13

Theory of Rent
In ordinary language, the term rent is used to refer to hire
charge for any good, such as furniture, a house or an apartment,
irrespective of whether it is used as a consumer good or
factor of production. In economic analysis, however, the term
rent is used to refer to the whole or a part of the earnings of
some factors of production. In the Ricardian sense may be
defined as the price for the original and indestructible powers
of the soil.'
According to Ricardo, rent emerges on account of
inelasticity in the supply of land. But his theory also takes
account of the fact that different plots of land are not equally
fertile, and rent is shown to emerge as a result of such
differences in fertility of different plots of land. However, in
land, as
the ultimate analysis, rent is due to the scarcity of
below.
will be seen from the discussion
with an increase in
In order to explain how rent emerges
first consider the case
the demand for the produce of land, uniform quality.
where different plots of land are not ofA and B, which can
land,
Assume that there are two grades of
A being the more fertile; a unit of labour
grow wheat,grade employed on one acre of
costing Rs. 1200 when
and capital of wheat, while when put
A-grade land, produces 15 quintals
B-grade land, it produces 12 quintals of wheat.
to one acre of Rs. 80 per quintal, the farmers of
is
lf the price of wheat cover their cost of cultivation; so their
A-grade land willjust B-grande land will not be
rent.
OWners cannot get any
 Micro Economics-Theory and Practice Theory ofRent
260 261
cultivated at all as the yield will not cover the cost of all land is already under
But if for somne
reason, such as the growth of
population, the cultivation. cultivation and
Re 80 per quintal. There will be no the price of wheat is
rent in this case, as the
demand for wheat goes up and its price rises to Rs. 100 vield just covers the cost of cultivation.
worthwhile to per
quintal, it will become just cultivate B-grade Now, if the demand for wheat
ond as well. Farmers of A-grade land will now have a increases and its price
production. Thied goes up, it may be found worthwhile by the farmers to resort
surplus of Rs. 300 over their cost of ointensive cultivation, ie., to apply
is known as differential surplus as it is due to the suneri
additional doses of
Jabour and capital on the same land. Suppose that the marginal
fertility of A-grade land. Competition among tenants will product when twO units of labour and capital are employed
ensure that this differential surplus goes to the owners of A on aone-acre plot of land is 12 quintals of wheat. If the price
grade land as rent. The example given above is summarised of wheat rises to Rs. 100 per quintal, the famrer will find it
in Table 1. just worthwhile to employ the second unit of labour and
Table 1. Rent As A Differential Surplus capital as the value of the marginal product will just cover the
cost of the second unit which, of course, is the same as that of
Value of output Rent when the first unit, viz., Rs. 1200. But from the yield of the first
Grade of cost of Output
At Rs. 80 At Rs. 100 price is
unit, the farmer will be left with a surplus of Rs. 300.
land Cultivation
per per Rs. 100 per It should be noted that this surplus arises because of the
quintal quintal quintal operation of diminishing returns. As in the other case, as a
Rs. 1500 Rs. 300
result of competition among the tenants, this surplus will
A Rs.1200 15 quintals Rs. 1200 accrue to the owners of land as rent. The ultimate cause of the
Rs. 1200 12 quintals Rs. 960 Rs. 1200 Nil emergence of this surplus is the scarcity of larnd. If land of
uniform quality had been unlimited in supply, it would not
B
intensive
Rent is thus shown to emerge as a different surplus, and have been necessary for the farmers to resort to
for its
cultivation of land with an increase in the demand
such rent is decribed as differential rent. emerged.
produce, and consequently no rernt would have
But differences in the fertility of different grades of With all land being of uniform quality, rent can arise
only
fundamental cause of the therefore, described
land should not be regarded as the because of scarcity of land. Such rent is,
of rent lies in the differential rent. In a sense,
emergence of rent. The ultimate cause as scarcity rent as distinct from just two aspects
Scarcity of land. If in the example given above, the supply of
have been
however, scarcity and differential rents are
A-grade land had been unlimited, it would not with an of the same thing.
