3 Prepositions of Modern Theory of Rent | Theories of Rent

The following points highlight the three prepositions of Modern Theory of Rent.

The prepositions are: 1. Scarcity Rent 2. Rent is a Generalized Surplus: Earned by all Factors 3. Measurement of Rent with Reference to Transfer Earnings.

Prepositions # 1. Scarcity Rent:

Modern economists are of this opinion that the main shortcoming of the Ricardian theory of rent is that it concentrates only on the differential aspects and neglects the scarcity ‘aspect of land’.

It fails to give a clear exposition of the ‘scarcity rent’ emerging on account of the scarcity of land in relation to demand.

The Ricardian theory only explains ‘differential rent’ accruing to superior lands over inferior ones. He has assumed that marginal land is no-rent land. When demand increases due to population growth, extensive cultivation has to be adopted so that marginal land becomes intra-marginal land, with the adoption of a lower quality of land for cultivation. In this the former marginal land now becomes super-marginal and starts yielding rent.

According to Ricardian system marginal land will always remain as no-rent land. But in reality, there is no such land which can be called as ‘no-rent land’ in existence. All lands whether superior or inferior, fetch rent. The differential rent theory loses its ground if we assume lack of heterogeneity in lands in an area. Modern economists have called the scarcity rent theory as more refined and realistic which adopts the framework of demand and supply analysis in the determination of rent.

Further Ricardo has closely relates the notion of rent with the notion of land as a free gift of nature—so it is land having no social cost as such. To modern economists, there is no need for such a separate theory. Like the reward for other factors, the determination of rent can also be explained in terms of the interaction of demand and supply forces.

Rent in based on the scarcity of the availability of land – it is immaterial whether it is of superior and inferior or any other quality. Rent emerges even if all lands are homogeneous if they are scarce in relation to demand.

Next we should assume that all lands is homogeneous and specific in use, but is scarce on account of its rigid supply. In any period whether long or short period, the supply of land in existence is perfectly inelastic. Therefore, the rise in the demand for land, with the growth of population, will intensify its relative scarcity, so the price of land i.e., rent, tends to rise further and further with the rise in demand.

Thus, we can illustrate in a better way as follows:

Here, in this diagramme SQ is the supply curve of land, which shows the availability of land which is fixed at OQ. As the demand curve (D₁) for land intersects the supply curve (SQ) at point E₁, like the equilibrium price, the equilibrium rent, OR₁ is determined. If demand increases to D₂, rent increases to OR₂. Similarly, with a further shift in the demand curve (D₃), rent rises to OR₃. Thus, rent rises because of demand pressure and scarcity of land.

In short, we can say that rent is demand determined. Ricardo too has accepted this fact that rent is demand determined. Further, he has also emphasised that as the demand for land shifts to the right, rent tends to increase. Like differential rent, scarcity rent is the producer’s surplus.

Again, the concept of differential rent also contains the element of scarcity. It implies that because the superior lands are scarce in relation to demand, they fetch rent. Differences in their surplus, are ultimately due to scarcity of better quality lands.

The concept of scarcity rent, implies that the rent emerges because of scarcity of land in general as against its demand. Evidently, the similarities between the two concepts of scarcity rent and different rent are more significant than their differences.

Marshall, has therefore written that:

“In a sense, all rents are scarcity rents, and all rents are differential rents.”

Prepositions # 2. Rent is a Generalized Surplus: Earned by all Factors:

Like Ricardo, modern economists are of this opinion that “Rent is a surplus”. But to modern economists “Rent is a generalized surplus” and it is not the earning of land alone. It can be earned by any factor of production which is scarce in relation to demand.

In their opinion scarcity implies inelasticity of supply. Inelasticity of supply is not a peculiarity of land alone. Other factors of production (Labour, Capital and Enterprise) too, are inelastic in supply, at least in the short period.

Marshall has thus written that—”If the supply of any factor of production is limited and incapable of such increase by man’s effort in any given period of time, then the income to be derived from it is to be regarded as of the nature of rent.” In short, any factor of production which is scarce, or inelastic in supply at any time, can earn rent.

