Modern Theory of Rent

Modern theory of rent does not confine itself to the determination of the reward of only land as a factor of production. Rent according to the modern concept can arise in respect of any factor of production Rent is a surplus payment in excess of transfer earning of that factor. Transfer earnings means the amount of money which any particular unit of a factor could earn in its heat best alternative use. Transfer earning care also be defined as the minimum earnings, which a unit of factor of production must be paid in order to induce it to stay in the present use, industry or occupation. In this regard, if a factor is getting less than this minimum, it will give up its present employment and shift to its neat best alternative employment. But if a factor in its present employment is earning more than minimum necessary to keep it in that employment the excess is called economic rent.

Let us give some examples to explain the concept of economic rent or surplus, according to modern concept of rent.

Suppose a Lecturer in economics is getting presenting Rs. 10,000/- per month from a college as salary suppose further that his next best employment can be in a bank where he can get Rs. 9,500.- in a month. If he cannot get 9,500/- in the college, he will take up job in a bank and earn that much. But since he is actually getting Rs. 10,000/- as a lecturer in a college, he is earning Rs. 500/- more than his neat best alternative employment. That is, he is earning Rs. 500 as economic rent.

Talking own their example, suppose, a piece of Land is used to the cultivation of cane in which the owner of land is earning Rs. 150,000/- If in the next alternative i.e. cultivation of cotton. It can produce Rs. 12,000/- then in its present use it is earning Rs, 3,000/- more than its transfer earning. This excess of Rs. 300 is surplus or economic rent.

From the above examples, it is clear that economic rent is the difference between the present earning and transfer earnings. In Joan Robinson’s words “the essence of the conception of rent is the conception of a surplus earned by a particular part of a factor of production over and above the minimum earning necessary to induce at to its work.”

Economists like Alfred Marshall, Mrs. Joan Robinson, K.E. Boulding and so on developed the modern theory of rent.

The two important concepts used in modern economic analysis of factor prices are the concepts of economic rent and what Marshall called transfer earning. Transfer earning is also known as opportunity cost and “Reservation price.”

Economic rent in the sense of surplus over transfer earning will arise. When the supply of the factor unit is less than perfectly elastic or not perfectly elastic. From the point of view elasticity of supply, there are three possibilities (i) When the supply is perfectly elastic (ii) When supply is perfectly inelastic & (iii) When supply is less than perfectly elastic.

(1)        When the supply of factor is perfectly elastic [u=¥]

In this case, when the supply of a factor is perfectly elastic. It means at a given price or remuneration, the entrepreneur can engage or employ any number of the factor units. It is clear that when the factor units are available at a minimum price or transfer earning, their equilibrium price will be equal to that minimum price. At this minimum price present earnings are equal to the transfer earnings. Hence there will be no rent or surplus earnings. This means no factor unit in such a situation will be able to earn more than its transfer earnings. The condition of no rent can be explained with the following figure.

Perfectly elastic supply

From the above figure the SS & DD are the supply and demand of a factor of production say the Land.  Supply of Land is the perfectly elastic, it is horizontal straight line, this means at given price OS, all factor units each factor unit are equal to OS. in horizontal and vertical axes, quantity of factor and price of the factor are measured respectively. In the figure, as DD & SS interests each other at point ‘P’, Librium quantity and factor price are determined at OM & OS (PM). Hence the total earnings are OSPM. Hence, the price of which is transfer earning of each factor unit is also equal to transfer earning of each factor unit, as a result there is no surplus and hence no economic rent. If this firm doesn’t pay the price as, the factor units will be shifted to some other use

Hence, It is clear that if the supply of any factor of production is perfectly elastic for a particular use or industry, then no factor unit can earn surplus or economic rent.

(ii)        When the supply of factor is in elastic [i.e. es = 0].

This is the case of the supply of Land for the community as a whole we know that land for the community is fixed and it can’t be increased or decreased what over the price offered. High price will not increases of low price will not decrease the supply of land. That is why it is said that Land has no supply price. As supply factor is absolute inelastic it is vertical straight lined to OY axis presented in the figure below. As the supply factor is fixed and this factor has here only one use. It can’t be transferred to any other uses hence transfer earning is equal to zero. Therefore, whole factor price earned from present use or occupation is equal to economic rent this is explained in the figure below.

Perfectly inelastic supply

In the above figure SS’ is perfectly inelastic supply curve, which is vertically straight lined to OY axis. DD is the demand curve of Land. DD & SS’ intersects at point P1. Hence, the equilibrium price is determined to op and total earning of Land are equal to OPP1S area. Since in this situation the transfer earnings of land are zero, the entire earnings of land i.e. OP P1S is rent or surplus.

