The Supply of Land to Alternative Uses

Aggregate supply of land: The amount of land available to the entire economy at various rental rates.

Since the return to land in the aggregate is a pure economic rent, a price does not have to be paid to call forth a supply of land. The supply of land is fixed and given at Q, and it is not affected by the level of rent, R. Since the supply of all land is independent of its price, we say that price has no allocative function in this case.

Figure 2 shows cost curves of four farms at 50-mile intervals from a city. Farm A is closer to town than Farm B, B is closer than C, and C is closer than D. The costs of production are lower at locations closer to the city; this land can be described as more productive.

 

Figure 2. The Importance of Location in Determining Rents

Graphs a-d show the cost curves for four different farms at four different locations. Farm A is closest tothe city, farm D is farthest away. Since costs of transportation increase the farther a farm is from the city, farm A will enjoy lower costs and higher productivity than any of its three competitors.

Since each farm is a price taker in a competitive market in town, all farms face the same price, P. Profits are shown by the shaded area in each panel. The land closer to town is more profitable because of its locational advantage and thus is in greater demand. The demand for land decreases as dielocation is farther from town. Farm D makes no profits; there would be no demand for land by farmers beyond this point. The varying profits bring forth varying demand and thus varying rental rates. The rental rates are bid up by potential farm owners until a normal profit is obtained at each location. The shaded area of profits at each location actually becomes the rental rate. The advantages of a productive location yield income in the form of rents to the suppliers of the land.

What happens to rents if the demand for corn, and thus its price, increases? The higher price for corn will increase profits. Even the land at greater distances than farm D will now be brought into production. With higher profits, the demand for land will increase, and thus rental rates will again rise. After rental rates have risen, normal profits will result at each location, given competitive markets. A decrease in the demand for corn and a reduction in its price will lead to the opposite results. Profits will fall, some distant farms will go out of business, and rental rates will fall, restoring a normal rate of return to farming.

Specialization of Resources and Inframarginal Rents

Resource specialization: The devotion of a resource to one particular occupation that is based on comparative advantage.

The concept of economic rent is more general than a rent payment in a lease agreement. An economic rent is defined as a payment to any factor of production — land, labor, or capital — above and beyond its opportunity cost. Rent, in other words, is an excess payment to a resource owner. This concept can easily be applied to resources other than land.

In general, we can detect the degree of resource specialization by observing the supply curve of the resource. The supply curve of a factor of production measures the willingness of its owner to supply its services at various prices. It therefore gives a measure of the opportunity cost of the resource at different prices.

Figure 3. Unspecialized and Specialized Resources

(a) The supply curve of an unspecialized resource Such resources earn no economic rents

(b) The normal case of economic specialization and an upward-sloping resource supply curve. Inframarginal rents accrue to the resource owners in the amount represented by P₂EP₀.

 

Examples are given in Figure 3. In part a, the supply curve of the resource is flat or perfectly elastic. This means that the resource is completely unspecialized with respect to its use in this industry. Any amount of the resource can be purchased at the same price, P₁. The resource's price is determined solely by the level of the supply function. This is the opposite extreme from the case of the perfectly inelastic supply curve of land given in Figure la. Whereas the return to land in the aggregate was a pure rent, the resource depicted in Figure 3a earns no rents. Completely unspecialized resources earn no rents.

 

Rents and Firms

Firms may also earn rents, and these rents are analogous to the firms' profits. In fact, the concept of economic rent as a return in excess of the opportunity cost of a factor of production is just another way to think about the profits earned by competitive and monopolistic firms. The purely competitive firm can earn quasi-rents, and the pure monopolist can earn monopoly rents.

Quasi-Rents

Quasi-rents are the return to the owner of a competitive firm in the short run. They are called quasi-rents because they are a short-run or temporary return. Figure 4 illustrates a short-run equilibrium for the competitive firm and industry. The firm earns an economic profit in the short run, which we have labeled as quasi-rent. This return is a rent because it exceeds the firm owner's opportunity cost (which by definition is included in the average total cost curve). Quasi-rents are temporary, entry of new firms into the industry will erode these returns over the long run. Keep in mind that quasi-rents can also be negative instead of positive, for the firm can suffer economic losses in the short run. The rents themselves are a return to the owner of the firm for decision making under conditions of risk and uncertainty.

Quasi-rent: The short-run payments to owners of capital in a competitive industry that exceed the opportunity cost of capital.

Figure 4. Quasi-Rents

Quasi-rents are illustrated as the economic profits earned by the owner of a competitive firm in the short run. They are rents because they are a return in excess of the owner's opportunity cost, included in the ATC curve. They are called quasi-rents because they are temporary and will be eroded by the entry of new firms in the long run.

Monopoly Rents

Figure 5 shows the case of a monopolist who makes profits of PABC. These profits are sometimes called monopoly rents because they are a return in excess of the monopolist's opportunity cost, which is reflected in the average total cost curve. Unlike the quasi-rents earned by the competitive firm, the monopoly rents earned by the monopolist will persist over time. They are permanent, short of an event that would threaten the monopolist's control of an industry But what happens if the monopolist sells the monopoly? Primarily, the monopolist will sell for the present value of future monopoly rents. Monopoly rents are therefore captured by the original owner of the monopoly; buyers of the monopoly right may earn only a competitive rate of return on their purchase of the monopoly

Monopoly rent: The payments to owners of capital in a monopolized industry that exceed the opportunity cost of capital.

Figure 5. Monopoly Rents

Monopoly profits can be called monopoly rents. They are returns in excess of the monopolist's opportunity costs, which are reflected in the ATC curve. Unlike quasi-rents, they persist over time because of the monopolist's dominant position in the market.

Rent Seeking

Rent seeking: The process of spending resources in an effort to obtain an economic transfer.

When competition is viewed as a dynamic, value-creating, evolutionary process, economic rents play a crucial role in stimulating entrepreneurial decisions and in prompting an efficient allocation of resources. Profit seeking is a normal feature of economic life in a competitive market. The returns of resource owners will be driven to normal levels by competitive profit seeking as some resource owners earn positive rents that promote entry into the industry and others earn negative rents that cause exit. In this basic sense, profit seeking in a competitive setting is socially beneficial.