Referring to my last article (Gondola Licence and transaction costs), I have discussed the relationship between licensing, information cost and price discrimination. My friend kindly pointed out that I have missed out one important constraint – Rent dissipation. In this article, I shall explain how licensing can restrict the dissipation of rent.
Rent Dissipation occurs when a valuable public good can be accessed with no restrictions – under competition its value will dissipate at the margin after being consumed by an additional person, until all rent is completely dissipated. A good example of rent dissipation is the case of overfishing. Assume there is a sea that anyone can get access to. Fishermen will crowd at the sea to fish until all fish have been captured. Rent of the sea decreases to zero as it cannot further produce any output (fish). The sea has become a wasted capital.
Furthermore, Rent Dissipation also creates another undesirable economic outcome. When valuable capital can be accessed with no restrictions, the first extractor may decide to destroy resources until an additional entry is worsen-off. For instance, a farmer, finding a farmland with rich soil, chooses to build (poor-quality) houses instead of plating crops on that land. It is to avoid competition because with no restrictive entry, anyone can step onto the farmland and plant its own crops. Hence it is better off for the farmer to destroy the rich resources so that further entrance is not profitable.
After all, without clearly defining property rights rent dissipation will occur. To combat it, licensing is a major solution. Unlike what I mentioned in my last article, this kind of licensing does not aim to reduce information cost; instead, it solely functions as a regulation system to keep rent being positive.
In Venice, customers riding on Gondola do not actually consume the ‘boat ride’ itself, but the beautiful view of Venice. If the Grand Canal had no restrictive entry, all Gondoliers would crowd at the Canal until all rent was dissipated, making sure no further customers could enjoy the sightseeing. The Grand Canal would then be packed with embarrassed and furious tourists, who could only be able to look at each other’s faces. The quality of water would also deteriorate at a fast rate. Therefore, it is important that licensing can restrict numbers of boats on the Canal, frequency of boat riding and when the boats can be ridden. Only with these well-defined property right regulations can rent keep positive at the margin such that the capital shall remain productive.