Before explaining economic rent, it is better to explain the different uses of term rent in different time phases. I think it will be more helpful to fully understand the meaning of land as used in the economic profession. So, let’s first know what the term land refers to in economics.

What is Land?
Different Usages of Rent in Economics
What is Land Rent?
What is Economic Rent?
Concept of Quasi-Rent
What is Contract Rent?
Economic Rent Vs Contract Rent
Classical Vs Modern Rent

What is Land?

The ordinary meaning of the land is the surface of the earth. But, in an economic sense, the usage of the term is slightly different. It refers to all the gifts of nature whose existence on the earth is without human efforts. So the term land, as used in economics, implies the surface of earth as well as natural resources.

Land is one of the major factors of production and it has passive characteristics because it alone cannot produce unless we combine other factors of production, especially labor.

One may puzzle, and may arise question why somebody has to pay a large sum of money when buying an acre of land in the urban area if it is a gift of nature.

Of course, one has to pay but that payment is rather for the transfer of ownership of land or the sacrifice of current usages. This is because land is freely available in the limited supply or freely available scarce resource. So, one seems to pay for land; but in essence, the payment is only for its scarcity, not for naturally gifted land.

Now, I think its a time to cover the main focus point of this article.

Different Usages of Rent in Economics

There are three uses of the term rent in an economic sense: land rent, economic rent, and quasi-rent. Because of the concept of classical economists that rent is the price for the use of land and land alone, the term rent is usually attributed to land. Classical economists consider the rent as the price paid to the fixed factor of production – land. It is the concept of land rent.

But, the modern view also incorporates the other factors of production to earn the rent, and this view relates to economic rent. Even others argue that the rent is earnings of the fixed factors in the short-run, and this view belongs to quasi-rent.

So, the different usages of the term rent depend on how it is ascribed to.

What is Land Rent?

It is the use of the term by the classical economists that they argue it is the land that can earn rent. It is freely available without any human efforts but in fixed supply. No other factors can earn rent, because their supplies are not fixed as that of land. It is the concept of the lend rent: Land alone earns rent.

The supply of land is perfectly inelastic even in the long run, so they do not have alternative uses and the entire payment is land rent. That is, the earning of the fixed factor in the long run is the land rent. This view considers the supply of land from the perspective of society as a whole (macro perspective). Rent does not enter into the cost of production in this perspective: it is not price-determining but price-determined.

Of course, there are some sorts of improvements such as drains, hedges, wells, irrigation, and like in the land. And, they increase the productivity of land. These improvements are man-made and constitute a capital investment. When we deduct the return on these improvement costs in the form of capital expenditure from the total price, we obtain the pure land rent.

That is, rent is the entire earning of land excluding the improvement costs in order of increasing the productivity of land. To the classicists, rent is surplus, superfluous, unnecessary, and functionless payment because rent is not a necessary payment to bring the land into existence or to make it available in society.

What is Economic Rent?

It is the modern use of the term rent which recognizes the alternative uses of the factors. Unlike the classical concept of land rent, it posits that all the factors of production can earn economic rent. The economic rent is defined as the surplus or excess of the payment over and above the minimum required amount to keep the factors in its current use. In other terms, economic rent is the excess of payment over the transfer earnings of factor or opportunity cost.

The transfer earning is the price of the next best use of the factor that results from the alternative uses. It is transfer earnings because it would transfer elsewhere from the present use if not paid the necessary payments. So, the transfer earning is the minimum necessary amount to keep the factor in its present use or occupation. It is also known as transfer cost.

The implicit assumption here is that the factors are always in the best manner. Unlike the classical view, this modern view considers the supply of land, for example, from the perspective of use, industry, or individual producer i.e. the micro perspective. Fixed factors (such as land) from the viewpoint of society as a whole may be the variable factor for the particular use, industry, or individual.

That is, the supply of the fixed factor from the viewpoint of a nation or society as a whole may be elastic for a particular use, industry, or individual. So, for the individual producer, the transfer earnings are similar to any other cost of production. Hence, at least that portion of the payment which is transfer earnings enters into the cost of production in modern view.

When does economic rent appear?

For the individual producer, when there is perfect competition among the bidders of the factor, the supply curve of the factor for an individual will be perfectly elastic implying a small change in price resulting in the entire movement of factor from one use or occupation to others. So, an entire payment which is transfer earning is the cost of the production for the individual producer, resulting in nil economic rent.

Economic rent arises when the supply of factors is less than perfectly elastic. Given the perfectly inelastic supply of factor, the entire payment for factor is economic rent (also known as pure economic rent). This is because there is nil transfer cost due to a lack of opportunity cost factors. Given the perfectly elastic supply, the entire payment is the transfer earnings, because every factor has the same transfer costs and no more surplus prevails. Finally, given the relatively elastic supply of factors, some parts of the payment are transfer costs while the rest of the amount is economic rent.

