Why does the division of resource earnings into economic rent and opportunity costs depend on the resource owner's elasticity of supply?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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To understand the connection between the opportunity cost/economic rent ratio and the elasticity of resource supply, we must first understand the relationship between opportunity cost and economic rent.  Let us imagine that I am a teacher and I am paid $60,000 per year.  Let us further imagine that, if I were not a teacher, I would be working in an office making $40,000 per year.  My opportunity cost for teaching is $40,000 per year in this case because I give up the $40,000 per year that I could make in an office so that I can be a teacher.  However, I make $20,000 more than my opportunity cost.  Everything that I make as a teacher that is over and above my opportunity cost is called my economic rent.  This is, in essence, the frosting on my cake.  It is the extra money that I get for doing my job over and above what I could get doing another job.

While I have used the example of my labor in this scenario, labor is not the only thing that has opportunity costs and economic rent.  Any resource that can be sold will have these things as well. 

Now that we have understood these concepts, we must turn to the idea of the elasticity of supply in a given market.  The supply of a resource is more elastic if there are other uses for that resource.  The supply is less elastic if there are fewer other uses for the resource.

What this means is that a resource that is less elastic will be able to get more economic rent when sold.  If I have a resource that only has one use, it will not have a very high opportunity cost.  For example, imagine that I have land that is good only for grazing cattle.  If I do not use it to graze cattle, it will have no economic value.  In such a case, my opportunity cost for using it to graze cattle is zero.  Anything I get for leasing it as pasture land is economic rent.  By contrast, if I have land that can be used for many things, I will have a higher opportunity cost no matter what I do with the land.

When the supply of a resource in a market is less elastic, there is lower opportunity cost.  This means that more of the resource’s earnings are in the form of economic rent.  This is why there is a connection between the division of resource earnings between rent and opportunity cost and the elasticity of supply.

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