0 pricing of factors of production economic rent

8/3/2019 0 Pricing of Factors of Production Economic Rent

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f r o m the m e a n i n g of r e n t in the e v e r y d a y u s a g e of t h e t e r m r e n t , an d wem u st f ir st try to u n d e r s t a n d ho w t h i s r a t h e r s p e c i a l i s e d u s a g e of t h e t e r mr e n t g r e w up.T H E H I S T O R Y OF TH E C O N C E P T OF E C O N O M I C R E N T : In the early part oft h e n i n e t e e n t h c e n t u r y , w h e n E n g l i s h e c o n o m i c s was in its i n f a n c y , t h e r ew a s a c o n t r o v e r s y a b o u t the h i g h p r i c e of c o r n (the g e n e r i c t e r m for allg r a i n s ) . S o m e p e o p l e h e l d t h a t c o r n had a h i g h p r i c e b e c a u s e the l a n d l o r d sw e r e c h a r g i n g v e r y h i g h r e n t s to the f a r m e r s wh o w e r e g r o w i n g c o r n ont h e i r l a n d . It w a s h e l d t h a t , in o r d e r to m e e t t h e s e h i g h r e n t s , the p r i c e t h a tf a r m e r s c h a r g e d for t h e i r c o r n ha d to be r a i s e d to a v e r y h i g h l e v e l. T h u s , itw a s a r g u e d , t h e p r i c e of c o r n w a s h i g h b e c a u s e the r e n t s of a g r i c u l t u r a l l a n dw e r e h i g h . The s e c o n d g r o u p , w h i c h i n c l u d e d D a v i d R i c a r d o , one of thegreat f i gures of E n g l i s h C l a s s i c a l e c o n o m i c s , h e l d t h a t the s i t u a t i o n wase x a c t l y the r e v e r s e . T h e p r i c e of c o r n w a s h i g h b e c a u s e t h e r e w a s a s h o r t a g eo f c o r n c a u s e d by t h e N a p o l e o n i c W a r s . B e c a u s e c o r n had a h i g h p r i c e t h e r ew a s k e e n c o m p e t i t i o n a m o n g s t fa r m e r s to o b t a i n l a n d and t h i s c o m p e t i t i o nb i d up the r e n t s of c o r n l a n d . If t h e p r i c e of c o r n w e r e to fal l so t h a t c o r ng r o w i n g b e c a m e le ss p r o f i ta b l e , t h e n t h e d e m a n d for l a n d w o u l d f a l l , a n d thep r i c e p a i d for the u s e of l a n d , i . e . , r e n t , w o u l d f a l l as w e l l . T h u s , t h i s s c h o o lh e l d t h a t the r e n t of c o r n l a n d w a s h i g h b e c a u s e the p r i c e of c o r n w a s h i g ha n d not vice versa. The m o d e r n s t u d e n t of e c o n o m i c s w i l l r e c o g n i s e in theR i c a r d i a n a r g u m e n t the i d e a of d e r i v e d d e m a n d . L a n d l o r d s , R i c a r d o wass a y i n g , c a n n o t j u s t c h a r g e any p r i c e t h e y w a n t for l a n d ; the p r i c e s t h e yg e t w i l l d e p e n d on d e m a n d and s u p p l y . The s u p p l y of l a n d is p r e t t y w e l lf i xed and the d e m a n d d e p e n d s on the p r i c e of c o r n . T h e h i g h e r is the p r i c eo f c o r n the m o r e p r o f i t a b l e w i l l it be to g r o w c o r n , the h i g h e r w i l l be thed e m a n d for c o r n l a n d , and t h e h i g h e r w i ll be t h e p r i c e p a i d for i ts u s e . T h u s ,t h e r e n t of c o r n l a n d d e p e n d s on the p r i c e of c o r n .

