RENTRENT

Ricardian Theory of Rent: Differential Ricardian Theory of Rent: Differential RentRent

Modern Theory of Rent: Scarcity RentModern Theory of Rent: Scarcity Rent

Quasi RentQuasi Rent

Concept of RentConcept of Rent

Rent refers to the compensation for the use Rent refers to the compensation for the use of somebody’s belongings for a period of of somebody’s belongings for a period of time. time.

In economics, the term rent originally meant In economics, the term rent originally meant the payment for the productive use of land.the payment for the productive use of land.

Modern economists define rent in a broader Modern economists define rent in a broader connotation connotation

Rent is the surplus earned by a factor over Rent is the surplus earned by a factor over and above the minimum earnings necessary and above the minimum earnings necessary to induce it to continue its work. to induce it to continue its work.

Contract RentContract Rent

A contractual payment agreed upon the right A contractual payment agreed upon the right for using a durable goods over a stated period. for using a durable goods over a stated period.

Contract rent includes economic rent plus Contract rent includes economic rent plus elements of interest on capital service elements of interest on capital service charges, profits, etc.charges, profits, etc.

Also termed as Gross Rent.Also termed as Gross Rent. Contract Rent = Economic Rent + Interest + Contract Rent = Economic Rent + Interest +

Wages + Depreciation + Profits Wages + Depreciation + Profits

Economic Rent Economic Rent Economic rent is the pure rent payable as the Economic rent is the pure rent payable as the

return of land alone, for its use. return of land alone, for its use. To classical economists, Economic rent was To classical economists, Economic rent was

applicable to land alone. applicable to land alone. To modern economist, economic rent means To modern economist, economic rent means

income or yield derived from any factor income or yield derived from any factor whose supply is inelastic. whose supply is inelastic.

Economic rent is thus the surplus over supply Economic rent is thus the surplus over supply price of the factor in terms of its opportunity price of the factor in terms of its opportunity cost.cost.

Economic rent = Gross Rent – (Interest + Economic rent = Gross Rent – (Interest + Wages + Depreciation + Wages + Depreciation +

Profits) Profits)

Ricardian Theory of RentRicardian Theory of Rent Ricardo believed …Ricardo believed …

Land is a free gift of nature, rent is a Land is a free gift of nature, rent is a true surplus, it is paid as the surplus true surplus, it is paid as the surplus over the cost of cultivation.over the cost of cultivation.

Rent is that portion of the produce Rent is that portion of the produce of the earth which is paid to the of the earth which is paid to the landlord for the use of the original landlord for the use of the original and indestructible power of the soil. and indestructible power of the soil.

Rent is a differential surplus earned Rent is a differential surplus earned by more fertile plot of land. by more fertile plot of land.

Ricardian Ricardian Theory:Assumptions Theory:Assumptions

Land is free gift of nature hence no supply price.Land is free gift of nature hence no supply price. Supply of land is fixed and perfectly inelastic.Supply of land is fixed and perfectly inelastic. Demand is the sole determining factor for rent.Demand is the sole determining factor for rent. Land is a heterogeneous factor of production.Land is a heterogeneous factor of production. Technique of production is given and unchanged.Technique of production is given and unchanged. Land is subject to the law of diminishing returns.Land is subject to the law of diminishing returns. There is perfect competition for the use of land.There is perfect competition for the use of land.

Ricardian Theory of RentRicardian Theory of Rent

Rent emerges on account of the Rent emerges on account of the difference in the quality of land. difference in the quality of land.

Superior lands yields a surplus due to Superior lands yields a surplus due to their differential advantages in their differential advantages in production over inferior or less fertile production over inferior or less fertile ones. ones.

The theory is also known as theory of The theory is also known as theory of differential advantage or theory of differential advantage or theory of differential rent.differential rent.

