Ricardian Theory of Rent: Subject-Matter, Assumptions and Explanation

Let us make an in-depth study of the Ricardian Theory of Rent:-

1. Subject-Matter of Ricardian Theory of Rent 2. Assumptions of the Ricardian Theory of Rent 3. Explanation 4. Criticism.

Subject-Matter of Ricardian Theory of Rent:

The Ricardian Theory of Rent was propounded by David Ricardo a brilliant economist of England in 19^th century.

This theory can be said as the basis of the modern concept of rent.

Ricardo defines as “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.” Hence, to him rent is paid by the tenant to the landlord for the use of natural productive properties of the soil.

He thus demarcated the payment made for the power of the soil from the payment made for the improvements on land. Rent is often, in fact, confounded with the interest on capital. It is gross rent, Economic rent however is a true surplus which is paid for the use of natural utility of land.

Land possesses Original and permanent properties with reference to its nature, situation environment and conformation and rent are paid for the use of land alone. These in turn reveal that rent accrues to the landlord both from extensive and intensive cultivation of land, as well as due to the situation of his land.

Rent, according to Ricardo, is a Unique factor payment which is not determined by the cost of production, because land is a free gift of nature—it has no cost of production. Hence, rent is a true surplus. It is paid as the surplus over the costs of cultivation involved. Thus, when the price of land produce tends to rise, assuming costs of cultivation, the payments made to labour and capital inputs being constant, a higher surplus is left out, so rent also becomes the same high. Because, this very surplus is payable as rent for the use of land. Obviously, if a land output fails to earn surplus revenue over costs, it bears no rent.

In fact, Ricardo looked upon rent as ‘differential surplus’ earned by more fertile plots of land in comparison, with the less fertile plots of land. When demand for land produce rises and price increases, the surplus over costs rises, rent tends to rise.

Assumptions of the Ricardian Theory of Rent:

Ricardo’s theory of rent is based on the following assumptions:

1. Land is a free gift of nature. It has no supply price, i.e., it has no social or opportunity cost for its emergence.

2. The supply of land is limited and fixed and is perfectly inelastic.

3. As there is no consideration for the cost of production for land as a factor of production, demand becomes the sole determining factor for rent as a price payable for the use of the natural productive capacity of land.

4. Land is a heterogeneous factor of production that is land is non-uniform in quality. The “original and indestructible powers of the soil” vary a great deal from land to land. Land is of different quality and productivity.

5. Technique of production is given and unchanged.

6. Land is subject to the law of diminishing returns.

7. There is perfect competition for the use of land, as well as in the market for land produce.

8. Land is cultivated in historical sequence, i.e., first the best land, then the less fertile and in this order.

Under these assumptions, Ricardo advanced the theory that rent emerges on account of the differences in the quality of land. Qualitatively, some lands are more fertile, while others are less fertile. Superior and more fertile lands yield a surplus due to their differential advantages in production over inferior or less fertile ones.

This producer’s surplus of superior land is described by Ricardo as rent. Hence, the more the fertility of land, the higher is the rent yield. The Ricardian theory may thus be called the “theory of differential advantage” or “differential theory of rent”.

Explanation of the Ricardian Theory of Rent:

To explain the Ricardian differential theory of rent, let us take an example of a self-sufficient small village community. Let us assume that there are only four plots of land P, Q, R and S labelled in the order of their fertility, i.e., P is the most fertile land, Q is inferior to P, R is inferior to Q and S is the least fertile. We may also assume that wheat is being cultivated on these plots. Again these plots are of the same size—only their soil fertility varies. Moreover, the same doses of labour and capital are being used on all these plots. An Extensive Method of cultivation is used.

Thus, to begin with, P grade land is cultivated first. That means, to view the situation in a historical perspective, when a community is first settled, it will use only the best land, i.e., grade P land. If grade P land is abundant in supply, there will be no rent, as nobody would pay for the use of land when its supply is abundant.

