In: Economics

# Theory of Rent in Economics.

What is Ricardian Theory of Rent in Economics? What are the assumptions of his theory? Illustrate in detail.

What are the Marginal Land according to the Ricardo? And is rent static, critically define it.

## Solutions

##### Expert Solution

THEORY OF RENT -

Rent is a payment made to the landlord for the use of land. The earlier economists believed that rent is payable only for the use of land, but the modern economists say that it can be earned on other factors of production also. The first theory of rent was given by one of the classical economists, David Ricardo and since then, many other concepts have evolved.

Ricardian Theory of Rent -

Ricardo had assumed that the rent is payable for the fertility of the soil of a piece of land. According to him,

“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."

In this way the payment given to the owner of the land against the original power of fertility of soil is the real rent and not the whole payment. This is so because the whole payment will also include payment for investments done on the land. Every landlord makes some expenditure on his land to make it really useful, which he wants to realise by letting out the land. Hence, the whole payment received by letting out the land is not pure rent.

In this way, rent has two measures. One, gross rent and second, pure rent or Economic Rent. Ricardo had clarified that only the second type of payment is purely for the fertility of soil and only this payment should be considered as pure rent.

Ricardo had further said that rent is the residual amount which is left after other factors of production have been duly paid. Hence, it belongs to the landlord and only he should get this amount. In this way, Recardo considered rent to be only a residual payment.

Assumptions of Ricardian Theory of Rent -

Ricardian Theory is based on the following assumptions.

1. Rent accrues only on land and not on other factors of production.

2. Rent accrues due to the fertility of soil which is original and indestructible.

3. Most fertile land will be used first and then we move to less fertile pieces of land.

4. There is always a marginal land on which no rent is earned.

5. It is also a long term concept like other concepts of classical economists.

Marginal Land -

According to Ricardo, land can be divided, into several categories, called 'grades of land, on the basis of fertility of soil. Mankind will first use the best quality land and then we move to lower quality grades of land. This process continues till we do not reach that grade where the revenue received from the land is equal to the cost incurred. In this situation, there should be no residual amount and, consequently, rent will become zero. This grade of land was called as ‘Marginal Land', by Ricardo.

In this way, we can call marginal land as that land which is the last grade of land under use, on which rent is zero and any land which is of a lower quality than this land can not be used for production.

For example, there are five grades of land called A, B, C, D and E. We spend a fixed amount of money on inputs on all these grades. The value of the products from all these grades is as follows.

Table -1

(Rent on Different Grades of Land)

 Grade of Land A B C D E Amount spent ($) 200 200 200 200 200 Value of Output ($) 500 400 300 200 100 Rent ($) 300 200 100 0 - The above table shows that on the A grade land which is the highest quality land, the output is highest. This goes on decreasing on B, C, D and E grades respectively. Accordingly, the amount of rent also goes on decreasing, which is Rs. 300 on A grade; Rs. 200 on B grade; Rs. 100 on C grade and nil on D grade. Hence, D grade land will be called the marginal land. E grade land will not be cultivated at all because the value of the crop on this land is less than the amount spent on that land. In this way, we can say that 'Rent is the produce of a land over and above the produce of the marginal land.' Is Rent Static? The rent arising on a piece of land and the marginal land is not static. It can change according to time and circumstances. If the price of the produce increases and costs remain the same, then not only the marginal land will change but the amount of rent will also change. For example, if in the above case, the price of food grains being produced is doubled, then value of output accruing on different grades of land A, B, C, D and E would become$1000, $800,$600, $400 and$200 respectively. Since cost does not increase, now grade D land can also earn rent (400-200) and the marginal land would now be 'E', instead of D. The amount of rent on A, B, C, and D would now be $800,$600, $400 and$200 respectively.

Similarly, if we assume that the costs as given in table-1 increase by 50 percent, then grade C land would now become marginal land and the amount of rent on A & B grades would be $200 ( 500-300) and$100 ( 400-300 ) respectively.

In this way, we see that the concept of rent as given by Recardo is not a static concept but a dynamic one.

According to Ricardo, rent does not affect the price of a product but is affected by it. This is because rent, according to him, is a residual payment. If the price of a product is high, costs remaining the same, the residual payment would be high and the rent will also increase. By this interpretation of rent, Ricardo changed a popular perception of that time. People used to believe that the main cause of high price of grain was that the rent of land, on which it was cultivated was high, and, therefore, costs, would rise. Ricardo, clarified that the price of crop was high not because of rent, but rent was high because the crop prices were at a high level. He made a famous statement on the price of corn,

"Corn is high not because rent is high, but rent is high because corn is high."

According to Ricardo, rent arises out of the original and indestructible powers of the soil and no human effort has been exerted on it. Hence, rent was regarded as an unearned income. It arises out of the shortage of high grade land.

Criticism -

Ricardo's Theory of rent has been criticized mostly for its assumptions. Modern economists are of the view that rent does not arise on land alone, it can arise on other factors as well. It is not on account of fertility of soil but on account of scarcity of a factor. It has also been said that it is not essential that the inost fertile land will be cultivated first. The reality is that the land which is closest is cultivated first. The interpretation of Ricardo that rent does not influence price but is influenced by it, has also not been accepted, because rent is decided first, the price is decided later by the market forces.

Inspite of these criticisms, Ricardian Theory of Rent is considered an important theory and has a prominent place in economic literature.

Rent is a payment made to the landlord for the use of land.