RentRent

Production is the result of the efforts of four factors of Production is the result of the efforts of four factors of production. The price that the owner of land gets for production. The price that the owner of land gets for allowing its use is generally termed as “rent”.allowing its use is generally termed as “rent”.

In general, rent is defined as “a payment made for the In general, rent is defined as “a payment made for the use of a material asset for a specified period of time.use of a material asset for a specified period of time.

But in economics by rent we mean the price paid for But in economics by rent we mean the price paid for the use of land only other kind of usage of a material the use of land only other kind of usage of a material asset is called Contract Rent and not Rent.asset is called Contract Rent and not Rent.

Therefore, to be explicit the surplus earning of a factor Therefore, to be explicit the surplus earning of a factor of production whose supply is less than perfectly of production whose supply is less than perfectly elastic is called rent in economics. elastic is called rent in economics.

Definition of rentDefinition of rent

Rent definition

Ricardian’s view Marshall’s view Modern concept view

Before defining rent according to Ricardo lets first understand what do we mean by Rent.

Land means all those gifts of nature in their original form which can neither reproduce by man or destroyed by him. Simply speaking land does not only mean the upper layer of the soil but also all that lies above or below the surface of earth. So forest resources minerals, fish or water are all included in the category of land.

Definition of rent according to Definition of rent according to Ricardian’s viewRicardian’s view

According to him “rent is defined as the price paid for the use of According to him “rent is defined as the price paid for the use of original and indestructible powers of soil.” original and indestructible powers of soil.”

To make the meaning of rent more understandable he has To make the meaning of rent more understandable he has further divided rent into two : Gross rent and Economic rentfurther divided rent into two : Gross rent and Economic rent

Gross rent: Rent paid under contract i.e. beside the price paid Gross rent: Rent paid under contract i.e. beside the price paid for the use of land, which includes interest on capital which is for the use of land, which includes interest on capital which is invested on the land e.g. tanks, wells and wages for the invested on the land e.g. tanks, wells and wages for the supervision of land supervision of land

Economic rent: is the only price paid for the services of land. Economic rent: is the only price paid for the services of land.

Ricardo was of the opinion that only land earns rent because its Ricardo was of the opinion that only land earns rent because its supply is perfectly inelastic. Its supply cannot be changed and it supply is perfectly inelastic. Its supply cannot be changed and it is also a free gift of natureis also a free gift of nature

Definition of rent according to Definition of rent according to Marshall’s viewMarshall’s view

Marshall defined rent as the income derived from Marshall defined rent as the income derived from the ownership of land and other free gifts of the ownership of land and other free gifts of nature.nature.

Marshall extended the term rent to include in it Marshall extended the term rent to include in it also the payment to man made equipments who also the payment to man made equipments who supply is inelastic like that of land in the short supply is inelastic like that of land in the short run. He called it “Quasi Rent”run. He called it “Quasi Rent”

According to Marshall land is a free gift of nature According to Marshall land is a free gift of nature only from the society point of view a s whole. But only from the society point of view a s whole. But when it comes to particular person firm or when it comes to particular person firm or industry it is available at price and supply is not industry it is available at price and supply is not perfectly inelastic perfectly inelastic

Definition of rent according to Definition of rent according to modern conceptmodern concept

According to it rent is defined as a According to it rent is defined as a “surplus”. The income which a factor earns “surplus”. The income which a factor earns over and above its minimum earning is a over and above its minimum earning is a surplus called “Rent”.surplus called “Rent”.

This minimum earning is also called This minimum earning is also called transfer earningtransfer earning

Transfer earning: It is the minimum Transfer earning: It is the minimum payment which a factor must earn in order payment which a factor must earn in order to stay in the present use. to stay in the present use.

Determination of rentDetermination of rent

Rent Determination

Ricardian theory of rent Modern theory of rent

There are manly two theories given by the economist in order to determine rent.

Ricardian theory of rentRicardian theory of rent

Ricardio said that rent is a surplus which accrues to Ricardio said that rent is a surplus which accrues to the owners of land by reason of relative advantage the owners of land by reason of relative advantage of fertility or situation or both which a particular plot of fertility or situation or both which a particular plot of land enjoys over less productive land.of land enjoys over less productive land.

