Classical Theory of Rent or �The Ricardian Theory of Rent�

Introduction

The Ricardian Theory of Rent was developed by David Ricardo, a classical economist, in the early 19th century. This theory explains the origin and nature of economic rent, particularly in the context of land.

Definition

According to Ricardo 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.” 

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According to Ricardo, rent is the payment made for the use of land. Rent arises due to the differences in the fertility of the land.

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Assumptions of the Theory�

• Differential Fertility of Land: Ricardo assumed that land differs in its fertility. Some land is more productive than others.
• Law of Diminishing Returns: As more and more labor and capital are applied to a piece of land, the additional output (marginal product) from that land will eventually decrease.

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Assumptions of the Theory�

• No Rent on Marginal Land: The land that just covers the cost of production (labor and capital) but does not generate surplus is known as marginal land. According to Ricardo, marginal land does not earn any rent.
• Ricardo assumed that only one factor of production, i.e. land, can only earn rent.

Assumptions of the Theory

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• Land is the gift of nature, and hence its supply is fixed or inelastic.
• He assumed that land can be used to produce only corn and it has no alternative use.
• Most fertile land will be used at first and then we move on to lesser fertile land.
• Rent accrues due to the fertility of soil which is original and indestructible.

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Assumptions of the Theory

• There is a perfect competition in the land-lease market. This means that there are many landlords willing to rent out their homogenous piece of land.
• It is a long term concept.
• In the Ricardian theory it is assumed that land, being a gift of nature, has no supply price and no cost of production. This means that from society’s point of view the entire return from land is a surplus earning.

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Reasons for Existence of Rent:�

• According to Ricardo rent arises for two main reasons:
• (1) Scarcity of land as a factor and
• (2) Differences in the fertility of the soil.

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Explanation

• According to Ricardo rent arises as the difference between production of Marginal land (On which zero rent accrues) and superior land.
• As there is general tendency to move from most fertile land (Attracts highest rent) to the less fertile land, a point comes where no rent accrues to what is called a Marginal land.
• So in this way Ricardo classified land into various grades according to their fertility. The most fertile land will attract highest rent and Marginal land will attract no rent indicating the land to be the infertile one

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Explanation

• Rent on Superior Land: When production starts, the most fertile lands (A-grade) are used first. These lands produce a surplus over and above the cost of production, which is considered as rent.
• Expansion to Less Fertile Land: As population grows, the demand for agricultural products increases, leading to the cultivation of less fertile lands (B-grade and C-grade). The rent on A-grade land increases as it yields more than B-grade land, and similarly, B-grade land earns rent over C-grade land.

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Explanation

• Marginal Land: The least fertile land in use, which just covers the cost of production without yielding any surplus, is called marginal land. No rent is paid on this land.

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Example

• Imagine there are three different plots of land: A, B, C and D. These plots differ in their fertility, which affects how much corn they can produce per acre.

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Let

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• Plot A (Most Fertile): Produces 40 quintals of corn per acre.
• Plot B (Less Fertile than Plot A): Produces 30 quintals of corn per acre
• Plot C (Less Fertile than Plot B): Produces 20 quintals of corn per acre.
• Plot D (Least Fertile): Produces 10 quintals of corn per acre.

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Example

• Assume that the cost of producing wheat (including labor and capital) is the same on all plots, say Rs.100 per acre. Also, assume the price of wheat in the market is Rs.10 per quintal.

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Example�Calculations�

• Plot A (Most Fertile):
• Output = 40 quintals
• Total Revenue = 40 × Rs.10 = Rs.400
• Cost of Production = Rs. 100
• Rent = Total Revenue - Cost of Production = Rs.400 – Rs.100 = Rs 300
• Plot B (Less Fertile):
• Output = 30 quintals
• Total Revenue = 30 × Rs.10 = Rs.300
• Cost of Production = Rs.100
• Rent = Total Revenue - Cost of Production = Rs.300 - Rs.100 = Rs.200

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Example

• Plot C (Less Fertile):
• Output = 20 quintals
• Total Revenue = 20 × Rs.10 = Rs.200
• Cost of Production = Rs.100
• Rent = Total Revenue - Cost of Production = Rs.200 - Rs.100 = Rs.100
• Plot D (Marginal Land, Least Fertile):
• Output = 10 quintals
• Total Revenue = 10 × Rs.10 = Rs.100
• Cost of Production = Rs.100
• Rent = Total Revenue - Cost of Production = Rs.100 - Rs.100 = Rs.0

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Example

• Interpretation:
• Plot A earns a rent of Rs.300 per acre because it is the most fertile.
• Plot B earns a rent of Rs.200 per acre because it is less fertile than A.
• Plot C earns a rent of Rs.100 per acre because it is less fertile than B.
• Plot D earns no rent because it is the least fertile and just covers the cost of production. It is considered the marginal land.

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Diagram

Implications of the Theory

• Rent as a Surplus: According to Ricardo, rent is a surplus and does not enter into the cost of production. It arises due to the differences in fertility and the scarcity of land.

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Implications of the Theory

• Rent and Price: Ricardo argued that rent does not determine the price of agricultural products. Instead, the price of the product determines the rent. As the price of agricultural products rises, the rent on more fertile land increases.

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Criticisms of the Theory

• Oversimplification: Critics argue that Ricardo’s theory is overly simplistic, as it assumes all rent arises solely from differences in fertility and ignores other factors like location and improvements in land productivity.
• Static Nature: The theory is static and doesn’t account for changes in agricultural technology or land use patterns over time.

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Criticisms of the Theory

• Ignores Urban Land Rent: Ricardo’s theory primarily focuses on agricultural land and does not explain rent in urban areas where factors like location play a more significant role.

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Conclusion

• The Ricardian Theory of Rent remains foundational in the study of economics, particularly in understanding the role of land in economic production and the concept of economic rent.

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