Here, differential income has been defined as under:

Differential Income = Reward earned by a factor – The minimum supply price of the factor.

The differential income so measured is regard as economic rent.

In this connection Mrs. Joan Robinson has written that:

“The essence of the conception of Rent is the conception of a surplus earned by a particular part of a factor of production over and above and minimum earnings necessary to induce it to do its work.” In the case of land as Ricardo has stated that it is a free gift of nature, so its supply price is zero.

Therefore, the entire surplus of farm produce becomes economic rent. Next, Ricardo has written that the supply of land is perfectly inelastic. As such, whenever demand for land increases, rent increases proportionately. Rent in the case of land, thus remains completely as a demand determined phenomenon. But in the case of other factors, like—labour, capital etc., there is some minimum supply price. So out of their total income, only that part which is in excess of the supply price (the minimum essential payment required to induce the factor to render its productive service) is termed as economic rent.

Mrs. Joan Robinson has written about the minimum supply of labour as—”the minimum payment which is necessary to induce him to continue to work with any given intensity is the real income which will maintain his physiological efficiency at an adequate level. “Similarly, the supply price of the entrepreneur is “the level of earnings which is sufficient to present him from relapsing into the ranks of employed labour.”

Owners of labour, entrepreneurial skill and capital, often receive a surplus. Over the necessary minimum due to scarcity of their resources in relation to demand in the economy. These factors earn rent so long as their supply remains less than perfectly elastic. Once their supply becomes elastic, so that it is adjusted perfectly well to the increased demand, their rewards tend to be the minimum.

Consequently, the differential income, i.e., economic rent, gets wiped out. Therefore, Rent is the exclusive attribute of land. It is also earned by other factors under the regular operation of the laws of demand and supply. Marshall, thus has remarked that “rent of land is seen, not as a thing by itself, but as the leading species of a large genus.”

Thus, it can be said that every factor of production, whether, it belongs to the category of land or not earns rent. The amount of rent earned, however depends on the relative degree of inelasticity of supply of the factor concerned to its demand.

Greater the degree of inelasticity of supply, large the relative surplus accrues to the factor’s earning in the form of economic rent. Therefore, a factor earns rent till its supply remains less than perfectly elastic. When its supply becomes perfectly elastic, it earns no surplus, no rent.

Prepositions # 3. Measurement of Rent with Reference to Transfer Earnings:

This concept was propounded by Mrs. Robinson. In this, the minimum supply price of the factor is measured in terms of its transfer earnings. According to Mrs. Robinson, “The price which is necessary to return a given unit of a factor in a certain industry may be called its transfer earnings or transfer price.” This concept is nothing but the opportunity cost of a factor. That is what the factors could earn in its next best alternative use or employment is his transfer earnings.

In order to retain a factor in its particular use, it must be paid at least equal to its opportunity cost or transfer earnings, i.e., what it could earn elsewhere. Thus, transfer earnings are the minimum supply price of a factor unit in a particular industry.

According to the modern concept of rent, we can measure rent as follows:

Rent = Surplus or differential income = Reward of factor in a particular industry – The minimum supply price of that factor in this industry.

Applying the concept of transfer earnings in this context, we may come to the conclusion that

Economic Rent = Current earnings of a factor – Its transfer earnings.

For example:

Suppose, a person is employed in an industrial concern and he is earning a monthly salary of Rs. 10,000. If he works in a commercial bank, he can get only Rs. 7,500 a month. Then Rs. 7,500 is his transfer earning. In the industrial concern, his salary includes an element of economic rent amounting to Rs. 2,500. (His current income Rs. 10,000 – his transfer earnings Rs. 7,500 = Economic Rent Rs. 2,500).

Just like Ricardo, modern economists, hold that rent is a differential surplus. But, their method of measuring rent is different from that of Ricardo. To Ricardo, rent as a surplus is measured by the difference between the productivity of intra-marginal land, (superior quality land) over the marginal land (inferior quality land).

To modern economists, economic rent is measured as surplus of current earnings of a factor in a particular occupation over its transfer earnings. As such, in modern economics, economic rent is treated as generalized concept. It is applicable to all factors when their present earning is in excess of their normal transfer earnings.