There are so many definitions of economic rent…
it is the payment to a factor of production above its value in its next highest- valued use( its opportunity cost) or
it is the payment to retain resources in their current use or
its is the portion of a payment to a resource that hoes not increase the quantity supplied or
is earnings- opportunity cost
yet they all sound so different.
Someone please explain to me economic rent as simple as possible.
To understand you must check the following equations:
Total Cost of a project = Explicit costs + Implicit costs …(1)
Economic profit = 0 …(2)
Accounting profit > 0 …(3)
Normal profit = Implicit costs …(4)
Implicit costs = Opportunity costs …(5)
Let’s talk about this:
A project must have always an accounting profit > 0 to be taken (3), right? It is strightforward.
But, accountability system only considers Explicit Costs which are shown in the P&L. What about the Implicit costs? You know now that it is the same than opportunity costs (5), thats why when we valorize a project we consider opportunity costs too. We consider Total Cost (1).
Since we consider always Total Cost, we cannot look at accounting profit only, we look at economic profit (2) which must be =0 to the project be taken. This is like the TIR >= WACC, if not, the economic profit is <0. Do you get it now?
The economic profit is =0 because it considers total cost, and covering the opportunity cost is Money in the pocket of the investor, so do not confuse economic profit with accounting profit. The nominal wealth and economic wealth are different. If the project covers the opportunity costs in its net revenue, the project is taken.
In an efficient economy, when you get an economic profit of zero you are in a Paretto Efficient point, you cannot be better, but you can be worse instead, that’s why the markets move. Some markets give a positive economic profit for a limited time, but the companies movements make that economic profit back to the zero level. This adjustments are done in a macro way and seen in the long-run, while in the short-run the companies are looking for positive economic profits or at least a zero economic profit.
Any question, please reply.
Regards
Thanks for your lengthy reply.
I get the economic profit and accounting profit, but I don’t see what it has to do with economic rent.
Bro, economic profit = economic rent
All the story I told you apply it for the economic rent…
What?! Really?!
I thought that was impossible because economic profit is profit while economic rent is a payment.
Are you saying that because
economic profit= accounting profit- implicit cost= earnings - opportunity cost= economic rent?
Isn’t profit a payment? Profit is net income, net income is money, money is a payment, so profit is a payment… can you follow this?
Your last question is correct, economic profit is another name for economic rent. Rent = profit.
Economic rent must be at least zero to a project be taken.
If you put it that way… it makes me more sense. Thanks
Glad to help !
It’s what you pay to live in your apartment on the 1st of each month. Only applies if your landlord is Alan Greenspan though.
Didn’t get your joke.
I would explain it to you but it really wasn’t that funny.
www.investopedia.com/terms/e/ economicrent.asp
Economic rent is the positive difference between the actual payment made for a factor of production (such as land, labor or capital) to its owner and the payment level expected by the owner, due to its exclusivity or scarcity.
Ok, thats a definition of it, but this paragraph do not help too much to understand where economic rent definition comes from.