Modern Theory of Rent

The modern theory of rent defined as a surplus but this surplus according to it, is earned by a factor unit over and above the minimum earnings necessary to induce it to remain in its present use. The minimum amount that a factor may earn in its present use to prevent it from moving away to some other use is called its reservation price or transfer earnings. The surplus of earnings of a factor over its transfer earnings or reservation price is called economic rent. This surplus may be earned by any factor of production. Land gets rent because of its scarcity. If there is any other factor whose supply is not flexible, it will get some surplus over the minimum payment acceptable to it and will thus get rent. Scarily is not confined to land alone. Even other factors may be in scarce supply that a factor will get due to its scarcity in the short – run is called Quasi Rent. But this quasi rent will disappear in the long – run when it is possible to increase the supply of the factor.

According to the modern theory, rent, like other factor shares, is determined by the equilibrium between demand for and supply of land. It is the scarcity of land in relation to its demand that determined rent. What is true of land is equally true of all other factors. Any factor of production will yield rent if its supply happens to be scarce compared to its demand.

When rent is defined in this manner, it becomes a part of the cost of production. Therefore, unlike the Ricardian concept, in the modern approach rent enters into price.

Transfer Earnings. The modern theory of rent is based on the concept of transfer earnings. Transfer earning of a factor is the amount which the factor will earn in its second best use. Transfer earning or reservation price is thus the opportunity cost of present job and thus any surplus of income over this transfer earning is economic rent.

Rent and Transfer Earnings. Modern economists thus base the concept of rent on the concept of transfer earnings. According to them, transfer earnings of a factor are a part of the cost of production and cannot be treated as a surplus. What a factor earns over and above its transfer earning is its true rent or surplus. Thus, the difference between the present earning of a factor and its transfer earnings is defined as economic rent. Thus, if a unit of a factor is earning more than what it might earn if transferred to the best paid alternative use, the surplus becomes rent.

The Division of Factor Earnings. Normally, the earnings of a factor of a production contain both the elements, transfer earning and the rent. But it is possible to imagine extreme cases where the factor gets an income only equal to its transfer earnings and thus there is rent. Or, it may also be imagined that the transfer earnings of a factor are zero, and hence whatever it is getting is all rent.