Economic rent and transfer earnings

Overview

Transfer earnings, economic rent as it applies to labour and two limiting cases.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Define transfer earnings.

   Model answer

   Transfer earnings are the minimum payment a worker must receive to keep them in their present job rather than moving to their next-best alternative. They are the opportunity cost of employing that worker in this use: whatever they could earn in the occupation they would otherwise choose. If the worker were paid anything less than their transfer earnings they would leave. Any payment above that level is not needed to keep them where they are.

2. 2

   Define economic rent as it applies to labour.

   Model answer

   Economic rent is the surplus a worker earns above their transfer earnings, that is, the part of their pay which exceeds the minimum needed to keep them in that job. It is a payment over and above the opportunity cost of their labour. Because it is not needed to hold them in place, in principle it could be removed without changing their decision to work in that occupation. Total earnings are transfer earnings plus economic rent.

3. 3

   A worker earns £34,000 a year and the best alternative job open to her pays £22,000. Calculate her transfer earnings and her economic rent.

   Model answer

   Her transfer earnings are the minimum she must be paid to stay rather than take the alternative, which is what the alternative pays: £22,000 a year. Her economic rent is the surplus above that: £34,000 minus £22,000 = £12,000 a year. The two add back to her total earnings, £22,000 + £12,000 = £34,000. If her pay fell below £22,000 she would move; any figure between £22,000 and £34,000 keeps her in post.

4. 4

   Draw and describe a competitive labour market diagram showing transfer earnings and economic rent.

   Model answer

   Put the wage rate in £ per hour on the vertical axis and the quantity of labour on the horizontal. Draw an upward-sloping labour supply curve and a downward-sloping labour demand curve crossing at wage W and employment L. Total earnings are the rectangle bounded by the wage line at W, the vertical axis, and a vertical line up from L. Transfer earnings are the area beneath the supply curve up to L, because the supply curve traces the minimum each successive worker will accept. Economic rent is the remaining area, lying between the wage line W and the supply curve. The two areas together fill the rectangle.

5. 5

   Why does the area under the labour supply curve represent transfer earnings?

   Model answer

   The labour supply curve shows, for each successive worker, the lowest wage at which that worker is willing to take the job, which is that worker's opportunity cost. Adding those minimum acceptable wages together for every worker up to the employment level gives the total that must be paid to keep exactly that many workers in the occupation. That total is the area beneath the supply curve, so transfer earnings are read off as that area and everything above it is surplus.

6. 6

   Why do most workers in a market earn some economic rent even though the supply curve shows their minimum acceptable wage?

   Model answer

   Because everyone doing the job is paid the same market wage, yet they differ in what they would have accepted. Only the very last worker taken on is paid exactly their minimum; every worker further down the supply curve would have done the job for less. The gap between the single market wage and each of those lower acceptable wages is that worker's economic rent, which is why the rent area is a wedge between the wage line and the supply curve rather than nothing at all.

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