T h e a r g u m e n t w a s e l a b o r a t e d by c o n s i d e r i n g l a n d to h a v e o n l y one u s e ,t h e g r o w i n g of c o r n . Thes u p p l y of l a n d w a s g i v e n andv i r t u a l l y u n c h a n g e a b l e , i . e . , l a n d w a s in p e r f e c t ly i n e l a s t i c s u p p l y a n d l a n d o w n e r s w o u l d p r e f e rt o r e n t out t h e i r l a n d for s o m e r e t u r n r a t h e r t h a n to l e a v e it i d l e . N o t h i n gh a d to be p a i d to p r e v e n t l a n d f r o m t r a n s f e r r i n g to a u s e o t h e r t h a n g r o w i n gc o r n b e c a u s e it had no o t h e r u s e , and no s e l f- r es p e c ti n g l a n d o w n e r w o u l dl e a v e his l a n d i d l e as l o n g as he c o u l d o b t a i n s o m e r e t u r n , no m a t t e r hows m a l l , by r e n t i n g it o u t . T h e r e f o r e , so w e n t the a r g u m e n t , all of t h e p a y m e n t to l a n d , i . e . , r e n t , is a s u r p l u s o v e r a n d a b o v e w h a t is n e c e s s a r y to k e e pit in its p r e s e n t u s e . Given the fixed supply of land, the p r i c e w i l l d e p e n d on thed e m a n d for l a n d w h i c h is i t se l f a f u n c t i o n of t h e p r i c e of c o r n .

R e n t , w h i c h was the t e r m for the p a y m e n t for the use of l a n d , t h u sb e c a m e the t e r m for a s u r p lu s p a y m e n t to a f a c t o r o v e r and a b o v e w h a t


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) R I C I N G O F F A C T O R S O F P R O D U C T I O N 4 3 9w a s n e c e s s a r y t o k e e p i t i n i ts p r e s e n t u s e . S u b s e q u e n t l y t w o fa c t s w e r er e a l i s e d . F i r s t , f a c t o r s o f p r o d u c t i o n o t h e r t h a n l a n d o ft e n e a r n a s u r p l u so v e r a n d a b o v e w h a t is n e c e s s a r y t o k e e p t h e m i n th e i r p r e s e n t u s e . M o v i es t a r s , f o r e x a m p l e , a r e i n v e r y s h o r t a n d p r e t t y w e l l fix ed s u p p l y , a n d t h e i rp o s s ib l e e a r n i n g s i n o t h e r o c c u p a t i o n s a r e p r o b a b l y q u i t e m o d e r a t e ; b u t ,b e c a u s e t h e r e i s a h u g e d e m a n d f o r t h e i r s e rv i c e s , t h e y m a y r e c e i v e p a y m e n t s g r e a t l y in e x c e s s o f w h a t i s n e e d e d t o k e e p t h e m f r o m t r a n s f e r r i n g t oo t h e r o c c u p a t i o n s . S e c o n d l y , it w a s r e a l is e d t h a t l a n d it s el f o f t en h a s m a n ya l t e r n a t i v e u s e s a n d , f r o m t h e p o i n t o f v i e w o f any one use, p a r t of t h e p a y m e n t m a d e t o l a n d w o u l d necessarily h a v e t o b e p a i d t o k e e p t h e l a n d i n i t sp r e s e n t u s e . T h u s i t a p p e a r e d t h a t a l l f a c t o rs o f p r o d u c t i o n w e r e p r e t t ym u c h t h e s a m e : p a r t of t h e p a y m e n t m a d e to t h e m w o u l d b e a p a y m e n tn e c e s s a r y t o k e e p t h e m f r o m t r a n s f e r r i n g t o o t h e r u se s , a n d p a r t a s u r p l u so v e r a n d a b o v e w h a t w a s n e c e s s a r y t o k e e p t h i s f a c t o r i n i ts p r e s e n t u s e .T h i s s u r p l u s c a m e t o b e c a l l e d E C O N O M I C R E N T .

