Economic rent is the concept of paying above market rate for a good or service due to scarcity or need. In the case of real estate, economic rent is when a party pays an exceedingly high payment to execute a transaction. Although the payment might be higher than the standard rate, the idea behind it is so that the transaction closes without risk.
Economic rent typically occurs when there is a scarcity of available property, products, services, or labor. While the word rent implies the term is directly tied into real estate, it can also apply to employees, services, products, and others. Pricing discrepancies occur when the party in question is a super athlete, famous musician, or an otherwise relatively in demand party where there are very few similar people to. Economic rent also refers to assets that are intangible and difficult to quantify in terms of value. This includes business ventures, undeveloped land, permits, patents, and unreleased products.
Economic rent also refers to bear minimum price it takes for a property owner, business owner, or worker to work, provide a service, or rent a property, or let another party borrow something.
Economic Rent Real World Example
The purchase of the Los Angeles Clippers for $2 billion remains one of the most intriguing business investments of all time. Steve Ballmer, the now owner of the Los Angeles Clippers’ purchase caused the average value of all NBA teams to increase significantly. His above average purchase cost of the Clippers helped him secure the purchase of the team thereby increasing the average value of an NBA team. The sudden increase in owner’s equity increased players’ salaries as well.
The economic rent or rate of an asset increases when one or a few parties in a given market, whether it be a real estate market or a business industry, pays above asking price, the average price for a good or service increases. The concept found within capitalism shows us that as a consumer’s demand a product and are willing to pay a premium price for it, the price of that good will increase.
In the NBA, the concept of economic rent is very clear as can be found on the market affect with Steve Ballmer’s purchase of the Clippers. Previous to Steve Ballmer’s purchase of the fledgling franchise for $2 billion, a few years prior the Clippers were valued at $500,000,000. The next franchise that was sold in the NBA was the sale of the Houston Rockets from Leslie Alexander to Tilman Fertitta for $2.2 billion. The Clippers purchase with Steve Ballmer paying above market rate caused the value of the Houston Rockets to increase.
Example of Economic Rent
Assume the business owner of a carpet cleaning business typically charges $200 to clean a home. If a client negotiates with the business owner for a lower price and the carpet cleaning owner agrees to $150, the $150 rate is the economic rent of the business owner. That is the minimum cost he/she is willing to accept for a job.
Each person or party has an economic rent that is dependent on the amount it costs to run the business, how valuable their time is, the amount of clients they have, outstanding debts, and personal or company goals. Essentially it is the minimum amount a party is willing to work for.
How Economic Rent Affects the Market
When consumers have the ability to pay the market price for a sustained period of time, it is telling sign that pricing will likely increase in the future. As more debt is created, both in terms of consumer and government debt, the average price per goods will increase because there is more money in circulation to cover that debt. An increased money supply is a necessity to a certain extent to cover the increase in population size. Too much money in the market, however can increase the cost of property due to an increased economic rent.
Interest rates typically rise when the economy is functioning properly and decrease in periods of recession and slow growth. The Federal Reserve manages the supply of money in the United States and it is their responsibility to pump more money into the economy to stimulate growth when the economy is decreasing and increase the cost of borrowing when the economy is doing well.
