The modern economists like Pareto, Mrs. Joan Robinson, Boulding, Stigler and Shepherd have tried to simplify and generalize the Ricardian theory of rent. According to them, the Ricardian theory of rent is too closely related to land. This creates an impression that rent is a peculiar earning of land only. The fact, however, is that other factors of production i.e., labor, capital and entrepreneurship may also be earning economic rent.
The determination of rent, the modem economists say, can be explained in the same manner as the reward of other factors, that is by demand and supply forces.
Determination of Economic Rent by Demand and Supply Analysis:
Demand for a Factor:
The demand for a factor which may be land, labor or capital is a derived demand. Land, say for example, is demanded for its produce. The higher the produce, the greater is the demand for land. A firm will pay rent equal to the marginal revenue productivity of land. The rent diminishes as more land is used due to the operation of law of diminishing returns. The demand curve of a factor is, therefore, negatively sloped which means more land will be used only at lower rents, other things of course remaining the same.
Supply of a factor:
The supply of land to a particular use (say industry) is quite elastic. It can be shifted to other uses by offering higher rent than that being earned by it now. The supply of a factor (to an industry) is, therefore, rent elastic. If higher rent is paid, the supply of a factor can be increased by withdrawing it from other uses. The supply curve of a factor (industry) slopes upward to the right.
Determination of Economic Rent:
The economic rent is determined by the intersection of demand and supply curves for a factor. In this figure (19.2), the demand curve for a factor say labor in a particular industry is DD/ and the supply curve of workers is SS/. The wage rate or factor price of labor as determined by the market forces is OW. The total workers employed in a particular industry at OW wage rate is OL. The total earning of the workers employed is equal to the area OWEL. At wage rate OW, there are workers who would work, at lower pay but they are also paid at OW wage rate. Those workers whose transfer earnings are less than this wage rate will be getting economic rent. The total economic rent earned by all the intra marginal workers is equal in the area WES. The marginal worker i.e., Lth worker (point L on fig. 19.2) is not obtaining any rent or surplus.
Economic Rent is a Surplus Return:
The modern economists are also of the view that rent as a surplus can be earned by other factors also. It is not peculiar to land alone as explained by Ricardo.
The modern theory of rent is that it is the difference between the actual earning of a factor unit over its transfer earnings. The transfer earnings of a factor of production is the minimum payment required for preventing that factor for transferring it to some other use. It is called the factor supply price in its present occupation.
For example, a worker earns $6000 per month in a factory. In the next best employment, he can get $5000 only per month. The surplus or excess of $1000 which a worker is earning over and above the minimum payment necessary for inducting him to work in the present occupation is the economic rent.
Economic Rent Depends on the Elasticity of Supply of the Factor of Production:
The proportion of the income of a factor that consists of economic rent depends on the elasticity of supply of the factor of production which may be; (i) totally inelastic supply (ii) perfectly elastic supply and (iii) less than perfectly elastic supply.
(i) Perfectly elastic supply. When the supply of a factor of production is perfectly elastic, then none of its income is economic rent. Its entire income is transfer earnings.
In the Fig. 19.3, the supply curve SS/ is a horizontal line. Whatever the amount of factor demanded, the supply price remains at OS. Hence, it earns no surplus in the nature of rent.
(ii) Totally inelastic supply. When the supply of a factor is totally inelastic, then its transfer earnings is zero. The entire income is economic rent.
In the fig. 19.4, the elasticity of the supply of factor of production is zero. It does not increase at all as its demand increases. The supply curve is vertical. The entire of factor income is a surplus which is shown by area ONST.
(iii) Less than perfectly elastic supply. If the supply of a factor of production is neither perfectly elastic nor perfectly inelastic as illustrated in fig.19.5, then some part of the factor income is economic rent and the other part is transfer earnings.
In Fig. 19.5, the supply curve SS/of a factor, say labor, is positively sloped. A firm must pay at least OS price to attract OL units of labor to the given use. If supply of a factor is to rise, the factor must be paid higher and higher wages to attract more units. The demand curve DD/(measuring the marginal revenue product of the labor) interests the supply curve at point R.
Now at OT equilibrium price, Quantity of the Factor ON units of labor are demanded and supplied. Since all the units of the Fig. 19.5 factor up to ON are paid the market price OT, the intra marginal units earn surplus above their supply price. The marginal unit i.e., Nth (point N on fig. 19.5) is not getting any rent. Here the total income of the factor is equal to the area OTRN. It is made up of its economic rent equal to the area STR and its transfer earnings equal to the area OSRN.