Question

Write short notes on (a) Transfer earnings (b) Economic rent

Short answer

Question: Define transfer earnings and economic rent and provide examples for each concept. Answer: Transfer earnings are the minimum amount a factor of production must earn to participate in its current use, typically having alternative uses with comparable compensation. For example, a professional athlete with a $45,000 earning from playing basketball would require at least that amount to choose soccer over basketball. Economic rent refers to the income earned by a factor of production over and above its transfer earnings, representing a surplus beyond its opportunity cost. In our athlete example, if they earn $50,000 playing soccer, their economic rent would be $5,000 ($50,000 - $45,000) since they chose soccer over basketball and earned income above their transfer earnings.

Step-by-step solution

(a) Transfer Earnings

Transfer earnings refer to the minimum amount that a factor of production (such as labor, land, or capital) must earn to be compelled to participate in its current use. In other words, it is the minimum payment necessary to keep that particular factor in its present occupation. Factors with transfer earnings usually have alternative uses where they can earn comparable compensation. For example, let's imagine a professional athlete who has the option of using their skills in different sports. The transfer earnings for this athlete would be the amount they would earn in their second-best alternative. If the athlete can earn \(50,000 a year playing soccer but can also earn \)45,000 a year playing basketball, their transfer earnings in soccer are $45,000 (the minimum amount they need to choose soccer over basketball). To better understand this concept, here's a breakdown of the steps: 1. Identify the factor of production (in this case, the professional athlete). 2. Determine the alternative uses of the factor (soccer and basketball). 3. Calculate the earnings for each alternative use. 4. Identify the second-best alternative earnings as transfer earnings.

(b) Economic Rent

Economic rent refers to the income earned by a factor of production over and above its transfer earnings. It is essentially the difference between the actual payment received by the factor and the transfer earnings. Economic rent thus represents a surplus that the factor earns beyond its opportunity cost (i.e., the minimum payment it would otherwise accept). Continuing with the previous example, let's calculate the economic rent for the athlete. We know that the athlete earns \(50,000 a year playing soccer and has a transfer earning of \)45,000. Therefore, the economic rent would be calculated as follows: Economic Rent = Actual Earnings - Transfer Earnings Economic Rent = \(50,000 - \)45,000 = $5,000 So, the athlete receives an economic rent of $5,000 by choosing to play soccer instead of basketball. Here's a breakdown of the steps to calculate economic rent: 1. Determine the actual earnings received by the factor of production (in our case, the athlete's income playing soccer). 2. Calculate the transfer earnings of the factor (already calculated in the previous part of the exercise). 3. Subtract the transfer earnings from the actual earnings to find the economic rent. In conclusion, transfer earnings and economic rent are two crucial concepts in economics that help us understand how factors of production allocate themselves in the market and how they earn income above their opportunity costs.