Economic Rent

Formal Definition

This refers to any payment to a factor over the minimum it has to be paid in order to keep it in its present employment.

I.e. the scarcer the supply of a factor, the greater the economic rent is likely to be

Transfer Earnings

Formal Definition

This is the minimum payment to a factor that is necessary to keep it in its present employment.

Simple Explanation of Economic Rent and Transfer Earnings

We will utilise a scenario:

• Bob has a toy car.

• Bob is willing to allow others to use his toy car.

• Sarah comes over and offers Bob 10 dollars to use his toy car. Bob originally agrees to this price.

• Now Jerry comes over and offers Bob 15 dollars to use his toy car.

• Bob now decides he will let Jerry use his toy car.

In this simple scenario, Bob is willing to accept 10 dollars as a minimum for someone to use his toy car, this figure is called the transfer earnings.

As seen, Bob, instead lets Jerry play with the car for 5 more dollars (15 dollars), that difference between what Sarah offered and what Jerry offered is what we call Economic Rent.

So the economic rent in this situation would be 5 dollars.

Diagram showing Economic Rent and Transfer Earnings

• As shown above, equilibrium occurs at \(E_0\) where the demand for labour equals the supply of labour.

• At equilibrium, \(W_0\) will be the wage rate where \(L_0\) will be employed.

• Since the reward for labour is wages, and give \(Wages = Wage Rate(W) \times Employment Level (L) \). Then the rectangle \(0 W_0 E_0 L_0\) is the share of income to Wages.

• This share of income can be divided into:

• • Economic Rent \(0 W_0 L_0\)
  • Transfer Earnings \(0 E_0 L_0\)