Rent, in the world of economics has two main meanings: 1. Income from hiring out land, property, vehicles or any other durable good. 2. Often referred to as ‘economic rent’, it is the difference between what people are paying for a factor of production and the minimum required for it (or he/she) to remain in current use.
Put simply, economic rent is any payment in excess of the cost of production. For example, if a professional sportsman is paid $30,000 per week to play in each match for his club, but he would quite happily do it for just $8,000, his economic rent is $22,000 per week.
In a perfect market – one with **perfect competition – economic rents do not exist – as new commercial enterprises enter the market, they compete until prices decline and all economic rents vanish. As the reduction of economic rents do not alter production decisions, they can be taxed without adversely affecting the real economy, that is, if they truly are economic rents.
** Perfect Competition refers to a theoretical free-market Utopia where there are several sellers and buyers – none of them has any significant impact on the prices of goods, and all buyers and sellers seek to maximize their income.
The difference between what one pays for a factor of production – in this case a soccer player – and the minimum required for it (him or her) to continue working, is its economic rent.
According to Business.Dictionary.com, rent is:
“1. General: Compensation paid by a tenant (or lessee) to the property owner (or lessor) for use or occupancy of a property. 2. Economics: Surplus generated by the supply of any resource (capital, human, natural) over the amount necessary to produce, or bring forth, the quantity of resources supplied.”
Economic rent – another example
Economic rent is the income that can be earned from land or any natural resource for which the supply is fixed – supply is perfectly inelastic. As the supply is perfectly inelastic, how much of that supply there is does not depend on any income that the resource is able to produce.
Rising demand does not lead to an increase in the supply because it is a natural product that was always available.
When humans first started populating the land, it was there for the taking – nobody made it, it was not the result of anybody’s efforts – it was a gift from nature. Hence, whatever rent or revenue that can be earned from the land is unearned by its owner.
To ‘rent out’ something means to lend it to somebody, a company or any entity for a fee. If a friend asks you to lend him some money, and he offers to loan his car to you in return, he is offering to rent out his car to you. The word ‘rent’ (without ‘out’) on its own: 1. As a noun means the money the borrower pays (the tenant pays rent to the landlord). 2: As a verb means the action of borrowing temporarily and paying for it (I am renting a car from Hertz).
For example, imagine there are two farmers who own two acres of land each. They both farm the land identically, with the same real capital. However, Farmer Giles is able to produce 2 tons of wheat from those two acres, while Farmer Jones is only able to produce 1 ton of wheat.
The difference between farmers Giles’ and Jones’ output is due solely to the fact that Farmer Giles’ soil is more fertile. If, in a free market economy, the price for 1 ton of wheat is $500, Farmer Giles earns $1,000 while Farmer Jones earns $500. The difference in land quality for wheat production is the sole reason for the $500 gap between the two farmers.
They both used identical agricultural methods, i.e. Farmer Giles did nothing to earn those extra $500 – it was a free gift from nature. Therefore, the $500 is considered the economic rent that Farmer Giles earned in excess of what Farmer Jones received.
Some economic rent has also been earned by farmer Jones, because without land he would have had no wheat. However, we cannot determine the economic rent without a reference, because even though he earned $500, a proportion of that money came from his efforts (labor) and whatever he spent on agricultural tools and machinery (capital).
Technically, to rent is to borrow and pay for it, while to hire is to lend and be paid. However, in the United States, ‘hire’ is often used with both meanings. In the USA and Canada, it is common to hear the person who paid to borrow a car saying: “I hired a car.” This second meaning of ‘hire’ is spreading into the other English-speaking countries. In order to prevent ambiguity, when you want to say that something was lent and money was paid, add the word ‘out’ – to ‘rent out’ or to ‘hire out’.
What is rent-seeking
In public-choice theory and economics, rent-seeking refers to trying to increase one’s share of existing current wealth without creating any new wealth.
If you use the resources of an individual, company or any organization to obtain economic gain from others – to make yourself richer – but do not reciprocate any benefits to society through wealth creation, you are rent-seeking.
When a company lobbies the government for grants, tariff protection, or loan subsidies – none of which create any benefit for society – it is rent-seeking. No extra wealth is created, the company becomes richer, and the taxpayer has to pay for it.
If you are CEO of a company and you succeed in obtaining subsidies or getting legislation passed that restricts competition and makes it harder for newcomers to enter the market – barriers to entry – you have managed to increase your share of existing wealth without increasing the size of that total wealth; you have been involved in rent-seeking.
Moreover, you have earned income without actually creating or producing anything at all – neither have you put any of your capital at risk.
In any environment where a closed-shop system exists, so does rent-seeking. There are cases when requiring a license makes sense – doctors and airline pilots should not practice until they have their flying or medical practice licenses for obvious reasons.
However, when wanting to work as an interior decorator, packer, florist, or taxi driver means obtaining an onerous license, the intention is clearly to create a giant barrier to entry, rather than protecting patients, passengers, etc.
Licensing requirements and other barriers to entry exist as a result of sustained lobbying efforts from people who work in the specific industries.
If fewer players are allowed to operate within an industry, it means that each participant gets a larger slice of the wealth pie. Licensing requirements contribute nothing to the creating of additional wealth – they do not make that wealth pie any larger.
Any closed-shop system is bad for consumers. Free competition drives down prices, while lack of competition and rent-seeking behaviors keep them high.
Government corruption and rent-seeking
Corruption among politicians and civil servants is also within the concept of rent-seeking.
Tax office bureaucrats who solicit and extract bribes for looking the other way or coming to ‘special arrangements’ are guilty of rent-seeking – they are making themselves richer without contributing to the wealth of society.
Regulatory Capture refers to a regulatory agency that was initially set up to police an industry and protect the consumer, but ends up working for the industry to the detriment of the consumer.
Regulatory capture is a bit like setting up a group to protect the sheep from the wolves, and eventually recruiting wolves into the group, and placing the rights of wolves above those of the sheep. Regulatory capture is seen as enabling extensive rent-seeking behavior.
It is uncommon to use ‘to hire’ for things that cannot be transported, such as a house, apartment or land. ‘To rent’ is commonly used for both transportable and non-transportable goods.
‘To Rent’ in other languages: alquilar (Spanish), louer (French), mieten (German), alugar (Portuguese), noleggiare (Italian), арендовать (Russian), do wynajęcia (Polish), att hyra (Swedish), at leje (Danish), å leie (Norwegian), vuokrata (Finnish), huren (Dutch), a inchiria (Romanian), pronajmout (Czech), 賃借する (Japanese), 租赁 (Chinese), للإيجار (Arabic), किराए के लिए (Hindi), di sewakan (Indonesian), untuk disewa (Malay), umupa (Filipino), and کرایہ پر (Urdu).
Video – What is economic rent?
This Investopedia video explains what economic rent is using simple terms and easy-to-understand examples.