T w o M E A N I N G S O F T H E T E R M R E N T : T h e t e r m e c o n o m i c r e n t is a m o s tu n f o r t u n a t e o n e . T h e a d j e c t i v e e c o n o m i c is o f te n d r o p p e d a n d th e e c o n o m i s t o f t e n s p e a k s o f r e n t w h e n h e m e a n s e c o n o m i c r e n t , t h u s c a u s i n g a c o n f u si o n b e t w e e n t h e c o n c e p t o f a s u r p l u s o v e r a n d a b o v e t ra n s f e r e a r n i n g sa n d t h e p a y m e n t m a d e t o l a n d l o r d s fo r t h e h i r i n g o f l a n d a n d b u i l d i n g s .W h e n a t e n a n t r e f e r s t o h i s r e n t h e is r e f e r r i n g t o w h a t h e p a y s h i s l a n d l o r d ,m u c h o f w h i c h is a tr a n s f e r e a r n i n g n e c e s s a r y t o p r e v e n t t h e l a n d a n d b u i l d i n g i n q u e s t i o n f r o m b e i n g t r a n s f e r r e d t o s o m e o t h e r u s e . I t i s u s u a l l y c l e a rf r o m t h e c o n t e x t w h e t h e r t h e t e r m r e n t i s b e i n g u s e d t o r e f e r t o a s u r p l u so v e r a n d a b o v e t r a n s f e r c o s t ( t h e e c o n o m i s t ' s u s a g e ) o r t o t h e t o t a l p a y m e n t m a d e f ro m t e n a n t t o l a n d l o r d ( t h e e v e r y d a y u s a g e ) b u t it is i m p o r t a n tt o g u a r d a g a i n s t c o n f u s i n g t h e t w o c o n c e p t s .T H E M O D E R N D I S T I N C T I O N B E T W E E N T R A N S F E R E A R N I N G S A N D E C O N O M I CR E N T : T r a n s f e r e a r n i n g s m a y b e d e f i n ed a s a n y p a y m e n t w h i c h m u s t b e 'm a d e t o a fa c t o r t o k e e p i t i n i ts p r e s e n t u s e , i . e ., a p a y m e n t n e c e s s a r y t o Ip r e v e n t t h e f a c t o r f ro m transferring t o s o m e a l t e r n a t i v e e m p l o y m e n t . E c o - |n o m i c r e n t m a y b e d e f i n e d a s a n y p a y m e n t m a d e t o a f a c t o r o v e r a n d a b o v et h a t n e c e s s a r y t o k e e p i t i n i ts p r e s e n t u s e ; e c o n o m i c r e n t , t h e r e f o r e , is t h ed i f f e re n c e b e t w e e n t h e f a c t o r 's a c t u a l e a r n i n g s a n d i ts t r a n s f e r e a r n i n g s .

I n m o s t c a s e s t h e a c t u a l e a r n i n g s o f a f a c t o r o f p r o d u c t i o n w i l l b e ac o m p o s i t e o f t r a n s f e r e a r n i n g s a n d e c o n o m i c r e n t ; it is p o s s i b l e , h o w e v e r , t oi m a g i n e l i m i t i n g c a se s i n w h i c h a l l e a r n i n g s a r e e i t h e r t r a n s f e r e a r n i n g s o re c o n o m i c r e n t . C o n s i d e r s o m e in d i v i d u a l firm o r s o m e i n d u s t r y fa c e d w i t ha p e r f e c t l y e l a s t i c s u p p l y c u r v e o f a f a c t o r o f p r o d u c t i o n ; i t w i l l b e a b l e t oo b t a i n a l l t h a t i t w a n t s a t t h e g o i n g p r i c e b u t , i f i t d o e s n o t p a y t h i s p r i c e , i t


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will not obtain any quanti ty of the factor. In such a case, whic h is illustratedin Figure 33 .2 , the whole pric e paid to the factor represents transfer earnings; the am ount that is ac tual ly paid must be paid to prevent the fac torfrom transferring to another use.

F ig 33.2 All of the income earnedby the factor is transfer earnings.

Q u a n t i t yNow consider the case of a fac tor that is fired in supply and has only one

u s e . Assume that this factor is put on the market by its owners and sold forwhatev er it will fetch, on the grounds that some income is bett er thannothing at all. The whole supply is owned by thousands of different ownersso there is no point in any one of them withholding his own (small) supply

F ig 33.3 All of the income earnedby the factor is an economic rent.

0 a bQ u a n t i t y

from the mark et in an effort to raise the price. Such a factor will be inperfectly inelastic suppl y: the am ount offered for sale will be the samewhatever the price. This case is illustrated in Figure 33 .3 . The whole of theprice that is paid to the factor is an economic rent because, if a lower pr icewere paid, the factor would not transfer to an alternative use. It might be


