Question

When the supply of a factor is perfectly elastic, the entire payment made to the factor is economic rent.

Short answer

Answer: When the supply of a factor is perfectly elastic, the entire payment made to the factor is considered economic rent because the market price for the factor does not change, and the minimum payment required to ensure its supply remains constant at the market price. In this situation, the entire payment equals the factor's opportunity cost (the minimum payment needed to bring forth its supply), and there is no surplus or excess payment that can be regarded as economic rent. Consequently, the whole payment made to the factor serves the purpose of bringing forth its supply and is considered as a part of the economic rent.

Step-by-step solution

Understanding Economic Rent

Economic rent is defined as the excess payment received by a factor of production that is beyond the amount required to bring forth its supply. In short, it is the difference between the actual payment made to a factor and the minimum payment needed to ensure its supply.

Understanding Perfectly Elastic Supply

Perfectly elastic supply refers to a situation when the quantity supplied of a factor is highly responsive to changes in its price. This means that the slightest change in price leads to an infinite change in the quantity supplied. In other words, there is no change in price, even as the quantity supplied changes. In a perfectly competitive factor market, the supply curve for a factor is perfectly elastic.

Relating Perfectly Elastic Supply and Economic Rent

When the supply of a factor is perfectly elastic, the entire payment made to the factor can be considered economic rent. This is because the market price for the factor does not change, and thus, the minimum payment required to ensure its supply remains constant at the market price. Suppose the supply curve of a factor is perfectly elastic at price P. This means that producers can hire any amount of the input at price P, and the price will not change. Since the payment received for a unit of input is also P, economic rent (ER) can be calculated as follows: ER = Actual Payment - Minimum Payment = P - P = 0

Explaining why the entire payment is Economic Rent

In a perfectly elastic supply scenario, the entire payment made to the factor equals its opportunity cost (the minimum payment needed to bring forth its supply), and there is no surplus or excess payment that can be regarded as economic rent. As a result, this zero economic rent means the entire payment made to the factor serves the purpose of bringing forth its supply and will all be considered as a part of the economic rent. This statement holds, as there is no other payment required to bring forth the supply that is not already accounted for in the actual payment made.

Key concepts

Understanding Economic Rent

Economic rent is a crucial term in the study of economics, especially when analyzing the distribution of income among the factors of production like land, labor, and capital. It represents the payment to a factor of production that exceeds what is necessary to keep that factor in its current use.

In simpler terms, if a company pays a worker \(50,000 per year because that's the going rate, but the worker would be willing to do the job for \)40,000, the economic rent is $10,000. This extra payment is not due to the worker's increased productivity or contribution to the company but rather because of market conditions or the scarcity of the worker's skills.

Additionally, understanding economic rent can help to clarify why some individuals or companies earn more than others. It's often tied to control over unique resources or talents not easily replicated. This concept is heavily intertwined with supply elasticity, and in the context of a perfectly elastic supply, it informs us that all payments to the factor are made purely to maintain its supply in the market.

Delving into Perfectly Elastic Supply

The idea of perfectly elastic supply is a theoretical extreme used in economics to exhibit a clear-cut scenario where the supply of a factor is infinitely responsive to price changes. However, it's worth noting that this does not actually happen often in real-life circumstances.

A supply curve is considered perfectly elastic when it is horizontal at a specific price level, indicating that the quantity supplied can change dramatically without any change in price. The concept is important in economic theory as it helps in understanding how different markets react to changes in price.

For a factor with perfectly elastic supply, any amount can be obtained at the preset price, and no additional cost is incurred for extra units. This scenario is hypothetical but provides a foundational understanding of how market mechanisms can work in a situation where one variable remains constant while others fluctuate.

Exploring Opportunity Cost

At the heart of every economic decision is the concept of opportunity cost, which refers to the value of the next best alternative that must be forgone when making a choice. In other words, it's the cost of what you are giving up to undertake a certain action or decision.

For example, if a student chooses to spend time studying for an exam instead of going out with friends, the opportunity cost is the enjoyment and social interaction forfeited in favor of better exam preparation. In business, opportunity cost might involve decisions about allocating resources, such as using a plot of land to build a factory instead of a farm.

Understanding opportunity cost is essential when evaluating the factors of production. Each factor utilized for one purpose has an alternative use that is given up. Therefore, the payment made to any factor equals at least the opportunity cost of employing it in its next best alternative use. Conceptually, if the opportunity cost of a factor is fully covered by the payment it receives, there is no economic rent involved, tying back to our previous discussions on economic rent and perfectly elastic supply.