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What is Economic Rent?

Ishani Chatterjee Shukla Jun 16, 2019
Have you heard of a concept called economic rent? No? Here, we will familiarize you with this important economic theory.
'Economic rent' should not be confused with the more common term 'rent' which is a payment for the temporary use of a good or property. This concept could be a little perplexing for those who are not familiar with the basic economic concepts such as factors of production and remuneration.
As per classical principles of economics, as propounded by Adam Smith, David Ricardo, and their followers, there are, broadly, three factors of production that go into the creation or manufacture of any product or service. These are land, labor, and capital.
Economic reasoning says that when any factor is employed for production, it becomes entitled to share the pecuniary benefits earned as a result of making the product commercially available to consumers. Such a monetary share is named as remuneration, which is also known by different terms.
Land (this term includes geographical land, building, and equipment) gets rent, labor (manual labor, both direct and indirect) gets wages, and capital gets interest. A fourth factor of production, entrepreneur is also often considered, which is entitled to profit.

Definition

Economic rent is the surplus income paid to a factor of production over the 'opportunity cost' incurred in procuring and using it. 
The definition by Henry George (best known for the single tax on land proposition) explains it as: "the part of the produce that accrues to the owners of land (or other natural capabilities) by virtue of ownership" and as "the share of wealth given to landowners because they have an exclusive right to the use of those natural capabilities." 
There are two main concepts regarding economic rent: the Classical factor rent and the Neoclassical Paretian rent. Let's look at each of these separately.

Concepts

As per the Classical factor rent concept, economic rent would include the following three parameters:

1. The rent should be a payment for using the services of a fixed resource, but it may not necessarily be an incentive for influencing the productivity of such a resource.
2. Such a payment has no effect, whatsoever, upon the supply of the input required for production.

3. Any factor of production whose supply is perfectly inelastic usually attracts rent, the best example of which is land.
Somewhat broader and more inclusive than the given theory, the Neoclassical Paretian rent concept includes additional factors, other than just natural resources. According to this theory, rent would include the following:

1. The excess earnings over the amount necessary to keep the factor in its current occupation.
2. Any differential amount that arises out of what a factor is actually paid and how much it needs to be paid to be kept in working condition for its current use.

3. Any excess amount above the opportunity cost, or normal return which is compulsory for retaining the working conditions of the resource for its current use.

How is it Different from Contract Rent?

Economic rent and contract rent are often confused with each other. While the former is calculated by taking into consideration various economic aspects of factors of production and their contribution to the income generation process, the latter is merely the rent agreed upon by the owner and the user of the resource in a legal contract.
The contract rent may be more, less, or equal to the economic rent. When it is lesser, it is because the owner of the factor is renting the resource below the prevailing competitive rate to attract business. On the other hand, when it is greater, it is because an element of interest has been added to the rent.