Relationship between Rent and Price

The upcoming discussion will update you about the relationship between rent and price.

One of the important conclusions, of course controversial ones, of the Ricardian theory of rent is whether rent enters into the price of the product or in the cost of production. According to Ricardo, rent of land does not enter into price since rent is determined by the price of the product or corn.

Rent cannot determine the price of the product. Whenever price of corn rises, rent of land also rises.

In the words of Ricardo:

“Corn is not high because rent is paid, but rent is paid because corn is high.”

According to Ricardo, under perfectly competitive conditions, price of corn equals marginal cost (P = MC) of production on the marginal land (or no-rent land). No surplus or rent emerges on marginal land. That is why rent does not enter into the cost of production of marginal land.

Thus, rent cannot influence the price of the product. Rather, rent is determined by the price of corn. This is because of the fact that, as population of a country rises, demands for corn or food rises. Rising demand for corn causes its price to shoot up. Farmers then go on cultivating more and more less fertile or marginal land to feed newer mouths.

Now the marginal land or no-rent land will yield a surplus or rent, and intra-marginal—as well as superior-most lands—will yield greater surplus. As price of corn rises, rent on intra-marginal land rises. Thus price of corn and its demand determines the volume of rent. This suggests that rent does not enter into price or cost of production. In Ricardo’s view: Rent is price-determined but not price- determining.

This Ricardian view is based on two fundamental assumptions. Firstly, the supply of land from the society’s point of view is fixed or limited in relation to demand. Secondly, land has no alternative use and, hence, its opportunity cost is zero. Since opportunity cost or the minimum supply price of land is zero, the entire earning of land is rent. In this situation, as price of corn rises, rent rises. So rent is determined by price.

But modern economists argue that land has alternative uses.

It can be used for a variety of purposes:

For wheat growing, jute growing, and so on. If a particular plot of land is put into wheat growing, it is not available for, say, jute growing. As there are alternative uses of land there are possibilities of transfer earnings. Such transfer earnings are regarded as opportunity cost or minimum supply price.

Ricardo could not dream of alternative uses of land. But modern economists argue that since land has alternative uses its supply price or opportunity cost is positive. Every use of land has to pay at least this opportunity cost or transfer earnings or minimum supply price if it is to be used for specific purposes.

Any earnings over the transfer earnings constitute rent. From the viewpoint of a firm or an industry, land rent enters into cost of production.

Whenever price for the use of land equals opportunity cost then such opportunity cost enters into cost of production. Further, if it exceeds opportunity cost, then the excess is to be included into the cost of production. Thus rent can influence cost of production or the price of the product.

Thus, the modern theory of rent teaches us that whether rent influences price or price influences rent depends on the viewpoint from which we look.

In P.A. Samuelson’s words:

“Whether rent is or is not a price- determining cost depends upon the viewpoint from which we look: firm or industry or the whole economy.”