Rent

Production is the result of the efforts of four factors of production. The price that the owner of land gets for allowing its use is generally termed as rent. In general, rent is defined as a payment made for the use of a material asset for a specified period of time. But in economics by rent we mean the price paid for the use of land only other kind of usage of a material asset is called Contract Rent and not Rent. Therefore, to be explicit the surplus earning of a factor of production whose supply is less than perfectly elastic is called rent in economics.

Definition of rent
Rent definition
Ricardians view Marshalls 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 Ricardians view

According to him rent is defined as the price paid for the use of original and indestructible powers of soil.
To make the meaning of rent more understandable he has further divided rent into two : Gross rent and Economic rent Gross rent: Rent paid under contract i.e. beside the price paid for the use of land, which includes interest on capital which is invested on the land e.g. tanks, wells and wages for the supervision 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 supply is perfectly inelastic. Its supply cannot be changed and it is also a free gift of nature

Definition of rent according to Marshalls view

Marshall defined rent as the income derived from the ownership of land and other free gifts of nature. Marshall extended the term rent to include in it also the payment to man made equipments who supply is inelastic like that of land in the short run. He called it Quasi Rent According to Marshall land is a free gift of nature only from the society point of view a s whole. But when it comes to particular person firm or industry it is available at price and supply is not perfectly inelastic

Definition of rent according to modern concept

According to it rent is defined as a surplus. The income which a factor earns over and above its minimum earning is a surplus called Rent. This minimum earning is also called transfer earning Transfer earning: It is the minimum payment which a factor must earn in order to stay in the present use.

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

Rent Determination Ricardian theory of rent Modern theory of rent

Ricardian theory of rent

a) b)

Ricardio said that rent is a surplus which accrues to the owners of land by reason of relative advantage of fertility or situation or both which a particular plot of land enjoys over less productive land. Thus, Ricardo defined rent as Rent is that portion of the produce of the earth which is paid to the land lords for the use of original and indestructible power of the soil. Thus, rent can arise due to two reasons: Difference in the productivity of various pieces of land Situational differences

Assumption of the theory

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

Explanation of the theory

a) b)

According to this theory rent arises due to niggardliness of nature and two facts leads to niggardliness Land is fixed in supply It differs in fertility

Ricardo considered as a surplus which arises due to the differences in fertility and situation. He took the assumption of the marginal land for explaining the origin of rent margin rent is also called no rent land. The land which has higher productivity than this marginal land is called Intra marginal land And according to Ricardo, rent is a surplus which is the difference between marginal and intra-marginal lands. Hence all the plots of land which produce more than the marginal land earn rent. So we can say that Ricardo believed rent to be a differential surplus earned by intra marginal lands over the earnings of marginal lands There are two farming techniques : Intensive cultivation and Extensive cultivation. Rent arises in both techniques.

Techniques

Farming techniques Extensive cultivation Intensive cultivation

Origin of rent under Extensive Cultivation

Extensive cultivation is the type of farming under which production is increased by using more land. Production (in tons) 25 Surplus i.e.

Grade of land A

Rent in tons
25-10=15

B
C D

20
15 10

20-10=10
15-10=5 10-10=0

RENT ON LAND A 25

PRODUCTION (IN TONS)

RENT ON LAND B 20 15 10 5 RENT ON LAND C NO RENT LAND

D GRADES OF LAND

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

Origin of rent under Intensive Cultivation

It is second type of farming. Here on the same piece of land, more units of labor and capital are employed to increase the production. Hence minor production will go on diminishing. Here marginal product refers to the addition made to the total production by using one more unit of labor and capital, other factor units remaining constant. The under given table explains that the first second and third units on rent not due to the difference of the fertility of land but due to diminishing returns on the same piece of land

Units of Labor and Capital 1st 2nd 3rd 4th

Marginal Production (in tons) 25 20 15 10

Surplus Production or Rent (in tons) 25-10=15 20-10=10 15-10=5 10-10=0

RENT OF UNIT 1st 25

PRODUCTION (IN TONS)

