Monday, November 10, 2014

Nice Real Life Example of "The Rental Rate of Capital". An important Micro Econ concept.

One of the more difficult (and frustrating, I think) concepts in the Microeconomics Unit on Firm structure is figuring out what is an implicit (opportunity) cost when calculating economic profit.

One determinant of implicit opportunity cost is "the Rental Rate of Capital". In short, the rental rate of capital is the dollar amount I could receive for a physical input (i.e. tools, machinery, land) if I rented it to someone else to use instead of using it myself.

This is important to economists because it helps to determine if resources are being employed in the most efficient way possible. If a piece of capital could be rented out to someone else for more than what it could produce for you, then this would (could) be considered a mis-allocation of resources.

Assume I can use a barn on my property and it contributes $1,000 to my income.  What if instead I could rent it out for some other purpose for $1,200?  An economist would suggest that is an inefficient allocation of resources to the tune of a net $200.00.

I know, that can be VERY subjective, but let's go with it.

Here is an excerpt from a very short article on an effort to help farmers put a dollar value on some "dead capital" they possess that could be employed in an alternative use.

Survey could help determine fair prices for farm-building rentals (HT:Morning AG Clips)

Farmers, producers and landowners who have agricultural buildings on their property they are no longer using can turn the vacant space into extra farm income, according to experts with Ohio State University’s College of Food, Agricultural, and Environmental Sciences. 
Whether it is a farm building or livestock facility, farmers who want to put unused space into service to generate additional farm income first need to know how to go about creating a leasing arrangement and how to determine an appropriate rental price, said David Marrison, an Ohio State University Extension educator. OSU Extension is the outreach arm of the college. 
Many farmers may want to rent out buildings on their properties, but sometimes it’s hard to put a number on that, so it’s good to know what the going rates are on buildings in the region,” Marrison said. “Farmers need to know how to utilize those old buildings, whether it be to rent them out to another farmer or producer for extra hay space or to milk dairy cows.” (emphasis mine)
Here is a link to the PDF that gives prices for a wide variety of physical capital that my be laying dormant down on the farm.

Putting a price of these things can help a farmer make more income but, more importantly for economists, see to it that there is a mechanism for a more optimal allocation of societal resources.
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