Subject-Economics

Course- M.A. Economics

Semester-IV
Topic –Theory of Rent
Keywords-Theory of Rent; Ricardo, Modern theory of rent

Presented By
Dr. Ankita Gupta
1 Department of Economics
Faculty of Social Science
M.G.Kashi Vidyapith –Varanasi
Email-ankitagupta@mgkvp.ac.in
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content is taken from the various books, journals and website
which are cited in the References page at the end. The content
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 LEARNING OBJECTIVES

After reading this e-content you will understand

the following points of Modern Theory and
Classical theory of Rent

Explanation of the Theory

Assumptions of the Theory
Reasons for Existence of Rent
Deductions from the Theory
Criticisms of the Theory

3
 WHY DO WE PAY RENT?
Before we start let’s freshen up
our basic concepts on the
classical theory of rent.
The quantity of land is limited,
and so is its productiveness
and quality.
If the superior land alone will
not support the population,
recourse must be made to
inferior lands
The differential advantage of
the superior land over the
4
inferior gives rise to Economic
Rent.
 CLASSICAL THEORY OF RENT
David Ricardo, an English classical economist, first developed a
theory in 1817 to explain the origin and nature of economic rent.
Ricardo used the economic and rent to analyse a particular
question. In the Napoleonic wars (18.05-1815) there were
large rise in corn and land prices.
Ricardo defined rent as, “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.”
Ricardo formulated this law based on the principles put forth
by Adam Smith in Wealth of Nations.
"The rent of land, therefore, considered as the price paid for the
use of the land, is naturally a monopoly price. It is not at all
proportioned to what the landlord may have laid out upon the
improvement of the land, or to what he can afford to take; but to
what the farmer can afford to give." — Adam Smith, An Inquiry
into the Nature and Causes of the Wealth of Nations, Book I, 5
Chapter XI "Of the Rent of Land"
ASSUMPTIONS OF THE THEORY
The theory of rent given by Ricardo is based on the
following assumptions:
1. Rent of land arises due to the differences in the fertility or
situation of the different plots of land.
2. The law of diminishing marginal returns holds in the case of
cultivation of land.
3. Ricardo looks at the supply of land from the standpoint of the
society as a whole.
4. It is assumed that land, being a gift of nature, has no supply price
and no cost of production.
-It arises owing to the original and indestructible powers of the soil.
-As the different plots of land differ in fertility, the produce from the
inferior plots of land diminishes though the total cost of
production in each plot of land is the same.
-So rent is not a part of cost, and being so it does not and cannot
enter into cost and price. This means that from society’s point of
view the entire return from land is a surplus earning.
6
 ECONOMIC RENT-DIFFERENTIAL PROFIT
Productiveness depends on fertility and
convenience of situation.

Economic Rent in its simplest form is the

differential profit that arises in the case of
production

Owing to differences in natural conditions due to:

Fertility of the soil

Advantages of situation 7
 SCARCITY

Rent arises for the scarcity of fertile land and

Economic Rent is the outcome of differences in the
productivity of superior or inferior land
Economic Rent exists, if a gift of nature is limited and
appropriate and differential profit arises by its use.
It is plain that the farmer may just as well pay for the
superior land as get the inferior land rent free.
Thus, rent arises out of the difference existing in the
productiveness of different soils under cultivation. The
amount of rent is determined by the degree of those
8
differences. This is known as Ricardo’s Theory of Rent.
SCARCITY RENT
Ricardo assumed that
land had only one use—to
grow corn. This meant
that its supply was fixed,
as shown in Figure. Hence
the price of land was
totally determined by the
demand for land. In other
words, all the price of a
factor of production in
perfectly inelastic supply
is economic rent—it has
no transfer earnings.
9
HOW IS RENT FIXED?

The laws of supply and demand, however, explain

the operation by which such rent is fixed, for just
as the competition of farmers will enable
landlords to claim that portion in excess of
ordinary profits, so, on the other hand, the
competition of landlords renders the exaction of
more than this impracticable.