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t h o u g h t t h a t , i n s u c h a c a s e a s t h i s , t h e fa c t o r w o u l d n o t c o m m a n d a n yp r i c e , b u t t h i s is n o t t h e c a s e . T h e p r i c e , a s i n a l l o t h e r f r e e - m a r k e t c a s e s , isd e t e r m i n e d b y d e m a n d a n d s u p p l y . T h e fix ed q u a n t i t y a v a i l a b l e i s, i n t h ee x a m p l e i ll u s t r a te d i n F i g u r e 3 3 . 3 , t h e a m o u n t Oa , w h i l e , if t h e p r i c e w e r ez e r o , t h e a m o u n t d e m a n d e d w o u l d b e Ob. T h u s a t a p r i c e o f z e r o t h e r ew o u l d b e e x c e s s d e m a n d fo r t h e f a c t o r , a n d c o m p e t i t i o n a m o n g s t b u y e r sw o u l d f o r c e t h e p r i c e u p w a r d s u n t i l i t r e a c h e d Op a n d t h e e x ce s s d e m a n dd i s a p p e a r e d . T h e e q u i l i b r i u m p r i c e p a i d t o t h e f a c t o r is Op, t h e q u a n t i t ye m p l o y e d i s Oa a n d , h e n c e , t o t a l f a c t o r i n c o m e is i n d i c a t e d b y t h e a r e a o ft h e r e c t a n g l e Opra.

F ig 33.4 Som e of t he i ncom e earn ed by the f ac tor is a tr ansf er earn ing an d ther e m a i n d e r is a n e c o n o m i c r e n t .

F i g u r e 3 3 . 4 s h o w s a n u p w a r d - s l o p i n g s u p p l y c u r v e o f a f a c t o r o f p r o d u c t io n . G i v e n t h e d e m a n d c u r v e , D, t h e e q u i l i b r i u m p r i c e w o u l d b e Op a n dt h e e q u i l i b r i u m e m p l o y m e n t Og; t o t a l f a c t o r e a r n i n g s w o u l d b e Opzg. I fOg u n i t s o f t h e f a c t o r a r e t o b e a t t r a c t e d i n t o t h e i n d u s t r y , a n d i f a s i n g l ep r i c e m u s t b e p a i d , t h e n i t i s n e c e s s a r y t o p a y t h e p r i c e Op. H o w e v e r , a l lb u t t h e l a s t u n i t ( i . e . , t h e Ogth, w h i c h m i g h t , s a y , b e t h e 1 5 , 0 0 0 t h ) w o u l d b ep r e p a r e d t o r e m a i n i n t h e i n d u s t r y f o r a p r i c e l es s t h a n Op. I n f a c t , Oa o ft h e s e u n i t s w o u l d b e p r e p a r e d t o r e m a i n if t h e p r i c e w e r e a s l o w a s Or . I f t h ep r i c e r o s e f r o m Or t o Os , a n a d d i t i o n a l ab u n i t s w o u l d b e a t t r a c t e d i n t o t h ei n d u s t r y ; if t h e p r i c e r o s e b y a f u r t h e r st u n i t s , a n a d d i t i o n a l be u n i t s w o u l de n t e r t h e i n d u s t r y . C l e a r l y , f o r a n y u n i t t h a t w e c a r e t o p i c k , t h e p o i n t o nt h e s u p p l y c u r v e c o r r e s p o n d i n g to i t s h o w s t h e m i n i m u m p r i c e t h a t m u s t


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b e p a i d in o r d e r to k e e p t h a t u n i t in the i n d u s t r y ( i . e . , its t r a n s f e r e a r n i n g s ) .E q u a l l y c l e a r l y , if t h e s u p p l y c u r v e s l o p e s u p w a r d , all p r e v i o u s u n i t s h a v el o w e r t r a n s f e r e a r n i n g s . C o n s i d e r , for e x a m p l e , the Odth u n i t ( p o s s i b l y the1 0 , 0 0 0 t h u n i t ) . The t r a n s f e r e a r n i n g s of t h i s u n i t ar e Ou; if a n y l e s s is p a i d ,t h i s u n i t w i l l not be s u p p l i e d , and if a n y m o r e is p a i d , it is a r e n t a p a y m e n t in e x c e s s of w h a t is n e c e s s a r y to k e e p the f a c t o r in its p r e s e n t use.

W e c o u l d r e p e a t the s a m e a r g u m e n t for e v e r y p o i n t ; we c o u l d s h o w , fore x a m p l e , t h a t the t r a n s f e r e a r n i n g s of t h e O a t h u n i t ar e Or, of t h e Obih u n i tOs and of t h e Octh u n i t Ot. R e p e t i t i o n of t h i s a r g u m e n t for e v e r y u n i t f r o mthe f i r s t to the Ogth. s h o w s t h a t the t o t a l t r a n s f e r e a r n i n g s of t h e Og u n i t s ist h e w h i t e a r e a below the s u p p l y c u r v e . S i n c e the t o t al p a y m e n t m a d e is ther e c t a n g l e Opzg, it f o l l o w s t h a t the e c o n o m i c r e n t e a r n e d by the f a c t o r is thes h a d e d a r e a above the s u p p l y c u r v e and b e l o w the l i n e pz.

