Economic Rent

Well, the concept of economic rent could be a little perplexing to comprehend for those who are not familiar with the basic economic concepts of factors of production and remuneration. To begin with, 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 factors are land, labor and capital. Economic logic says that when any factor is employed for the production of any utility in the form of a good or a service, such factor becomes entitled to share the pecuniary benefits earned as a result of making the resulting utility commercially available to consumers. Such pecuniary share is known as remuneration and the remuneration that each factor is allotted is known by different names.

Extending this remuneration logic, Land (this term includes geographical land, building and manufacturing 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 and the remuneration this factor is entitled to is profit. Now that you've been introduced to the various factors of production and their remunerations, as per economics, let's proceed towards our rendezvous with economic rent.

What is Economic Rent?

As discussed earlier, economic rent is the surplus over the cost incurred in procuring and involving a factor, especially land, building and equipment, in the production process for manufacturing an economic utility. This surplus is the remuneration for that factor of production. The economic rent definition that has been proposed by Henry George (the main figure behind the single tax on land proposition) explains economic rent 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."

To put it simply, the fee or monetary consideration that is paid for using fixed (natural or man-made) resources without having ownership of the same is called rent. For instance, when you take up residence in someone's house without buying it, you pay the rent for using that part of the landlord's house, right? There are two main economic concepts regarding economic rent - the Classical factor rent concept and the Neoclassical Paretian rent concept. Let's look at each of these separately.

Concepts of Economic Rent

According to the Classical factor rent concept, economic rent would include the following three parameters:-

1. The rent should be a payment for using the utilities or services of a fixed resource but it may not necessarily be an incentive for influencing the productivity of such 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 above concept, the Neoclassical Paretian rent concept includes additional resources, other than just natural resources, under the aegis of rent attracting resources. According to this broader concept, rent would include the following:-

1. Any payment made for taking advantage of the utilities of an economic resource but such payment may not serve as an incentive for influencing the productivity of such resource;
2. Rent would include any differential amount that arises out of the difference between what a factor of production 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.

Economic Rent and Contract Rent are often confused with each other. While economic rent is calculated by keeping in consideration various economic aspects of factors of production and their contribution in the production/ income generation process, contact rent 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 contract rent is lesser than the economic rent (the latter being the competitive rent amount), it is because the owner of the factor is renting his resource below the prevailing competitive rate to attract business. When the contract rent is more than the economic rent (at the prevailing competitive rate), it is because an element of interest has been added to the latter (which may be due to many reasons). Hope that helps!