This analysis conveys that factor units having smaller opportunity costs or transfer costs gain a larger surplus while the factors having larger transfer costs smaller surplus. But, the marginal unit earns no surplus at all. Note that the usage of the term rent as a price for the use of land, and rent as the surplus earning of land is a quite different concept. They are equivalent only when the supply of the factor is perfectly inelastic. Also, note that the economic rent has emerged based on factors’ ability to earn transfer cost.

Concept of Quasi-Rent

This concept of quasi-rent is the extended form of the classical concept of land rent to the earnings of fixed factors (like machinery, building, etc.) in the short run. This is Marshall who coined this view. Like the land, change in the price of machinery, buildings, or the like does not alter their supply.

Once they are produced and used, it is very difficult to move these factors elsewhere to earn the transfer earnings in the short run i.e., these factors have specific uses and lack alternative uses. It means that such factors possess nil transfer earnings in the short run. Hence, the entire payment to the fixed factors (including land and others) over and above the nil transfer earning is quasi-rent.

It is quasi-rent because it is characterized as the rent from short-run fixed factors. But in the long run, these short-run fixed factors are moveable elsewhere to earn the transfer earnings and their supplies are changeable because they are man-made. Accordingly, the quasi-rent is temporary and vanishes in the long run.

Logically, there needs some costs of keeping the machinery in the running order. Therefore, the more precise definition of quasi-rent is the excess of the short-run earnings over the cost of keeping machinery in the running order. Alternatively, quasi-rent is the total income earned minus total variable cost.

Both variable and fixed factors jointly operate in short-run production. So, it is quite reasonable to deduct the total variable cost from the total revenue to get the price of the fixed factors. Note that the short-run costs of keeping the machinery in running order are included in the total variable cost.

What is Contract Rent?

The contract rent is what we usually practice in our day-to-day lives. Sometimes, it is referred to as the gross rent. It is the actual payment made to the owner of the factors. It is just like the periodical payment to the owner of the house, the owner of machinery and equipment, the owner of the land, or the like.

The determination of contract rent takes place by the mutual agreement between the parties involved – owner and renter – and includes the economic rent, transfer earnings, and other improvements to the factors. These improvements, undertaken by the owner of the factors, take place in the form of capital expenditures. The rewards for these improvements in the form of interests for the capital expenditures undertaken by the owner of factors are, thus, included in the contract rent. As to land, such improvements could be the expenditures incurred by the landlord in hedges, drains, wells, and the like.

Economic Rent Vs Contract Rent

In modern economic literature, all the factors of production such as land, labor, capital, and entrepreneur earn rent. This concept of rent is economic rent. And it is the excess amount over the transfer earnings paid to the owner of the factors. Whereas in the practical sense, the term contract rent refers to the gross payment to the owner of the factors in exchange for their use.

Thus, the most significant difference between economic rent and contract rent is that economic rent is concerned with the economic meaning of rent whereas contract rent is concerned with the practical meaning of rent.

Classical Vs Modern Rent

The comparison between classical and modern views of rent proceeds with the identification of similarities and differences between these views.

Similarities

  • Both views accept the concept of scarcity rent.
  • Classical and modern Views use a concept of derived demand concept (read Recardian theory of rent here)
  • Both Views use the concept of economic rent despite the classical view limiting the concept of rent to pure economic rent.
  • Rent is the price determined in both concepts.
  • Both views use the demand for and supply approach in a determination of rent despite the classical view being implicit.

Differences

  • The classical view postulates that only land earns rent: land rent/pure economic rent whereas the modern view argues that all factors of production earn rent.
  • While rent is a surplus, superfluous, and unnecessary reward for the use of land for classical economists, it is an excess amount over transfer earnings for modern economists.
  • The classical view does not identify the alternative uses of land, but the modern view does identify the alternative uses of factors.
  • The classical view is related to the long run whereas the modern view is related to both the long- and short run.
  • Rent does not enter into the cost of production in the classical view whereas transfer earning, which looks like rent in the classical view, enters into the cost of production in the modern view.
  • While the classical view uses a society’s viewpoint regarding the supply of land i.e., macro perspective; the modern view uses a viewpoint of industries, uses, or individuals regarding the supply of factors i.e., micro perspective.
  • Rent is not price-determining in classical view while it is to the extent that transfer earnings inter the cost of production in modern view.
  • The classical view is concerned with pure economic rent whereas the modern view regards pure economic rent as a special case of the economic rent.

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