Macroeconomics - Economic Rent and Opportunity Cost

I. Economic Rent

Economic Differences of Small and Large Incomes
These differences are best explained by the concept of marginal revenue product, which we discussed earlier in the chapter. Remember that marginal revenue product of a resource is defined as the increase in a firm's total revenue attributable to employing one more unit of that resource. The increase in output due to adding one more resource unit is called the marginal product. The relationship between additional resources and output implies that skilled laborers are three times as productive as unskilled labor, and therefore, firms are willing to pay skilled laborers three times as much as unskilled labor.

Keeping this in mind, workers with large incomes are associated with a high marginal revenue product, while those with small incomes are associated with a low marginal revenue product. For example, a star baseball pitcher (skilled labor) will have a high marginal revenue product, while a dishwasher (unskilled labor) will have a low marginal revenue product. Very few people are qualified to pitch in Major League Baseball, while there are many people qualified to wash dishes.

Economic Rent and Opportunity Costs
Economic rent is the difference between what an owner of a factor of production (such as land, capital or labor) receives and the opportunity cost for that owner.

Let's suppose the factor of production is labor. In this example, the laborer receives $20/per hour for their job, and the minimum salary they'd be willing to work for (opportunity cost) is $16/per hour. This $4/hour difference is the laborer's economic rent. In the case of the superstar baseball pitcher, most of the salary earned may be economic rent. Most of a wages of a dishwasher is opportunity cost, since these types of jobs pay minimum wage.If the factor of production is a plot of land, the supply curve would be perfectly vertical, since there is no way for the landowner to supply additional land. In this case, all money received is economic rent.

The size of economic rent received by a owner of a factor of production is determined by the elasticity of supply for that particular good or service.

  • If the elasticity of supply is neither elastic nor inelastic, the supply curve will slope upward and the supplier's income would be split between economic rent and opportunity cost.
  • If the elasticity of supply is inelastic, the supply curve would be perfectly vertical and the supplier's entire income would be comprised of economic rent. For example, if the supply were a particular plot of land, or a
  • If the elasticity of supply is elastic, the supply curve would be perfectly horizontal, and the supplier's entire income would be comprised of opportunity cost.
Look Out!
Do not confuse "economic rent" with "rent". The rent paid each month to live in an apartment, or to lease a car is not the same. Remember that economic rent is simply a component of the income received by a supplier of a good or service.
Monitoring Cycles, Jobs, and Price Level


Related Articles
  1. Economics

    What is Economic Rent?

    Economic rent typically occurs when a product, service or property is in short supply, but demand is high.
  2. Economics

    Economics Basics: Elasticity

    Investopedia Explains: What elasticity is, how to calculate elasticity, the difference between elastic and inelastic curves, and the various factors that impact elasticity.
  3. Home & Auto

    Renters' Guide: Introduction

    Renting property rather than owning is an option for many people who are not yet ready to settle down, who will be living in an area only temporarily, who are not willing or able to meet the ...
  4. Economics

    What's Demand Elasticity?

    Demand elasticity is the measure of how demand changes as other factors change. Demand elasticity is often referred to as price elasticity of demand because price is most often the factor used ...
  5. Home & Auto

    Renters' Guide: Who Rents Property?

    People who rent property rather than purchase a home do so either out of necessity or by choice. People who rent out of necessity may do so because they are: Saving for a down payment on ...
  6. Fundamental Analysis

    How Demand Changes With a Variation in Price

    What is demand elasticity?
  7. Budgeting

    Do You Need A Rent Receipt?

    Landlords don't always bother to send receipts to renters. But there are important reasons renters should insist on getting proof they paid their rent.
  8. Personal Finance

    Why We Splurge When Times Are Good

    The concept of elasticity of demand is part of every purchase you make. Find out how it works.
  9. Home & Auto

    Is Homeownership A Smart Investment Again?

    Homeownership remains cheaper than renting across the nation. However, these findings speak broadly to the national market, and there are several situations where it still makes more sense to ...
  10. Home & Auto

    Is Now The Time To Buy Or Rent?

    While you can snag serious deals in this current economy, it doesn’t mean that buying a home is the best choice for you right now.
RELATED TERMS
  1. Rent Control

    A price control that limits the amount a property owner can charge ...
  2. Owners' Equivalent Rent - OER

    The amount of rent that could be paid to substitute a currently ...
  3. Rent Ceiling

    A maximum price a landlord is allowed to charge for rent. Rent ...
  4. Labor Market

    The labor market refers to the supply and demand for labor, in ...
  5. Rent Regulation

    A law that limits the amount and frequency with which landlords ...
  6. Total Revenue Test

    A test that approximates the price elasticity of demand by comparing ...
RELATED FAQS
  1. What factors influence a change in supply elasticity?

    Learn about the supply elasticity of goods and services, some factors that influence supply elasticity and how these factors ... Read Answer >>
  2. How does price elasticity change in relation to supply and demand?

    Learn about how variations in price elasticity affect the supply and demand curves and what factors cause differences in ... Read Answer >>
  3. What is the difference between price inelasticity and inelasticity of demand?

    Learn how supply, demand and pricing are interrelated by studying the concepts used by economists to measure pricing fluctuations. Read Answer >>
  4. If a particular good's price elasticity is high, does this mean the supplier should ...

    Learn the basics of price elasticity of supply and demand and how each influences a company's production of goods and pricing ... Read Answer >>
  5. How does price elasticity affect supply?

    Read more about the price elasticity of supply, the law of supply and why a price change would alter the distribution of ... Read Answer >>
  6. What's the difference between economic value added (EVA) and economic rent?

    Understand the difference between economic value added and economic rent. Learn what each economic principle is used to measure ... Read Answer >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center