Theory of Rent in economics

14/03/2020 1 By indiafreenotes

According to modern economists, rent is considered as the payment made against the use of land by a tenant. They explained the concept of rent with respect to demand and supply of land.

The demand of land is not direct but derived demand. It is derived from the demand of products that are produced on the land.

In case, the demand of a product increases, then the demand of land also increases and vice-versa. This results in the increase or decrease of rent. For example, with increase in the population of a country, the demand for food increases. This results in the increase of requirement for land and its rent.

The demand of land depends on the marginal productivity of land, which is governed by the law of diminishing returns. Therefore, the demand curve would slope downwards. In such a case, it can be said that the rent of land can be obtained with the help of marginal productivity.

On the other hand, the supply of land is constant for the whole industry; however, an individual organization can increase its supply of land by purchasing more land. The supply of land is perfectly inelastic. This implies that the supply of land would remain the same even if the rent increases or decreases. Therefore, the supply price of land is zero.

For determining rent with the help of demand and supply of land, certain assumptions are made, which are as follows:

(i) Assumes that only one type of land and crop is used for cultivation. In such a case, there would only be one demand and supply curve.

(ii) Assumes that rent exists only in a perfectly competitive market.

Figure:1 shows how demand and supply forces of land interact to obtain rent of land:

In Figure-1, SS represents the supply curve of land that remains constant. Firstly, the demand curve of land was DD that intersects SS at point E. At point E, the rent is equal to OR (= SE). In case, the rent decreases to OR”, then the demand of land increases and rent come back to OR.

Similarly, if rent increases to OR’, then the demand of land declines and rent reaches OR again. D”D” is representing the no-rent condition when the cultivation of land occurs in a new country with plenty of good land. Therefore, OR is the rent at the equilibrium position where supply and demand of land becomes equal.

However, in case the land is of different types, then the demand and supply curve would be different for different lands. In case of an industry, the supply of land does not remain constant. The supply can be increased or decreased by purchasing or selling land or by paying more or less rent. Therefore, in case of a single industry the supply of land is elastic. The supply curve has an upward slope.

Figure: 2 shows the determination of rent in case of an industry:

In Figure-2, at demand DD the rent is OR and the quantity of land is OM. In case the demand reaches D’D’, the rent becomes OR’ with OM’ quantity of land. The land that was previously used for various purposes is now used for a specific industry. In case, the demand of land decline to D”D”, then the rent of land would be OR” and the quantity of land would be OM”. The modern theory of rent is based on the concept of transfer earnings.

Some of the modern economists have defined rent as follows:

According to Hibbdon, “Rent is the difference between the actual payment to a factor and its supply price or transfer earning.”

As per Boulding, “Economic rent may be defined as any payment to a factor of production which is in excess of the minimum amount necessary to keep the factor in its present occupation.