This article resorts to explain in much clear manner the Ricardian theory of rent. Before starting this article, we recommend first being familiar with the concept of land rent and economic rent (Click Here to Read), which will make your learning journey easier and smoother. Wish you all the best!
Now assuming you have read the recommended article, let us move to a fuller explanation of the theory.
Statement of Theory
It is a classical theory of rent propounded by David Ricardo, an eminent economist of the 19th century. Ricardo limits the concept of rent as land rent. In Ricardo’s words, “Rent is 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.” 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. Put differently, rent is the price for the use of the ‘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 the price of using the 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 land rent; had there been no scarcity of land, no such thing as land rent would exist.
This theory rests on the following premises:
Assumptions
- The supply of land is perfectly inelastic or fixed because he views it from the standpoint of society as a whole.
The land is only used to produce ‘corn’ or otherwise is left idle. This means that land does not have alternative uses and, therefore, nil transfer earnings.
- Land differs in quality concerning fertility and location: Some lands are more fertile than others due to such factors as the nature of soils, rainfall, and other climate factors; while some lands are very well located near the market center to sell the produce.
- Perfect competition in the land market: A large number of landowners are willing to rent their lands and a large number of farmers/producers are willing to hire land.
- Land is the 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. Also, when the units of land are not homogeneous, land rent arises due to scarcity as well as differences in the quality of land.
Scarcity Rent
Assuming only labor and capital as the factors of production, the cost of production refers to 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 the cost of production (cost of labor and capital). Because the price of produce equals the long-run average cost of production in a perfectly competitive market. Accordingly, there will be no land rent because there will be plenty of land 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 an increase in population, an increase in demand for produce, an increase in the price of produce, and an increase in the demand for land by the producers. It is not the price of land pushing the 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 land reduces the price to its initial state, and no more surpluses exist.
Only if there exists a shortage of land i.e., scarcity of land exists, the land rent emerges. There will be no more land to meet the increased demand for land. Accordingly, the price of produce remains higher and creates a surplus. The rent that results from the scarcity of land is the scarcity of rent.
Differential Rent
In reality, land differs in terms of fertility and location i.e., there are different classes of lands – some are superior while others are inferior. Superior land yields produce at a 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 land.
Differential rent is of primary importance to Ricardo because it drops the unrealistic assumption of homogeneity of lands. If the scarcity of superior land did not exist, 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 the 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 that 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 earned by the intra-marginal land by deducting the average cost from the price gained by the marginal land because the 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 the surplus depends on the average cost of production i.e. superior land earns more surplus as compared to inferior land.
Under Intensive Cultivation
When intensive cultivation, the average cost of production rises due to the operation of a 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. The operation of a law of diminishing returns tends 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 the margin of intensive cultivation equalizes the price of produce.
But in practice, intensive and extensive cultivation jointly operate.
In this way, the price of produce or demand conditions for land solely determines the rent. Also, note that the land rent is not part of the production cost, it is rather a superfluous or surplus payment.