Thus, Ricardo defined rent as “Rent is that portion Thus, Ricardo defined rent as “Rent is that portion of the produce of the earth which is paid to the land of the produce of the earth which is paid to the land lords for the use of original and indestructible power lords for the use of original and indestructible power of the soil”.of the soil”.

Thus, rent can arise due to two reasons: Thus, rent can arise due to two reasons: a)a) Difference in the productivity of various pieces of Difference in the productivity of various pieces of

landlandb)b) Situational differences Situational differences

Assumption of the theoryAssumption of the theory

Fixed supply of land Fixed supply of land Original powers Original powers Indestructible powers Indestructible powers Cultivation in order of fertility Cultivation in order of fertility Law of diminishing returns Law of diminishing returns Difference in fertility Difference in fertility Free gift Free gift Perfect competition Perfect competition Long run Long run Marginal land: which is just covering its cost only i.e. Marginal land: which is just covering its cost only i.e.

income from it is equal to its cost income from it is equal to its cost Different situations Different situations

Explanation of the theory Explanation of the theory

According to this theory rent arises due to niggardliness of According to this theory rent arises due to niggardliness of nature and two facts leads to niggardliness nature and two facts leads to niggardliness

a)a) Land is fixed in supplyLand is fixed in supplyb)b) It differs in fertility It differs in fertility Ricardo considered as a surplus which arises due to the differences in Ricardo considered as a surplus which arises due to the differences in

fertility and situation. He took the assumption of the marginal fertility and situation. He took the assumption of the marginal land for explaining the origin of rent margin rent is also called no land for explaining the origin of rent margin rent is also called no rent land. The land which has higher productivity than this rent land. The land which has higher productivity than this marginal land is called Intra marginal land And according to marginal land is called Intra marginal land And according to Ricardo, rent is a surplus which is the difference between Ricardo, rent is a surplus which is the difference between marginal and intra-marginal lands. Hence all the plots of land marginal and intra-marginal lands. Hence all the plots of land which produce more than the marginal land earn rent. So we can which produce more than the marginal land earn rent. So we can say that Ricardo believed rent to be a differential surplus earned say that Ricardo believed rent to be a differential surplus earned by intra marginal lands over the earnings of marginal landsby intra marginal lands over the earnings of marginal lands

There are two farming techniques : Intensive cultivation and There are two farming techniques : Intensive cultivation and Extensive cultivation. Rent arises in both techniques.Extensive cultivation. Rent arises in both techniques.

Techniques Techniques

Farming techniques

Extensive cultivation Intensive cultivation

Origin of rent under Extensive Origin of rent under Extensive CultivationCultivation

Extensive cultivation is the type of Extensive cultivation is the type of farming under which production is farming under which production is increased by using more land.increased by using more land.

Grade of landGrade of land ProductionProduction

((in tonsin tons))SurplusSurplus i.e. i.e.

Rent in tonsRent in tons

AA 2525 25-10=1525-10=15

BB 2020 20-10=1020-10=10

CC 1515 15-10=515-10=5

DD 1010 10-10=010-10=0

O A B C D

5

10

15

20

25

GRADES OF LAND

RENT ON LAND A

RENT ON LAND B

RENT ON LAND C

NO RENT LAND

PR

OD

UC

TIO

N (

IN T

ON

S)

Hence rent is the surplus between Hence rent is the surplus between the production of the marginal and the production of the marginal and intra marginal lands intra marginal lands

Origin of rent under Intensive Origin of rent under Intensive CultivationCultivation

It is second type of farming. Here on the same piece It is second type of farming. Here on the same piece of land, more units of labor and capital are employed of land, more units of labor and capital are employed to increase the production.to increase the production.

Hence minor production will go on diminishing. Here Hence minor production will go on diminishing. Here marginal product refers to the addition made to the marginal product refers to the addition made to the total production by using one more unit of labor and total production by using one more unit of labor and capital, other factor units remaining constant.capital, other factor units remaining constant.

