economic_rent,_wetz

economic_rent,_wetz - MWHPVEL 6 mer FCQNOMKé flies-pr...

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Unformatted text preview: MWHPVEL. 6-} mer FCQNOMKé. flies-pr. cwwt: i amass-m; _,__- obj-«Rh, 10:95” b7 Souths-wrst ECONOMIC RENT In the 19th century, there was no cause dearer to the hearts of l enjoy being a higth overpaid actor oppressed tenants than the promise that rent would be abol- ished in a communist state. These tenants, along with lawyers (Roger Home) and politicians, thought of economic rent as solely what is paid Translation: An actor‘s economic rent by the tenant to the landlordlf nothing is paid, then there is no rent. However, Henry George (a 19th-century economist) and can be substantial. his followers knew that rent is a naturally occurring surplus. It is the potential return arising solely from the use of a particular site. Anyone who has use of that site has access to its economic rent. It cannot be abolished by any law or destroyed by agreements between landlords and tenants. The most that can occur is that the potential is not tapped, which is a deadweight loss. Specifically, the concept Economic rent The pm of economic rent, based on factor supplyis defined as the portion of total paym fion of my payment to a to a factor that is in excess of what is required to keep the factor in its current 0 factor that is in excess of pation. Economic rent is the same concept as producer surplus (discussed in Chapt What 5? réqUired *0 keep the 10) except that the surplus accrues to the factor. From Figure 16.3, the total (2101151- fw“ '" "5 “"6” OCCUW' amount necessary to retain the level X, in this occupation is given by the area OABX ($22533? As we will discuss in Chapter 17, if firms could perfectly discriminate among fag ‘ solely gr the love of the tor suppliers, total payment would be OABXe. Perfectly competitive markets, beware; game, his whole salary is do not work in this manner. A11 similar inputs are paid the same price. However, ..= economlc ’5’"- factor owners would settle for less, which leads to economic rent. For example terms of labor, a worker receiving a wage rate of $25 per hour may be willing to w for only $20 per hour. The $5 difference is a per-hour surplus (economic rent) ac ing to the workerlu Figure 16.3, total factor payments are OveBXr Subtracting the necessary to retain the level Xe in this occupation, 0 e, from the total factor 131 ments, OveBXe, results in economic rent, AveB. Do you have high or low economic ren. _ If you can ofi'er a relatively unique service that is in high demand (acting), then your eco nomic rent will be very high. In contrast, ifyou ofl’er common Services that are not in h 3‘ demand, then your economic rent will be very low. Economic Rent and Opportunity Cost Secretaries have numerous employment opportunities at approximately the wage, so their opportunity cost for working at a particular place is large relative their wage rate. Any factor of production that has many alternative uses will have :_ very elastic supply curve for one type of employment. This factor can receive aim as high a price elsewhere, so quantity supplied will be reduced sharply for a small - Reservation wage. decline in factor price. As illustrated in Figure 16.4, economic rent is small for facto The lowest W095 0 Worker with this very elastic supply. The factor earns only slightly in excess of what it migh !5 Winif‘g *0 accept“) W°rk earn elsewhere (opportunity cost). This opportunity cost is represented by the area '" " g'vel‘ PCCUW‘C’” £29" OABX leavin littl ' t A F :1: lab mark th an efecmcm may be M”, ,, gvery e economic ren ,area 1293. or e or ct, ewagerat mg b work Of a wage is just above the wage at which a worker would just be willing to supply his or h below the union wage role. labor services (called the reservation wage). Thus, a worker’s opportunity cost Figure 16.3 Economic rent. The area below the wage rate and above the supply curve represents” economic rent. Economic rent Xe 9i ' ,resuIting in low economic rent. This high opportunity cost results in the supply gfworkers being very responsive to a change in wages. A decline in wages can result this opportunity cost exceeding the income from working, and thus, result in a ecline in the number of workers. In the extreme, a perfectly elastic supply curve ts in zero economic rent accruing to the factor, so the reservation wage (in gen- . ,called the reservation price) is equal to the wagerate. The opportunity cost is en equal to the total factor