10
 THE LAND MARGIN

The land margin is made the central point in the theory

of rent . In Ricardo’s theory of rent, we have two
margins—

1) Resort to inferior lands leading to extensive margin,

2) The law of diminishing returns leading to an intensive

margin.

The pervasiveness of this theory has made it

Law of Rent
11
 EXPLANATION OF THEORY

Figure shows the

different rents that result
when plots of land of
different fertility are
cultivated extensively. It
illustrates graphically how
differences in rent arise.

12
MARGINAL LAND
We see that, under extensive
cultivation only, rents will vary
in amount of different pieces
of land because the
application of the same
amounts of labor and capital
to different plots will yield
different results.
We observe that E- land is
cultivated, but that the
return in sufficient only to
pay for the labour and
capital costs involved.
Hence, there is no marginal
product attributable to land
E and no income for the
owner.
13
RENT A SURPLUS OF A RESIDUAL ELEMENT
When returns to producers who use land are sufficient
to pay only for labour and capital costs, the land is
called marginal or no-rent land.
If land is so poor that it will not even pay labor and
capital costs, like the F land in our illustration, it is
called sub- marginal land.
Such land will not be used at all.
Rent is a surplus over and above no-rent land.
Ricardo’s theory assumes that no-rent land exists.
In his words, “There is always some kind for which no
rent is paid in the strict sense of the term, i.e., land
which yields no return except for the capital and
labour spent on it.”
14
RENT AS TRANSFER EARNINGS
The surplus is the true economic rent. In other words,
economic (or theoretical) rent is the difference in net
productiveness between the land in question and land
on the margin of cultivation, when the land is put to
the best possible use.
The four factors of production are capable of being
used in any of several enterprises as well as the
industry in which they are actually employed.

15
IMPLICATIONS
Land according to Ricardo is limited in supply and of
different grades of fertility.

Rent arises as differential advantage which superior

lands possess over the inferior lands.

Rent arise from the operation of the Law of

Dimin-ishing Returns.

Rent is a surplus over and above no rent land.

Rent does not enter into price.

16
 CRITICISMS OF THE THEORY
Ricardian theory has been criticised on the
following grounds:

(i) He restricted rent to land;

(ii) It is simply based on the natural variation of the

fertility of different pieces of land;

(iii) He took no account of the fact that there are

competing uses for some land, and as a result it is not
necessarily the least fertile land that will first go out of
17
cultivation.
-
 CONTD…..

Ricardo considers land as fixed in supply. Of course, land is

fixed in an absolute sense. But land has alternative uses.
So the supply of land to a particular use is not fixed
(inelastic). For example, the supply of wheat land is not
absolutely fixed at any given time.
- Ricardo’s order of cultivation of lands is also not realistic. If
the price of wheat falls the marginal land need not
necessarily go out of cultivation first. Superior grades of
land might cease to be cultivated if a fall in the price of its
output causes such land being demanded for other
purposes (e.g., for constructing houses).
- The productivity of land does not depend entirely on
fertility. It also depends on such factors as position,
investment and effective use of capital. 18
 CONTD…
4. Critics have pointed out that land does not possess
any original and indestructible powers, as the fertility
of land gradually dimi-nishes, unless fertilisers are
applied regularly.
5. Ricardo’s assumption of no-rent land is unrealistic as,
in reality; every plot of land earns some rent,
although the amount may be small.
6. Ricardo restricted rent to land only, but modern
economists have shown that rent arises in return to
any factor of production, the supply of which is
inelastic.
7. According to Ricardo, rent does not enter into price
(cost) but from the point of view of an individual farm 19
rent forms a part of cost and price.
MODERN THEORY OF RENT

