AP MICROECONOMICS
UNIT #6
FACTOR MARKETS
Lecture #5
Economic Rent, Profit, and Interest
ECONOMIC RENT BASICS
■ Rent: price paid for use land (natural
resource) that is a fixed supply
■ Fixed supply makes it inelastic in the short
run and long run
■ Supply and Demand Analysis assumes
– All land is of the same quality
– All land has a single use
Land Rent in Littleville
Annual Rent per Acre
D
$2,000
S
E
D
S
1,000
Acres of Land
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
ECONOMIC RENT DEMAND
■ Demand is the ONLY active determinant of
rent since supply is fixed
– Based on price of the product produced
on the land
– Land’s productivity/quality – location,
what it can be used for, etc.
– Prices of other resources used with the
land
RENT DETERMINATION
Land Rent (Dollars)
S
R1
D1
R2
D2
R3
D3
0
a
b
L0
Acres of Land
D4
D4 is a
“free
good”
ECONOMIC RENT
■ Rent can have no “Incentive Function”
– other resources do because they allow
you to make more available at a higher
price
■ Some argue that rent shouldn’t have to be
paid because it costs nothing to produce
– Why should rent be paid to those who
got it by inheritance or some other
advantage?
HENRY GEORGE AND THE
“SINGLE TAX” MOVEMENT
■ Land should be taxed heavily and shared
with the public & should be the only tax
■ Most efficient tax:
– Taxing other goods or income could
cause reallocation of that resource
– Taxing land heavily would not lead to
reallocation because it can’t be used for
anything else
INTEREST
■ Stated as a percentage: it’s the money paid
for the loan of money
■ MONEY IS NOT A RESOURCE!
– BUSINESSES “buy” the use of money
because it can be used to acquire other
capital goods
ECONOMIC PROFIT
■ Review
– Economic Profit is what remains after
both explicit and implicit costs are
subtracted from total revenue
– Normal Profits are the payments
necessary to have the use of the
entrepreneur
ENTREPRENEUR’S PROFIT
■ Entrepreneur gets normal profits plus any
economics profits that may occur
■ Why?
– The economy is not static (constant,
unchanging, predictable), but dynamic
– In dynamic economies there are risks
– Profit is reward for taking risks
MANAGING RISK
■ Insurable risks: buying insurance shields
the firm from some risks (fire, etc.)
■ Uninsurable risks: cannot be controlled or
predicted
SOURCES OF RISK
■ Changes in the Overall Economy (recession,
unemployment, etc.)
■ Changes in the Economic Structure
(consumer tastes, availability of resources,
etc.)
■ Changes in Government Policy (taxes,
regulations, etc.)
PROFIT IN MONOPOLIES
■ Different from risk-taking profit
■ Monopoly power can
– Reduce risk and or negative effects
– Allow room for innovation in oder to
sustain profits
PROFIT AND CAPITALISM
■ Motivates innovation that leads to growth
■ Leads to most productive means of
allocating resources
– Away from unsuccessful firms
– To profitable firms
ECONOMIC PROFIT
■ Land Rents: Complicated Version
– Capital invested on any piece of land must yield the
same return as capital invested on any other piece of
land that is actually in use.
– Any land that is exactly on the borderline between being
used and not being used is called marginal land.
The Determination of Rent
■ Land Rents: Complicated Version
– Rent on a piece of land = cost of producing the output
on that land minus the cost of producing it on marginal
land
15-2 Nonrent Costs and Rent
on Three Pieces of Land
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Determination of Rent
■ Land Rents: Complicated Version
–  demand 
■
community uses land previously thought to be
submarginal
■
more intensive exploitation of already used land
The Determination of Rent
■ Land Rents: Complicated Version
– This increases the differential between other plots of
land and marginal land and, therefore, increases rent.
ECONOMIC RENT AS IT RELATES
TO SALARIES
■ The payment for labor has two parts
– The minimum amount needed to acquire the input
– The bonus to inputs of higher quality (workers with
exceptional skills)
■ Rent is not a consideration in whether to work
or not, but rather it is “gravy”
■ Almost all inputs receive some rent
– Inputs provided by a large number of suppliers at
constant cost with equal quality will not
RENT SEEKING
■ The search and battle for opportunities to charge or
collect payments above and beyond the amount
necessary to create the source of the income (trying to
make more money without producing more for
customers)
■ One example is a monopoly license
–
–
–
Ex. A monopoly license for cable broadcasting is expected
to generate $900 million rent over its lifetime
Companies will spend close to that amount in lobbying for
the license
For example, if 10 companies are competing for the license,
they would be willing to spend $90 million for a 1 in 10
chance of winning the license
RENT SEEKING (continued)
■ Forms of rent-seeking
– Protection racket
■
Gangs taking a cut from shopkeeper’s pocket
– A cartel of firms agreeing to raise prices
– A union demanding higher wages without offering an
increase in productivity
– Lobbying the government for tax, spending, or regulatory
policies that benefit the lobbyists at the expense of
taxpayers or consumers or some other rivals
The Determination of Rent
■ Generalization: Economic Rent Seeking
– Economic rent is any payment made to a factor above
the amount necessary to induce any of that factor to be
supplied to its present employment.
– Some portion of every factor’s income will consist of
economic rent in this sense, unless the factor’s supply
curve is horizontal.
Application of Rent Theory: Salaries of
Professional Athletes
■ When athletes would be willing to play for quite a bit less than their
salary, the “excess” salary is economic rent.
– This same analysis applies to any factor of production whose
supply curve is not horizontal.
– Only those factors that can be reproduced by a number of
producers at constant cost earn no rents.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
“A-ROD”: Earning Lots of Rent
■ Alex Rodriquez, Texas Rangers, recently signed a 10-year,
$252 million contract
■ This makes him the highest paid athlete in history.
■ Assuming he would play baseball for significantly less, much
of his contract represents economic rent
Rent Controls: The Misplaced Analogy
■ People sometimes think that rents on housing are economic rents.
– They could then be lowered without reducing the quantity
supplied.
■ This may be true in the short run.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Rent Controls: The Misplaced Analogy
■ But in the long run, the housing market is quite competitive.
– An effective rent control law is, therefore, likely to lead to a
reduction in housing and consequent shortages.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.