Factor pricing refers to determination of rewards paid to factors of production:
These factor prices are determined by the demand and supply of factors in factor markets. Demand for factors is generally derived demand (depends on demand for final goods).
Rent is the reward paid for the use of land (and other natural resources). In modern economics, rent can also mean payment for any factor whose supply is fixed (economic rent).
Ricardo explained rent as differential surplus arising due to:
Key idea: Rent arises because land is scarce and non-uniform. The least fertile land in cultivation (marginal land) earns zero rent, and superior lands earn rent equal to the excess produce over marginal land.
Wages are the reward for labour services.
Types:
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Factor pricing refers to determination of rewards paid to factors of production:
These factor prices are determined by the demand and supply of factors in factor markets. Demand for factors is generally derived demand (depends on demand for final goods).
Rent is the reward paid for the use of land (and other natural resources). In modern economics, rent can also mean payment for any factor whose supply is fixed (economic rent).
Ricardo explained rent as differential surplus arising due to:
Key idea: Rent arises because land is scarce and non-uniform. The least fertile land in cultivation (marginal land) earns zero rent, and superior lands earn rent equal to the excess produce over marginal land.
Wages are the reward for labour services.
Types:
This theory states that wages are determined by the marginal productivity of labour. In competitive conditions, a firm employs labour up to the point where: where is marginal revenue product of labour and is wage rate.
Thus, wage tends to equal the value contributed by the last (marginal) worker employed.
Interest is the reward for the use of capital (loanable funds).
Types:
Keynes explained interest as a monetary phenomenon determined by:
People demand money for:
Interest rate is the reward for parting with liquidity. When money supply is fixed, higher liquidity preference raises interest rate and lower liquidity preference reduces interest rate.
Profit is the reward for entrepreneurship and risk-bearing. It is the surplus remaining after paying all costs.
Types (basic):
Knight argued that profit is a reward for bearing uncertainty (uninsurable risk).
Entrepreneur earns profit for making decisions under uncertainty and bearing the consequences.
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Ricardo explained rent as differential surplus arising due to differences in fertility and location of land. Since land is scarce and non-uniform, superior lands produce more than inferior lands with same input. The least fertile land in cultivation (marginal land) earns zero rent, and rent on superior land equals excess produce over marginal land.
Marginal productivity theory states wages are determined by the marginal productivity (marginal revenue product) of labour. A profit-maximising firm employs labour up to the point where MRP of labour equals wage rate (MRP = W). Demand for labour is derived from demand for the product, so when product demand rises, labour demand and wages tend to rise.
Factor pricing refers to determination of rewards paid to factors of production—rent for land, wages for labour, interest for capital and profit for entrepreneurship. These factor prices are determined by the demand and supply of factors in factor markets. Demand for factors is derived from demand for the goods and services produced by them.
Ricardian theory of rent: David Ricardo explained rent as a differential surplus arising due to the scarcity and non-uniformity of land. Lands differ in fertility and location advantages. When population grows and demand for food increases, cultivation extends from superior land to inferior land. The least fertile land in cultivation is called marginal land and it yields no surplus over cost; therefore it earns zero rent.
Superior lands produce more output with the same inputs compared to marginal land. The difference between output of superior land and marginal land is the rent. Thus rent is not a cost of production but a surplus arising from differential advantages. Rent increases when demand for agricultural produce increases and cultivation extends to less fertile lands.
Hence, Ricardian rent is determined by differences in productivity and the existence of marginal land with zero rent.