payments, making a factor owner indifierent between pplying the factor or not supplying the factor. ._ In contrast, professional football players generally have limited opportunities at proximately the same wage. Their wage rate is substantially above the wage at 'ch they would just be Willing to supply their labor services (reservation wage), so cit economic rent is relatively large (Figure 16.5). A decrease in a football player’s .e“ Competitive Input Markets Chapter 16 525 Figure 16.4 Low level of economic rent associated will-t an eluslie market supply curve. The factor price is just above the reservation price. A decline in the factor price can then result in the opportunity cost exceeding the revenue generated fi'om supplying the factor. Figure 16.5 Economic rent associated with em inelastic supply curve. The factor price is substantially above the reservation wage of supplying the factor, so a decline in the factor price will have limited impact on the factor supply. Example |6.2 Calculating Economic Rent Consider the following inverse inPUt market demand and supply functions: v = IO — XD, input demand, v = 2 + X5, input supply. Consumer surplus Equating demand with supply and solving for X gives m—x=2+x m=¢ n=s ‘ Economic rent is then the area below the equilibrium price and above the supply curve. (6 - 2)(4 - 0H2 = $8. Consumer surplus is also (I0 — 6)(4 - 0)."2 = $8. Recall that consumer surplus,which flows to the firm employing this input, is the area below the demand curve and above the equilibrium price. instead. if the market‘supply curve is perfectly elastic—for example, v = 6-—economic rent would be zero. The _,‘. reservation price to retain the level Xe in this market would equal the price of the input. ve. In contrast. if the mar- " ket supply curve is perfectly inelastic—for example,X5 = 4—economic rent would be 6(4) = $24. Perfectly elastic supply Perfecin inelosiic supply Zero economic rent wage will have limited impact on decreasing supply (relatively inelastic supply). Some football players would be Willing to play football for free. Alternative earning possi- bilities (opportunity cost) of football players are generally quite low, so a large part of ' their wage is economic rent. In Figure 16.5, the oppornmity cost is ABXe, with the shaded area representing economic rent. As the labor supply curve becomes more ‘ inelastic, the opportlmity cos’t declines with an associated increase in economic rent. -_ LAND RENT Henry George applied the idea of large economic rents accruing to factor owners ' with highly inelastic supply curves to land.2 He assumed that land is in fixed supply? Competitive Input Markets Chapter 16 527 (perfectly inelastic). In Figure 16.6, no matter what the level of demand, the supply of Lfland is fixed at M“. Given the demand curve MD, a return (economic rent) to the Jandowners is 0905.114“. With the demand curve MD', return is OvIA‘M“. Thus, an increase in the demand for land has no effect other than to enrich the landowners. enry George proposed that those rents accruing to such fortunate landowners be r. ed at a very high level because this taxation would have no effect on the quantity .-of land provided. He assumed a zero supply response, so a tax on land would not cre- inefficiencies. Note that there is no deadweight loss in Figure 16.6 from a tax causing a shift in demand from MD’ to MD. Given no deadweight loss, some propo- i. cuts of this Henry George 17920131 even suggested this should be the only method fof tax collection.5 1 This type of single-tax scheme may be worth considering in an agrarian economy where all land is of the same type yielding the same producfivity.When land has only ’one main use, the opportunity cost is near zero, resulting in a highly inelastic supply _.____ "curve. However, for most economies there are multiple uses for land, such as for res- , dential, commercial, or industrial development. Thus, an opportunity cost exists for -; land in a particular activity, which creates inefficiencies associated with the ingle—tax scheme.We investigated the deadweight loss associated with these ineffi- "_ciencies in Chapter 10. Should only land be taxed? No, such a single-tax scheme distorts 121:!» Ethe market for land, which results in an inqfl‘icient allocation afland. It might be feasible to tax other factors used in a production activity where alter- ?" tive uses are slight. For example, a high tax rate on professional sports players uld have little or no efiect on the number and quality of professional players. Such tax would not greatly distort the market allocations (there would be little if any deadweight loss), plus disadvantaged youth would not see sports as a substitute for ; education for achieving success. The Major League Baseball Commission has consid- ered taxing players' salaries in an effort to reduce these salaries; it would then use the .