Transcript WHY DOES RENT ARISEx

 The
term rent is used for that payment which is
made regularly for a fixed period for the use of the
services of the goods.
 E.g.
house, shop, furniture, crockery etc. or for
availing of the services of factors of production.
 Rent
is the price paid for the use of the original
and destructible powers of the soil.
 Contract
Rent - Contract rent is the payment which is
made for the use of land and the capital invested thereon,
or pre-determined conditions.
 Economic
Rent – Economic rent is the price paid for
the use of the services of land. Economic rent is also
referred to as surplus because it is received by the landlord
without any effort. So it is also called Economic Surplus.
Opportunity cost of a factor used in the work yielding
maximum income, is the price of the output that the factor
concerned can earn by working in the next best alternative
use. Such price is called transfer earning or opportunity
cost.
 The amount by which actual earning of a factor is higher
than its transfer earning is called rent.

Rent = Actual Earning – Transfer Earning

E.g. Suppose, the peon in your college receives Rs.2000 p.m
as wage. If he gets employment in a bank on Rs.2500 p.m
as wage, then the difference between his actual earning
and transfer earning (Rs. 2500- Rs. 2000) = Rs. 500 will be
called rent.
 Rent can form part of the income of each factor of
production, viz., labour, capital, enterpreneur besides land.

 Economic
Rent- Payment made for the use of land alone
is called economic rent. Economic rent refers to the
payment for the use of land only. Economic rent is also
called Surplus, because it emerges without any effort on
the part of a land lord. It is also called Economic Surplus.
 Gross
Rent- Gross rent refers to that rent which is paid
for the services of land and the capital invested on it.
Followings are the constituents of gross rent:
(a) Economic rent refers to the payment made for the use
of land.
(b) Interest on capital invested for improvement of land, e.g.
digging of a well, drainage, farm house , bonding, terracing
etc.
(c) Reward for the risk taken by the landlord by investing
his capital on the improvement of land.
 Scarcity
Rent- It is the price paid for the use of the
homogeneous land when its supply is limited in relation to
demand. If all rent is homogeneous, but demand for land
exceeds its supply, then the entire land will earn economic
rent by virtue of its scarcity. Thus, rent will arise when
supply of land is inelastic.
 Differential
Rent- Rent arises because of difference in
the fertility of land. Some land is more fertile and some
land is less fertile. When farmers are compelled to cultivate
less fertile land then owners of more fertile land get
relatively more production. This surplus or relatively more
production which arises due to difference in the fertility of
land is called Differential Rent.
 Situation
Rent- Rent also arises on account of
difference in situation of land. It is called situation rent.
Thus the surplus that landlord enjoys on account of
difference in situation.
Two main theories of rent are:
(1) Ricardian Theory of Rent
(2) Modern Theory of Rent


According to them, the amount of labour employed for the
cultivation of land is rewarded by nature by yielding
produce which is many times more than the labour
involved . This excess production is called net product or
rent.
According to Ricardo, “Rent is that portion of the produce
of the earth which is paid to the landlord for the use of
original and indestructible powers of the soil.
(1)There is difference in the fertility of land. Some lands are
superior or fertile, while others are inferior or less fertile.
(2)From the point of view of the entire economy, supply of
land is fixed. It cannot be increased or decreased.
(3)Land has only one use, i.e. cultivation. There are no
alternative uses of land.
(4)There is no perfect competition in product market, hence
one kind of agriculture production sells the entire market
at one price.
(5)Law of diminishing returns operates in agriculture.
1 Fertility of soil is neither Original nor Indestructible :
According to Ricardo, rent is paid to the landlord for the
use of original and indestructible powers of soil.
According to critics there is no original and indestructible
powers of land. If land is not treated with fertilizers and
manures, its fertility will be lost. Likewise, if the so-called
inferior land is properly cared for, by using good
manures,irrigation facilities, pesticides etc.
2 Historically Wrong: Ricardo’s assertion that people,first of
all,bring most bring most fertile land under cultivation is
not supported by historical facts. American economist
Carey said that it was not true that new settlers in
American first of all cultivated the best land.
3) Marginal or No-rent Land: According to Ricardo in every
country there is no rent or marginal land.Critics point out that
marginal or no rent land is not necessary.
4)Rent is not due to Fertility but due to scarcity: Ricardo’s
assertion that rent arises due to difference in fertility is also
wrong. In reality, rent arises because of scarcity. If all land is
uniformly fertile,but its demand is more than its supply,then it
will command rent.
5)Rent does not enter into price: Acording to Ricardo, rent is not
included in the price of a product. It means rise or fall in rent
will not evoke corresponding rise or fall in price of the product.
Critics hold that under certain circumstances rent does enter
into price.
6)Rent is not paid only for land : According to Ricardian
theory,rent is not paid for the use of land alone. But according to
modern economists like Mrs.Joan Robinson, rent can also be
paid for all other scarce factors of production than land.
7)It does not throw proper light on Determination of Rent :
Ricardian theory refers to a general truth that a good quality
product will always fetch a fancy price. Similarly , a more fertile
land will command more rent than less fertile land.
8)Difficulty in Measuring the productivity of land only due to its
Original Fertility : Critics are of the view that fertility of land is
influenced both by its original power and the capital invested on
it. It is almost impossible to know as to how much productivity
of land is due to its original power.
9)Every land has some Fertility : If Ricardian theory is
logically examined , it would mean that marginal land on
which no rent arises should have no original fertile power.
But according to critics it is wrong to assert that marginal
or no-rent land lacks original fertile power.
10)Incomplete Theory of Rent : Ricardian theory of Rent
simply tells how the share of rent is determined out of the
national income from the point of view of the whole
economy. It does not tell how rent is determined for the
industry and firm.