Rent Rent SurplusSurplus

Intra-Marginal LandIntra-Marginal Land

Rent Rent SurplusSurplus

Marginal Land Marginal Land (No Rent Land)(No Rent Land)

Rent Rent SurplusSurplus

A B C D

6

10

14

20

Input cost

20000-6000=

14000

14000-6000=

8000

10000-6000=

4000

6000-6000=

No rent

Types of Land

Ou

tpu

t / r

etu

rn

Ricardian Theory of RentRicardian Theory of Rent Land ALand A

A

P=AR=MR

Produce

Rent

MC

Q

AC

R S

P

Ricardian Theory of RentRicardian Theory of Rent Land BLand B

B

P=AR=MR

Produce

Rent

MC

Q

AC

R S

P

Ricardian Theory of RentRicardian Theory of Rent Land CLand C

C

P=AR=MR

Produce

rent

MC

Q

AC

R S

P

Ricardian Theory of RentRicardian Theory of Rent Land DLand D

D

P=AR=MR

Produce

Rent

MC

Q

AC

P

Ricardian Theory…Ricardian Theory… Rent is a surplus payment. Rent is a surplus payment. Rent is a differential surplus yield of Rent is a differential surplus yield of

more fertile land as against less fertile more fertile land as against less fertile land.land.

Rent arises because of differential Rent arises because of differential fertility of landfertility of land

Super quality lands yield rent against Super quality lands yield rent against marginal lands that are relatively marginal lands that are relatively inferior.inferior.

Rent is price-determined and not price-Rent is price-determined and not price-determining.determining.

Ricardian Theory …Ricardian Theory … ““Corn is not high because rent is paid, Corn is not high because rent is paid,

but rent is paid because corn is highbut rent is paid because corn is high.”.” Rent rises when price of land output Rent rises when price of land output

rises and not that price is high because rises and not that price is high because rent is high.rent is high.

Rent does not enter price of the produce Rent does not enter price of the produce of land is an important corollary.of land is an important corollary.

More fertile land earns surplus return as More fertile land earns surplus return as rent; marginal land fetches not rent, rent; marginal land fetches not rent, hence rent does not enter price.hence rent does not enter price.

Hence rent is a differential surplus.Hence rent is a differential surplus.

Ricardian Theory: CriticismsRicardian Theory: Criticisms The definition of rent has been criticised, The definition of rent has been criticised,

‘payment made for the use of original & indestructible ‘payment made for the use of original & indestructible

power of soil’. power of soil’. In the present atomic era, one In the present atomic era, one cannot claim anything to be indestructible.cannot claim anything to be indestructible.

Ricardo believed that land is cultivated in Ricardo believed that land is cultivated in a particular order from most to least a particular order from most to least fertile. fertile. Lands which are most convenient Lands which are most convenient are cultivated first.are cultivated first.

Ricardo emphasised rent is Ricardo emphasised rent is ‘payment made for ‘payment made for

the use of original & indestructible power of soil’. the use of original & indestructible power of soil’. It is It is difficult to ascertain which powers of the difficult to ascertain which powers of the land are original and which are not.land are original and which are not.

Ricardian Theory: CriticismsRicardian Theory: Criticisms If no-rent land exists, it would be difficult to If no-rent land exists, it would be difficult to

measure differential rent of intra-marginal measure differential rent of intra-marginal landslands

The assumption of perfect competition is The assumption of perfect competition is unrealistic.unrealistic.

For Ricardo, rent is not a component of the For Ricardo, rent is not a component of the cost of production. cost of production. Modern economists Modern economists disagree that rent does not exist in price. The disagree that rent does not exist in price. The modern view is rent cannot be price-modern view is rent cannot be price-determining, but it is price-determined.determining, but it is price-determined.

The modern view believes that Rent would The modern view believes that Rent would arise even if lands are of the same quality. arise even if lands are of the same quality. Rent arises due to inelastic supply of a factor.Rent arises due to inelastic supply of a factor.

Modern Theory of RentModern Theory of Rent Rent arises due to scarcity of land. Rent arises due to scarcity of land.

all lands, inferior or superior do fetch all lands, inferior or superior do fetch rent, thus the assumption of marginal rent, thus the assumption of marginal rent as no rent land doesn’t hold waterrent as no rent land doesn’t hold water

Demand and supply forces determine Demand and supply forces determine rent.rent.

Rent emerges even if all land is Rent emerges even if all land is homogenous due to scarcity of land.homogenous due to scarcity of land.

Supply of land is perfectly inelastic.Supply of land is perfectly inelastic. Rising population intensifies the relative Rising population intensifies the relative

scarcity leading to further rise in the scarcity leading to further rise in the price of land. price of land.

Scarcity rent is demand determined.Scarcity rent is demand determined.

What’s similar between What’s similar between Ricardo and Marshall ?Ricardo and Marshall ?