B-grade land land is of
necessary to resort to the cultivation of in the case where all
The emnergence of rent diagrammatically
increase in the demand for wheat. So, no rent will
emerge in in Fig. 1. Units
all-land were of uniform quality is illustrated horizontal axis,
a case. On the other hand, even if are measured along the
such
land in of labour and capital are used in a fixed
proportion,
uniform quality, rent would arise if the supply of assuming that labour and
capital
average revenue
Scarce in relation to demand. Suppose that each
one-acre plOt with one plough. The
unit of Such as, one man product curves in the
intial
of land can grow 15 quintals of wheat when one product and marginal
revenue
and that
labour and capital costing Rs. 1200isemployed on it,
 Micro Economics-Theory and Practice Theory of Rent 263
262
represented by ARP, and Relation Between Rent and Price
situation are MRP, respectively. Gince rent is demand-determined, it is the result of price
unit of labour and capital is OW such that
line through Wis tangent to ARP, Through the
The price per
horizontal the and not the cause of
it. As
point of tangency P, the MRP, passes. In this situation, OL,
ricardo put it, price is high
not
because rent is paid but rent is high because price is high. In
units of labour and capital are employed according to the other words, the price of a commodity does not depend on
profit maximising principle; total revenue product just cOvers #he amount of rent paid to Some factors used in its production.
the total cost so that there is no rent., Now Suppose that the
The relationship between rent and price is the other way
price of the produce goes up because of an increase in dema rOund. When the price of a commodity increases because of
The marginal revenue
product curve shifts upward to the an increase in the demand for it, rent paid to the fixed or
position MRP, in the figure. (The new position of the average specific factor also increases. Rent is thus price-determined
necessarv fos
revenue product curve is not shown as it is not and not price-determining. This is also expressed by saying
Our illustration).The amount of labour and capital emploved that rent does not enter into the cost of production of a
between MPp
increases to OL,, as given by the intersection commodity which determines its price. I GC.-2 7 50
and the horizontal line through W. The value of the totali
MRP,. is OROP I This relationship between rent and price holds true
product represented by the area under
Thetotal cost of production is equalto the area WRQP,.
Thus. irrespective of whether the question is looked at from the
cultivation induced point of view of the economy as a whole as Ricardo did or
rent has emerged as a result to intensive
by an increase in demand and consequent rise in the
price of from the point of view of a particular industry as is done by
shown to define rent
the produce. The assence of rent, whether it is the opportunity cost approach provided we
emerge as adifferential surplus or as a
result of intensive appropriately. From the point of view of the economy as a
demand supply is
cultivation, lies in the fact that it is exclusively whole, the total amount of Jand is fixed, i.e., its
absolutely characterised by zero elasticity. Consequently, the rent paid
determined as the supply of land isassumed to be
payment as it does not affect the
inelastic. is a surplus or unnecessary as a part of
supply of land, and hence, cannot be regarded
necessary cost of production.
the point of view of
When the question is looked at from the excess of
a particular industry, rent which is defined as a
transfer earnings is, again
actual earnings of a factor over its this
payment. The non-payment of will
Surplus or unnecessary other factor,
whether it is land or some
ARP, rent to the factor, Rent in this
W
that particular industry. of the cost
MRP, MRP, not affect its supply to element
be regarded as an
Sense cannot, therefore, is used to refer to
However, if the terms rent
X
L of production. that part
L
land in a particular use,
plot of
Units of Labour and Capital the total earnings of a
cultivation
Hig. Emergence of rent with intensive
 Micro
264
Economics-Theory and Practi
of its earnings which represents its transfer price is a
.heory of Rent 265
(A) IfRicardo's definition is followed, the marginal land
payment for retaining it in its presernt use. This necessary
actual earnings of afactor, therefore, constitutes a part of the will possess no original power of fertility. But, as a
cost of production from the point of view of a part of the matter of fact, each price of land, by its very nature,
industry. From the point of view of an individual particular
must possess some original or indestructible power
cultivator,
bowever, actual rent he pays forms part of his cost production of fertility. It is not possible to think of any land
which is completely deprived of such natural qualities.
Criticisms of Ricardian Theory of Rent Land of all kinds, Whether it produces rent or not,
possesses the fertility.
Ricardian theory of rent has been criticised on many
grounds. The following are the main points of criticism: (5) The concept of marginal land is said to be imaginary,
theoretical and not realistic.
(1) Ricardo states that rent is paid for the use of the
original and indestructible powers of the soil. This (6) Modern economists are of the opinion that rent no
more confines to land, but can also be traced to
expression is not very much accurate. It is pointed other factors of production.
out by the critics that there are no inherent and
indestructible powers of the soil. The powers of the (7) According to the German Historical School, the
soil, for which rent is paid, are not always original, supply of land is limited in comparison to the demand
in some cases they are acquired. Fertility of the soil for it, and, therefore, rent will arise on all kinds of
is destructible. Good lands, after a few years of land, superior or inferior. In other words, according
cultivation lose their fertility because the chemical to the critics, the reward for land (rent) arises
composition on which fertility depends is exhausted because of its scarcity rather than the differences in
after a few years of continuous cultivation. the fertility.
land do
(2) Again, the assumption of perfect competition, on (8) It is argued that the (original) qualities of
invested in it,
which the theory is based, is unrealistic, It does not not exist separately from the capital creates
exist in pracital life. It makes the theory unrealistic and are, therefore, indistinguishable. ThisRicardian
too. the difficulty in the implementation of the
theory of rent.
