Foldvary: Rent in an Economic Simulation
|December 31, 2004||Posted by Fred Foldvary under Progress Report, The Progress Report|
Rent in an Economic Simulation
by Fred E. Foldvary, Senior Editor
In my economics classes, I conduct an economics simulation so that students can experience being entrepreneurs, workers, bankers, government officials, customers, and citizens. This is not a computer simulation, but a real simulation with actual goods, money, and people. In typical economics textbooks, the role of land and its rent is either totally ignored or else briefly discussed in the section on how taxes reduce the social surplus. Since in reality, land is of great importance, it is a significant part of the simulation. But how can one simulate rent?
I divide the classroom into three sections of about equal size. The three districts are poorland, middleland, and richland. What is it that makes one area rich and the other area poor? It is the differing productivity of the areas. In poorland, a worker produces one unit of a good. In middleland, a worker produces two units. In richland, a worker produces three units. The employer is considered a worker also and also produces the same ratio of goods.
Students who are in richland are at first happy to be in this district. But later they will realize that the citizens and workers do not necessarily get this higher wealth. Since in the simulation the quality of labor is the same in all districts, and workers are free to move to any district, wages will tend to equalize. The difference is due to the productivity of the land, not the workers. So the factor that receives the greater wealth is land. The differences in productivity create differential rent, which is in fact the source of rent. But who gets that rent is up to the citizens, and it is likewise up to the student-citizens of the economic simulation.
By the rules of the simulation, poorland is rent-free. One landlord is selected randomly for middleland, and another landlord for richland. Poorland is therefore the margin of production, the least productive land in use. At the beginning of the simulation, the student-citizens enact a constitution by majority vote. The very first issue to decide on is the land tenure. Shall the landlords keep the rent, or shall it be distributed equally among all the citizens?
I conduct the simulation during the last week of the course, when students have learned about supply and demand, the effects of various taxes, and the role of the factors of production: land, labor, and capital goods. So most of the time, they vote to distribute the land rent equally. But sometimes they vote to let the landlords keep it. Why? Students who vote for landlord-kept rent say they hope to be a landlord and get rich. They might also not appreciate what happens when the landlords get all the rent. One of the purposes of the simulation is to supplement abstract book learning with a real-life experience about wages, rent, money, prices, and entrepreneurship.
For currency, I use the notes of the Monopoly game, but the money is not fiat, as it can be redeemed on demand for one Hershey’s chocolate “hug” (a Hershey’s chocolate “kiss” hugged by white chocolate) at a rate of $10 for one hug, and hugs can likewise be converted to currency at the same rate. Thus the currency is a commodity money. (The $500 notes of the game are treated as $5, and the $100 notes as $1.) At the close of the simulation, any currency remaining can be converted into hugs.
After enacting a constitution, students elect a council. The main role of the council government is to protect property rights. The council enacts a law prohibiting theft, set the penalty for theft, and hires one or more police officers to enforce it. The council then usually enacts taxes to pay for the police and maybe payments to the council members. What should be taxed? Often they tax the land rent, but sometimes income and sales and other transactions.
Each student is given $10 to begin with. Those who want to be bankers then establish banks that accept deposits and pay interest. Students then can volunteer to be merchant entrepreneurs. They decide which good to produce (I provide miniature chocolate bars of various types). A merchant must also decide which district to produce in, since he may only hire workers within that district. He declares how many workers he will hire, at what wage.
The rent is paid only by the merchants. If the rent is kept by the landlords, a landlord may declare any rent he wishes, so long as it is the same for all merchants. If the rent is equally distributed, the rent paid is the economic rent, which is the differential rent. Half the output in middleland is economic rent, since for the same amount of labor, twice as much is produced relative to poorland. Two-thirds of the output in richland is economic rent, since three times is produces as in poorland.
Merchants have to pay rent, wages, and also taxes if the council has enacted taxes on them. They either form partnerships or borrow funds from the banks in order to pay these costs. After selling the goods, they repay loans to the banks, including interest. They need to price the goods to cover the costs and have a profit left.
A citizen may choose to be self-employed. In poorland, a self-employed student earns one hug or $10. In middleland, his gross income is $20, and in richland it is $30. But they too are merchants who pay rent. The option of self-employment creates a natural minimum wage of $10, since that is what a self-employed person gets in poorland. This $10 wage at the margin sets the general wage level for all others. It anchors the whole economy to this wage.
When all the merchants have declared their wage offers, they hire workers. A student may only have one job, such as employee, merchant, banker, or government official. Landlording, however, is not considered a job. Wage offers have not been totally uniform, but they tend to be within some narrow range, so the workers in richland do not necessarily get paid more than those in poorland. So, what about the rent?
If the landlord keeps the rent, what happens depends on the amount of rent charged. If one landlord charges the full economic rent but another charges less than the full economic rent, all the merchants want to be located in the district where the rental paid is less than the full economic rent, since the economic rent they are not charged for becomes profit for them. Some of that rent may go to higher “wages,” which is really rent given to the workers. Once all the citizens of that land are employed, merchants must then produce in other lands.
Suppose there are 30 students, 10 in each land, and there are 60 units of goods. Suppose everyone is self-employed. Then the wealth is $100 wages in poorland, $100 wages and $100 rent in middleland, and $100 wages and $200 rent in richland. There will be $300 in wages and $300 in rent. We can see that half the wealth goes to the landlords!
Landlords in this case know that they will be getting rich, and they also become the merchants. They will be paying the rent to themselves. Folks in the real world might think that company owners are rich from commerce, but in the simulation, it is clear that merchants who are also landowners get rich because they get the rent as well as profits from the enterprise.
If the economic rent is distributed equally, then income becomes equalized. If some bankers or merchants become wealthy, it is due to their initiative and entrepreneurship, not because they by chance got to be landlords.
When the workers, landlords, merchants, officials, and others have been paid, they can then buy the consumer goods. The merchants declare their prices, and student-customers buy the goods, which they can then consume.
The simulation enables students to better learn the roles of economic actors: entrepreneurs, governors, employees, consumers, bankers. They can better appreciate how wages, interest rates, and prices are set. They also can experience the role of rent. If the landlords keep the rent, they see how much of the wealth has gone to the landlords, who then often also become the merchants and get even richer. If the rent is distributed equally, they see how the differing productivity does not go to workers but to land rent, which they all benefit from.
You can do this simulation yourself if you can get 20 or more participants.
It’s an enjoyable way to teach economics. Host an economics party, where the goodies are distributed by the simulation. If you teach economics, you could do this twice, once at the beginning of the course and again at the end. See how the participants choose to distribute the rent. Go to the link above for more details, and feel free to consult with me if you have any questions. Have some fun, and learn some economics!
Copyright 2004 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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