Modern Theory Of Rent

According to them, the Ricardian theory of rent is too closely related to land. 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 determination of rent, the modem economists say, can be explained in the same manner as the reward of other factors, that is by demand and supply forces.

The modern economists like Pareto, Mrs. Joan Robinson, Boulding, Stigler, Shepherd, have tried to simplify and generalize the Ricardian theory of rent, According to them, the Ricardian theory of rent is too closely related to land. This creates on impression that rent is a peculiar earning of land only. The fact, however, is that other factors of production i.e., labour, capital and entrepreneurship may also be earning economic rent. The determination of rent, the modem economists say, can be explained in the same manner as the reward of other factors, that is by demand and supply forces.

Demand and supply analysis

Demand for a factor. The demand for a factor which may be land, labour or capital is a derived demand. Land, say for instance, is demanded for its produce. The higher the produce, the greater is the demand for land. A firm will pay rent equal to the marginal revenue productively of land. 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.

Supply of a factor

The supply of landto a particular use (say industry) is quite elastic. It can be shifted to other uses by offering higher rent than that being earned by it now. The supply of a factor (to an industry) is, therefore, rent elastic. If higher rent is paid, the supply of a factor can be increased by withdrawing it from other uses. The supply curve of a factor (industry) slopes upward to the right.

Determination of rent.

The economic rent is determined by the intersection of demand and supply curves for a factor. In this figure (19.2), the demand curve for a factor say labour in a particular industry is DD’ and the supply curve of workers is SS’. The wage rate or factor price of labour as

workers employed in a particular industry at OW wage rate is OL. The total earning of the workers employed is equal to the area OWEL. At wage rate OW, there are workers who would work at lower pay but they are also paid at OW wage rate. Those workers whose transfer earnings are less than this wage rate will be getting economic rent The total economic rent earned by all the intra marginal workers is equal in the area WES. The marginal worker i.e., Lth worker is not obtaining any rent or surplus.

figure_19.2

Rent is a surplus return. The modern economists are also of the view that rent as a surplus can be earned by other factors also. It is not peculiar to land alone as explained by Ricardo. The modern theory of rent is that it is the difference between the actual earning of a factor unit over its transfer earnings. 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 01 its present occupation. For example, a worker earns Re. 6000 per month in a factory. In the next best employment, he can get Rs. 5000 only per month. The surplus or excess of Rs. 1000.0 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.

Economic rent depends on the elasticity of supply of the factor of production

The proportion of the income of’ a factor that consists of economic rent depends on the elasticity of supply of the factor of production which may be (1) totally inelastic supply (2) perfectly elastic supply and (3) less than perfectly elastic supply.

(1) Perfectly elastic supply. When the supply of a factor of production is perfectly elastic, then none of its income is economic rent. Its entire income is transfer earnings.

Perfectly elastic supply fig.19.3Perfectly elastic supply fig.19.4

In the Fig. 19.3,, the s,upply curve SS’ is a horizontal line. Whatever the amount of nature of rent. factor demanded, the supply price remains at OS. Hence, it earns no surplus in the

(2)  Totally inelastic supply. When the supply of a factor is totally inelastic, then its transfer earnings is zero. The entire income is economic rent. In fig. 19.4, the elasticity of the supply of factor of production is zero. It does not increase at all as its demand increases. The supply curve is vertical. The entire factor income is a surplus which is shown by area ONST.

(3)  Less than perfectly elastic supply. If the supply of a factor of production is neither perfectly elastic nor perfectly inelastic as illustrated in fig. 19.5, then some part of the factor income is economic rent and the other part is transfer earnings. In Fig. 19.5, the supply curve SS’ of a factor, say labour, is positively sloped. A firm must pay at least OS price to attract OL units of labour-to the given use. If supply of a factor is to rise,•the factor must be paid higher and higher wages to attract more units. The demand curve DD’ (measuring the marginal revenue product of the labour) interests the supply curve at point R. Now at OT equilibrium price, ON ‘units of labour are demanded and supplied. Since all the units of the factor upto ON are paid the market price OT, the intra margihal units earn surplus above their supply price. The. marginal unit i.e. Nth is not getting any rent. Here the total income of the factor is equal to the area OTRN. It is made up of its economic rent-equal to the area STR and its transfer earnings equal to the area OSRN.

Less than perfectly elastic supply fig. 19.5

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