Question

The possibility of earning economic rent is great if (LO5) a) the supply of a factor is very high relative to demand b) the demand for a factor is very high relative to supply c) both demand for a factor and supply of a factor are high d) both demand for a factor and supply of a factor are low

Short answer

The possibility of earning economic rent is great if the demand for a factor is very high relative to supply. Therefore, the correct answer is Option B.

Step-by-step solution

Analyze Option A

Option A mentions a situation where the supply of a factor is very high relative to demand. In such a situation, due to the higher availability of the factor, its price would likely be low, resulting to less or no economic rent.

Analyze Option B

Option B states a condition where the demand for a factor is very high relative to supply. As per economic principles, when demand outstrips supply, the price of that factor tends to rise. This situation enables the owner of the factor to earn a greater economic rent.

Analyze Option C

In Option C, both demand for a factor and supply of a factor are high. Though there is a high demand for the factor, there is also a high supply to meet the demand. This balance might not significantly drive up the price to generate a robust economic rent.

Analyze Option D

Option D talks about both demand for a factor and supply of a factor being low. In this scenario, due to the low demand for the factor, its price would not increase, therefore, the possibility of earning economic rent would be low or non existent.

Identify the correct answer

Once we understand the implications of each scenario, we can conclude that the possibility of earning economic rent is great if the demand for a factor is very high relative to its supply. So, the answer will be Option B.

Confirmation of the answer

To confirm that the chosen answer is correct, it can be matched with the basic principle of economic rent which states that a factor can earn economic rent when the demand for it exceeds its supply leading to an increase in its price. This principle aligns with our chosen answer, Option B. Hence, we can confidently say that Option B is the correct answer.

Key concepts

Supply and Demand

In the context of understanding economic rent, the concepts of supply and demand are crucial. These two forces are the backbone of market economics and affect the pricing of goods and services, including factors of production like labor, land, and capital.

Supply refers to the quantity of a product or service that the market can offer. When the supply of a particular factor is high and exceeds demand, the price tends to decrease. Consequently, the economic rent - the extra payment over what is required to keep a factor in its current use, is minimal or absent because there isn't competition driving up prices.

On the other hand, when the demand for a factor is high and there is limited supply, prices are driven up as consumers compete to acquire the factor. This leads to a large economic rent, as factor owners can charge more due to the scarcity of their resource. Therefore, understanding the relationship between supply and demand is essential for recognizing when and why economic rent occurs.

Factor Market Analysis

The concept of factor market analysis focuses on how the factors of production, such as land, labor, and capital, are bought and sold in the factor markets. In these markets, the principles of supply and demand apply just as they do in the markets for goods and services.

A high demand for a specific skill or resource, paired with a limited supply, can result in substantial economic rent. This is because the owners of the scarce resource can command higher prices. For instance, a technology company may be willing to pay a premium for software engineers with specialized skills that are in short supply, thus generating economic rent for these individuals.

Understanding factor market analysis helps assess the earning potential of different factors of production. It answers why certain jobs pay more and why some business ventures are more profitable than others, providing crucial insights into the dynamics of economic rent and the role of scarcity in factor markets.

Price Determination

The mechanism of price determination is closely related to the concepts of supply and demand. In a competitive market, the price of a factor of production is determined by the intersection of supply and demand curves. The point where the two curves meet is known as the equilibrium price.

However, in situations where the supply is limited or the demand is exceptionally high, the market may experience what is known as price surges. In the case of a factor market, this results in economic rent. For example, prime real estate in a bustling city center may earn significant economic rent due to its scarcity and high demand from businesses.

Understanding how prices are determined is essential for comprehending economic rent. It emphasizes the conditions under which a factor can generate a surplus over and above its opportunity cost. In essence, it's the unique characteristics of the factor—such as location, quality, or talent—that cannot be easily replicated, and thus, command a higher price in the market.