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 after that developed by
economists like Jevons, Pareto, Marshall, Joan
Robinson etc.
According to modern theory, economic rent is a
surplus which is not peculiar to land alone. It can be
a part of income of labour, capital, entrepreneur.
According to modern version rent is a surplus which
arises due to difference between actual earning and
transfer earning.
Modern economists like Pareto, Mrs. Joan Robinson,
Boulding, Stigler, Shepherd, have tried to simplify 20
and generalize the classical theory of rent
CONTD…
This creates on impression that rent is a peculiar earning of land only
The fact, however, is that other factors of production i.e., labor, capital
and entrepreneurship may also be earning economic rent.
The essential factors of rent are the relative scarcity of the products that
land can yield.
The transfer earnings of a factor of production is the minimum payment
required for preventing that factor for transferring it to some other use.

It is called the factor supply price in its present occupation.

For example, a worker earns Rs.6000/- per month in a factory. In the

next best employment, he can get Rs.5000/- only per month. The surplus
or excess of Rs1000/- which a worker is earning over and above the
minimum payment necessary for inducting him to work in the present
occupation is the economic rent.
That is: Rent = Actual Earning-Transfer Earning. 21
 WHAT IS TRANSFER EARNING?
In this universe, each factor of production has
varied uses. When we transfer one factor from one
use to another, we have to sacrifice the income
earned by it from its earlier use. Sacrifice of
earning is called transfer earning.
Basically, the concept of transfer earning in
economics is introduced by Prof. Benham.
According to him, “The amount of money which
any particular unit could earn in its best paid
alternative use is sometimes called its transfer
earnings.” A similar idea was developed by Pigou.
Different economists consider transfer earnings as
that amount of money which any particular unit
22
could cam in its best paid alternative use.
FEATURES OF MODERN RENT THEORY
Some of the major features of modern rent
theories are:
Rent is a type of income produced through
a difference of actual earnings and transfer
earning.
Rent comes from income of all the
production factors.
Rent is increased due to the scarcity of
land in the particular area
Fundamentally speaking, rent is paid
because the produce of the land is scarce in
relation to its demand, rent will arise even
if all the land in a country is exactly alike.
The demand also increases due to labor
and overall economic conditions.
Rent arises when the supply of the factor
is inelastic or partially elastic.
23
 MODERN CONCEPT OF RENT
Modern Definitions of Rent:
“Rent is a payment in excess of transfer earning.”
Stonier and Hague
“The essence of the conception of rent is the
conception of a surplus earned by a particular part
of a factor of production over and above the
minimum sum necessary to induce it to do its
work”. Mrs. Joan Robinson

Rent is no longer regarded as being applicable only

to land.

It is the surplus which accrues to any factor of

production the supply of which is fixed.

According to the concept of Transfer earnings what a

24
factor earns over and above its transfer earnings is
its true rent.
 CONTD…..
Thus, the difference between the present earnings of a factor and its
transfer earnings amounts to rent. In case there is an acre of land that
can be utilized only for growing cotton and for nothing else, its transfer
earnings become zero. The entire cotton crop is, therefore, its rent. But if the
second best use to which that land may be put is, that we may grow wheat on
it, the position will be different.
Wheat crop will then become the transfer earning and the cotton crop will
constitute rent. Thus, if a unit of a factor is earning more than what it might
earn if transferred to the best paid alternative, the surplus becomes rent.
Thus, if an acre of land when used to growing of cotton yields Rs. 1,000 and
when transferred to the use of growing wheat yields Rs. 800 then Rs. 200 is
its rent.
If a piece of land called forth a payment of, say, Rs. 100 per annum in a
particular use, this represents the minimum that would have to be paid by any
other would be user. This minimum price is the transfer earnings of the land.
Only payments in excess of these earnings are rents in the economic
meaning of the word.

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DIFFERENTIAL RENTS FOR URBAN LAND
Urban land is used for the erection of dwelling
houses, and industrial, office, and business
premises

As the population of a town increases, competition

among business men will drive up shop and office
rents, and, thus, also the economic or ground rent
of the land on which the buildings stand.