T h e f o l l o w i n g e x a m p l e i l l u s t r a t e s why a r i s i n g s u p p l y c u r v e s i n v o l v e sr e n t s : if u n i v e r s i t i e s i n c r e a s e the s a l a r i e s p a i d to p r o f e s s o r s of e c o n o m i c s ino r d e r to a t t r a c t a d d i t i o n a l e c o n o m i s t s i n t o u n i v e r s i t y t e a c h i n g (and a w a yf r o m i n d u s t r y and g o v e r n m e n t ) , t h o se e c o n o m i s t s who are p e r s u a d e d tos h i f t i n t o u n i v e r s i t y t e a c h i n g w i l l be r e c e i v i n g o n l y t r a n s f e r e a r n i n g s . Butt h o s e e c o n o m i s t s whow e r e a l re a d y c o n t e n t to be u n i v e r s i t y p r o f e s s o r s w i l lfin d t h e i r s a l a r i e s h a v e i n c r e a s e d as w e l l , and t h i s i n c r e a s e w i l l be a r e n t tot h e m .

F i g u r e s 3 3 . 2 , 3 a nd 4 s u g g e s t the f o ll o w in g i m p o r t a n t c o n c l u s i o n :

The more elastic the supply curve, the less the amountof the payment to factors that is a rent and the morethat is a transfer earning.

K i n d s o f Transfe rsH o w m u c h o f a g i v e n p a y m e n t to a f a c t o r is an e c o n o m i c r e n t and h o w m u c his a t r an s f e r e a r n i n g d e p e n d s on w h a t s o r t of t r a n s f e r we are c o n s i d e r i n g .

I f w e c o n s i d e r the t r a n s f e r of a f a c t o r f r o m on e firm to a n o t h e r w i t h i n as i n g l e i n d u s t r y for w h i c h the s u p p l y of t h e f a c t o r s h o u l d be h i g h l y e l a s t i c ,t h e n p r e t t y w e l l all of t h e f a c t o r ' s e a r n i n g s w i l l be t r a n s f e r e a r n i n g s . If thef ir m i n q u e s t i o n did not pay the f a c t o r the g o i n g p r i c e , t h e n the f a c t o rw o u l d t r a n s f e r to a n o t h e r f i r m in the s a m e i n d u s t r y . If w e are c o n s i d e r i n gt h e t r a n s f e r of a f a c t o r f r o m one i n d u s t r y to a n o t h e r , t h e n p a r t of t h e p a y m e n t m ay be a t r a n s f e r e a r n i n g and p a r t an e c o n o m i c r e n t , s i n c e m o b i l i t yw i l l be less and t h u s t h e s u p p l y c u r v e l e ss e l a s t i c . We c a n n o t p o i n t to a g i v e nf a c t o r , a l a b o u r e r , say, and a s s e r t t h a t of h i s i n c o m e of 1 , 0 0 0 , 8 0 0 is at r a n s f e r e a r n i n g and 2 0 0 a r e n t , for it all d e p e n d s on w h a t t r a n s f e r we arec o n s i d e r i n g .


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P R I C I N G O F F A C T O R S O F P R O D U C T I O N 4 43