(3) According to Ricardo, the best land is first put does not enter into cost
under cultivation and later on land is brought under (9) According to Ricardo, rent
does not affect price.
cultivation on the merit of its goodness. This point of production;and therefore, it
determined by price. Rent will
has been criticised by Carey and Roscher. They But, in fact, it is itself
produce is high and it will
point out that in new countries the best lands are be greater if price of the This relationship between
not invariably cultivated first. Those lands situated be lower if price is less.
point out, is not always
nearby the human habitation are first cultivated rent and price, the critics nodern writers, sometimes
whether they are good or not. Thus, the order of true. According to the and thus
cost of production
cultivation laid down by Ricardo is wrong. rent enters into the
 267
Micro Econonics-Theory and Practice Theory ofRent transfer
266 defined as a surplus over the
In brief rent can be earnings (or
affects the price of the produce. For instance, for an earnings of a factor of production. Transfer any
individual farmer (who cultivates the land), the entire amount of money which
opportunity cost) means the next best alternative use.
rent paid by him to the landlord is an item of cost narticular unit could earn in its
and influences the price of the produce. arises only when the supply
Rent int he sense of surplus factor
may be land or any other
Modern Theory of Rent of any factor of production (itelastic. As far as the elasticity of
According to the modern view, land is a non-specific input) is less than perfectly three possibilities:
supply is concerned, there are
factor. It can be put to several uses. If it is put to one use, it perfectly
cannot be available for the other uses. For example, if land is (a) The supply of a factor of production may be
elastic in which case will be zero.
put under cotton cultivation, it is not available for rice
cultivation. Thus, land has an opportunity cost of its own. production may be perfectly
(b) The supply of a factor of entire price of the factor
This can be illustrated with an example. Suppose land is put inelastic in which case the
under rice cultivation and it yields a rent of Rs. 150 per will be assumed as rent.
hectare per annum. If now the same land is devoted to cotton between these two
(c) There may be a situation in
cultivation it yields an annual rent of Rs. 200. In this case, Rs. not
extremes (i.e., elasticity of supply is elastic but
150is the minimum price (or, the transfer earnings) that has perfectly elastic) where the rent will arise.
to be paid to enable the land to continue to remain under
cotton cultivation. So the land under question is enjoying a In these three conditions, rent as a surplus over the
rent of Rs. 50 per hectare. For an individual farmer, the rent transfer earnings will be different.
that he pays to the landlord is a cost item and, along with
other items, it must be included in the total cost of production,
which ultimately determines the market price of agricultural Price
Factor
produce. It is thus clear that, according to the modern view,
the rent does enter into price. So far as the urban rent is
E
concerned, it surely enters into price. For example, the prices P
charged from the customers in the fashionable shopping
centres in the cities are invariably higher than the prices D
charged elsewhere for the simple reason that the shops in the
fashionable shopping centres have to pay higher rents for
their premises. Davenport says that rent is heither 'price Quantity of the Factor of Production
determined' or 'price-determining. Both rent and price are
determined by the scarcity of the products of larnd in relation Fig. (A)
to their demand. In case, the products of land are scarce in If the supply curve of a factor of production is perfectly
relation to the demand, both price and rent would register an inelastic as shown in Fig. A, then its transfer earnings will be
increase.
268 Micro EconomicsTheory and Practice 269
Theory of Rent
zero. It will be the case for specific factors of
production Ioan Robinson, rent is a surplus over the minimum supply
which cannot be transferred to any other use. The supply o "the essence of
price of the factor of production. He states,
such a factor is absolutely fixed and it has only one of rent is the concept of a surplus earned
by a
whether it is used or not. The minimum supply price can use,h the concept over and over the
particular part of a factor of production its works.
zero. The actual price of such a factor will be determined minimum earnings necessary to induce it to do
factor is the price below
its demand. In fig. A the demand curve DD intersects th Here the minimum supply price of a
offer its services. In
supply curve SS at point E; therefore, the price of the factor is which that factor will not be willing to
price respresents the
OP. This price or the entire income is the surplus and hence other words, the minimum supply production. But due to its
rent. transfer earnings of the factor of
production gets a reward which is
scarce supply, a factor of
Now, if the supply curve of a factor of production is its minimum supply price.