The under given table explains that the first second The under given table explains that the first second and third units on rent not due to the difference of and third units on rent not due to the difference of the fertility of land but due to diminishing returns on the fertility of land but due to diminishing returns on the same piece of land the same piece of land

Units of Labor Units of Labor and Capitaland Capital

Marginal Marginal ProductionProduction

((in tonsin tons))

Surplus Surplus Production or Production or RentRent (in tons) (in tons)

11stst 2525 25-10=1525-10=15

22ndnd 2020 20-10=1020-10=10

33rdrd 1515 15-10=515-10=5

44thth 1010 10-10=010-10=0

O 1st 2nd 3rd 4th

5

10

15

20

25

UNITS OF LABOUR AND CAPITAL

RENT OF UNIT 1st

RENT OF UNIT 2nd

RENT OF UNIT 3rd

NO RENT UNIT OR

MARGINAL UNIT

PR

OD

UC

TIO

N (

IN T

ON

S)

Thus ricardo rent was a surplus Thus ricardo rent was a surplus which the intra marginal lands and which the intra marginal lands and units of labor and capital earn over units of labor and capital earn over and above the production of and above the production of marginal units or marginal lands marginal units or marginal lands

Criticism of Ricardo theoryCriticism of Ricardo theory

No original and indestructible powers No original and indestructible powers Historically wrong Historically wrong Neglect of scarcity rent Neglect of scarcity rent Wrong assumption of perfect competition.Wrong assumption of perfect competition. Wrong assumption of no rent land Wrong assumption of no rent land Every land has fertilityEvery land has fertility Rent element in all factors Rent element in all factors Rent enters into priceRent enters into price It fails to determine rent It fails to determine rent Wrong idea of the application of the law of Wrong idea of the application of the law of

diminishing returns diminishing returns

Conclusion of the theoryConclusion of the theory

Though this theory fails to determine Though this theory fails to determine rent but it occupies an important place rent but it occupies an important place in economic theory the nature and in economic theory the nature and origin of rent stands as the singular origin of rent stands as the singular contribution to understanding of the contribution to understanding of the determination of factors shares. All the determination of factors shares. All the other theory is simply a modification or other theory is simply a modification or improved version of their theoryimproved version of their theory

Modern theory of rent is an improvement over Modern theory of rent is an improvement over the Ricardian theory is that it is not only land the Ricardian theory is that it is not only land which can earn rent but other factors of which can earn rent but other factors of production i.e. labor, capital, organisation production i.e. labor, capital, organisation and entrepreneur are also entitled to rent. and entrepreneur are also entitled to rent. Land is scare. So it earns scarcity rent. Lands Land is scare. So it earns scarcity rent. Lands differ in fertility. So they earn differential rents differ in fertility. So they earn differential rents

The Ricardian theory was failing to determine The Ricardian theory was failing to determine how rent is determined but their question was how rent is determined but their question was answered by modern theory.answered by modern theory.

To determine rent the modern economics To determine rent the modern economics have developed & supply theory for the have developed & supply theory for the purpose.purpose.

The theory is also known as ‘Scarcity The theory is also known as ‘Scarcity Theory of Rent’ the theory explains Theory of Rent’ the theory explains that rent doesn’t arise due to fertility that rent doesn’t arise due to fertility differences of land alone but due to differences of land alone but due to more demand in relation to supply of more demand in relation to supply of all factors. The more the scarcity of all factors. The more the scarcity of land and the other factors, the higher land and the other factors, the higher will be the size of rent earned. Hence will be the size of rent earned. Hence the forces of demand and supply the forces of demand and supply together determine rent together determine rent

Demand SideDemand Side

The demand for land is indirect or derived. The demand for land is indirect or derived. In fact, land is demanded for it produces In fact, land is demanded for it produces something. The higher is the demand for something. The higher is the demand for the goods produced on land, the demand the goods produced on land, the demand for land itself will be more therefore the for land itself will be more therefore the price of land (rent) will be more and price of land (rent) will be more and therefore the price of land (rent) will be therefore the price of land (rent) will be higher. Marginal productivity of land higher. Marginal productivity of land determines the demand for it. As we go on determines the demand for it. As we go on investing more and more on the same investing more and more on the same land, its marginal productivity of land land, its marginal productivity of land equals its price which is rent.equals its price which is rent.

Supply SideSupply Side

The supply of land can’t be altered for the society The supply of land can’t be altered for the society as a whole.as a whole.