We have noted that where the demand for

agricultural produce increases, it is likely that either
production will be intensified by using more labour
and capital, or production will be commenced on
26
land not used so far for agricultural purposes.
 CONTD…
As people are prepared to pay the highest rents (i.e.,
commercial rents) for houses in the most fashionable
residential parts of the town and for offices and shops in the
main commercial centre, the demand for land in these parts
of the town will be the highest. The same applies to building
land. If office rents, for instance, increase, land suitable for
the building of blocks of offices will be used more intensively
by erecting higher buildings. This accounts for the sky
scrapers in the business centre of New Delhi.
Which may be land, labor or capital -The rent diminishes
as more land is used due to the operation of law of
diminishing returns. The demand curve of a factor is,
therefore, negatively sloped which means more land will be
used only at lower rents, other things of course remaining
the same.
It can be shifted to other uses by offering higher rent than
that being earned by it now
If higher rent is paid, the supply of a factor can be
increased by withdrawing it from other uses. 27
DETERMINING RENT- MODERN THEORY
DEMAND AND SUPPLY ANALYSIS:
(A) Demand For a Factor: B)Supply of a factor.

The demand for a factor

The supply of land to a
is a derived demand.
particular use (say
Land
industry) is quite elastic.
The higher the produce, the
The supply of a factor (to
greater is the demand for
an industry) is, therefore,
land.
rent elastic. The supply
A firm will pay rent equal to curve of a factor (industry)
the marginal revenue slopes upward to the right.
productively of land. FIG-X
The demand curve of a
factor is, negatively
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sloped
 THEORY OF RENT
Classical Theory
The classical theory of rent
is too closely related to
land.
Economic Rent in its
simplest form is the
differential profit it arises
Owing to differences in
natural conditions due to:
Fertility of the soil
Advantages of situation
Economic Rent exists, if a
gift of nature is limited and
appropriate and differential
profit arises by its use.
Modern Theory
Modern economists contend
that differences in fertility of
land do not form the basis of
the general principle of rent.
In modern economics rent
is no longer regarded as
being applicable only to
land. It is the surplus
which accrues to any factor
of production the supply of
which is fixed.
The scarcity of land is, in
fact, derived from the
scarcity of its products.
29
 THEORY OF RENT
Classical Theory
Different rents that result
when plots of land of
different fertility are
cultivated extensively.
Ricardo’s theory assumes
that no-rent land exists.
Modern Theory
The determination of rent, the
modern economists say, can be
explained in the same manner
as the reward of other factors,
that is by demand and supply
forces.
It is the surplus which accrues
to any factor of production, the
supply of which is fixed.
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RENT OF MINES

Mines differ from agricultural land. Fertility

of land can be renewed by the stock of
mineral in a mine is fixed and exhaustible.
The rent of a mine represents the rent
proper arising from differentials in value of
produce and situation and compensation
for the exhaustion of the minerals.
Rent does not enter into price.
Rent forms no part of the price of
agricultural produce because price is
fixed by the cost of that portion produced
at the greatest disadvantage.