more than its transfer earnrings or
perfectly elastic as shown in Fig. B, then the actual earnings earnings represents the rent of
This surplus over the transfer
will be equal to its transfer earnings, because the price of the of production, the supply
the factor. For non-specific factors elastic. It states that if the
factor is fixed. For example, under perfect competition the curve is positively sloped or
it is
leave
supply of a factor of production for an individual firm is factor is not paid theminimum supply price, then it will
perfectly elastic. In this case the demand curve will determine into its next best paid alternative
the present use and will enter
the equilibrium quantity of the factor used. Here the rent will C, SS is the supply curve
be zero, becasue the factor will receive no surplus over its
use. This case has been shown in Fig.
demand curve DD at point E.
which is elastic. It cuts the factor
quantity of the
transfer earnings. In real life, no factor has a perfectly elastic Therefore, OX will be the equilibrium
supply. equal or OR. The supply
used and the factor price will be
vertical axis; which indicates
curve starts from point S on the
be paid will be OS and,
that the minimum supply price to
Factor
Price
D
Price
Factor
D
X
X
Quantity of the Factor of Production
D
Fig. (B)
X
Now, suppose that the supply curve of a factor of
production is elastic but not perfectly elastic, then a part of Quantity of the Factor of Production
the income (price) of the factor is rent. Accroding to Mrs. Fig. (C)
 271
270 Micro EconomicsTheory and Practice Theory of Rent becomes interest in
the
factor in the short run man-made instruments
thereafter, the supply price will increase for the other what is quasi-rent on
though the returns the long
units. If in equilibrium OX units of the factor are employed, long run. Thus, they are not so in
are similar to rent, quasi-rent. The
then the price paid to the last unit of the factor is just equal to in the short run are described as applied to the
That is why these
its transfer earnings. But the intra-marginal units will product run.
can be generalised
and
asurplus a surplus over their transfer earnings. In Fig. the concept of quasi-rent as skilled personnel specialised
such
total earnings of the factor are equal to the area OREX Wwhile earningsof any factor, fixed in the short run.
the job, whose supply is
for a particular
the transfer earnings are equal to the area OSEX. Thus, quasi-rent
broader sense of the term, whole. In
suplus or rent will be equal to the shaded area SRE(=OREX - In the other the
but to the firm as a
factor
OSEX). relates not to a particular defined as the
a whole, quasi-rent. is
To sum up, when the supply of a factor of production is the context of the firm as or sale-proceeds over
the total
excess of the total receipts production. Whether the fixed
perfectly inelastic, its entire earning is rent; when the supply
prime (or variable) costs or
is perfectly elastic, the entire earning istransfer earning so
cost will be covered partly,
fully or more than fully by the
run, the
that rent is zero. Between these two extreme situations, the of demand. In the short
price depends upon the state any
more the curve is elastic, lower is the element of rent in the
firm's decision to produce is not dependent on whether
total earning and higher is the elemernt of transfer earning. of fixed cost is covered at all.
That is why the excess of
part
decribed as quasi-rent.
QUASI-RENT total receipts over total prime cost is in the fig.
This broader concept of quasi-rent is illustrated OQ
The term quasi-rent was introduced into economic When the price is ON, the firm is at equilibrium with
If
literature by Marshall. According to Marshall, quasi-rent output, and the price just covers the average variable cost.
refers to the earnings of man-made instruments of production the price is ON,. the firm will produce OQ, output; since the
such as implements, machines, etc., in the short-run. The
supply of these instruments of production is fixed in the Y
ME
G.C,27 5
short-run by definition. The earnings of these instruments of AVC
production, therefore, are analogous to rent. But these cannot Cost
Price
Y
P
be regarded as rent proper because given sufficient time, the N, AR. = MR.
supply of these instruments can be adusted to demand for P
them. So in the long run, these earnings are to be treated as AR, = MR,
R R.
the returns on the (money) capital invested in these instruments AR = MR
of production; and these returns over the long run must be
sufficient to cover the cost of the investment includihg interest
on the (money) capial invested. In other words, the rate of
X
return on the investment will, in the long run, tend to become
equal to the rate of interest, given competitive conditions in Output
the industry. This is what Marshall meant when he said that
Fig. Quasi-rent to tlhe Firm