We know that land has alternative uses i.e. it can We know that land has alternative uses i.e. it can be used in several ways. So, for a particular be used in several ways. So, for a particular industry or firm or individual, the supply of land industry or firm or individual, the supply of land can be changed, i.e. it is elastic. Any individual can be changed, i.e. it is elastic. Any individual can get more land by bidding up its price. Hence can get more land by bidding up its price. Hence the supply curve of the land for an individual firm the supply curve of the land for an individual firm or industry is having an ‘upward slope’.or industry is having an ‘upward slope’.

Rent is determined at the point where demand for Rent is determined at the point where demand for and supply of land intersect each other. This is and supply of land intersect each other. This is shown through a diagram given below.shown through a diagram given below.

Modern theory is also applicable Modern theory is also applicable when land differs in fertility when land differs in fertility

The different-fertility lands will have The different-fertility lands will have separate demand curves for them. separate demand curves for them. The price for more fertile and better The price for more fertile and better situated land will be higher than situated land will be higher than those of the others. And their those of the others. And their equilibrium equilibrium

O Q2 Q Q3

R2

R

R1

S

E2

E

E1

S

D2

D

D1

D1

D

D2

DEMAND AND

SUPPLY OF LAND

REN

T

Modern theory is also applicable when Modern theory is also applicable when lands differ in fertility lands differ in fertility

The different-fertility lands will have The different-fertility lands will have separate demands curves for them. separate demands curves for them. The price of more fertile and better The price of more fertile and better situated land will be higher than those situated land will be higher than those of the others. And their equilibrium of the others. And their equilibrium rents will also be higher than those of rents will also be higher than those of the less fertile and relatively less the less fertile and relatively less favorably situated lands.favorably situated lands.

Rent as a surplusRent as a surplus

Modern economists agree to the idea of Modern economists agree to the idea of the surplus being rent as advocated by the surplus being rent as advocated by Ricardo. But they differ on the point Ricardo. But they differ on the point that rent is earned only by land. that rent is earned only by land. Modern economist are the opinion that Modern economist are the opinion that other factors of production than land other factors of production than land can also earn rent. The features of in-can also earn rent. The features of in-elasticity of supply is also found among elasticity of supply is also found among other factors of production in the short other factors of production in the short run.run.

Rent and transfer earningsRent and transfer earnings

Rent =Actual earning – Transfer earningRent =Actual earning – Transfer earning

Where:Where: The income which a factor actually gets from its The income which a factor actually gets from its

present work or job is called its ‘actual earning’ present work or job is called its ‘actual earning’ Transfer earning refers to the price which a Transfer earning refers to the price which a

factor unit must get in its present use in order factor unit must get in its present use in order to stay in its present employment.to stay in its present employment.

Specific and non-specific Specific and non-specific factorsfactors

Specific factors are those which can be put Specific factors are those which can be put only to one use. These have no alternative only to one use. These have no alternative use in other words, they have no next use in other words, they have no next based use. So, their transfer earning is based use. So, their transfer earning is zero. And the whole of their actual earning zero. And the whole of their actual earning is rent. On the other hand, non-specific is rent. On the other hand, non-specific factors are those which can be put to more factors are those which can be put to more than one uses. They have alternative uses. than one uses. They have alternative uses.

Hence the share of rent is specific factors Hence the share of rent is specific factors is more than that in the non-specific ones. is more than that in the non-specific ones.

The supply of land as a factor of The supply of land as a factor of production can be of three types:production can be of three types:

Perfectly Inelastic SupplyPerfectly Inelastic Supply Perfectly Elastic SupplyPerfectly Elastic Supply Elastic SupplyElastic Supply

Perfectly Inelastic SupplyPerfectly Inelastic Supply

From the society's view point, land From the society's view point, land supply cannot be either increased or supply cannot be either increased or decreased. It is a given. It has no decreased. It is a given. It has no alternative use. So, it has no transfer alternative use. So, it has no transfer earning. The whole of its actual earning. The whole of its actual earning is rent.earning is rent.

