Question

The city of New Orleans has 200 advertising companies, 199 of which employ designers of normal ability at a salary of $100,000 a year. The companies that employ normal designers each collect $500,000 in revenue a year, which is just enough to ensure that each earns exactly a normal profit. The 200th company, however, employs Janus Jacobs, an unusually talented designer. Because of Jacobs's talent, this company collects $1,000,000 in revenue a year.

Required:
a. How much will Jacobs earn?
b. What proportion of his annual salary will be economic rent?
c. Will the advertising company for which Jacobs works be able to earn an economic profit?

Answer 1

a. Jacob should earn= $100,000 + ($1,000,000 - $500,000)

= $100,000 + $500,000

=$600,000

Hence, Jacob earns $600,000

b. The economic rent is the amount by which payment of Jacob(600,000) exceed the reservation price of the supplier(100,000)

Thus, the economic rent = 600,000 - 100,000 = $500,000

Proportion of Economic rent = Economy rent / Salary of jacob

= $500,000 / $600,000

= 5/6

Hence, the proportion of the economic rent of Jacob is salary is 5/6

c. The advertising company will not be able to make an economic profit because if they withhold some additional revenue made because of hiring Jacob, then he will switch to another advertising company at a higher salary and that company keep on making profit. The company should bid for Jacob until firm are indifferent on paying $600,000 or hiring someone else for $100,000 . Thus, the bidding of Jacob will continue until the salary of Jacob has bid up to a level where no company can make economic profits