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Suppose Mr. Pang, a school teacher, is earning $33,000 a month. Suppose further that
the highest-valued alternative occupation available to him is a property agent, which monthly
income is expected to be $20,000 a month.
In this example, the anticipated return that Mr. Pang is earning is $33,000. He needs to, at
least, earn $20,000 a month as a school teacher in order to keep him in the teaching profession.
Thus the transfer earnings of being a school teacher to Mr. Pang is $20,000 and the (economic)
rent of being a school teacher to Mr. Pang is $13,000.
The (economic) rent (i.e. the $13,000) can be taken away without affecting his choice of
being a school teacher. For example, if the government requires all school teacher to obtain a
licence that requires each school teacher to pay $13,000 a month, Mr. Pang would still choose to
be a school teacher.
The relative magnitude of transfer earning and (economic) rent depends on which
“another use” is referred to
The relative magnitude of transfer earning and (economic) rent depends on which
“another use” is referred to. Suppose Mr. Pang can chose be a school teacher in another school,
which monthly income is also $33,000 a month. In this case, if “another use” is referred to “being
employed in another school”, the transfer earnings of being a teacher in this school is $33,000
while the (economic) rent of being a teacher in this school is very close to zero.
$ S
Rent
Transfer earnings
D
0
Quantity of factor input
Normal Case
$ S $
Rent
Transfer earnings
D D
0 0
Quantity of factor input Quantity of factor input
Special Case 1 : Supply of the factor is fixed Special Case 2 : Supply of the factor is perfectly elastic
In this case, all the expected return are rent. In this case, all the expected return are transfer earnings.
Profit
Definitions of Profit
Profit is
v the unanticipated windfall gain in wealth.
v the actual rate of return over and above the market interest rate.
Is ‘profit maximization’ a useful postulate?
‘Profit maximization’ is not a useful postulate because profit is windfall in nature. One
cannot maximize something that is unexpected. Thus profit cannot be maximized. It does affect
decision-making and is useless in explaining and predicting behaviour.