Economic Rent

Economic rent is the difference between the marginal product of a factor of production in its most productive use and in its next best alternative. For example, an unskilled worker working for a construction company might have a wage of $20,000/year, which in a perfectly competitive market in equilibrium will equal the value of his marginal product. His next best alternative is to work for some other construction company, again for $20,000/year (the going rate). His economic rent is therefore zero.

However, if it were discovered that he had talent as a baseball player, he might be hired and put under contract by a baseball team, at $50,000 per year. Since his contract stipulates that he cannot play for any other team, his next best alternative is still to work for a construction company at $20,000 per year. If the value of his marginal product is now $50,000, then his economic rent is $30,000. However, if he becomes a superstar player, and his presence increases ticket sales by a million dollars a year, then the value of his marginal product is a million dollars and his economic rent is $980,000. He is still only paid $50,000, which is 5.1% of his economic rent. The baseball club keeps the other 94.9%. Eventually, his contract expires and he becomes a free agent. Other baseball clubs will be willing to pay up to the value of his marginal product and he will become a million-dollar ball player—but since his “next best alternative” is now to be a million-dollar ball player for a different club, his economic rent is again zero.