Modern Theory of Rent

1. MODERN THEORY OF RENT

2. DR. LAXMI NARAYAN YADAV ASSISTANT PROFESSOR OF ECONOMICS GOVT. P.G. COLLEGE MAHENDERGARH E-mail: [email protected]

3. DEFINITION Boulding: Economic rent may be defined as payment made to a factor of production in excess of the minimum amount necessary to keep the factor in its present occupation. In modern economic usage , rent is represented as the difference between the total return to a factor of production (land, labour, or capital) and its supply price —that is, the minimum amount necessary to attain its services.

4. Modren Theory of Rent The modern economists like Pareto, Mrs. Joan Robinson, Boulding, Stigler, Shepherd, opined the Ricardian theory of rent is too closely related to land. Boulding and Joan Robinson emphasized that whenever the supply of factor units to an industry or economy is not perfectly elastic, a part of the earnings of a factor will consist of surplus or economic rent, since the full price they get are not necessary to make all the factor units available.

5. Modern Theory of Rent According to the modern theory of rent, the rent of a factor, from the point of view of any industry, is the difference between its actual earnings and transfer earnings. Rent = Present Earnings - Transfer Earnings . Transfer earning refers to the amount of money, which a factor of production could earn in its next best-paid use (opportunity cost).

6. Modern Theory of Rent According to the modern theory, rent, in the sense of surplus, arises when the supply of land is less than perfectly elastic. From the point of view of elasticity of supply, there are three possibilities. Totally inelastic supply Perfectly elastic supply and Less than perfectly elastic supply.

7. Whole produce is rent Modern Theory of Rent When Supply of Factor is Perfectly Inelastic D` D Here Present Earnings = ORxOS = ORES Transfer Earnings = Zero Rent = Present Earnings - Transfer Earnings . Thus Rent = ORES E S` R O S Hectare of Land Price

8. Modern Theory of Rent Now if demand increases from DD’ to D D Then Rent increases from ORES to OPFS D F D S` E D` D R O S P

9. Modern Theory of Rent Rent = Present Earnings - Transfer Earnings . Here: Present Earnings = OSEM Transfer Earning = OSEM Rent = OSEM-OSEM = ZERO When Supply of Factor is Perfectly Elastic E S` S O M Hectare of Land Price D` D

10. Modern Theory of Rent Then Present Earnings increases from OSEM to OSFN Transfer Earning also increases to OSFN Rent = ZERO D F D Now if demand increases from DD’ to D D N E S` S O M Hectare of Land Price D` D

11. When Supply of Factor is Elastic A th unit of Factor has a supply price equal to AQ. In other words, AQ must be paid to the A th unit of land in order to keep it in the wheat industry. A th unit of land obtains price (AH = OP) while its transfer earnings are only AQ. Therefore, A th unit of land earns QH as economic rent (QH = AH-AQ) F I D K B R C J S T E L U S S O Price M D D H A Q

12. 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. FEATURES OF MODERN THEORY OF RENT 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 .

13. FEATURES OF MODERN THEORY OF RENT Amount of rent depends upon the difference between actual earning and transfer earning. 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.

14. 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. MODERN THEORY IS A MODIFIED AND AMPLIFIED FORM OF RICARDIAN THEORY

15. MODIFICATION OF RICARDIAN THEORY Modern theory of Rent has made the following modification: Measurement of Rent: According to Ricardian Theory, rent is 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. MODERN THEORY IS A MODIFIED AND AMPLIFIED FORM OF RICARDIAN THEORY

16. 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. MODIFICATION OF RICARDIAN THEORY

17. 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. MODIFICATION OF RICARDIAN THEORY

18. There are two views of economists in respect of rent and price : ( i ) Ricardian view (ii) Modern view RENT AND PRICE 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’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. 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.

19. 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: From point of view of Economy From the point of view of industry From the point of view of firm Modern View RENT AND PRICE

20. 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. Modern View RENT AND PRICE

21. 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. Rent and Price: Modern View 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.

22. 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 From the point of view of firm/ individual producer Rent and Price: Modern View

23. RELATION BETWEEN RENT AND PRICE AREA RELATION From the point of view of an economy Entire income of land will be called rent, but rent will not enter price From the point of view of an industry 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 From the point of view of a Firm Rent enters price ; i.e., influences the price

24. 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 . DIFFERENCE BETWEEN RICARDIAN AND MODERN THEORY OF RENT 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.

25. 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 DIFFERENCE BETWEEN RICARDIAN AND MODERN THEORY OF RENT