Rent: Meaning and Economic Rent

Meaning of Rent:

Rent is a much-used word. Everyone is familiar with it. But every time it is used it has a different meaning.

It may mean what a tenant periodically pays to his landlord for the use of a house or a piece of land. It also refers to the payment made for the hire of a sewing machine or a radio set or a piece of furniture, etc.

Thus, quite often we mix up ‘rent’ with the terms ‘fare’ ‘hire’ or rental.

Contract Rent:

We should carefully distinguish between contract rent and economic rent. In ordinary speech, rent refers to the total amount of money paid as a hiring charge or for the use of land. It is contract rent. What a-cultivator is actually paying to the landlord is the contract rent. It includes economic rent, i.e., payment for the use of land as well as interest on capital invested therein.

Economic Rent:

The classical economists used the term economic rent as that part of the total payment which is made for the use of land only as distinguished from the payment made for the capital invested therein. Suppose a tenant is paying annually Rs. 200 to his landlord. This amount is contract rent. If out of this sum, Rs. 50 represents interest on capital invested, say, in the tube-well, the remaining Rs. 150, being only for the use of land, is economic rent.

Modern economists, however, use the term economic rent or simply the word rent in the sense of the return not only of land but also of any factor of production whose supply is completely inelastic.We know that an important peculiarity of land is its complete fixity of supply. But we find that under certain circumstances and for some length of time factors other than land may also come to have an inelastic supply.

It is only logical to treat alike the returns of, or the reward for, the services of all such factors as are in inelastic supply. Thus, according to modern economists, rent is not confined to land and other free gifts of nature alone but to all factors of production, when they are in inelastic supply.

When any factor is in less than perfectly elastic supply, it yields a surplus exploited below:

Economic Rent—A Surplus:

In Economics, rent is increasingly being used in the sense of a surplus, i.e., what a factor of production earns over and above what is essential to maintain its supplies in its present occupation. It can be easily understood that rent in this sense can arise only when the supply of a factor of production is less than perfectly elastic, and this is the case not only with land but with other factors also under certain circumstancesas mentioned above.

In case the supply of a factor is perfectly elastic, it cannot earn any surplus over and above its supply price, because whenever such a factor is found to be earning more than its supply price, more units of this factor will rush in and the surplus earnings will disappear.

This is so because, under perfect competition, the market price of a factor must equal its supply price. But when supply is not perfectly responsive to changes in the reward of a factor, it can continue to earn more than what is necessary to call forth its supplies without any fear of new units of factors coming in to deprive it of extra reward.

The supply of land in general, though not for a particular use, is absolutely inelastic; and as such, its supply is independent of what it earns. That is, higher rent cannot attract more of it, and lower rent cannot drive it out. Its supply price being zero, the whole of its earnings is called rent in the economic sense. Economic rent is the surplus which remains to the cultivator after he has paid all the expenses of production and has remunerated himself for his own productive effort.

It is an excess or surplus over costs or expenses. It is for this reason that the use of the term rent is commonly associated with land, although as defined here, the concept of rent is applicable to all factors.

Economic rent is surplus over transfer earnings as explained below:

Economic Rent and Transfer Earnings:

Modern economists make use of the concept of transfer earnings in explaining economic rent. The transfer earnings represent the amount which a factor can earn in its next best paid alternative use. Suppose a piece of land yields in its present use Rs. 500 a year and suppose further that if it is transferred to its next best use, it will yield Rs. 400. In its present use, it yields Rs. 100 more than in-its next best use. This sum of Rs. 100 is a sort of surplus that the land is yielding in its present use.

This surplus is called rent. To retain this piece of land in its present use a sum of Rs. 400 (its transfer earning) is essential, but actually it yields Rs. 500, i.e., Rs. 100 extra. The price which is necessary to retain a given unit of a factor in a certain industry may be called its transfer earnings or transfer price. If, however, the factor is earning over and above its transfer earnings or transfer price, the surplus or excess earnings is economic rent.

In the modern sense, therefore, economic rent means surplus or excess over ‘transfer earnings. This sort of surplus or economic rent is not peculiar to land, it may be found in all factors. How does rent arise? More than a century and a half back, David Ricardo supplied the answer in the Theory of Rent associated with his name.