David Ricardo’s theory of rent

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Ricardo on wagesMalthus’ “dismal science”: population naturally grows faster than the food supply. Such growth ultimately checked by starvation and disease→ demographic necessity of misery for the majority.The Poor Laws – 19th century welfare. Seen as leading to rise in fertility → increasing demand for food → rising food prices → lowering real wages → rising poverty and infant mortality.“The Iron Law of Wages” – wage growth and population growth are proportional but tend to stabilize each other. Wage growth above subsistence level leads to population growth which both decreases the real wage back to subsistence level and stems the population growth.The “natural wage” (long run average wage) will thus equal the bare minimum necessary for survival, and this will stabilize the size of the population. 2

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Ricardo on profits

The equalization of the rate of profit

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Ricardo on profits

The equalization of the rate of profit

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Ricardo on profits

The equalization of the rate of profit

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The equalization of the rate of profit

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Ricardo on profits

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Ricardo on profits

The equalization of the rate of profit

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Ricardo on profits

The equalization of the rate of profit

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What is rent?“rent is defined as the price paid for the use of the original and indestructible powers of the soil.” Here “rent” is 1) only agricultural 2) only the charges for the land itself, ignoring all extra charges for developments of the land (e.g. fences, irrigation, buildings etc.).Rent as residual: Ricardo followed Smith in seeing rent as that which is left over after the natural wages of labor and any other costs have been paid for, and the average profit on capital has been attained.For Ricardo rent is a premium which the owners of land are able to charge by reason of a relative advantage of fertility which a particular plot of land enjoys over less productive land.

The Corn Laws and the extension of cultivation

The Corn Laws and the extension of cultivation

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If rent is essentially a premium charged on the relative fertility of the land, then:

As long as there is land of the same fertility that is not being cultivated then no rent can be charged.

It is only when all the highly fertile land is cultivated that the owners of that land can charge a premium to those who want to use it.

(this also requires that all land is owned, for or only then does land cease to be a freely available resource like water, air or sunlight)

natural wage

It is is helpful to think of rent in terms of agricultural output.One portion of this output will go to reproducing the agricultural workers at the level of subsistence or the “natural wage.”The rest is the “surplus product” which will be divided between the landlord's rent and the capitalist farmer’s profit.What determines the division of this surplus product?

Ricardo’s theory of the equalization of the rate of profit implies that capitalist farmers will not be able to consistently make more than the average rate of profit.If the landlord demands a rent so high that the capitalist farmer cannot make the average rate of profit then no capitalist will rent the land.Yet if the capitalist demands a rent so low that she makes more than the average rate of profit then the landlord will easily be able to find other capitalists who will rent the land for less

Therefore rent will tend to be set just high enough for the capitalist to make the average rate of profit.

Rent is “differential” for Ricardo because it is defined as the difference between the total surplus agricultural product and the average rate of profit in the economy as a whole.

rent

avg. profit

Land of less fertility will be cultivated as long as its surplus product is at least as much as the average rate of profit.Ricardo calls this land the “marginal land” since it is the least fertile land which is profitable to cultivate. Because rent is the difference between the total surplus product and the average rate of profit, the marginal land may be defined as the “land which yields no rent.”

marginal land

rent

avg. profit

Less fertile land will not be profitable to cultivate unless the average rate of profit falls relative to the prices of the agricultural output.One way this may happen is if the population rises, driving up food prices and drawing more capital into agriculture.This will lead to land of less fertility being brought under cultivation.

marginal land

rent

avg. profit

The productivity of the capital invested in this newly cultivated land will be less than the capital previously invested in agriculture.Since all surplus on other lands above the level of the marginal land is taken by landlords as rent, the extension of cultivation has the effect of driving down profits on all land.Rising agricultural prices may mean that the total product of the new marginal land is equal in value to the total product of the previous marginal land. However, since the natural wage is fixed by the costs of subsistence it will absorb a larger proportion of this value and the relative share of profits will be diminished in terms of both physical output and value.