Ricardian Theory of Rent is a significant theory. It was
Ricardo who, first of all made an attempt to examine rent
in a scientific manner. Although, the theory is not free from
its defects, yet it has significant both from theoretical and
practical point of view. Ricardo’s theory tells us that when
the supply of a factor is limited and its demand increases,
then it gets a surplus which is called Rent. From practical
point of view, it can be said that socialists were inspired by
Ricardian theory while formulating their progressive
policies like abolition of zamindari , nationalization of land
etc.


Modern theory of Rent is an amplified and modified version of
Ricardian Theory of Rent. It was first of all discussed by J.S. Mill
and subsequently developed by economists like Jevons, Pareto
etc. According to modern theory, economic rent is a surplus
which is not peculiar to land alone. It can be a part of the income
of labour, capital and entrepreneur. Economic rent may be
defined as any payment to factor of production which is in
excess of its total supply price. Supply price refers to the
minimum earning required to keep the factor in its present
occupation. It is called transfer earning. Rent is a surplus that
arises due to difference between actual earning and transfer
earning.
Rent = Actual Earning – Transfer Earning
Modern theory of rent concurs with the opinion of Ricardo , that main
reason for emergence of rent is the scarcity of land. Supply of other
factors like labour capital etc may also become scare in relation to
their demand. In that case , the income earned by these scare factors
in excess of their minimum income, is called economic rent .
Austrian economist PROF. WIESER has divided all factors of
production into two parts :(i) Specific factors and (ii) Non Specific
Factors. Specific factors are those factors which have only one use, for
instance a farm used for growing wheat alone or a textile labourer
having wearing skill alone. Such factors have no mobility at all . On the
other hand , non specific factors are those factors which have mobility
and can be put to different uses.



Modern economists hold that just as price of a
commodity is determined by its demand and supply,
likewise rent of a factor of production is also
determined by its demand and supply. Modern
economist have studied the determination of rent in
two parts;
(1) Rent of land
(2) General concept of rent as the difference
between the actual earning and transfer earning.


According to modern economists, rent arises
because of scarcity of land. Scarcity of land means
that demand for land is more than its supply. Rent
will be determined at that point where demand for
land is equal to its supply.
(1) DEMAND FOR LAND : Like other factors of
production demand for land is derived demand. It
means that demand for land depends upon the
demand for agricultural products. If demand for
foodgrains increases there is increase in demand for
land as well.

(2) SUPPLY OF LAND : Supply of land for an economy ,as
whole, is fixed. Its supply is perfectly inelastic . It means ,
increase in price of land will not evoke any increase in its
supply. Rent of land will be determined at a point where
demand for and supply of land are equal. It is shown in the
figure. SS is the supply curve of land. It is parallel to the OY
axis meaning thereby that supply of land remains fixed at OS .
Initial demand curve of land DD. Both intersect each other at
point E . At this equilibrium position OR rent is determined .
If due to rise in population demand curve of land shifts
upward to D1D1 then new equilibrium point will be E1 rent
will rise to OR1. On the other hand if demand curve shifts
downward to D2D2 then new equilibrium point will be E2
and at this equilibrium point rent will fall to OR2 . Demand
curve of land can be D3D3 . This situation arises in a newly
settled country where demand for land is less than its supply.
Y
D1
R1
E1
D
D1
RENT
R
E
D2
D
R2
D3
E2
D2
D3
X
According to modern economists rent is the difference between
actual earning and transfer earning or opportunity cost. In this
sense , rent can be a part of the income of each factor of production
, viz capital labour and entrepreneur etc. But these factors will
earn rent only when their supply is less than perfectly elastic .
Supply of factors of production can be three types.
(1) SUPPLY OF FACTORS OF PRODUCTION CAN BE PERFECTLY
ELASTIC . In this case rent is zero .
(2) SUPPLY OF FACTORS OF PRODUCTION CAN BE PERFECTLY
INELASTIC. In this case , all the income earned by a factor is
called rent.
(3) SUPPLY OF FACTORS OF PRODUCTION CAN BE LESS THAN
PERFECTLY ELASTIC. In this case , that part of the income ,
earned by a factor, which is above its transfer earning is called
rent




