Winter Will Be Here Soon -- Study hard as finals approach...


 
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Rent: An Explanation

 

OK, let me explain it from ground zero. There are many
different meanings of the word "rent" in economics, but the
#1 modern usage is "An earning in excess of opportunity
cost." A worker earning $10 an hour, when their alternative
on the open market is merely $9, is considered to earn a
$1/hr rent. (Why use the word "rent"? Well, it all goes
back to Ricardo and other classical economists. Since the
land is just "there," they figured that from some point of
view, the opportunity cost of land is zero. The term rent
then got expanded to apply to anything "land-like"; i.e.,
any resource that is "just there" and the existence of
which does not depend upon its being paid.) The general
assumption is that rents are just useless inefficiencies.
They are basically just like the government granting a
monopoly on salt; the price of salt then exceeds its
opportunity cost, and for no good reason. A quasi-rent is
different. It LOOKS a lot like a normal rent; from a
superficial viewpoint, it is a reward paid to a factor
which exceeds its opportunity cost. But if you look deeper,
you see that in fact, the rent is a necessary incentive for
something. For example, a patent looks a lot like a
monopoly salt grant on the surface. The pricing policies of
the patent-holder and the salt-monopolist look a lot alike.
But the crucial difference is that the patent-holder had to
do something to GET the rent; he had to develop a new
product. In the long-run, no industry can earn more than
the normal rate of return, so the effect of the patent is
just to get more people to try to invent products; enough
people so that inventing things earns the same average rate
of return as anything else. What do quasi-rents compensate
for? The obvious example is innovation. A lot of
innovations are hard to patent, but an industry leader like
Microsoft can be reimbursed for its R&D by winning a
leading position in the market. Other good candidates
include search (a worker earns more money because looking
around for better jobs takes effort which must be
compensated). Also -- quasi-rents may be paid for product
variety. When products are heterogeneous, there is room to
charge a little above opportunity cost; but the incentive
effect of this "breathing space" is to encourage the
satisfaction of consumers' diverse tastes. Of course, it
would be more efficient to pay a one-time, lump-sum
"bounty," and then price the product at opportunity cost;
but that usually isn't workable. The real world system is
pretty damn good, once you give it a chance to understand
it on its own terms.

 




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