(iii)      When supply of factor is less than perfectly elastic

Now let us take a case when the supply is less than perfectly elastic i.e. it is somewhat elastic or supply curve in this case is positively sloped. This means that the transfer earning of all the factor units are not equal. As in some industry use, the price of the factor increase or more and more of the factor units will offer their services to this industry. In and their word if the price of any factor increases in a particular occupation for that occupation if the transfer earnings are less in another alternative uses hence, Supply of factor of production depends on its transfer earnings this can be explained from the following figure.

Elastic but not perfectly elastic supply

From the figure, on o x and on o y-axes, Quantity of Land and price of factor are measured respectively. Where SS curve is positively sloped means not perfectly elastic. SS curve indication what quantity of the factor will be available at various prices. In other words, It shows the transfer earnings of different factor units. Thus, transfer earning of 4th unit of factor is AA’ where as the price is OP. In other words AA’ amount must be paid to the 4th unit of Land to keep the factor in the same industry. So, this price (AA’) is the minimum price. Hence, surplus or rent unit factor of Land is EA’. It is assumed that all factor units are equally useful for the industry. Hence, the price of all factor units in the industry will be same for the Bth unit of factor. Transfer earning of Bth unit is BB’ and the price is OP hence surplus is FB’. In the same manner economic rent or surplus of other units can be calculated except Dth unit of Land, all other previous factors are earning economic rent differently according to their transfer earnings. From the figure, at point N, DD & supply curve intersects and OD is the equilibrium quantity o y the factor used and the equilibrium price is all factors are OPND where as the transfer earnings are O S N D. If we deduct the transfer earnings, we get PNS; dotted area is called economic rent.

From the above figure, one theory is obvious that the units of Land having larger earnings in other uses need to be paid higher prices to attract them to the present industry or occupation and those with smaller earnings in the other uses need to be paid relatively smaller prices to attract them into the present industry or occupation. In this way, modern theory is also called Demand and supply theory of Rent.

  1. Change in size of the existing population
  2. Change in the technique of production
  3. Change in the number and quality of human wants
  4. Change in the supply of capital
  5. Change in the structure of business organization

These changes affect both the demand and supply sides in the economy. For example, if the demand for a commodity increases due to change in the size of population (while cost of production remaining the same) prize of commodity rises, and then profit of entrepreneur will emerge. Similarly, if new technology in the production is introduced goods will be produced at cheap products and when price is assumed to be constant these will be profit.

The above changed are the general changes. Apart from these changes there are two kinds of changes (i) innovations and (ii) exogenous changes

Innovations

Innovation represent changes introduced by entrepreneur himself, who can introduce new products a new and cheaper method of production a new method of marketing storage. These kinds of innovative techniques will bring reduction in the cost of production and increase the demand, as “result entrepreneur to introduce such innovation by other similar entrepreneurs and the profit will be disappeared. But as an entrepreneur continues new invocation, the profit may be continued again,

Exogenous changes

Exogenous changes refer those changes, which are external to the firms or industries in an economy. These charges affect all the firms in an industry or sometimes all the industries in the economy. The example of exogenous charges are war, inflection (consistent rise in price level), depression change in monetary and fiscal policies of government, change in consumers’ preferences, tastes habits, change in preference between income and leisure and so on. For example, during the war period there will be more demand of goods as a result prize will be higher than the cost and profit will emerge.

Thus analyzing this theory of profit it is concluded that profit is due to the changes in the economy. Hence, profits are a dynamic surplus.

Criticism

The dynamic profit of J.B. Clark has been cruised by economist F.H. knight, Trussing on the following grounds.

  1. Profit without dynamic changes.

Prof. J.B. Clark has argued that profit is emerged due to the dynamic charges in the economy. In the regard, Clark has mentioned fire kinds of generic changes. Profits may also emerge in the absence of Clark’s fire dynamic changes. According to critics, if future fluctuations are predictable, competition will not itself accurately and profits will come into existence.

  1. Comparative Static

According to Prof. A.K. Das Gupta, Clark’s notion of economic dynamic is in fact one of comparation static. Economic dynamic represents continuous changes in the economy but this concept under clerks theory of profit is not realized due to the dynamic changes is not the pure profit but only frictional profit.

2 thoughts on “Modern Theory of Rent”

  1. I and also my guys were found to be examining the nice tips and tricks on your site then all of a sudden I had a terrible suspicion I never expressed respect to the site owner for them. Those young men appeared to be certainly happy to read all of them and already have certainly been enjoying them. Appreciate your turning out to be really accommodating and also for picking this sort of excellent tips millions of individuals are really wanting to discover. Our honest apologies for not saying thanks to you earlier.

  2. I’m just writing to let you be aware of of the fine experience my girl had browsing your web site. She came to find some issues, not to mention how it is like to have a great giving mindset to have certain people completely understand various tortuous subject matter. You truly surpassed her desires. Many thanks for presenting such informative, dependable, informative and easy tips on that topic to Mary.

Leave a Reply

Your email address will not be published. Required fields are marked *