Economic rent and transfer earnings

Economic rent

Earnings for a worker (or class of workers) can be broken down into two components - economic rent and transfer earnings. Economic rent can be earned by any worker who receives a wage greater than is required to keep them supplying their labour in a particular labour market.

Transfer earnings

Transfers earnings is the pay necessary to prevent a worker from transferring to their next best source of employment. Transfer earnings represent the opportunity cost to the worker of remaining in a current labour market. If they do not receive at least their transfer earnings, they will move to their next best source of employment.

Diagram for economic rent and transfer earnings

Economic rent transfer earnings the basic diagram

Explaining economic rent and transfer earnings

Graphically, any point on the labour supply curve represents the minimum a worker is prepared to work for, and just covers their opportunity cost.

Diagram to explain the difference between economic rent and transfer earnings

Receiving less than opportunity cost means the wage for a given quantity supplied is insufficient to prevent the worker transferring to their next best source of employment. If the wage for a given quantity of labour in in excess of this, the worker is earning economic rent.

The importance of elasticity of supply

Whether a worker (or any other factor) earns more than their transfer earnings depends upon the elasticity of supply of labour, or any other factor.

In extreme cases, where only one or a few individuals supply their talent, they can earn very high economic rent.

Land and economic rent

We can understand how a factor can derive economic rent by looking at land as a factor of production. At any one point in time the supply of land is fixed. Land does not 'choose' to supply itself, but it exists, and unless natural disasters reduce its availability it is there to be used.

Hence the supply curve of land is fixed and is perfectly vertical.

The reward to land is exclusively economic rent

The price of land (its rental value) is, therefore, determined by the demand for that land. Hence, all the reward to land is rent - there are no transfer earnings.

Changes in rental values are determined by change in demand, rather than supply. [Of course, where land can be taken out of supply, then relative supply will have an impact, but at any one time, only rent is earned.)

As land is put to more use, and as more consumers enter the market, demand is driven up, and rent increases match that increase in demand.

All factors can earn economic rent when there is a level of scarcity to their supply.

A semi-skilled worker

For a semi-skilled work, the elasticity of supply will be relatively elastic, with the supply curve having a relatively flat gradient. In this case, most of the reward is transfer earnings, with a small amount of economic rent.

What does a semi-skilled worker get in terms of economic rent and transfer earnings?

An elite sports star

We can contrast this for the earnings going to a much more highly skilled worker. For the elite sports star, particular players may be almost unique - and certainly there would only be a few supplying their services to sports clubs.

The reward to elite sports players - diagram

In this case, the elasticity of supply of labour is very inelastic - if they are 5 super-elite performers, raising wages may have no impact on the number of elite superstars - it is impossible to become an elite player over-night, if at all.

Graphically the labour supply curve is nearly perfectly inelastic.

In this case, most of the reward is economic rent.

Comparing the average and elite player

The reward to an average sports player

While the concept of economic rent and transfer earnings provides a sound economic model to explain some of the pay levels of elite sports stars, it can also be used to explain why workers of a similar grade might be rewarded differently.

For example, a senior airline pilot who can fly 5 different types of plane is rarer than one who can fly 2 types. Hence, the senior pilot can gain more economic rent. However, there are many other ways to explain wage differentials without using economic rent and transfer earnings as a theory.

Quasi-economic rent

Quasi-economic rent refers to the short-term economic rent that can be earned when a particular skill is in short supply. In the longer term this will be eroded away as new individuals enter the market having acquired the required skills.

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