Economic Rent

Economic Rent

Definition

Economic rent can have different connotations depending on the context:

1. In Economics: Economic rent is the cost commanded by a factor of production that is unique or inelastic in supply. This occurs when payment to a factor exceeds the opportunity cost of employing that factor. The factor’s inelastic supply means that its price reflects the rental income that is not directly tied to additional productive activity.

   Example: The portion of rental income attributable to the land is often considered economic rent, since the land will exist no matter what the rental rate is. In this context, it is seen as “unearned” income by its owner.

2. In Appraisal: Economic rent is synonymous with market rent, representing the potential income that could be earned by leasing a property under current market conditions.

   Example: Big Buy Foods is using a store for $1,000 per month rent. If the landlord could rent the store on a new lease now, it would command $4,000 per month. Here, the $1,000 is the contract rent, locked in by the old agreement, whereas the $4,000 represents the economic rent or market rent, reflecting the current market conditions which the landlord could achieve now.

Examples

1. Property Lease Differences:

   • A property rented out in a rapidly developing urban area originally leased at a low rate to a tenant, while current market conditions significantly increase potential rental earnings. The original contract rent and newer economic rent exhibit this difference.

2. Natural Resources:

   • A landowner who leases land for drilling oil may command economic rent far above the normal rate for rented land, driven by the unique and valuable resource on that land.

Frequently Asked Questions (FAQs)

1. What is the primary difference between economic rent and contract rent?

   • Economic rent (market rent) refers to the potential or current market value that the property could command, while contract rent is the stipulated amount based on a pre-existing lease agreement.

2. Why is economic rent considered “unearned” income?

   • Economic rent is seen as income earned on factors that the owner has made no additional input efforts for its generation, such as land’s value resting on location, not on build or developed infrastructure.

3. Can economic rent change over time?

   • Yes, economic rent fluctuates based on real estate market dynamics, shifts in demand and supply for properties, and overall changes in economic conditions.

Related Terms with Definitions

1. Market Rent:

   • The rental income a property could generate if it were available on the rental market at the current rates.

2. Contract Rent:

   • The rental income stipulated by a pre-existing lease agreement between the tenant and landlord.

3. Inelastic Supply:

   • A situation where an increase in price does not result in a significant increase in the quantity supplied.

4. Opportunity Cost:

   • The cost of forgoing the next best alternative when making a decision.

Online Resources

• Investopedia on Economic Rent
• The Economist - Economic Rent Explained
• Urban Land Institute (ULI)

References

1. Samuelson, Paul A., and Nordhaus, William D. “Economics.” McGraw-Hill, 19th Edition.
2. Gwartney, James D., et al. “Economics: Private and Public Choice.” Cengage Learning, 16th Edition.
3. O’Sullivan, Arthur, and Sheffrin, Steven M. “Economics: Principles in Action.” Pearson Prentice Hall.

Suggested Books for Further Studies

1. “Rent Seeking and Human Capital: How the Hunt for Rents is Ruining our Economy” by David Brown
2. “Essentials of Economics” by N. Gregory Mankiw
3. “Property and the Pursuit of Rent” by Charlie Dereksen

Real Estate Basics: Economic Rent Fundamentals Quiz