Transcript Location Utility & Economic Rent

Rent is?
• The Broadway play?
• What you pay your
landlord?
• An economic concept?
Contract Rent
• Def. - actual
payments “tenants”
make for their use of
property owned by
someone else.
Rent
Housing services
Owner of house
Contract Rent
• Amount of rent for a given
house is determined by
– Supply factors
• Costs to owner to make
house available for rent
• Other houses available for
rent
– Demand factors
• Number of families wanting
to rent
• Amount renters can afford
to pay
How much would you pay?
• Assume you want to
earn your living
making widgets. How
much could you afford
to pay to rent a factory
building?
• Estimate all variable
and fixed cost (VfC)
except cost of
“building services”
How much would you pay?
– Compare costs without
–
–
–
–
cost of building services
included (VC + fc) to total
revenue (TR)
Building Rent = TR – VC fc
If (VC + fc) > TR then can’t
afford to pay rent
So, don’t go into widget
business
Building has no “widget”
value, i.e. economic rent is
zero
How much would you pay?
• Suppose TR > VC + fc
• Is difference enough to cover
contract rent building owners want?
– No – don’t go into widget business
– Yes
• Exactly equals amount building owner
wants, or
• Amount owner wants is less than amount
by which TR > VC + fc
– Widget maker gets to keep this difference
Example
Gross revenue from sale of widgets . . . . . . .$10,000
Cost of inputs (factors of production) . . . . . . . . 8,500
Net revenue . . . . . . . . . . . . . . . . . . . . . . . 2,000
Returns to management . . . . . . . . . . . . . . 1,500
Residual (available to pay rent) . . . . . . $500
Example
• Assume minimum cost to rent building is
$600 (supply price), then can’t go into widget
business in this building
• Assume minimum supply price is $500, then
go into business and just breakeven
• Assume minimum supply price is $400, then
widget maker’s profit is increased by $100.
Example
• Who gets (captures) this “extra” or
“pure” profit?
• Widget maker in this example
• Under what circumstances would
building owner get the $100?
• Building owner sees that widget maker
is getting rich so she raises rent by
$100
Example
Gross revenue from sale of widgets . . . . . . .$10,000
Cost of inputs (factors of production) . . . . . . . . (8,500)
Net revenue . . . . . . . . . . . . . . . . . . . . . . . 2,000
Returns to management . . . . . . . . . . . . . . (1,500)
Residual (available to pay rent) . . . . . . $500
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . (400)
Extra or pure profit . . . . . . . . . . . . . . . . . . $100
Economic rent
• Surplus of income
from selling a good
or service above
minimum supply
price it takes to
bring a factor into
production, i.e. pure
profit
– $100 in the example
Economic rent
Surplus of income above the minimum supply
price it takes to bring a factor into production,
can also be thought of as pure profit
Price (P)
MC
ATC
P1
P2
Economic Rent =
(P1 - P2) *Q1
Quantity
Q2 Q1
Land Rent
• Economic rent when
land is the factor of
production analyzed
• Surplus of income
from selling product
of land above
minimum supply
price for land
Land Rent
• Total land rent may
have several
components
– Site or soil rent - return to
bare ground
– Improvement rent - return
to improvements like
buildings
– Location rent - return due
to favorable location
– Fertility or site quality
rent - return due to
productivity of soil
• These are the factors
that would be considered in a appraisal of
land to determine its fair
market value or fair
market rent for its use