Like differential rent, scarcity rent Like differential rent, scarcity rent is the producer’s surplus.is the producer’s surplus.

The concept of differential rent The concept of differential rent also contains the element of also contains the element of scarcity.scarcity.

““All rents are scarcity rents, and All rents are scarcity rents, and all rents are differential rents”. –all rents are differential rents”. –Alfred MarshalAlfred Marshal

Modern Theory of RentModern Theory of Rent

Scarcity RentScarcity Rent

Q

R1

R2

R3

D1

D2

D3

S

O

Rent

Quantity of Land

Modern Theory of RentModern Theory of Rent Rent is generalized surplus earned by all Rent is generalized surplus earned by all

factors.factors. To modern economist, Rent is not the peculiar To modern economist, Rent is not the peculiar

earning of land alone.earning of land alone. Income earned by any factors due to scarcity in a Income earned by any factors due to scarcity in a

given period of time is rent.given period of time is rent. Rent is surplus earning of a factor in excess Rent is surplus earning of a factor in excess

of its supply price to attract it into the of its supply price to attract it into the particular use becomes a generalized particular use becomes a generalized surplus.surplus.

The rent depends on the relative degree of The rent depends on the relative degree of inelasticity of supply.inelasticity of supply.

A factor earns rent till its supply remains A factor earns rent till its supply remains less than perfectly elastic. less than perfectly elastic.

Modern Theory of RentModern Theory of Rent The concept of Transfer Earnings to The concept of Transfer Earnings to

measure the surplusmeasure the surplus Rent is a surplus, earned by a factor, is Rent is a surplus, earned by a factor, is

measured with reference to transfer measured with reference to transfer earnings, in the prevailing employment.earnings, in the prevailing employment.

Transfer earnings are the opportunity Transfer earnings are the opportunity cost of factor.cost of factor.

Economic Rent = Current earning of a Economic Rent = Current earning of a factor – Its transfer earning.factor – Its transfer earning.

Quasi RentQuasi Rent Short run earnings of some factors of Short run earnings of some factors of

production, especially man-made production, especially man-made instruments are fixed in supply in the short instruments are fixed in supply in the short run. In the long run their supply is elastic.run. In the long run their supply is elastic.

In the short run when the demand In the short run when the demand increases, their income rises and they increases, their income rises and they earn surplus. earn surplus.

But in the long run as the supply becomes But in the long run as the supply becomes elastic the surplus earned by these factors elastic the surplus earned by these factors disappears.disappears.

Though the earnings look like rent it Though the earnings look like rent it cannot be regarded as rent. Marshall cannot be regarded as rent. Marshall therefore called it quasi rent.therefore called it quasi rent.

Quasi RentQuasi Rent

Quasi rent is thus a short term temporary Quasi rent is thus a short term temporary surplus earnings of some factors.surplus earnings of some factors.

““Quasi rent of a machine is its total short –Quasi rent of a machine is its total short –period receipts less the total costs of hiring period receipts less the total costs of hiring the variable factors used in association with the variable factors used in association with it to produce out put and of keeping the it to produce out put and of keeping the machine in running order in the short run.” machine in running order in the short run.”

-Stonier and Hague -Stonier and Hague

Quasi Rent …Quasi Rent … To a firm the surplus of revenue received To a firm the surplus of revenue received

over the variable costs incurred in producing over the variable costs incurred in producing output in the short –run is quasi rent.output in the short –run is quasi rent.

QR = STR – STVC QR = STR – STVC Thus, any part of fixed cost covered by the Thus, any part of fixed cost covered by the

price in the short run is broadly treated as price in the short run is broadly treated as quasi rent.quasi rent.

Quasi rent is price determined.Quasi rent is price determined. Quasi rent is different from supernormal or Quasi rent is different from supernormal or

normal profits. Supernormal profits = Price – normal profits. Supernormal profits = Price – ATC.ATC.

Profits can be negative, but quasi rent cannot Profits can be negative, but quasi rent cannot be negative because price is less than AVC be negative because price is less than AVC the firm will no longer remain in the business.the firm will no longer remain in the business.

Modern Theory of RentModern Theory of Rent Quasi RentQuasi Rent

D=AR1=MR1

MC

AC

AVC

Quantity

D=AR2=MR2

D=AR=MR

Price/Cost

Q1QO

P

P1

P2

D=AR3=MR3

P3

E

Q2 Q3

E1

E2

E3