(Economic) Rent

In equilibrium of a market or game, the traders (or players) participate voluntarily because their payoff exceeds the one from abstaining to engage in the trade (or to play the game): in equilibrium, the participants earn profits. Part of the equilibrium profits is explained by ordinary trading or exchange activity; part of it accrues to a trader (player) by owning a fixed idiosyncratic resource which is not consumed in the transaction (interaction). The last part is called a player's (trader's) rent. An economic rent is thus the 'wage' for some fixed resource which is necessary for and valuable in a transaction but in monopolistic possession of some trader.

Apart from the costs of not using his outside options (i.e. turning to another partner for exchange), it is the rent on such idiosyncratic factors which must be conceded to a player in order to ensure his participation in the exchange process. For example, traders draw a rent from making accessible a fixed resource like 'land' (which is where the term comes from), from uniquely owning a patent or license protecting a technological achievement or professional activity, or from uniquely owning private information about a fact that influences all players' payoffs.

In analogy to rents acrrueing to a trader from possessing idiosyncratic property rights or 'tangible' assets, the equilibrium profits acrrueing to a player solely from possessing payoff-relevant information are called his information rent. The familiar consumer's surplus from microeconomics is a simple example. The consumer is left a surplus from being able to buy all the quantities consumed at the price of the last consumed unit, instead of having to pay higher prices for earlier units consumed. This 'surplus' corresponds to her information rent for knowing her entire schedule of marginal willingnesses-to-pay for different quantities of the object. If the seller instead knew this schedule of marginal valuations, he could squeeze out all the profits from the customer by selling each unit at a different price, just demanding the consumer's marginal valuation for each unit. The fact that the consumer's information is private thus guarantees him a consumer's rent.

If the seller faces a single customer that she knows very well, having observed his choices at varying prices for a long time, she could devise a schedule of quantity discounts that extracts nearly all of the consumer's rent. This changes when the seller faces a set of competing consumers, each of which has private information on his marginal willingness-to-pay for different quantities. The schedule of discounts must now prevent lower-valued consumers from copying the quantity demanded by higher-valued consumers (and thus get much for a small payment). Typically, this is achieved by selling each additional unit of quantity at a slightly lower price than the previous one, thus inducing customers with higher valuations to choose quantities such large that low-valuation customers will find it too costly to mimic choosing a large quantity. (See the entry on incentive compatibility.) In this way, however, the seller thus increases the equilibrium profits of high-valuation customers disproportionately (relative to those for low-valuations customers), i.e. she pays larger information rents to higher marginal valuations (types) of customers.

The upshot of all this is that in a game where the seller designs an incentive compatible price schedule so that the players implicitly 'sell' their private information by revealing it through their equilibrium choices, the players do not loose their information rents. Instead, the very possibility that lower typed customers can mimic the choices of higher typed customers forces the seller to leave higher information rents to higher types, which which own 'more valuable' private information. In this sense, paying information rents to economic agents is intimately related to providing incentives for the revelation private information in strategic contexts.

Entry by: Jan Vleugels

December 1, 1997
Direct questions and comments to: Glossary master