Supply of a factor is perfectly elastic when change in
its demand at existing rate is followed by
corresponding change in supply . Such a factor is not
scare . At the existing rate , any amount of that factor
is available . Consequently its actual earning and
transfer earning will be equal. There being no
difference between the two , rent will be zero.
Actual earning = Transfer earning
Rent= Actual earning –Transfer earning=zero
Y
D
10%
D1
S
RATE OF INTEREST
15%
S
5%
D
D1
X
20
40
CAPITAL

In the figure units of capital are shown on ox axis
and rate of interest on OY axis. SS is the supply curve
of capital . Its being parallel to OX axis indicates that
supply of capital is perfectly elastic . Supposing ,
initially the demand curve of capital is DD. This
demand curve DD cuts supply curve SS at point E


Supply of a factor of production is perfectly inelastic
when increase or decrease in its demand is not
followed by any change in its supply . In this case ,
transfer earning is zero. Transfer earning being zero
, the difference between actual earning and transfer
earning will be equal to actual earning. Thus, all the
actual earning will be rent.
Rent = Actual Earning (since Transfer Earning is
zero)
Y
D1
S
50
RENT
40
PERFECTLY INELASTIC
SUPPLY
D
E1
30
E
20
D1
10
O
D
I
2
UNITS OF LAND
X

In the figure units of land are shown on OX axis and
rent on OY axis . SS is the supply curve of land . It is
parallel to OY axis , signifying that rise or fall in the
price of land will evoke no change in its supply .
When demand for land is DD , it cuts supply curve SS
at point E. At point E the actual earning of land and
its transfer earning is zero. If demand curve rises to
D1D1 then new equilibrium is established at point
E1 . Thus the entire income of factor whose supply is
perfectly inelastic , as for instance land ,is called
rent.
Supply of a factor is said to be less then perfectly
elastic when increase In its demand is followed by
relatively less increase in its supply . In this situation
, when demand for factor increases its supply does
not increase in the same proportion , as such, the
actual earning of the factor exceeds its transfer
earning . Thus the factor will get rent equivalent to
the difference between its actual earning and
transfer earning.




The main feature of modern theory of rent are as under;
(1) Rent can be a part of the income of all factors of
production . Entire income of land is called rent because
its supply is perfectly inelastic . But in this case of other
factors , only a part of their income is of the nature of
rent .
(2) Amount of rent depends upon the difference
between actual earning and transfer earning .
(3) Rent arises when the supply of the factor is either
perfectly inelastic or less elastic . On the other hand no
rent arise when the supply of the factor is perfectly
elastic.



(1) According to Ricardian , rent is peculiar to land only . But the
modern economists hold that rent can be a part of the income of
each factor of production .
(2)According to RICARDIAN THEORY , rent is the reward for the
original and indestructible powers of the soil . Modern theory of
rent attributes it to the difference between actual earning and
transfer earning.
(3) According to Ricardo , rent does not enter into price . Rent is not
price determining , it is price determined . But according to modern
theory of rent , relation between rent and price is not so simple ,
from the point of view of an economy , rent does not enter in price ,
but from the point of view of a firm it does not enter into price

MODERN THEORY OF RENT HAS AMPLIFIED AND
MODIFIED THE RICARDIAN THEORY OF RENT
(1)
AMPLIFICATION OF RICARDIAN THEORY
According to the Ricardian theory , rent is that portion of the produce
of the earth which is paid to the landlord for the use of the
original and indestructible powers of the soil. Rent therefore is
peculiar to land alone . It is not available to other factors of
production . But according to modern theory , rent is also earned
by other factors , such as labour , capital entrepreneur etc, reason
being that rent arises when a factor becomes either specific or its
supply less than perfectly elastic.

(2) MODIFICATION OF RICARDIAN THEORY

Modern theory of Rent has made the following
modifications in Ricardian Theory:
(i) Measurement of Rent : According to Ricardian Theory
, rent is measured from the difference between the
produce of marginal land and that of intra marginal
lands. This concept is based on the assumption that
there does exist a land that earns no rent , but in reality
there does not exist any land . Consequently , rent in
Ricardian sense cannot be measured . According to
modern theory , rent is measured from the difference
between actual earning and transfer earning.

