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Chapter 31: Problem 2

The market for some good or service is shown by the demand and supply curves below. a. Illustrate what transfer earnings and economic rent are. b. Explain what would occur if the demand for the good or service were to increase.

Short Answer

Expert verified
Answer: When the demand for a good or service increases, both transfer earnings and economic rent also increase. The transfer earnings represent the minimum income that suppliers accept to provide the goods or services, while the economic rent represents the surplus income beyond transfer earnings at the market price. As the demand increases, the new equilibrium is reached at a higher price and a higher quantity, leading to an increase in both transfer earnings and economic rent.

Step by step solution

01

Defining Transfer Earnings and Economic Rent

Transfer earnings refer to the minimum payment needed to keep a resource employed in its current use. In other words, it represents the minimum wage or price that a resource can accept to stay in its present employment. Economic rent, on the other hand, is the payment made to a resource over and above its transfer earnings. It represents excess earnings over the minimum earnings needed to continue using the resource.
02

Illustrating Transfer Earnings and Economic Rent

Let's assume that the demand for a good or service is given by the demand curve D and the supply curve is given by S. The point where the demand and supply curves intersect is the equilibrium point, with the equilibrium price P* and quantity Q*. Transfer earnings can be represented by the area below the equilibrium price upto the supply curve (area A), as it represents the minimum income that suppliers would accept to provide the goods or services. Economic rent can be represented by the area between the demand curve and the equilibrium price (area B), as it represents the surplus income beyond transfer earnings at the market price.
03

Analyzing the Effect of an Increase in Demand

Now, let's analyze what would happen if the demand for the good or service were to increase. This would cause a shift in the demand curve to the right, from D to D'. As a result, the new equilibrium would be attained at a higher price P*' and a higher quantity Q*'. Due to the increase in equilibrium price, transfer earnings increase and can now be represented by the area below the new price up to the supply curve (area C). The economic rent also increases and can now be represented by the area between the new demand curve (D') and the new equilibrium price (P*') (area D). Hence, an increase in demand results in an increase in both transfer earnings and economic rent.

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