Economic rent, unlike contract rent, cannot be determined by bargaining. Nor is it necessary that a piece of land be rented to a tenant in order that its economic rent may appear. The owner of a farm receives economic rent just as truly when he himself operates it as when he permits a tenant to operate it.
The simplest approach to an understanding of economic rent is made by examining an ideal situation in which only a few persons are concerned. Let us assume, therefore, that ten families take up their residence on an isolated island composed, let us say first, of several different kinds of soil. Let us assume also that one of the families engages in wheat-farming on the land best adapted to wheat, while the other nine engage in fishing, manufacturing, or commerce, or even in some other kind of farming. Obviously, the wheat farmer can raise wheat cheaper than any other one - say 80 cents a bushel - for he has the best wheat land. As the number of people on the island increases, more wheat will be necessary and consequently more wheat land will need to be brought under cultivation. Necessarily the farmers that take up wheat-raising must resort to a poorer grade of wheat land than the first farmer possesses. But they will not grow wheat even on free land unless the price of wheat is high enough to return to them interest on their capital and wages for their labor. We may expect Under the increased demand for wheat that the price will rise, say to $1.00 a bushel. Under these new conditions the first wheat farmer, without having his expenses increased, will enjoy the increased price of 20 cents a bushel. If his land produces 40 bushels per acre it yields him an economic rent of $8 (40 times 20 cents) per acre. As population continues to increase, the extra demand for wheat forces its price upward. Farmers will then resort to the cultivation of poorer wheat lands, with the result that our first wheat farmer, also all the others except the one on the poorest piece of wheat land, will get an additional income which we call economic rent. We may say, therefore, that one of the sources of economic rent is the differences that exist in the fertility of soil.
We might have assumed that all of the land on our islands was of the same fertility. Suppose that nine of the ten families settle in a village, while the tenth family takes up the nearest piece of land for wheat-farming. Here again an increase in population will increase the demand for wheat with a corresponding increase in price. Consequently, other families will take up land for the purpose of growing wheat. This land, according to our assumption, is as well adapted to wheat-raising as the first farmer's land, but not so well located in reference to the village market. The second farmer, therefore, will be compelled to undergo transportation expenses from which the first wheat farmer is free. Since the price of wheat is uniform in the village market, the first farmer will enjoy an advantage over the second farmer. Here is a second source of economic rent. A complete explanation of the sources of economic rent is beyond the scope of this book. We may say, however, that economic rent arises from differences; in agriculture it arises chiefly from differences due to fertility and location.