(ii) Cause of emergence of Rent : The logic given by
the modern theory regarding the cause of
emergence of rent is more realistic. According to
Ricardo , scarcity of land gives rise to rent . Because
of scarcity of land , people have either to use of
inferior land or put more and more units of labour
and capital on the same piece of land . There is
difference in amount of produce of inferior and
superior land . Due to difference , superior land
enjoys some surplus over inferior land.


(iii) RENT AND PRICE
Modern theory is a modified form of Ricardian
theory , in respect of relation between rent and
price . According to Ricardo , rent does not enter
into price . But according to modern economists it is
not wholly true . They hold that from the point of
view of an economy , rent does not enter into price

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


THERE ARE TWO VIEWS OF ECONOMISTS IN RESPECT OF RENT AND PRICE :
(1) RICARDIAN VIEW
(2) MODERN VIEW
RICARDIAN VIEW
Ricardo is of view that the rent does not enter in price . It is
price that influences rent and not rent that influences price .
Ricardo said ,” corn is not high because rent is paid , but rent is
paid because corn is high. Ricardo’s view is based on the
assumption that (i) supply of land is limited for the society (ii)
land has no cost of production and (iii) land has only one use. So
rise in population leads to increase in demand for land . People
are compelled to bring marginal land for cultivation . Marginal
land is no rent land . It does not yield any rent . However price of
agricultural produce is determined by the cost of production of
the produce raised on marginal land.



Modern view of rent is more comprehensive and logical .
According to this theory , it is wrong on the part of
Ricardo to assert that rent never enters into price .
Modern economists view the relationship between rent
and price from three different angles:
(1) From point of view of Economy :
From the point of view of the entire economy , land is a
free gift of nature . Total supply of land is perfectly
inelastic , so there is no need of paying any minimum
supply price for its use. In other words , from the point
of view of economy transfer earning of land is zero.
Accordingly , entire earning of land is a surplus or rent.
 From

the point of view of industry
Land can have alternative uses for an industry . In order
to make use of land , the industry will have to pay a
minimum price equivalent to its transfer earning . If
more price than the transfer earning is required to be
paid for the land for a given industry , then the amount
by which the price is more than transfer earning will be
called its rent . Thus from the point of view of industry ,
transfer earning of the land is included in the cost and so
influences the price ; but the income, over and above the
transfer earning , called rent , is not included in cost and
accordingly does not influences the price.
 (3)
From the point of view of
individual producer

Price that an individual producer pays for the land ,
is very much a part and parcel of his expense and so
is included in the average cost of production of the
commodity . As such from the point of view of an
individual producer , rent influences price , that is ,
rent enters price of the product
AREA
RELATION BETWEEN
RENT AND PRICE
1. From the point of view of an
economy
Entire income of land will be called rent, but
rent will not enter price
2. From the point of view of an
industry
(a) Minimum price or transfer earning of
land will enter in price
(b) Earning of land which is above the
transfer earning is called rent and does
not enter in price
3. From the point of view of an
individual producer
Rent enters price ; i.e., influences the price

The concept of quasi rent is introduced in economics by Dr.
Marshall . It refers to the additional income earned by factors ,
other than land , whose supply is fixed in the short period . In the
words of Marshall ,’’ The term quasi rent will be used in the present
volume as income derived from machines and other appliances of
production made by man.” Term Quasi is derived from Latin
meaning “ AS IF” . It therefore , refers to ‘as if rent” . Marshall also
believed like Ricardo , that land earns rent because its supply is
scarce . In short run , supply of man made means of production is
also scarce so the income of these means is “as if rent “ . But it is not
called rent , because in the long run there supply can be increased
according to increased demand . So in the long run they do not get
any surplus or rent . Thus the income of the man made means of
production , in the short run , is like rent but in the long run, it is
not like rent . Concept of quasi rent is applied to the income of any
factor of production whose supply is fixed in the short period.


In the broad sense , quasi rent is not related to any
particular factor of production . It is related to the total
cost of a firm . In the short period , the firm’s total cost
is composed of two elements ; (i) fixed cost (ii) variable
costs in the short run , due to fall in the demand , a firm
continues its production so long as its variable costs are
covered by the prevailing price of the product and will
suffer the loss of fixed costs . Thus whatever revenue a
firm earns in the short period over and above its
variable costs , is called quasi rent
QUASI RENT = TOTAL REVENUE- TOTAL
VARIABLE COSTS
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