In this article we will discuss about the relation between rent and price.
Generally, the money received as price by the units of an input used by a firm is a part of its cost of production, and, as such, enters into the price of the output. Here we shall try to explain if rent received by an input is a part of the cost of production, and, therefore, enters into the price of the output.
The relation between rent and price or the answer to the question if rent does enter into price depends upon our angle of consideration. In the Ricardian theory, it is said from the point of view of the society or the country as a whole that land is a gift of nature and the society has to incur no cost for getting land, and the supply of land is completely fixed.
In this theory it is also assumed that land can produce only one type of crop and it has no alternative use. Since land is costless and it has no alternative use, the rent of land or the price to be paid for getting its supply is zero in the Ricardian theory, as long as the supply of land is greater than its demand, because of competition among the landlords.
Therefore, if a plot of first grade land is cultivated at a cost Rs 100 (including normal profit) and if 25 quintals of output are produced, then the price of the crop would be Rs 4 per quintal. In this case, the owner of the land does not get anything as rent and, of course, he did not want any rent when he allowed his land to be cultivated.
But when, under the pressure of demand for food-grains, its price rises to Rs 5 (say), so that the cost of production of the second grade land might be covered, the farmer of the first grade plot gets a surplus of Rs 25 over and above his cost of Rs 100, by selling 25 quintals of his output.
In the Ricardian theory, this surplus of Rs 25 is the rent to be handed over to the landlord, and it is a surplus, it is not a part of cost of production. Therefore, in the Ricardian theory, rent does not enter into price. In this theory, price does not rise as there is a rise in rent, rather, rent rises as there is a rise in price.
On the other hand, in the modern theory of rent, land has many alternative uses. For example, a particular plot of land may be used for jute production or it may be used for wheat production. In these circumstances, the supply of land from the point of view of a particular industry, say, jute production, is not fixed.
If the jute grower pays the landlord the amount he gets from the wheat grower, i.e., if he pays the minimum supply price of the land, he would be able to bring the land under jute production. Similarly, the supply of land under jute production may increase further if the jute growers, by paying the minimum supply prices to some other landlords, may be able to obtain their land for jute production.
Therefore, in the modern theory, the supply price of land is positive, it is not zero. In our example, the jute farmer has to pay the landlord the supply price of land to obtain it for jute production. This supply price that is paid to the landlord is rent; it is called contractual rent. It is a fixed contracted amount that the landlord has to be paid per period. It is a part of cost of production of the jute grower.
Therefore, this contractual rent would enter into his price calculations. In equilibrium, the jute farmer would receive a price that covers his cost of production which includes the contractual rent and his normal profit.
However, if the price of jute increases further under pressure of demand to enable cultivation on a lower grade land, our jute farmer now would receive a surplus amount that is to be paid to the landlord for the superior quality of his land.
This surplus amount is economic rent, which is not a part of cost of production and, therefore, which does not enter into the price of jute. Economic rent on a plot of land rises as the price of the product rises, and not the other way round.
We may conclude, therefore, that economic rent—whether in the Ricardian theory or in the modern theory—does not enter into price. It may be noted that rent of land in the Ricardian theory is economic rent, for it is a surplus over and above the minimum supply price—which is zero because land has no alternative use, and Ricardian rent of land does not enter into price.
In the modern theory also, economic rent does not enter into price; of course, contractual rent, as we have seen, enters into, price.