E c o n o m i c R e n t a n d Transfer Earnings i n t h e P a y m e n t t o L a b o u rL a b o u r i s a b l e t o m o v e f r o m j o b t o j o b a n d s o m e t h i n g m u s t b e p a i d t o k e e pa g i v e n u n i t o f l a b o u r i n i ts p r e s e n t u s e ; w h a t h a s to b e p a i d f o r t h i s r e a s o nis a tr a n s f e r e a r n i n g t o l a b o u r . H o w m u c h h a s t o b e p a i d t o k e e p l a b o u r i ni ts p r e s e n t u s e d e p e n d s u p o n w h a t t h e u s e i s . L e t u s s a y , fo r e x a m p l e , t h a tc a r p e n t e r s r e c e i v e 3 f o r w o r k i n g a n o r m a l 8-hour d a y . T h e n a s i n g l e s m a l lc o n s t r u c t i o n f irm w i l l h a v e t o p a y 3 p e r d a y o r it w i l l n o t o b t a i n t h e s e r v i c e s o f a n y c a r p e n t e r s . T o t h a t o n e firm t h e w h o l e 3 is a t r a n s f e r p a y m e n t ;i f t h e w h o l e 3 w e r e n o t p a i d , c a r p e n t e r s w o u l d n o t r e m a i n w i t h t h a t firm .B u t c o n s i d e r w h a t w o u l d h a p p e n i f t h e c o n s t r u c t i o n i n d u s t r y e n c o u n t e r e dd i f f ic u l t ie s s o t h a t a l l c o n s t r u c t i o n firm s w e r e f o r c e d t o r e d u c e t h e w a g e so f fe r e d t o c a r p e n t e r s . I n t h i s c a s e c a r p e n t e r s c o u l d n o t m o v e t o o t h e r c o n s t r u c t i o n firm s t o g e t m o r e m o n e y . I f t h e y d o n o t li k e t h e w a g e s o f f e r e d ,t h e y w i l l h a v e t o m o v e t o a n o t h e r i n d u s t r y . I f t h e b e s t t h e y c a n d o e l s e w h e r e i s 2 \0s p e r d a y , t h e n t h e y w i ll n o t b e g i n t o l e a v e t h e c o n s t r u c t i o ni n d u s t r y u n t i l w a g e s i n t h a t i n d u s t r y fa ll b e l o w 2 \0s. I n t h i s c a s e t h et r a n s f e r e a r n i n g s o f c a r p e n t e r s i n c o n s t r u c t i o n a r e 2 \0s a n d , w h e n t h e yw e r e r e c e i v i n g 3 ( p r e s u m a b l y b e c a u s e t h e r e w a s a h e a v y d e m a n d fo r t h e i rs e r v i c e s ) , t h e a d d i t i o n a l \0s w a s a n e c o n o m i c r e n t f r o m t h e p o i n t of v i e w o ft h e c o n s t r u c t i o n i n d u s t r y . N o w c o n s i d e r w h a t w o u l d h a p p e n if t h e r e w a s ad e c l i n e i n t h e d e m a n d f o r c a r p e n t e r s in a l l i n d u s t r i e s . T h e o n l y t h i n g l e ftt o d o , i f o n e d i d n o t l ik e t h e w a g e s , w o u l d b e t o m o v e t o a n o t h e r o c c u p a t i o n :i n o t h e r w o r d s o n e m u s t c e a s e to b e a c a r p e n t e r . I f n o o n e w a s i n d u c e d t od o t h i s u n t i l t h e w a g e f e l l t o 2 , t h e n 2 w o u l d b e t h e t r a n s f e r e a r n i n g s f o rc a r p e n t e r s i n g e n e r a l . T h e w a g e o f 2 m u s t b e p a i d t o p e r s u a d e p e o p l e t ob e c a r p e n t e r s a t a ll . T h e i m p o r t a n t g e n e r a l m o r a l t o t h i s s t o r y is a s f o l lo w s :h o w m u c h o f a n y g i v e n p a y m e n t r e p re s e n t s tr a n s fe r e a r n i n g s a n d h o w m u c he c o n o m i c r e n t d e p e n d s o n w h a t s o r t o f a t r a n s f e r w e a r e c o n s i d e r i n g ; o n ef r o m firm t o f i r m , o n e f r o m i n d u s t r y t o i n d u s t r y , o n e f r o m o c c u p a t i o n t oo c c u p a t i o n , o r p o s s i b l y o n e f ro m a r e a t o a r e a .

S o m e v e r y h i g h l y s p e c i a l i s e d t y p e s o f l a b o u r a r e i n v e r y i n e l a s t i c s u p p l y .T h i s is p a r t i c u l a r l y t r u e o f p e r s o n s s u c h a s s i n g e r s a n d a c t o r s w h o h a v e as p e c i al t a l e n t w h i c h c a n n o t b e d u p l i c a t e d , w h a t e v e r t h e t r a i n i n g . T h ee a r n i n g s t h a t s u c h p e r s o n s re c e i v e a r e m o s t l y in t h e n a t u r e o f a n e c o n o m i cr e n t : t h e y e n j o y t h e i r o c c u p a t i o n s a n d w o u l d p u r s u e t h e m f or v e r y m u c hle ss t h a n t h e h i g h r e m u n e r a t i o n t h a t t h e y a c t u a l l y re c e i v e . T h e i r h i g hr e w a r d s r e s u l t f r o m t h e f a c t t h a t t h e y a r e in very scarce supply relative to thedeman d for their services. I f t h e d e m a n d f o r t h e i r s e r v i c e s w e r e t o r i se t h e i re a r n i n g s w o u l d ri s e p e r m a n e n t l y , w h i l e i f t h e d e m a n d fe ll t h e i r e a r n i n g sw o u l d f all p e r m a n e n t l y .

