- Transfer earnings are the minimum payment required to keep a factor of production in its present use. It is the opportunity cost an individual forgoes when deciding to work in one job rather than the next best alternative.
- Example - a man may decide to work as a shop assistant because they pay is better than if he was a waiter. By making this decision he forgoes the opportunity to work at, for example, Pizza Express. The opportunity is seen in terms of this forgone alternative. If Pizza Express were to raise its wage rates in order to attract more staff, there would come a point where the shop assistant might reconsider his decision and decide to be a shop assistant after all, as the opportunity cost of being a shop assistant has risen.
- Economic rent is a payment received by a factor of production over and above what would be needed to keep it in its present value. I.e. it is the amount which someone can earn which is in excess of their transfer earnings (what they could earn elsewhere). It is a demand determined reward to labour and will be earned when labour is to some degree in inelastic supply.
- Example – doctors are in almost perfectly inelastic supply because the number of places available to study medicine is determined by the government and the profession. To the extent that the demand for doctors exceeds the supply, they will be able to negotiate higher salaries than most could earn as research scientists or in other occupations
- The factor that determines the level of economic rent in comparison to transfer earnings is the elasticity of supply of labour. The more inelastic the supply, the greater proportion of total earnings that is made up of economic rent and therefore there are fewer transfer earnings. Conversely, the more elastic the labour supply is, the more transfer earnings make up of total earnings, and so the economic rent is less.
- Example – The difference in the earnings of two jobs, for example surgeons and shop assistants demonstrates the importance of supply. Firstly, surgeons are inelastic in supply, especially in the short run. This is because the education required to become a surgeon is long and demanding, and is essential for entry into the occupation. Also, not everyone has the required abilities to become and surgeon. This means that the supply of surgeons is limited, and does not vary greatly with wage rates. So in this case, a large proportion of surgeons’ total earnings are made up of economic rent.
- However, in the case of shop assistant there is far less training required, a wider range of possible people suitable for the occupation. So, the labour supply would be relatively elastic, meaning economic rent will be relatively less important than in the case for surgeons. If the wage rates for butchers was to increase, a large amount of people, who would be able to work in the occupation, would be attracted to it (eventually casing wage rates to fall).
These notes are aimed at people studying for A2 Economics, but will also be suitable for other courses and exam boards.
Originally submitted by BillPitt on TSR Forums.