“tax revenue to support ball clubs with relatively fewer resources. Figure 16.6 Land rent. If the supply curve for land is perfectly inelasn'c, there is no supply response to a change in factor price. y). Some 1g, possi- e part of with the .es more nic rent. owners Part 1 Input Markets lZéS:6lll‘CE':!rents ,aré'largest in'ithe'agric'ultural :Secton-sugf. V _‘ ' .‘g'esting-Ja igher‘iaxi':tate." omenin'terms‘lfefipréfer; - Table 16.1 Optimal Tax Rates by Sector: Tux Sector obserVation, David Ricardo made one of the most important conclusions in classical economics: More fertile land tends to command a higher rent.4 Ricardo's analysis Agricultural Manufacturing Utilities T m}. supply curves for wheat. The market for wheat determines the equilibrium price for mmpo 'on wheat. At this equilibrium, an owner of a low—cost land parcel earns a relatively large - Oll'er pure profit, with p > SATC. Considering this profit as a return to land, the low-cost firm is earning relatively high rents (Ricardian rent) for its land. A medium-cost firm A j Competitive Input Markets Chapter lb 529 3 figure 16.7 Ricardicm rent. A low~cosi firm earns higher pure profit {Ricardion rent} relative to the mediumcosi and marginal ' firm. The marginal firm earns only a normal profit, so firms with higher cost than this marginal firm will have no incentive to enter this i market Marginal Firm Market Low-Cost Firm p Medium-Cost Firm p SMC SMC SA TC SMC Pure profit (Ricordian rent] earns less profit (Ricardian rent):Price is still greater than SATC, Oil prices have fallen lately.We include this but not as great as for the low-cost firm. In contrast, the marginal firm-is earning a zero pure profit (Ricardim map = many news for the benefit of gas stations. which additional parcels of land brought into wheat production will result in a loss, so there is no incentive for these parcels to be f brought into production. The presence or absence of Ricardian months (William D.Tammeus). ' rent in a market works toward allocating resources to their most ; CffiCiCIlt use. I, Ricardo’s analysis indicates how the demand for land is a demand derived from Ricardiun rem Prom [ the output market.The level of the market demand curve for output determines how accruing to on inp'ut E9” much land can be profitably cultivated and how much profit in the form of Ricardian the Prop, a collegiafe Gm. rent will be generated. His theory explains why some firms earn a pure profit in com- leir'c association makes from : Petitive markets:When managerial ability, location, or land fertility differ. its student athletes. For example, a favorably situated store (firm) will earn positive pure profits while :7 stores at the margin earn only normal profits. But it is not the store’s cost of produc- .' tion (cost of petroleumJ—for example, the rent it pays for a particular location—that _:. determines the store’s output prices (price of gasoline). Output prices are determined by the market demand and supply curves for these outputs. Those prices, in turn, a determine profit (Ricardian rent). Thus in a perfectly competitive output market, it is not true that a store can offer lower prices because it does not have to pay “high downtown rents.” If its rent is lower than downtown, the store may earn a short-run .. pure profit. But in the long run, the store will only experience a normal profit as any ' . pure profit gets capitalized into the firm’s costs. Thus the store’s prices may be less, but it is not because its rent is less. Output prices are determined in the markets for these outputs, not by the cost of production. Do high state rents result in high product prices? Na, in a perfectly competitive market, rents do not determine product prices. The market supply and demand determine a product’s price. otherwise would not learn of it for six ...
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This note was uploaded on 06/09/2011 for the course ECON 330 taught by Professor Marble during the Spring '11 term at University of Texas.

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economic_rent,_wetz - MWHPVEL 6 mer FCQNOMKé flies-pr...

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