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Question

Difficulty: Very hardFactors of Production and Their Rewards

A firm's annual accounting records show that total revenue generated is fully exhausted by contractual payments made for building rent, factory worker wages, and loan interest. Which statement accurately analyzes the economic reward accrued by the entrepreneur under these conditions?

  1. The entrepreneur earns zero pure economic profit, reflecting that residual returns disappear when explicit factor rewards equal total revenue.Answer
  2. B
    The entrepreneur receives a contractual wage reward, as managerial risk-bearing functions are treated identically to variable labor inputs.
  3. C
    The entrepreneur earns a fixed interest payment, because capital investment guarantees a non-zero return regardless of business outcomes.
  4. D
    The entrepreneur receives economic rent, since land and fixed physical facilities absorb all remaining production yields.

Answer

The entrepreneur earns zero pure economic profit, reflecting that residual returns disappear when explicit factor rewards equal total revenue.
Unlike land (rent), labor (wages), and capital (interest) which receive fixed or contractual rewards, the entrepreneur receives a residual reward known as profit. If total revenue exactly covers all explicit factor rewards, the remaining residual is zero, meaning pure economic profit is zero.

Step-by-Step Solution

1
Identify the rewards associated with each factor of production mentioned in the scenario.
Building rent goes to land, worker wages go to labor, and loan interest goes to capital. These are all contractual (explicit) factor payments.
Land, labor, and capital receive contractual returns that are determined in advance.
2
Analyze the nature of the entrepreneur's reward.
The entrepreneur receives profit, which is a residual (non-contractual) reward for organization and risk-bearing.
Profit is calculated as Total Revenue minus Total Factor Costs (explicit and implicit).
3
Evaluate the condition where Total Revenue equals total explicit contractual costs.
Since Total Revenue minus Total Contractual Costs equals zero, the residual reward (economic profit) is zero.
When all revenue goes toward covering contractual factor returns, no surplus remains for the entrepreneur.

Key Concept

Residual vs. Contractual Factor Rewards
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Topics

Factors of Production and Their Rewards

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