This article resorts to explain in much clear manner the Ricardian theory of rent. Before starting this article, we recommend first be familiar with the concept of land rent and economic rent (Click Here to Read), which will make your learning journey more easy and smooth. Wish you all the best!
Now assuming you have read the recommended article, lets us move to fuller explanation of the theory.
Statement of Theory
It is a classical theory of rent propounded by the David Ricardo, an eminent economist of the 19th century. Ricardo limits the concept of rent as a land rent. In Ricardo’s words, “Rent is that portion of produce of earth which is paid to the landlord for the use of the original and indestructible powers of the soil.” It means that rent is the reward for the use of only land i.e. land rent.
Any return on the improvement costs in the form of capital investments has to be deducted to obtain the price for the use of only land. Putting differently, rent is the price for the use of ‘original and indestructible power of soil’. This implies that one should deduct returns on investment in the form of improvement costs from the contract rent, which is the gross payment to the landlord, to obtain price of using land. Ricardo views the supply of land from the perspective of society as a whole and given. So, it is scarcity that gives rise to the land rent; had there been no scarcity of land, no such thing as land rent would exist.
This theory rests on the following premises:
- Supply of land is perfectly inelastic or fixed, because he views it from the standpoint of a society as a whole.
Land is only used to produce ‘corn’ or otherwise is left idle. This means that land do not have alternative uses and, therefore, nil transfer earning.
- Land differs in quality in respect of fertility and location: Some land are more fertile than other due to such factors as nature of soils, rainfall, and other climate factors; while some lands very well locate near the market center to sold the produce.
- Perfect competition in the land market: Large number of land owners who are willing to rent their lands and large number of farmers/producers who are willing to hire lands.
- Land is the free gift of nature, so there is no supply cost or production cost of land. This way, rent does not enter into the cost of production.
- Operation of the law of diminishing returns in the production.
Given the assumptions of the theory, land rent emerges mainly due to the scarcity of land. When the units of land are homogeneous, land rent arises due to the scarcity of homogeneous land. And also, when the units of land are not homogeneous, land rent arises due to scarcity as well as difference in the quality of lands.
Assuming only labor and capital the factors of production, the cost of production refers the price paid to labor and capital. As long as the demand for land is smaller than the supply of land (no shortage of land), there will not be surplus payment over cost of production (cost of labor and capital). Because, the price of produce equals the long run average cost of production in the perfectly competitive market. Accordingly, there will be no land rent because there will be plenty of lands to meet the increased demand for land. Here the surplus refers to the producer’s surplus or differential gain.
The demand for land is the derived demand in that it results from the increased demand for produce, which again results from the increased population. The sequels are: increase in population, increase in demand for produce, increase in the price of produce, and increase in the demand for land by the producers. It is not price of land pushing price of produce up, but the high price of produce pushing up the price of land through the high demand for land.
Higher profit due to increased price of produce induces the producers. The increased supply of produce by using more lands reduces the price to its initial state, and no more surpluses exist.
Only if the there exist a shortage of land i.e., scarcity of land exists, the land rent emerges. There will be no more lands to meet the increased demand for land. And accordingly, price of produce remains higher and creates the surplus. The rent that results from the scarcity of land is the scarcity rent.
In reality, land differs in terms of fertility and location i.e., there are different classes of lands –some are superior while other inferior. Superior land yields produce at the smaller cost (because of the high fertility and low transportation costs) than the inferior land. So, the differential rent occurs due to the scarcity of the superior land and differences in the productivity of the various kinds of lands.
Differential rent is of primary importance to Ricardo because it drops out the unrealistic assumption of homogeneity of lands. If the scarcity of the superior land would not have existed, there would be nothing such as land rent. On the contrary, scarcity of the superior land results in the land rent or differential rent. Either the extensive cultivation, in which inferior class of land comes under cultivation, or the intensive cultivation, in which usages of more doses of labor and capital take place in the same plot of land, addresses the derived demand for land.
Under Extensive Cultivation
As the price of produce increases up, it will be possible to bring the inferior land under cultivation. Marginal land or no rent land is the one which equalizes the price to the average cost of production and earns no surplus at all. That is, marginal land just covers the cost of production (cost of labor and capital) to be it worthwhile to bring an inferior land under cultivation. Intra-marginal lands (all superior lands above marginal land), on the other hand, earn surplus because of the lower average cost than the price of the produce. We obtain rent earn by the intra-marginal land by deducting the average cost from the price gained by the marginal land, because margin of extensive cultivation equalizes the price of produce.
Note that the concept of marginal land is not fixed, it varies along with the changes in the price of produce. The size of surplus depends on the average cost of production i.e. superior land earns more surplus as compared to the inferior land.
Under Intensive Cultivation
When done the intensive cultivation, average cost of production raise up due to the operation of law of diminishing returns. As a result, the surplus also continuously decreases. The output also increases to some extent by employing more doses of labor and capital which could offset the increased price but does not restore to its initial state. Operation of law of diminishing returns tend to increase the cost of production. We obtain the land rent by deducting the average cost from the price obtained by the margin of intensive cultivation because margin of intensive cultivation equalizes the price of produce.
But in practice, intensive and extensive cultivation jointly operate.
In this way, price of produce or demand conditions for land solely determines the rent. Also note that the land rent is not the part of the production cost, it is rather a superfluous or surplus payments.