If the demand for wheat is only up to 200 quintals, cultivation of land P is sufficient and there is no rent. But with the growth of population, as the demand for food increases, say up to 340 quintals, the scarcity of land P is felt, and inferior land Q will be brought under cultivation. Now, when the cost of cultivation of land P and Q is the same, because the same amount of labour and capital is applied, yet land P yields 200 quintals of wheat while land Q yields 140 quintals.

This means that land P realizes a surplus of 60 quintals over the yield of land Q. It is a producer’s surplus or a rent which can be claimed by the owner of the land i.e., it is a surplus of superior land over inferior land. Again, if the demand for food increases still further, to say 440 quintals, land R will have to be brought under cultivation. It yields, with the same amount of capital and labour, say 200 quintals of wheat. Then, as compared to land R, land Q yields a surplus of 40 quintals of wheat (140-100); while land P yield a surplus of 100 quintals (200-100) which will be claimed by their respective owners.

As population continues to grow and the demand for wheat increases, it becomes necessary, in due course, to cultivate land of a still poorer quality, i.e., grade S land. When S grade S land is brought under cultivation with the same amount of labour and capital, it may yield 60 quintals of wheat.

Now land yield a surplus of 140 quintals of wheat, Q yields 100 quintals and land R also now yields 60 quintals. Thus, land R which did not get any rent previously also earns rent when an inferior quality of land i.e., land S is brought under cultivation.

We may also express the same thing in terms of money by putting the price of labour and capital against the price of wheat. Here, we consider rent as the surplus over cost of production. Suppose, the price of the given amount of labour and capital is Rs. 12,000. That means the cost of cultivation of each land is Rs. 12,000.

Now, the price of wheat in a perfectly competitive market is such that total revenue equals total cost of marginal land. Thus, marginal land must fetch a total revenue of Rs. 12,000 and for this, the market price of wheat has to be Rs. 400 per quintal.

Thus, rent yields of different lands would be as shown in the figure given below:

In short, the summary or the gist of the Ricardian theory is that more fertile land yields more and more rent as more and more less fertile land is brought under cultivation. As Ricardo has said that “with every step of rise in the population, which shall oblige a country to have resource to land of a worse quality, to enable it to raise its supply of food, rent on all the more fertile land will rise.”

Ricardo describes superior or more fertile land as Intra-marginal or Superior-marginal land, while the last category of less fertile land as the marginal land. Marginal land is so called because it provides just enough revenue to cover its cost of cultivation.

Eventually, when even more inferior land is brought under cultivation, it is regarded marginal land and the previous marginal land now becomes super-marginal land. Marginal land is ‘No-Rent Land’. Super-marginal land earns equal to the difference of its surplus yield over the yield of marginal land. Thus,

Different Rent: Surplus = Yield of Super-marginal land – Yield of marginal land.

Diagrammatical Presentation:

Taking into consideration the arithmetical illustra­tion of the example given above, the differential rent of different lands may diagrammatically be represented as in the figure given below:

Significant Point of Ricardian Theory:

Important gist’s of Ricardian Theory of Rent are as follows:

1. Rent is a differential surplus yield of more fertile land as against less fertile land. We can say that it is a reward as the excess of what is required to keep land in its present employment. Therefore, it can be said that it is a surplus payment.

2. It is an accepted fact that all lands are not of the same quality. Consequently, super-quality land yields rent against marginal lands which are relatively inferior. Thus, Rent is the reward earned by land because its supply is scarce and inelastic.

3. In short, it is said that rent arises because of the differential fertility of land.

4. Rent is not a cost of production which must be paid in order to ensure supply of land. Rent is determined entirely by demand. Supply of land does not increase or decrease in response to changes in rent. It is in the nature of an unearned surplus. If demand for land rises, rents rise, if the demand for land falls, rent also fall. Therefore it is said that rent plays no part in determining the prices of land output.

