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 $Wages=WageRate\left(W\right)\times EmploymentLevel\left(L\right)$. Then the rectangle $0W_0{E}_0{L}_0$ is the share of income to Wages.

• This share of income can be divided into:

• • Economic Rent $0W_0{L}_0$
  • Transfer Earnings $0E_0{L}_0$