Subject 1. Types of Profit Measures

Economic Rent

The total income received by an owner of a factor of production is made up of its economic rent and its opportunity cost.

  • Economic rent is the income received by the owner of a factor of production over and above the amount required to induce that owner to offer the factor for use.
  • The opportunity cost of using a factor is the income required to induce its owner to offer the resource for use, which is the value of the factor in its next best use.

The following figure illustrates the division of a factor income into economic rent and opportunity cost.

The portion of income comprised of economic rent depends upon the elasticity of supply for the factor.

  • The less elastic the supply for a factor, the greater the share of income that is comprised by economic rent. When the supply is perfectly inelastic, all of the income is economic rent.

  • The more elastic the supply for a factor, the smaller the share of income that is economic rent. When the supply is perfectly elastic, none of the income is economic rent.

Practice Question 1

Which statement is true?

A. When the supply is perfectly inelastic, all of the income is economic rent.
B. When the supply is perfectly elastic, all of the income is economic rent.
C. When the demand is perfectly inelastic, all of the income is economic rent.
D. When the demand is perfectly elastic, all of the income is opportunity cost.
Correct Answer: A

B. When the supply is perfectly elastic, all of the income is opportunity cost.

Practice Question 2

When the supply curve of a factor is perfectly elastic, the factor income is most likely ______.

A. entirely economic rent
B. entirely opportunity cost
C. part economic rent and part opportunity cost
Correct Answer: B

When the supply of a factor is perfectly elastic (the supply curve is horizontal), the entire factor income is opportunity cost.

Practice Question 3

Which of the statements is true?

A. The less inelastic the supply for a factor, the greater the share of income that is comprised by economic rent.
B. The less elastic the supply for a factor, the greater the share of income that is comprised by economic rent.
C. The less inelastic the demand for a factor, the greater the share of income that is comprised by economic rent.
Correct Answer: B

When the supply is perfectly inelastic, all of the income is economic rent.

Practice Question 4

Which of the statements is (are) true?

I. The less inelastic the supply for a factor, the greater the share of income that is comprised by opportunity cost.
II. The less elastic the supply for a factor, the greater the share of income that is comprised by economic rent.
III. The less inelastic the demand for a factor, the greater the share of income that is comprised by economic rent.
IV. The less elastic the demand for a factor, the greater the share of income that is comprised by opportunity cost.

A. I and II
B. I and III
C. II and IV
Correct Answer: A

When the supply is perfectly inelastic, all of the income is economic rent.

Practice Question 5

Let's suppose the factor of production is labor. The laborer receives $20/hour for their job, and the minimum salary they'd be willing to work for is $16/hour. The laborer's economic rent is ______.

A. $0
B. $4
C. $20
Correct Answer: B

$16 is the laborer's opportunity cost. $20 - $16 = $4

Practice Question 6

Which statement is false?

A. Most of the salary earned by a superstar baseball pitcher may be economic rent.
B. Most of the wages of a fast-food restaurant worker are opportunity cost.
C. If the supply is perfectly inelastic, the supplier's entire income would be comprised of opportunity cost.
Correct Answer: C

B is true. This is because the job pays minimum wage.

If the supply is perfectly elastic (NOT inelastic), the supply curve would be perfectly horizontal, and the supplier's entire income would be comprised of opportunity cost. If the supply is neither elastic nor inelastic, the supply curve will slope upward and the supplier's income would be split between economic rent and opportunity cost.