What Is Modern Theory of Rent? Definition & Explanation

The modern theory of rent is the concept of lending a piece of land for the sake of production of anything like goods and services or for residential purposes. The payments are made in return for the allotment of land, it is the surplus payment made by the borrower in return of rented property.

The theory of rent dates back to 1817. His views and definitions on the rents and payments were later refined by the modern economists Joan Robinson, Stigler, and Pareto in succession. The Ricardian theory was developed with the addition of other important factors other than a mere piece of land.

It included production, workforce, machinery used, capital spending, and planning to execute the work. Joan Robinson modified the definition of rent as a surplus earned by a particular part of a factor of production over and above the minimum earnings necessary to induce it to do work.

The Ricardian Theory

Ricardo was among the pioneers of modern economics, he presented the theory of rent in 1817 in the aftermath of the high rise of corn and land prices after the Napoleonic wars. He analyzed the increase in both land and corn price and interrelated the both in his theory as, “Rent is a portion of the produce of the earth that is paid to the landlord for the use of the original and indestructible powers of the soil”.

The land rent arises because of the soil fertility ratio or the location of a piece of land. Ricardo considered land as a gift of nature, all the earnings from it are surplus revenues as it has no supply price or cost of production. Also, Ricardo stated that the land price increases with the scarcity factor that is inversely proportional to the cost of land. The second important point was the degree of productive capacity or fertility of the land, some lands are more productive than other hence cost more.

Modern Rent Theories

As the theory of Ricardo was related to a piece of land, which too was free of cost and was considered a gift of nature ignoring the fact of its value over the period of time, capital spent on shaping the land, labor, and other factors of production applied to it. The economic rent was redefined by Mrs. Joan Robinson from an industrial perspective.

She said that from an industrial point of view, when an industry is manufacturing a product relates to the land acquired for the production facility and the difference between earnings actually received and its price is called its rent from an industrial point of view.

Benham defined rent as the sum paid to the factors that need not be paid in order to retain the factors in the industry. Stigler defined it as the excess of its return in the best use over its possible return in other uses as a modern theory of rent. All the above-stated theories defined rent as not merely a surplus payment factor but a combinational payment made in return for labor, capital, entrepreneurial idea, and production factor.

Features of Modern Rent Theory

Some of the major features of modern rent theories are:

• Rent is a type of income produced through a difference in actual earnings and transfer earning.
• Rent comes from the income of all the production factors.
• Rent is increased due to the scarcity of land in a particular area; the demand also increases due to labor and overall economic conditions. Rent arises when the supply of the factor is inelastic or partially elastic. More land means lesser rent and vice versa; if an industry needs more land, it will have to pay lesser rent compared to the already acquired space.

Urban land is most expensive due to the scarcity factors i.e. lesser land available in a locality. Here, the term commercial rent is introduced along with rent for residence. The competition is tougher and the land is scarce for homes, offices, industry so the best available option is to erect multi-story buildings in a smaller piece of land to meet the needs. The rents are higher, multi-fold times higher than agricultural lands in competitive commercial and residential urban areas.

Scarcity Theory of Rent

Scarcity theory applies everywhere; it states that the price of land or rent increases when the demand for specific land increases than its supply. Rent is specified at a point where both demand and supply equates. Supply and Demand theories of rent are critical in determining the rent of a property.

Demand for land is dependent on the scarcity of available land; more fertile land means it is scarcer and expensive for agriculture. If more land is being used, it’s price will go down automatically. The supply theory states that the supply of land on earth is perfectly inelastic i.e. the area of land never increases nor decreases.

In a supply-demand curve, the supply curve always inclines upwards while demand slopes downward; the point where both meet is known as economic rent. There are three possible factors of supply in view of rent theory, they are:

1. Perfectly Elastic Supply

The supply is perfectly elastic when the whole of the income transfers earnings i.e. none of the income is economic rent and supply is perfectly elastic. Here, the actual earnings become equal to transfer earning rent.

Actual Earning = Transfer Earning Rent

2. Inelastic Supply

Here, the transfer earnings are zero, and the total income becomes its economic rent. The elasticity of the factor of supply becomes zero and supply does not increase whatever the demand, the income is surplus.

Rent = Actual Earning

3. Supply less than Perfectly Elastic

It relates to Joan Robinson’s concept of transfer earnings that says the transfer earning is a price necessary to retain a given unit of a factor in any industry. Here, the supply of a factor of production is neither perfectly elastic or inelastic; it is a balanced view of rent theory of supply and demand factor where rent and transfer earning have adequate shares to define the income.