitated by certification. Some of those who would have opted for a medical career may well decide to be lawyers or business people or technologists.

However, a political restriction on the numbers of people entering into the competitive market for medical services has the effect of raising the return on investments in medical training, especially for those already practicing, by creating an artificial scarcity of physicians. To the extent that a constraint on entrants to the medical profession actually increases the returns to physicians 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 physicians is economic rent as herein 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

External links

References

  1. ^ a b Shepherd, A. Ross (1970). "Economic Rent and the Industry Supply Curve". Southern Economic Journal 37 (2): 209–211. doi:10.2307/1056131. http://www.jstor.org/pss/1056131. Retrieved 2010-05-27. 
  2. ^ Kittrell, Edward R. (1957). "Ricardo and the Taxation of Economic Rents". American Journal of Economics and Sociology 16 (4): 379–390. doi:10.1111/j.1536-7150.1957.tb00200.x. http://www.jstor.org/stable/3484887. Retrieved 2010-05-27. 
  3. ^ Goode, Richard B. (1984). Government finance in developing countries. Brookings Institution Press. ISBN 9780815731955. http://books.google.com/?id=3nM1F7y2P4sC&pg=PA185&lpg=PA185&dq=taxation+%22economic+rent%22&q=taxation%20%22economic%20rent%22. Retrieved 2010-05-27. 
  4. ^ Hammes, John K (1985). "Chapter 6 - Economic Rent Considerations In International Mineral Development Finance". Finance For The Minerals Industry. AIME. ISBN 0-89520-435-5. http://www.onemine.org/search/summary.cfm/Economic-Rent-Considerations-In-International-Mineral-Development-Finance?d=FC582F4D81FDBE6087EAC1D53E6ED2CE076A23FA4EF170F6F2200E47581703FA31345. Retrieved 2010-07-18 
  5. ^ Tollison, Robert D (1982). "Rent seeking: A Survey". Kyklos 35 (4): 575–602. doi:10.1111/j.1467-6435.1982.tb00174.x. http://www3.interscience.wiley.com/journal/119558672/abstract. Retrieved 2010-07-21. 
  6. ^ George, Henry (1880). "Chapter 11 The Law of Rent". Progress and Poverty (4 ed.). Robert Schalkenbach Foundation 2006. ISBN 0665095228. http://www.henrygeorge.org/pchp11.htm 
  7. ^ "Definition of economic rent". HighBeam.com: Online Dictionary (www.highbeam.com). 2001-01-01. http://www.highbeam.com/doc/1O19-economicrent.html. Retrieved 2010-05-27. 
  8. ^ a b Wessels, Walter J. (2000). "Chapter 27 Economic Rents". Economics (3 ed.). Barrons Educational Series Inc. p. 479. ISBN 0-7641-1274-0. http://books.google.com/?id=0hggJhQQQboC&pg=PA480&lpg=PA480&dq=%22economic+rent%22 
  9. ^ Bird, Ronald; Tarascio, Vincent J (1999). "Paretian Rent versus Pareto's Rent Theory : A Clarification and Correction". In John Cunningham Wood and Michael McLure. Vilfredo Pareto: critical assessments of leading economists. 2. Routledge (Taylor & Francis Group). p. 474. ISBN 0-415-18501-7. http://books.google.com/?id=pB1IX9rFH4cC&lpg=PA475&dq=%22Paretian%20Rent%22&pg=PA473#v=onepage&q. 
  10. ^ Foldvary, Fred E. (Jan 2008). "The marginalists who confronted land". The American Journal of Economics and Sociology. http://findarticles.com/p/articles/mi_m0254/is_1_67/ai_n25146056/pg_16/. 
  11. ^ "Definition: economic rent". Research Tools Economics A–Z. The Economist (economist.com). http://www.economist.com/research/Economics/alphabetic.cfm?LETTER=R#rent. Retrieved 2010-05-27. 
  12. ^ Morton, John S.; Goodman, Rae Jean B. (2003). "The Story of Economic Rent: What do Land, Athletics and Government have in Common". Advanced Placement Economics (3 ed.). National Council on Economic Education. p. 266. ISBN 1-56183-566-8. http://books.google.com/?id=SYe93WTv4-YC&pg=PA264&lpg=PA264&dq=%22economic+rent%22. 
  13. ^ "Wealth of Nations B.I, Ch.6, Of the Component Parts of the Price of Commodities"

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