RENT OF UNIT 2nd 20 15 10 5 RENT OF UNIT 3rd NO RENT UNIT OR MARGINAL UNIT

1st

2nd

3rd

4th

UNITS OF LABOUR AND CAPITAL

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

Criticism of Ricardo theory

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

Conclusion of the theory

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

Modern theory of rent is an improvement over the Ricardian theory is that it is not only land which can earn rent but other factors of production i.e. labor, capital, organisation and entrepreneur are also entitled to rent. Land is scare. So it earns scarcity rent. Lands differ in fertility. So they earn differential rents The Ricardian theory was failing to determine how rent is determined but their question was answered by modern theory. To determine rent the modern economics have developed & supply theory for the purpose.

The theory is also known as Scarcity Theory of Rent the theory explains that rent doesnt arise due to fertility differences of land alone but due to more demand in relation to supply of all factors. The more the scarcity of land and the other factors, the higher will be the size of rent earned. Hence the forces of demand and supply together determine rent

Demand Side

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

Supply Side

The supply of land cant be altered for the society as a whole. We know that land has alternative uses i.e. it can be used in several ways. So, for a particular industry or firm or individual, the supply of land can be changed, i.e. it is elastic. Any individual can get more land by bidding up its price. Hence the supply curve of the land for an individual firm or industry is having an upward slope. Rent is determined at the point where demand for and supply of land intersect each other. This is shown through a diagram given below.

Modern theory is also applicable when land differs in fertility The different-fertility lands will have separate demand curves for them. The price for more fertile and better situated land will be higher than those of the others. And their equilibrium

D1

RENT

D R1 R R2 E2 D2 E E1

D1

D
S D2

Q2

Q3

DEMAND AND SUPPLY OF LAND

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

Rent as a surplus

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

Rent and transfer earnings

Rent =Actual earning Transfer earning
Where: The income which a factor actually gets from its present work or job is called its actual earning Transfer earning refers to the price which a factor unit must get in its present use in order to stay in its present employment.

Specific and non-specific factors

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

The supply of land as a factor of production can be of three types: Perfectly Inelastic Supply Perfectly Elastic Supply Elastic Supply

Perfectly Inelastic Supply

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

PRICE

D1 D

P1

E1

E D ACTUAL EARNING =RENT

D1

DEMAND AND SUPPLY OF LAND

Perfectly Elastic Supply

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

PRICE AND RENT

D1

E P NO RENT EARNING D

E1

D1

M1

DEMAND AND

Elastic Supply

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

D1

PRICE

D S1 E1 RENT EARNING E

P1 P S

D1 D O M M1

DEMAND AND SUPPLY OF LAND

Modern Theory as an Improvement Over Ricardian Theory of Rent

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

RENT VERSUSES QUASI-RENT

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

Similarities
a) b)

c)

d)

Rent and Quasi-rent both are surplus or excess earnings. Both arise due to rise in demand for land and man-made factors. Rent and Quasi-rent are similar also because both accrue due to the fixed or inelastic supply of factors. Rent and Quasi-rent are both measured by the differences between the actual earning and transfer earning of a factor

Differences
Despite the similarities given above, rent and Quasi-rent differ. The following points show it : i. Rent is earned by the free gifts of nature such as land. But Quasi-rent is the excess income earn by the man-made factors. ii. Rent is earned both in short run and long run. While Quasi-rent occurs only in short run because in the long run, man-made factors have their perfectly elastic supply.

iii.

iv.

v.

Rent is permanent earning while Quasirent is transitory. In other words, Quasirent is not a cost in the short period. Rent is never zero. But Quasi-rent becomes zero when price is equal to average variable costs. Rent is the difference between total earnings and total costs. But Quasi-rent is the difference between total earnings and variable costs.

Rent is an un earned income while Quasi-rent is a necessary payment for the firm to produce the output. Hence rent and Quasi-rent differ mainly in the duration of the time period. The former belongs to the short run as well as to the long run. While the later arises only in the short run.
vi.