RICARDIAN THEORY OF RENT Definition Rent is that

RICARDIAN THEORY OF RENT Definition: Rent is that portion of the produce of earth which is paid to the landlord for the use of the ‘original and indestructible powers of the soil’.

Assumptions: Supply of land is fixed. Single composite crop, say corn. Land differs in quality - in fertility and location. Perfect competition in land market. According to Ricardian theory there are two types of rent: Differential rent and Scarcity rent.

Differential Rent: Here the rent arises due difference in land’s quality – in fertility and situation. More fertile and/or better situated land will have less cost of production, in other words lower average cost than the less fertile land. The farmers will first use the best grade land then lower grades of land successively. For example, three grade of land, in terms of fertility and location – A, B, C. Here A > B > C.

Figure-1: DIFFERENTIAL RENT Grade – A Grade – B MC Grade - C MC MC Y R S P 1 E L K AC H Q P 2 M M 1 Output X AC F A C N N 1 Output P 3 G T Output AR MR

Explanation of Figure - 1 First farmer uses grade – A land here the minimum AC is ML at OM output, but with increasing population when output requirement also rises the AC is M 1 Q at OM 1 level of output. If further increase in output the farmers will move to grade – B land. Here the farmers will continue to produce till ON 1 level of output. Beyond this if output requirement increases the farmers will move to grade – C. here the output level is OT and the market price will be P 3…

Contd… The price is same for the corn produced in all the grades –A, B, or C land. Thus the rent is generated for grade - A is RSQE and grade B have KHGF, where as grade – C will have no rent because it’s a marginal land. Grade – A land have more rent than grade – B because the AC of grade – A is lower than grade – B.

SCARCITY RENT THEORY Meaning: According to Ricardo, rent arises due to scarcity of land.

ASSUMPTIONS: Land is homogenous – both in fertility and location. Single crop ‘corn’. Input factors are labour and capital. Perfect competition in corn and land market. Land supply is completely inelastic.

EXPLANATION OF THEORY As long as the land is idle land is available in the market the price of corn will be equal to the minimum of Average cost of production. If a landlord charge more than the AC then the farmers will move to the other persons to get land for cultivation, because the idle land is still available in the market. Once the land is exhausted and the demand of corn continue to rise to meet the increasing population the price will be above the minimum of AC per unit of output, hence rent arises. See figure – 2 below:

FIGURE - 2 Y MC AC Price of corn H P 1 F P 0 REN T E L O M 0 Output M 1 X

ILLUSTRATION OF FIGURE - 2 Till OM 0 level of output price of corn will be OP 0 which is equal to the minimum of AC, that is M 0 L. When the output level is OM 1 the price is OP 1, which is more than the AC, that is M 1 E, because the land is completely exhausted and still more corn is demanded and hence more corn is produced to meet the demand. The difference in the price and average cost of corn arises due to the scarcity of the land available. The area P 1 FEH is the rent to the landlord, when the output level is OM 1.

LIMITATIONS The assumption of difference in the fertility of land strictly the cultivation on land from most fertile to less fertile is practically do not exist in the real world. The assumption both - corn and land markets are non existing in the real world. The different societies behave differently. The relation between landlord and the farmers are not purely economic, so other important aspects are ignored.