What is Economic Rent?
Economic rent is any excess payment for a service, good or property above and beyond the minimum amount at which the person receiving payment would still have agreed to the deal. Although the term originated in terms of land, it can apply to any good, service or property which can be hired. Economic rent is both an indicator of market imperfections and a guide to the effects of taxation.
One example of economic rent would be an employee who is hired for $50,000 US Dollars (USD) but would have still taken the job at $40,000 USD. In this situation, the "economic rent" is $10,000 USD. The figure can also be referred to as unearned income. Although in this example the employee does work for the money, the extra $10,000 USD is said to be "unearned" because it is above and beyond the value the employee placed on his or her labor when deciding he or she would have done the work for $40,000 USD.
The term refers to rent, since it was first developed to solve an apparent problem with determining the flow of money in the production process. At most stages which brought together raw materials, labor and manufacturing equipment costs, the numbers added up in line with the value each step added to the process. Two stores selling the same final product might pay very different rents on identical properties if one was in a better location for attracting customers. In this case the landowner of the property with the higher rent is able to get extra income thanks to circumstances beyond his direct responsibility or control, such as other shops in the same area creating a busy location for shoppers. This income was explained as economic rent.
In theory, the free market would eliminate economic rent. In the example of the employee, the higher salary should mean more people would be attracted to working for the firm, dropping the salary down until people are working for the lowest amount they would accept. In reality this might not happen, as there may not be enough people with the necessary skills to fill the posts, or those with the skills may be unwilling to relocate. Such issues are known as market barriers. The extent of economic rent may indicate how strong those barriers are.
Economic rent can also be a guide to taxation. In theory the government could tax the employee in the above example and take some or even all of their income above $40,000 USD without affecting their willingness to continue working in the job. The same logic could apply to any form of economic rent. In reality the added tax may cause resentment and thus political repercussions.
Confusingly some economists use the term economic rent in the everyday meaning of rent: the flat amount of money paid in return for use of land or property, regardless of any other factors. This runs the risk of confusion and it is best to avoid using the phrase for this meaning if this is a concern. Fortunately the context usually makes it clear enough which definition is being used.
Written by John Lister