D1

D

D1

D

SO

P

S

E1

E

DEMAND AND SUPPLY OF LAND

PR

ICE

P1

ACTUAL EARNING =RENT

Perfectly Elastic SupplyPerfectly Elastic Supply

It means that we can get land as It means that we can get land as much as we desire at a given price of much as we desire at a given price of it. It is possible only when the it. It is possible only when the transfer earning of the all units of transfer earning of the all units of land is the same. In this situation, land is the same. In this situation, transfer earning (TE) will be equal transfer earning (TE) will be equal actual earning (AE). So no rent will actual earning (AE). So no rent will be earned.be earned.

D1D

D1D

M M1

O

P SE1E

DEMAND AND

PR

ICE A

ND

REN

T

NO RENT EARNING

Elastic SupplyElastic Supply

But, actually for a particular firm or But, actually for a particular firm or industry, supply of land is neither industry, supply of land is neither perfectly inelastic nor perfectly elastic. perfectly inelastic nor perfectly elastic. It is in between these two. Hence It is in between these two. Hence supply of land is less elastic. In this supply of land is less elastic. In this situation, actual earning will be more situation, actual earning will be more than its transfer earning. So rent will be than its transfer earning. So rent will be earned equal to the difference between earned equal to the difference between these two.these two.

D1

D

D1

D

M M1

O

P

S1

E1

E

DEMAND AND SUPPLY OF LAND

PR

ICE

EARNING

P1

S

RENT

Modern Theory as an Modern Theory as an Improvement Over Ricardian Improvement Over Ricardian

Theory of RentTheory of Rent

Amplification of Ricardian theoryAmplification of Ricardian theory Modification of the Ricardian TheoryModification of the Ricardian Theory Rent and Price Rent and Price

RENT VERSUSES QUASI-RENT VERSUSES QUASI-RENTRENT

If we study the concepts of rent and If we study the concepts of rent and Quasi-rent, we find that there are a Quasi-rent, we find that there are a few similarities, and some few similarities, and some differences between the two. We can differences between the two. We can discuss both of these here. discuss both of these here.

SimilaritiesSimilaritiesa)a) Rent and Quasi-rent both are surplus or Rent and Quasi-rent both are surplus or

excess earnings.excess earnings.

b)b) Both arise due to rise in demand for land Both arise due to rise in demand for land and man-made factors. and man-made factors.

c)c) Rent and Quasi-rent are similar also Rent and Quasi-rent are similar also because both accrue due to the fixed or because both accrue due to the fixed or inelastic supply of factors. inelastic supply of factors.

d)d) Rent and Quasi-rent are both measured Rent and Quasi-rent are both measured by the differences between the actual by the differences between the actual earning and transfer earning of a factor earning and transfer earning of a factor

DifferencesDifferences

Despite the similarities given above, rent and Despite the similarities given above, rent and Quasi-rent differ. The following points Quasi-rent differ. The following points show it :show it :

i.i. Rent is earned by the free gifts of nature Rent is earned by the free gifts of nature such as land. But Quasi-rent is the excess such as land. But Quasi-rent is the excess income earn by the man-made factors.income earn by the man-made factors.

ii.ii. Rent is earned both in short run and long Rent is earned both in short run and long run. While Quasi-rent occurs only in short run. While Quasi-rent occurs only in short run because in the long run, man-made run because in the long run, man-made factors have their perfectly elastic supply.factors have their perfectly elastic supply.

iii.iii. Rent is permanent earning while Rent is permanent earning while Quasi-rent is transitory. In other Quasi-rent is transitory. In other words, Quasi-rent is not a cost in words, Quasi-rent is not a cost in the short period. the short period.

iv.iv. Rent is never zero. But Quasi-rent Rent is never zero. But Quasi-rent becomes zero when price is equal becomes zero when price is equal to average variable costs.to average variable costs.

v.v. Rent is the difference between total Rent is the difference between total earnings and total costs. But Quasi-earnings and total costs. But Quasi-rent is the difference between total rent is the difference between total earnings and variable costs. earnings and variable costs.

vi.vi. Rent is an un earned income while Rent is an un earned income while Quasi-rent is a necessary payment Quasi-rent is a necessary payment for the firm to produce the output. for the firm to produce the output.

Hence rent and Quasi-rent differ Hence rent and Quasi-rent differ mainly in the duration of the time mainly in the duration of the time period. The former belongs to the period. The former belongs to the short run as well as to the long run. short run as well as to the long run. While the later arises only in the While the later arises only in the short run.short run.