Question

In which of the following situation(s) will owners who supply factors of production be most likely to earn economic rents?

a. Highly elastic supply of the factor; highly elastic demand for the factor

b. Highly elastic supply of the factor; highly inelastic demand for the factor

c. Highly inelastic supply of the factor; highly inelastic demand for the factor

Short answer

The correct answer is option (c) Highly inelastic supply of the factor; highly inelastic demand for the factor - In this case, the factor of production will earn a high level of rent.

Step-by-step solution

- Introduction

Economic rent is distinct from the rent paid to landowners for the temporary use of their property. The payment made to a factor of production over and beyond its opportunity cost is known as economic rent.

The minimal payment required to keep a production factor in its current state. It is the remuneration that the production factor anticipates to receive in its next best alternative use. If the owner does not obtain the minimal amount, he will redirect the input to another purpose.

Any factor of production whose supply is limited by nature or by their exclusivity due to their ability, training, skill, and productivity can earn economic rent. The amount of economic rent earned is determined by:

- (a) Highly elastic supply of the factor; highly elastic demand for the factor

- Highly elastic factor supply: The market's supply of unskilled employees is usually highly elastic. It signifies that there are multiple persons willing to take the work at a certain wage rate. If the price is raised little, the quantity supplied increases more than proportionately.

- Demand for the factor is very elastic: If demand for the factor is highly elastic, a small rise in the price of the factor of production will significantly reduce demand.

- Economic rent: As a result of the factor market's rivalry, the gap between the next best payout elsewhere and the current earnings will be relatively little. As a result, economic rent will be at a certain amount.

The graph above depicts the degree of economic rent for labour with a highly elastic supply in the market. At point $E$the demand curve DD and the supply curve SS connect, determining the market's equilibrium price for such labour. The total wage is calculated by multiplying the wage per hour by the number of hours worked each week, i.e. $O{P}_1{}^{*}O{Q}_1=O{P}_{1}E{Q}_1$However, Out of this wage, localid="1651887051867" ${\mathrm{OSEQ}}_1$is the opportunity cost or projected minimum wage, and ${\mathrm{SP}}_1\mathrm{E}$is the economic rent. As can be seen, the economic rent is quite low.

- (b) Highly elastic supply of the factor; highly inelastic demand for the factor

- Highly elastic supply of the factor: If the factor of production has a highly elastic supply that means a slight change in the price of factor will affect the supply of that factor more than proportionately.

- Demand for the factor is very inelastic, which means that a significant change in the factor's price will effect demand less than proportionately.

- The factor's economic rent will be low in this scenario since the factor's supply is very elastic.

Along with an elastic supply curve for the factor of production, a new inelastic demand curve for the factor $\left(D_1{D}_1\right)$is introduced in the diagram above. Consider the inelastic demand curve and the supply curve $SS$. It is clear that the level of economic rent does not change.

- Highly inelastic supply of the factor; highly inelastic demand for the factor

- Inelastic factor supply: The supply of highly skilled workers is inelastic since it is impossible to duplicate their expertise, efficiency, or talent. Even if the price is increased greatly, the supply of the factor will increase less than proportionately.

- Highly inelastic factor demand: Highly inelastic factor demand means that even if the price rises much, demand for the factor falls less than proportionately.

- Conclusion

Level of economic rent: Thus, in this case, the factor of production will earn a high level of rent.

Both the supply curve SS and the demand curve DD are substantially inelastic in the diagram above. The point at where the demand and supply curves cross is called $E$. ${\mathrm{OP}}_1$is the equilibrium price, and ${\mathrm{OQ}}_1$is the quantity demanded. ${\mathrm{OP}}_1^{*}{\mathrm{OQ}}_1={\mathrm{OP}}_{1}E{Q}_1$is the total payment made to the factor. ${\mathrm{OSEQ}}_1$represents the opportunity cost, while ${\mathrm{SP}}_1{\mathrm{EQ}}_1$represents the economic rent.