marginal land

rent

avg. profit

Rising agricultural prices due to the increased difficulty of agricultural production will cause wages to rise in all other sectors as capitalists will have to pay their workers more in order to maintain them at a subsistence level.This will cause profits to decline in all sectors of the economy.Also, if the population continues to rise, increasing the demand for agricultural goods, a greater and greater proportion of total capital will flow into the agricultural sector and the diminishing productivity of capital in agriculture will increasingly regulate the average rate of profit.

marginal land

natural wage

marginal land

uncultivated land

STATIONARY STATE

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For Ricardo the stationary state was inevitable since capital accumulation inevitably led to population growth which inevitably led to diminishing returns in agriculture as the margin is pushed to less and less fertile land.The stationary state may be staved off by the fact that as it approaches a greater and greater share of wealth is taken by landholders who tend to invest it less productively than capitalists. They thus create less demand for labor and the population will accordingly grow less sharply.Foreign trade also delays the advent of the stationary state since it dramatically increases the potential agricultural land at all levels of fertility (repeal of the Corn Laws).Technical change also delays the advent of the stationary state since it leads to the same amount of capital/labor producing more output on the same land. Yet Ricardo believed that such productivity gains could not go on forever and would thus eventually run up against the process of diminishing returns that he describes.

The stationary state and the limits to growth

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Ricardo’s idea that rent is determined at the agricultural margin has been enormously influential and has been accepted with varying degrees of reservation by most subsequent economic thinkers, including both Marx and neo-classical theorists. The latter transferred Ricardo’s conception of the “marginal product” to other “factors of production” like labor and capital, and founded the “marginalist revolution” on the contribution of this idea to a theory of consumer demand.History has shown a tremendous development of both counter-tendencies to the falling rate of profit which Ricardo identifies: foreign trade and technical change. Yet foreign trade can only be extended as long as there still remain restrictions to trade. And while we have have seen that technical change can be very rapid, there is no more reason to suppose now than in Ricardo’s time that innovation will continue at the same rate indefinitely. Demographers predict that world population will stabilize in the next 70-100 years. In combination with our increasing awareness of the limits of natural resources (including soil fertility) does this indicate that the stationary state is again on the horizon?

How has history treated Ricardo’s theory?

Origin of rent under Extensive Cultivation

• Extensive cultivation is the type of farming under which production is increased by using more land.

Grade of landGrade of land ProductionProduction(in tons)(in tons)

SurplusSurplus i.e. i.e.Rent in tonsRent in tons

AA 2525 25-10=1525-10=15

BB 2020 20-10=1020-10=10

CC 1515 15-10=515-10=5

DD 1010 10-10=010-10=0

O A B C D

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10

15

20

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GRADES OF LAND

RENT ON LAND A

RENT ON LAND B

RENT ON LAND C

NO RENT LAND

PRO

DU

CTIO

N (I

N T

ON

S)

Units of Labor Units of Labor and Capitaland Capital

Marginal Marginal ProductionProduction(in tons)(in tons)

Surplus Surplus Production or Production or RentRent (in tons) (in tons)

11stst 2525 25-10=1525-10=15

22ndnd 2020 20-10=1020-10=10

33rdrd 1515 15-10=515-10=5

44thth 1010 10-10=010-10=0

O 1st 2nd 3rd 4th

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10

15

20

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UNITS OF LABOUR AND CAPITAL

RENT OF UNIT 1st

RENT OF UNIT 2nd

RENT OF UNIT 3rd

NO RENT UNIT OR

MARGINAL UNIT

PRO

DU

CTIO

N (I

N T

ON

S)

Ricardo: Value, Distribution, and Growth

Capital-Labor Input(Capital and Labor are Complements)

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Rent

Profit

WageBill

Ricardo: Value, Distribution, and Growth

Capital-Labor Input(Capital and Labor are Complements)

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w*

Rent

Profit

WageBill

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Ricardo: Value, Distribution, and Growth

Capital-Labor Input(Capital and Labor are Complements)

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duct

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K1

w*

Rent

WageBill

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Profit squeezed to zero Growth ceases