User:Aggie menezes/Temp/Modern Theory of Rent1.doc

SCARCITY RENT (MODERN THEORY OF RENT)

As the quantity of land available for use is scarce relative to demand, a price must be paid for its use. This price (commonly called ‘Rent’) for the use of land is obtained by those who are vested with the ownership of land. Modern economic theory uses the term ‘rent’ in the following senses:


 * 1) It is a payment made for the use of fixed factors of production whose existence is not dependent on any human effort or sacrifice. In this sense, it refers to being ‘Land Rent’.
 * 2) It is surplus earned by a unit of a factor over and above the minimum earnings necessary to induce it to stay in the present use, industry or occupation. In this sense it refers to being ‘Economic Rent’.
 * 3) It is the earnings of fixed capital equipment like machinery in the short run, as the supply of these equipments in this period is inelastic. In this sense it is refers to being ‘Quasi Rent’.

It was Prof David Ricardo who first analyzed the concept of rent by espousing the notion of ‘Differential Rent’. However, it was Prof. Pareto who moved the rent thinking away from the Ricardian interpretation by defining rent in terms of ‘Transfer Earnings’. The difference between the Ricardian concept and the Paretian concepts is that the former is concerned with whether or not a factor is supplied to the economy as a whole, while the latter is concerned with the question as to whether or not a factor is supplied to a particular present occupation or particular industry.

Prof K. Boulding (The Concept of Economic Surplus, AER, Dec 1945) and Prof Joan Robinson (Economics of Imperfect Competition) emphasized that whenever the supply of factor units to an industry or economy is not perfectly elastic, a part of the earnings of that factor will consist of surplus or economic rent, since the full price they get are not necessary to make all the factor units available. If the supply is not perfectly elastic, some factors units will be available at a price lower than the price that they actually receive – the difference between the actual price and the one necessary to make them available is surplus or economic rent.

According to modern economists, rent would arise even if all the land was equally fertile. They maintain that rent arises because the supply of land is relatively scarce with respect to its demand. Hence, it is scarcity rent and not differential rent which is a more acceptable explanation of rent today. The price which is necessary to retain a given unit of a factor in a certain industry is called its transfer price. Thus, transfer price is nothing but the opportunity cost of a factor.

Transfer Price / Earnings

It is the minimum payment, necessary to keep a factor of production in its existing use and thus discourages the movement of the factor to other employment. It is determined by the reservation price governing the supply of that particular factor. Hence, it involves the basic costs incurred in maintaining the factor’s productivity. It is a significant concept in determining rent. In fact rent is defined to be the surplus earned over and above the transfer price of the factor.

A ( RQE) is the total transfer price of the factor.

Rent as a surplus over transfer price

According to modern economists, economic rent could be defined as : The surplus earnings of a factor, in excess of its transfer price or the minimum necessary payment to attract it into a particular use.

According to Prof. Joan Robinson, rent arises when there is a scarcity of land due to an increase in its demand. Rent is therefore based on the availability of land and not on whether it is of a superior or of an inferior quality. Rent would therefore arise even if all the land was homogeneous, but scarce in relation to its demand. The modern concept of rent is therefore called Scarcity Rent.

a.Rent and the total supply of available land.

B

D1 ==== Price of Land ====

P1 E1

D

P D1  E

D2

D0 P2  D  E2

D2

S ==== Qd & Qs ====

In this case the supply curve (SB) is perfectly inelastic and is parallel to the Y-axis. The demand keeps changing and so does the rent. The demand curve DD intersects it at E and so the rent is OP. The total earnings of the land are shown by the rectangle OPES. In this case, since the transfer earning is zero, the entire income is a surplus and so can be treated as rent. When the demand increases to D1D1, the rent increases as the total earnings increases to OP1E1S and the entire earnings is considered as rent. Similarly, if the demand decreases to D2D2, the total rent earned becomes less (OP2E2S).

The total earnings of land will be A(□ OPES) (when the demand is DD).

Now Economic Rent = Total Earnings - Total Transfer Earnings

= A(□ OPES) - ZERO

= A(□ OPES)

b.Rent and the supply of land for a specific occupation

In this case the supply curve (SB) is relatively inelastic. The demand keeps changing and so does the rent.

The demand curve DD intersects it at E and so the rent is OP. The total rent of the land is shown by the shaded area OPES. Rent arises due to the existence of a transfer earning. For instance, at OQ amount of land, the minimum expected price is MQ, but the owner actually gets NQ and due to this, the rent is as high as MN. As the demand curve shifts to D1D1, the rent increases to OP1E1S.

Thus, it follows that scarcity rent is demand determined and so all the factors affecting the demand for land will naturally affect rent. Hence, population growth and an increasing density of population in a particular area intensifies the scarcity of land, leading to an accompanying escalation in the rent rate.

Now Economic Rent = Total Earnings - Total Transfer Earnings

= A(□ OPEL) - A( SLE)

= A(□ OPES)

In conclusion it can be said that for the modern economists, rent does not emerge only due to the Ricardian notion of quality differentials but also due to the differences between the demand and the supply of the various qualities of land from time to time and from place to place. The modern interpretation of rent maintains:


 * Rent is an inverse function of the elasticity of the supply of land.
 * Rent is a direct function of the demand for land.

Quasi-Rent

It could be defined as the surplus income earned by certain factors, over and above their normal earnings. This concept was introduced by Prof. Alfred Marshall. It refers to the short run earnings of some factors of production, especially capital equipment and other man-made factors which possess a relatively inelastic supply in the short run. In the short run as their supply is inelastic, when the demand for them increases, their income rises and they earn a surplus. The surplus earned by these factors is temporary, as their supply increases and adjusts itself to the demand in the long run. Since, this surplus earning is purely temporary, it cannot be considered strictly as rent and so Marshall termed it as “Quasi-Rent” (ie., nearly rent).

Economists have interpreted quasi rent as the surplus of revenue received over and above the variable cost incurred in producing a particular level of output in the short period. This can be shown as follows :

In the above situation, the quasi-rent earned is EV, as this is the amount which is over and above the average variable cost incurred – ie., EV is quasi-rent earned.