31
 CONTD….
Briefly the steps in the argument are:
(a) Producers sell their goods for what they can get and not a
cheaply as their expenses permit;
(b) The price tends to equal the costs of the marginal producer
(or the marginal product);
(c) The position of the price fixes that of the margin which
pays no rents;
(d) Producers over the margin receive a rent which increases
or decreases; with a rise or fall in the price;
(e) Therefore, the rent is the result of the price, and not a
cause of it.
Some writers, however, contend that rent enters into price.
Rent as explained by the modern theory of rent is just as much
an element of cost of production as are profits, wages and
interest. Although the rent of a piece of land is to some extent
determined by the price of the product obtained from it, rent is
one of the payments a tenant has to take into consideration
when judging whether or not use of land will be profitable and
it must, with other costs, be covered by receipts from the 32
product of the land.
 CONTD…..
In fashionable and high class localities sellers have to pay
high rents and, therefore, they charge high prices than in
moderate localities where rents are relatively lower. On may
be able to buy the same cloth cheaper in Karol Bagh, Delhi
than in Connaught place, New Delhi. This also explains why
footpath sellers sell cheaply because they pay no rent.
In those exceptional cases where rent is an element of the
marginal expenses of production, rent will enter into the price
of produce. If the state has a monopoly of land in a country,
and if it exacts a rent even for the use of the marginal land
(the poorest land in cultivation), then this rent will enter into
the price of agricultural produce.
Higher rents are paid for shops in the centre of the town than
for shops on the outskirts, although the prices charged for
certain goods, such as tobacco, matches and news-papers, are
much the same in all shops. The rents are higher because
demand for these sites relative to supply is high and not
because prices in general higher in the centre of a town than
in the suburbs. Thus, rent depends on price and not price on
rent. It is the rise in price that pushes out the margin.
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 QUASI RENT
In modern economics rent is no
longer regarded as being
applicable only to land.
It is the surplus which accrues to
any factor of production, the
supply of which is fixed.
The theory of rent may be applied
to profits, or earnings of
management, which bear a strong
resemblance to rent.
They are often termed rent of
ability for they vary with ability
as rent varies with fertility
34
CONTD…
There is an element of rent present in some men’s
wages, i.e., the extra income earned by some natural
ability.
For example, an artist or musician with special gifts
will be able to ask a very high price for his services.
The theory of rent cannot be applied to interest as the
two differ in many ways.
Land is limited, capital is not; rent tends to rise,
interest tends to fall.
Some economists give the term ‘Quasi-rent’ to any
gains which is due to a special advantage and which,
therefore, is similar to rent.
They give the term Quasi-rent to profits as they are a
surplus due to the exceptional business power of the
owner of the business and 35
CONTD….
Strictly speaking, however, the term is reserved for those
gains which are due to the fact that the agent of production
is for a short time, limited in amount.
Whenever there is a sudden increase in demand for a
particular form of goods or service, someone is sure to gain
by it. This gain, which is due to circumstances rather than
to ability, is a quasi-rent. By its nature it is usually
temporary.
• However, some of the payments made under the name of
rent include an element of interest, e.g., the rent of a farm
includes a payment for the use of the farm-house and
buildings, which are really interest because the buildings are
capital, not land. Also, fertilizers and manures sunk in the
soil increase the yield, i.e., the extra return from the land is
rent, although it could be regarded as profit from the outlay,
or interest.
36
GLOSSARY
Decreasing returns to scale is a property of
production function that holds when a
proportional increase in all inputs results in an
increase in output by less than the proportion.
Demand curve is a graphical representation of
the demand function. It gives the quantity
demanded by the consumer at each price.
Demand function A consumer’s demand
function for a good gives the amount of the good
that the consumer chooses at different levels of
its price when the other things remain
unchanged.
37
 REFERENCES
https://www.economicsdiscussion.net/rent/ricardian-theory-of-rent/the-
ricardian-theory-of-rent-with-diagram

https://journals.sagepub.com/doi/abs/10.1177/030981687700300105?journ
alCode=cnca
https://www.economics.utoronto.ca/munro5/ECONRENT.pdf
https://www.economicsdiscussion.net/theory-of-rent/modern-theory-of-
rent-explained/7486
A.KOUTSYANNIS-MICROECONOMIC THEORY-PALGRAVE
MACMILLAN-ISBN 978-1-349-15603-0
Microeconomic. Theory. Andreu Mas-Colell Michael D. Whinston
and. Jerry R. Green. New York Oxford OXFORD UNIVERSITY PRESS.
1995 ...
https://www.economicsdiscussion.net/rent/ricardian-theory-of-rent/the-
ricardian-theory-of-rent-with
https://www.youtube.com/watch?v=uDKYDh1Vpvw
https://www.slideshare.net/luxminy/ricardian-theory-of-rent-46384548
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