Ricardian Rent

Ricardian Rent
Recent activity on Feb 06, 2019
2 Answers
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B
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asked on Feb 06, 2019

Maybe a bit too specific, but can someone explain me the "Ricardian Rent"?

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Guennael
Expert
replied on Feb 06, 2019
Ex-MBB, Experienced Hire; I will teach you not only the how, but also the why of case interviews

https://en.wikipedia.org/wiki/Law_of_rent

The rent will adjust to what the highest willing renter will pay. If I think Sidi's flat is worth $1/month but you are willing to pay $10, guess what Sidi will charge?

Put another way, Sidi will come between you and your profit, and make the most amount of money he can get away with. I want to be like Sidi when I grow up, we all should :)

This gets a little more interesting when you consider the cost of production: here, the cost will move upwards until it exactly matches the revenue from the most expensive unit of production, so that unit operates at break-even. Everyone else therefore makes outsized profits equal to the delta between their own cost and the market price. This is the "scarcity rent" that power production companies in the US love so much: Power price is designed to afford the most expensive gas plants to break-even, so cheaper variable, base power sources (hydro, wind, even nuclear) will make outsized profits. Every producer then does a race of the bottom to create cheaepr units of production, thereby slowly decreasing the highest marginal cost of production, and therefore the price to us consumers.

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Sidi
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replied on Feb 06, 2019
McKinsey Senior EM & BCG Consultant | Interviewer at McK & BCG for 7 years | Coached 300+ candidates secure MBB offers

Hi Bele!

Have a look at the below videos which explain the concept quite well:

  • https://www.youtube.com/watch?v=cBpHD3q3g_8
  • https://www.youtube.com/watch?v=yyv1xYDWAxk

Moreover, here is an explanation based on an illustrative example: http://www.landvaluetax.org/theory/ricardos-law-simply-explained.html

Hope this helps!

Cheers, Sidi

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Guennael gave the best answer

Guennael

Ex-MBB, Experienced Hire; I will teach you not only the how, but also the why of case interviews
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