Rent Theory.pdf

This PPT contains matter for Rent theory in the syllabus of Business economics/managerial economics/Micro economics students.

1. Rent theory
Dr.RuchiJain
Associate Professor
Department of Financial Studies
IIS(deemed to be University), Jaipur

2. Meaning
•In economics, Rent is that type of payment
which is made to the owner of the land for the
use of land.
•According to the modern economists rent is a
surplus over opportunity cost which is
calculated in case of any factor of production
whose supply is inelastic.

3. Types Of
Rent
Gross
Rent
Economic
Rent
Contract
Rent

4. Gross Rent
•The payment which is made to the landlord for the use of land is
called gross rent.
•It consists of the following elements:
Economic rent which is paid for the use of land.
Payment as interest on capital Investment e.g. well etc.
Remuneration for Risks
Managerial Expenses
Gross Rent = Economic Rent + Interest on Capital Investment + Remuneration for
Risks + Managerial Expenses

5. Economic Rent
•Acc. To classical economists or David Ricardo
Rent is the payment for the use of land is
called economic rent.
•It is derived from the ownership of land and
other free gifts of nature.
•It is the difference between the costs of super-
marginal lands and marginal lands.
•Acc. To modern economists it is a surplus over
the opportunity cost of a factor of production.
Economic Rent = Gross rent –(Interest on Capital invested + Remuneration of Risks +
Managerial Expenses)

6. Contract Rent
•It is rent which is determined mutually by an
agreement between the landlord and the
cultivator.
•Contract rent may be greater or lesser or
equal to economic rent depending upon the
supply of land and demand for land for
cultivation purposes.

7. Economic rent vs. Contract rent
Economic Rent Contract Rent
Imaginary and theoretical conceptPractical and realistic concept
Differencebetween the cost of super-
marginal land and cost of marginal land.
Determined between landlord and
cultivator on the basis of economic forces
of demand and supply.
Increaseswith the decrease in the produce
of marginal land and Decreases with the
increase in the produce of marginal land.
Not affected by the change in the produce
of marginal land and it is affected by the
contract deed between the land lord and
the tenants.
It doesnot exploit the tenants as there is
no high rent because no marginal land
exists.
Chances of exploitation of peasants when
demand for land increases.
Accrues to all the factors of production.Accruesto the owner of land.
Not predetermined because it depends
upon the fertility and location of land.
It is certain and predetermined because it
depends upon contract between landlord
and tenants.

8. Ricardiantheory of rent
•Classical theory of rent ---known as Ricardian
Theory of rent
•Propounded by –David Ricardo
•According to David Ricardo, “Rent is that
portion of the produce of the Earth which is
paid to the land lord for the use of the original
and Indestructible powers of the soil.”
Two things:
1.original and Indestructible powers of the soil
2.Niggardliness of nature

9. Assumptions
1)Rent is the payment for the use of land.(original and
indestructible powers of land)
2)Most fertile land first brought under cultivation and
thereafter less fertile.
3)Marginal Land or no rent land---the value of produce
on such land= cost of production of the produce.
4)Land is used for the production of food grains only
and not for other uses.
5)Perfect competition in factor and commodity market.
6)The law of diminishing returns operates in agriculture.
7)Rent on land arises either due to differential fertility
or due to differential situation of land.

10. Determination
of Rent
Differentials in
Fertility
Rent under
Extensive
cultivation
Rent Under
intensive
Cultivation
Difference in
location

11. Difference in fertility
Rent Under Extensive Cultivation
Categorie
s of Land
Marginal
Produce(
quintals)
Produce
of
Marginal
Land
(quintals)
Rent
(quintals)
A 120 30 120-30=90
B 90 30 90-30=60
C 60 30 60-30=30
D 30 30 30-30=0
To increase
the
production
increase the
Size of land
Marginal
land

12. Difference in fertility
Rent Under Intensive Cultivation
Unitsof
labour
and
capital
Marginal
Produce
(quintals)
Produce
of
Marginal
units
(quintals)
Rent
(quintals)
1 120 30 120-30=90
2 90 30 90-30=60
3 60 30 60-30=30
4 30 30 30-30=0
Size of land
remain
constant and
increase the
doses of
labourand
capital
No Rent Unit or
marginal unit
Marginal
Unit

13. Difference in Location
Land located nearer to
Mandi–Rent is less as there
will be less transportation
cost
Land located far away from
Mandi–Rent is more as
there will be more
transportation cost
Irrespective of same quantity of output and identical in
fertility, rent differs due to difference in location of land.

14. Criticism of the theory
1)Original and indestructible power of soil are
imaginary
2)Absence of Historical Evidence
3)Absence of no rent Land or Marginal land
4)Rent arises due to scarcity of land
5)Rent element in all factors of production
6)Unrealistic and imaginary assumption
7)Law of diminishing returns can be postponed
8)Rent does not determine price
9)Labourand capital are not a single identical
factors of production.