A n i m p o r t a n t p o l i c y i m p l i c a t i o n o f t h e d i s t i n c t i o n b e t w e e n r e n t s a n d


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t r a n s f e r e a r n i n g s c o n c e r n s t h e e f f e c t i v e n e s s o f w a g e in c r e a s e s o n s u p p l y . F o re x a m p l e , i f t h e C e n t r a l A u t h o r i t i e s fe e l t h a t it i s i n t h e n a t i o n a l i n t e r e s t t oh a v e m o r e p h y s i c i s t s , s h o u l d t h e y s u b s i d i s e p h y s i c i s t s ' s a l a r i e s ? I n t h e l o n gr u n , s u c h a p o l i c y m a y w e l l h a v e a n e f fe c t u p o n s u p p l y . I t m a y i n f l u e n c es c h o o l b o y s u n c e r t a i n a b o u t w h e t h e r t o b e c o m e e n g i n e e r s o r p h y s i c i s ts t ob e c o m e p h y s i c i s t s . B u t i t w i l l a l s o m e a n t h a t a g r e a t d e a l o f m o n e y w i ll h a v et o b e s p e n t o n e x t r a p a y m e n t s t o p e o p l e w h o a r e a l r e a d y p h y s i c i s ts . A n dt h e s e p a y m e n t s w i ll b e e c o n o m i c r e n t s , s i n c e e x i s t i n g p h y s i c is t s h a v e d e m o n s t r a t e d t h a t t h e y a r e p r e p a r e d t o b e p h y s i c i s ts a t t h e i r o l d s a l a r i e s . A l t h o u g hs o m e m a y h a v e b e e n c o n s i d e r i n g t r a n s f e r r i n g t o a n o t h e r o c c u p a t i o n , s u c hm o v e m e n t s a r e n o t c o m m o n . 1 A n a l t e r n a t i v e p o l ic y , w h i c h m a y p r o d u c em o r e p h y s i c i st s p e r p o u n d , i s t o s u b s i d i s e s c h o l a r s h i p s a n d s t u d e n t s h i p s f ors t u d e n t s w h o w i ll t r a i n t o b e c o m e p h y s i c i s ts . T h i s p o l ic y o p e r a t e s o n l y o nt h o s e o n t h e m a r g i n o f e n t e r i n g o r l e a v i n g t h e o c c u p a t i o n a n d d o e s n o tp r o v i d e e x t r a r e n t fo r t h o s e a l r e a d y i n it . T h e D e p a r t m e n t o f S c i e n t if i c a n dI n d u s t r i a l R e s e a r c h i n B r i t a i n a n d t h e N a t i o n a l S c i e n c e F o u n d a t i o n in t h eU S d o p r e c i s e l y th i s . I n t h e s a m e w a y , f o o t b a l l t e a m s a n d m o v i e s t u d i o sp r o v i d e t r a i n i n g s c h o o l s . If t h e s u p p l y c u r v e i s q u i t e i n e l a s t i c , a n i n c r e a s ei n t h e q u a n t i t y s u p p l i e d m a y b e m o r e e a s il y a c h i e v e d b y s h i ft i n g t h e s u p p l yc u r v e t o t h e r i g h t t h r o u g h p o l i c ie s s u c h a s t h o s e o u t l i n e d a b o v e r a t h e r t h a nb y m o v i n g a l o n g i t b y r a i s i n g t h e m a r k e t p r i c e o f t h e f a c t o r .

