Quasi-rent

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Quasi-rent is an analytical term in economics, for the income earned, in excess of post-investment opportunity cost, by a sunk cost investment. Alfred Marshall (1842-1924) was the first to observe quasi-rents.

In general, an economic rent is the difference between the income from a factor of production in a particular use, and either the cost of bringing the factor into economic use (Classical factor rent), or the opportunity cost of using the factor, where opportunity cost is defined as the current income minus the income available in the next best use (Paretian factor rent). In other words, economic rent is the difference between the income in the current use of the factor and the absolute minimum required to draw a factor into a particular use (from no use at all, or from the next best use), (see detailed page economic rent.)

Many capital investments take the form of sunk cost investments in more or less specialized capital equipment, research and development, or training. For sunk cost investments, once the investment has been made, the cost of drawing the result into economic use may be minimal. For specialized equipment or training, the next best use may not pay much, so a large part of what is realized, constitutes a kind of rent. However, a sunk cost investment will only be made in the expectation that the resulting factor (e.g. capital equipment) can be employed to realize income above costs; the expectation of profitable income induced the creation of the capital factor.

While a true rent is an income in excess of what is necessary to bring a factor into productive use, a quasi-rent is only a Paretian Rent excluding the sunk cost investment. The income realized by a sunk cost investment constitutes a rent to the extent that it exceeds the amount that would be realized in the next best use of the investment, e.g. (you already bought the hammer and there is nothing you can do about it. If you don't use it to drive nails, then maybe it will make a good paper weight). Viewed in a long-term frame that includes the investment decision, the same income is not a rent, but instead might legitimately be called interest.

The existence of sunk cost investments and quasi-rents point to important problems for both business strategy and public policy, particularly in connection with natural monopolies. A business enterprise might form, for example, to build and operate a bridge across a river, charging a toll. Efficiency requires that the bridge be fully utilized, but any toll charged will discourage some crossings. A toll set at a rate which keeps the bridge fully utilized, will not necessarily include any return on (or even recovery of) the investment in the bridge, while a higher toll, which does yield a return, will not necessarily result in its full, efficient utilization.

Government policy is sometimes designed or manipulated to ensure that particular sunk cost investments earn larger quasi-rents. Patents may be considered an example of such an intervention. In the absence of patents and other intellectual property law, the sunk cost investment in research behind an invention could only earn a quasi-rent to the extent that secrecy or intellectual property protections inhibited competitors from freely utilizing the results of the research. Once the sunk cost investment in research has been made, of course, efficiency would require that the results (i.e. the invention) be freely and widely disseminated, which would reduce the return, a quasi-rent, on the research. Patents give a time-limited legal right to charge for the use of an invention, which creates a potential quasi-rent, and return on investment.

See also

• Natural monopoly