15. Modern Theory of Rent
•Modern economists criticized Ricardiantheory
of rent.
•According to this theory rent not only arises in
case of land but other factors of production
namely labour, capital, entrepreneur and
organization may get rent during SHORT
period because their supply cannot adjusted
to their demand.

16. Basis of the Theory
Specific factors of
Production
•Used in specific
purpose only
•Do not have
business mobility
Non specific factors
of production
•Factors which can
be put to various
uses.
Modern theory is based on this specific characteristics of a factor.
Each factor of production has his characteristics of partially specific and
partially non-specific.
Each factor of production has RENT element to the extent to which the factor
is specific.
Any factor of
production can be
easily obtained.
Any factor of
production which is
specific at a time may
also become non
specific in future.
There is partial specific
and partial non-specific
characteristics in each
factor of production.

17. Explanation
•This theory explains that rent is a surplus to
any factor of production over its actual
earning at present in any use.
•Transfer earningis the minimum
remuneration which is to be paid to any factor
of production in order to maintain that factor
in that industry or use.
•Higher the payment over transfer earning of
any factor higher will be the rent.
Rent= Actual Earning-Transfer earning

18. Economic rent: it
is the surplus
over the total
actual earning
and transfer
earning.
Transfer Earning:
it is a check on
the transfer of
the factor from
one use to
another.
The Higher the
difference between
actual earning and
transfer earning of a
factor of production
higher will be the rent
of that factor of
production.
If the transfer earning
is zero then whatever
the payment is
received by the factor
of production will be
rent.
If the total earning is
transfer earning then
there will be no rent
or rent will be zero.
Economic rent= Actual earning-Transfer Earning
Actual EarningTransfer Earning
/Opportunity Cost
Rent= Actual Earning –
Transfer Earning
4,000 4,000 4,000-4,000=0(zero)
4,000 0 4,000-0=4,000
4,000 3,000 4,000-3,000=1,000
4,000 5,000 1,000(the factor will leave the
industry and earn 5,000
which is actual earning and it
is surplus over the actual
earning(5,000-4,000)

19. Causes of Arising Rent
•Rent arises on account of the specific use of
any factor of production.
•More a specific of factor of production more is
the rent on that factor.
•The specific characteristics of a factor will be
only when that factor of production is scarce
or its supply is limited to its demand.
•The rent is the result of specificity and it can
be found in any factor of production if its
supply is less than perfectly elastic or inelastic.

20. Explanation with the help of Diagram
Perfectly Elastic supply of a
Factor and Zero Rent
Supply of a Factor is Perfectly
Inelastic and Rent
When the supply of a factor of
production is perfectly elastic then the
factor will not earn rent because at a
given price unlimited supply of that
factor is available.
There is no surplus over the transfer of
that factor and the rent iszero
If the supply of Factor is perfectly inelastic,
thetransfer earning of the factor will be
zero and whatever the income is rent, the
factor of production has the specific use
which cannot be used else where and the
transfer earning or opportunity cost of such
factor is zero and the payment received by
the factor is totally rent.

21. Explanation with the help of Diagram
Less than perfectly elastic supply
and rent
•If the supply of a factor is
less than perfectly elastic
then we can say that the
factor of production is
partially specific and
partially non-specific . The
income received by the
factor is the mixture of
opportunity cost and rent.
Economic Rent=Actual Earning of the factor-Transfer earning of the factor
= OLEW-OLES
=WES

22. Comparison between RicardianTheory and
Modern Theory of Rent
Basis of
comparison
Ricardiantheory Modern theory
Meaning of RentRent is paid for the use of
original and indestructible
powers of land to thelandlord.
Rent is surplus over thetransfer
earnings of a factor of
production.
Causes of RentDifferentialsin fertility of land
and its location.
Scarcity of a factor of production
or specific use of a factor.
Calculationof RentDifference between Marginal
land and super marginal land.
Differencebetween actual
earnings and transfer earnings.
Rent and PriceRent does not affect price but
it is affected by price.
Rent is a part of cost of
production from the point of an
individual producer and it affects
the price.
Realistic or
imaginary
Based on Imaginary and
unrealistic assumptions. Hence
not an useful theory.
More realistic and useful.

23. Quasi Rent
•Concept was propounded by Alfred Marshall.
•According to this concept of rent the income derived from machine and other man
made appliances, tools , equipmentsduring short period the supply of these
cannot be changed is called quasi rent.
•It is a surplus earned by machine in the short period over its running cost which
shows how much the short period earning from a machine exceeds the short
period cost of maintaining it.
•Quasi rent is related with the short period only as the supply of factors being
stable .
•With the expansion of time the quasi rent disappears because all the costs and
variable costs and factors of production are variable , no factor of production is
fixed.
Quasi Rent= Total Revenue-Total Variable Cost
QR= TR-TVC