5. In the end, it can be said that rent is price-determined and not price-determining.

Criticisms of the Ricardian Theory of Rent:

The Ricardian Theory of Rent has been severely criticised for its unrealistic assumptions:

1. There are no Original and Indestructible Powers of the Soil:

It is assumed that rent is a payment for the use of the ‘original and indestructible ‘powers of soil. But it is difficult to decide which powers of the land are original and which are the result of human action. Economists like Stonier and Hague have criticised the definition of rent as given by Ricardo.

In their view, the concept of rent as payment made for the use of ‘original and indestructible powers of the soil’ is rather hazy. This is because of the fact that ever since pre-historic times, the landscape of most countries has been drastically changed by man—imagination of agriculturists, industrialists and statesmen.

In the present atomic era, one cannot claim anything to be indestructible. The followers of Ricardo, however may defend him by saying that what is meant as original and indestructible is the climate, rainfall etc. associated with a particular region or a given land. In this sense, perhaps one has to agree with the Ricardo’s definition of rent.

2. The Best Land is not Cultivated First:

Ricardo’s assumption that the best soils are cultivated first is not borne out by historical facts. There is no empirical evidence in economic history of the world to this effect. It is the location or situation of land which is more significant rather than fertility in its selection for cultivation. Lands which are most convenient are cultivated first. The theory thus lacks historical support.

3. In Real life no-rent Land do not Exist:

It is difficult to measure differential rent of super-marginal units of land. Though there may be a marginal land which just covers, the cost of producing the product. The use of the concept of no-rent land is not essential for the study of the theory of rent. Even if a piece of land does not earn rent in one use, it can be put to some other use where it can earn a surplus.

4. Assumption of Perfect Competition is Unrealistic:

The theory assumes perfect competition, which is unrealistic. Thus, the Ricardian theory is grossly hypothetical and practically irrelevant.

5. Rent is not Price-Determinant:

Modern economists totally disagree with Ricardo’s statement that rent does not enter into price. Ricardo wrongly maintains that rent is not a component of the cost of production. At present, the modern view is that rent enters price. Land is a factor of production, so its price i.e., rent becomes a part of the cost of production.

Thus, when price is based on the cost of production, rent does affect price. From Society’s point of view land may be a free gift of nature, but to an individual farmer, it is certainly not a free gift, so, when price for land, i.e., rent, is paid, it cannot be price-determined but it is price-determining.

6. Scarcity and not Fertility is the Cause of Emergence of Rent:

The Ricardian theory is based on the assumption that lands differ in fertility. None can deny this but to say that more fertile lands earn high rents and less fertile lands earn low rents is not true. Rent arises not because of the fertility of land, but because land is scarce in relation to its demand. Since land is fixed in supply. Therefore, the realistic approach to the problems of the emergence of rent is through the scarcity principle rather than the differential principle.

7. Rent also Arises in the Short-Run:

The theory of rent as discussed like various classical doctrines is applicable only in the long-run. It has been called as unrealistic, since rent also arises in the short-run when in-fact the supply of factors is fixed and Marshall prefers to call it as quasi-rent.

8. Rent is not a Payment for the Use of Land Only:

According to Ricardo rent is a payment made for the use of land only. But it is not land alone that is fixed in supply in relation to its demand. Even other factors are fixed in supply at a period of time and thus earn a surplus which is rent. Marshall was right in saying that ‘rent is a leading species of a large genus.’

Conclusion:

Despite the above written weaknesses or drawbacks the Ricardian theory of rent “brings out clearly certain points which are of great importance from the standpoint of policy’. Here, the concept of marginal land is introduced by Ricardo for the first time. It gave impetus to later economists, like Marshall, etc. to think in terms of “margin.”

Again, Ricardo’s theory of differential rent signifies that rent is just an ‘unearned income”. The landlord do nothing to earn rent. Therefore, a tax like land revenue, collected from the landlord, is quite justifiable. Further, Ricardo’s assumption of diminishing returns in agriculture and the pressure on land due to rise in population, still holds true for the less developed countries. Following Professor Robertson, it can be said that Ricardo’s Rent Theory has by no means lost its vitality and instructiveness even today.