Ricardian Theory of Rent
Just as the Malthusian theory of population has been the basis for all further studies in population, the Ricardian theory of rent has been the basis for all discussion on the problem of rent. The theory is named after David Ricardo, an eminent economist of the 19th century. It is one of the earliest and popular explanations of the nature of rent. 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 power of the soil”. So according to him, rent is a payment made for the use of the “original and indestructible powers of the soil”. In other words, in the strict sense, rent is a payment made for the use of land. Ricardo believed that rent arose because of the differences in the fertility of land. Not all lands are equally fertile and so lands of superior fertility command an advantage over the others. Superior lands get rent. Rent is a differential surplus.
Explanation of the Theory
Ricardo explained his theory of rent with the aid of an example of colonization. Suppose some people go to a new country and settle down there. To begin with, they will cultivate all the best lands available. There may be no need to pay rent so long as such best lands are freely available. Suppose another batch of people go and settle down in the new country after sometime. Naturally, the demand for agricultural produce will increase. And in course of time, the first-grade lands alone cannot produce all the food grains that are needed, on account of the operation of the Law of diminishing Returns. The Law of Diminishing Returns is the basis of the Ricardian theory of rent. So the second-grade lands will have to be cultivated in order to meet the needs of the growing population.
If the second-grade lands are to be brought under cultivation, the price of the grain prevailing in the market must be sufficient to meet the cost of production in the second-grade lands. Otherwise, the second grade lands will go out of cultivation. Since under conditions of competition there will be only one price for a commodity, all the produce, whether it is from the first-grade lands or from the second-grade lands will have the same price. When the second-grade lands are cultivated, the first-grade lands will yield a surplus over and above their expenses of production. This surplus is called rent.
In our present example, only the first-grade land yields rent. The second-grade land covers only the expenses of production. But suppose the demand for food grains further increases. Then inferior lands (In our example, third-grade lands) will be brought under cultivation. Then, even the second-grade lands will yield rent and the rent of the first-grade lands will increase further. The land that is just able to meet its expenses of production is known as no-rent land. Rent indicates the differential advantage of the superior land over the marginal land. While discussing the relationship between rent and price, Ricardo has stated that rent does not enter price. According to him, rent is price-determined, i.e., it is determined by price. Rent is high because price is high and price is high not because rent is high. Ricardo came to the conclusion that rent did not enter price because according to him, there are some no-rent lands. Still their produce has a price on the market and rent does not enter price here because the marginal lands do not get any rent at all.
Rent arises because of differences in the fertility of land. Besides difference in fertility, rent may also arise because of situational advantage. Some lands enjoy situational advantage. For example, they may be nearer to the market. That may help them in saving a lot of transport costs. Even if all lands are equally fertile, lands possessing situational advantage command some superiority over other lands. Thus, rent arises because of differences in fertility and in situation.
Diagrammatic Illustration of the Ricardian Theory of Rent
In figure 1, grades of land are shown along the ‘X’ axis and the output up the ‘Y’ axis. Suppose a farmer by incurring the same expenses of production (say $2,000 on each of the three grades of land) gets 100 units, 50 units and 25 units from first, second and third grade lands respectively. Then the first two grades of land will yield a rent equal to the value of 75 units and 25 units respectively.
It can be explained in detail. Now in the cultivation of the first grade land, the farmer spends $2,000 and gets 100 units. The cost of each unit then is $20. So price should not be less than $20 with regard to the first grade land. On the second grade land too, production expenses are the same, that is, $2,000. But it yields an output of 50 units only. Hence, cost per unit becomes $40. So if a farmer has to be persuaded to cultivate the second grade land, he must get a price of at least $40 per unit. Only then, it will cover his cost of production. (In this connection, it should be remembered that most of the early economists believed that the value of a thing is determined by its cost of production.
Since there will be only one price for a commodity at a time, even the farmer who cultivated the first grade land gets a price of $40 per unit. So he will get a surplus amount equal to the value of 50 units (i.e. $2,000). When the third grade land is cultivated, the second grade land will also get rent since price goes up and the farmer who cultivates the first-grade land will get a higher rent because the price is higher now. That is why Ricardo said, “Rent is high because price is high and price is high not because rent is high.” In our diagram, the first and the second grade lands will yield rent and the third grade land yields no rent. Rent is shown by the shaded area in the diagram.
Criticism of the Ricardian Theory of Rent
- Some of Ricardo’s critics have raised objection against the order of cultivation described by him. According to Ricardo, the best lands are cultivated first. But there is no historical proof for this. Best lands are not always cultivated first.
- Objection has been raised against the use of the phrase “original and indestructible powers of the soil.” It is argued that there are no such original powers of the soil and its powers are not indestructible. For, the fertility of lands may decrease in course of time by continuous cultivation.
- Ricardo considers rent as a peculiar feature of land alone. But many modern economists feel that rent is not something that is specially applicable to land alone. It can be extended to other factors of production such as labor and capital. Whenever the supply of any factor is inelastic in relation to the demand for it, rent arises.
- Many economists have attacked Ricardo’s view that rent is determined by price and it does not get included in price. From the point of view of a single firm, rent enters price.
- Scarcity is the basic fact of economic life. According to Ricardo, if all lands are of equal fertility and if they have the same situational advantage, rent will not arise. Rent arises because there are differences in fertility and situational advantage. But even if all lands are equally fertile, if there is scarcity of land in relation to the demand for it, rent will arise. Thus, Ricardian theory does not take note of scarcity rent.
- Lastly, Ricardian theory is based on the assumption of perfect competition. Only under perfect competition, all units of a good are homogeneous and there is only one price for a good at a time. But in the real world, imperfect competition is the rule.
- In spite of the above criticisms, it must be said that the Ricardian theory of rent underlines the point that increasing pressure of population on land will result in the cultivation of inferior lands.
© 2013 Sundaram Ponnusamy