Question

Explain the concept of economic rent and how it differs from economic profit?

Answer 1

Firstly economic activity is anything which involve the production, distribution and consumption of goods and services at all levels i.e it primarily deals or talks about money.
So economic profit is any profit(i.e money) earned from any source be it from business entity, housing rent, profit from various other services etc
On the other hand economic rent is a factor of production. You make payment for the rent to the owner for the benefits recieved. Now profit recieved is a economic profit and the rent you pay is a economic rent.

Economic profit(EP) is absolute. Economic rent(ER) is relative. Economic rent arises because of relative advantage one set of application of factors has over the other.

Example: I buy a house(1st) for 10 INR. Sell it for 15 INR. EP = 5. ER = ?

If there were only one house in the whole world, ER = 0. Suppose there is another house(2nd) in a polluted area. Everything is the same other than pollution. I buy that house for 5 and sell it for 10. So, the ER for my 1st house, I sold for 15 is 15 - 10 = 5.

Suppose there is another(3rd) house. I buy it for 15. Sell it for 20. Everything is the same except the distance to the city center. Because of that ER = 20 - 10 = 10.

Suppose there is a 4th house in the same locality as the 2nd. It is relatively worse in quality. The capital and labor costs of all the houses are the same = 2INR. I buy the 4th house for 3 INR and sell it for 6.

Now, ER on 3rd house = 20 - 6 = 14, 2nd = 10 - 6 = 4, 1st = 15 - 6 = 9.

Had the 4th house not been constructed, the relative advantage of other houses that arose because of it would be absent.

It must be observed that all the 4 houses have been profitable. Because they sold for more than it took to construct them. It is assumed that any activity takes place only if at least pays its way, i.e., loss = 0.

Another example,

I own a house worth 10 INR. My friend constructs his house and declares its worth 15 INR. I compare my house with/to his and raise my house's worth to 30 INR. Capital and labor cost = 5 for both houses. But the city centre is closer to my house than my friend's. Mind you that I haven't sold the house yet. But, I earned a ER on the house = 30 - 15 = 15. It is necessary that I should be able to sell it for 30 and my friend for 15. Suppose, he can sell it for 10 and I for 20, ER = 20 -10 = 10. We need not sell it.

Applied to daily cases, I rent a house for 20 INR. ER = 20. I own a house. But I rent it because of the relative advantage I get.

ER is not necessarily paid or received as you have observed above. It may or may not be equal to EP. ER can be greater than less than or equal to EP. ER can be non zero and EP can be zero and vice versa. My house is worth 30 INR. I incurred 10 INR in its construction. My friend’s house is worth 20 INR. Same construction cost. I sold my house for 10 INR. ER = 30 - 20 = 10, EP = 10 - 20 = -10.

I buy a house worth 30. My friend constructs a house worth 20. ER = 30 - 20 = 10. Same capital and labor costs for both houses. EP = 0. I haven’t sold the house.

Economic Rent is a pecuniary quantification of relative advantage a property/object has over the least preferred but feasible property/object. It may not be realized.