R e n t a n d Trans fer Earnings in the R e t ur n t o C ap i t a lI f a p i e c e o f c a p i t a l e q u i p m e n t h a s s e v e r a l u s e s t h e n t h e a n a l y s i s o f t h e l a s ts e c t i o n c a n b e r e p e a t e d fo r t h e c a s e o f t h e m a c h i n e . M a n y m a c h i n e s , h o w e v e r , o n c e t h e y a r e c o n s t r u c t e d , a r e u t t e r l y s p e c if i c , h a v i n g o n l y o n e u s e . I nt h i s c a s e , a n y i n c o m e t h a t i s m a d e f r o m t h e o p e r a t i o n o f t h e m a c h i n e i s i nt h e n a t u r e . o f a r e n t . A s s u m e , f or e x a m p l e , t h a t w h e n a m a c h i n e w a s i n s t a l l e d i t w a s e x p e c t e d t o e a r n 5 0 0 p e r a n n u m i n e x c e ss o f a ll i ts o p e r a t i n gc o s t s . I f t h e d e m a n d f o r t h e p r o d u c t n o w f al ls o f f s o t h a t t h e m a c h i n e c a no n l y e a r n 2 0 0 , it w i l l s ti ll b e w o r t h w h i l e o p e r a t i n g i t r a t h e r t h a n t h r o w i n gi t a w a y . I n fa c t , a s s u m i n g t h e m a c h i n e t o h a v e o n l y o n e u s e , i t w i l l p a y t ok e e p it i n o p e r a t i o n r a t h e r t h a n s c r a p i t , a s l o n g a s i t y i e l d s a n y r e t u r n a ta l l o v e r it s o p e r a t i n g c o s t s . 2 T h u s , i f t h e m a c h i n e d o e s y i e l d a r e t u r n o f, s a y ,

1 The problem is different where internation al m obility is high as it is with physicists.One of the reasons for the considerable migration of trained physicists of all ages from Britainto the United States is very much h igher m onetary rewards to be earned in the US compa redwith the U K . Clearly , many British physicists are being paid less than their intern ationa ltransfer earnings and the result is a steady, net flow from Britain to America.

2 T his is just anot her way of stating the proposition given in Chap ter 27, page 356 , thatit pays a firm to continue in operation in the short run as long as it can cover its variable costsof production .


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5 0 0 p e r a n n u m i n a n y o n e y e a r , w e c a n s a y t h a t a ll o f t h e r e t u r n i s a ne c o n o m i c r e n t b e c a u s e t h e m a c h i n e w o u l d s ti ll h a v e b e e n a l l o c a t e d t o i tsp r e s e n t u s e - it h a s n o o t h e r - a s l o n g a s i t y i e l d e d e v e n 1 a b o v e i ts o p e r a t i n g c o s t s . T h u s , once the machine has been installed, a n y n e t i n c o m e t h a t i t e a r n si s a r e n t ( i . e . , a p a y m e n t n o t n e c e s s a r y t o k e e p i t i n i ts p r e s e n t u s e ) . H o w e v e r , t h e m a c h i n e w i ll i n t i m e w e a r o u t a n d i t w i l l n o t b e r e p l a c e d u n l e s si t i s e x p e c t e d t o e a r n a r e t u r n o v e r i t s l i f e t i m e s u f f ic i e n t t o m a k e i t a g o o di n v e s t m e n t f o r i ts o w n e r . T h u s , o v e r t h e l o n g r u n , s o m e of t h e r e v e n u ee a r n e d b y t h e m a c h i n e i s a t ra n s f e r e a r n i n g ; if t h e p a y m e n t is n o t m a d e , am a c h i n e w i l l n o t c o n t i n u e t o b e a l l o c a t e d t o t h a t u s e i n t h e l o n g r u n . I n a n yo n e y e a r , h o w e v e r , t h e i n c o m e e a r n e d c a n s i n k t o z e r o w i t h o u t a f f e c t i n gt h e a l l o c a t i o n o f e x i s t i n g m a c h i n e s t o d i f f e r e n t u s e s i n t h e e c o n o m y .

I n t h i s c a s e , w h e t h e r a p a y m e n t m a d e t o a f a c t o r is a n e c o n o m i c r e n t o ra t r a n s f e r e a r n i n g d e p e n d s o n t h e t i m e s p a n u n d e r c o n s i d e r a t i o n . I n t h es h o r t r u n a l l o f t h e i n c o m e o f a m a c h i n e is i n t h e n a t u r e o f a r e n t , w h i l e i nt h e l o n g r u n s o m e o f i t is i n t h e n a t u r e o f a t r a n s f e r p a y m e n t . F a c t o r p a y m e n t s w h i c h a r e e c o n o m i c r e n t s i n t h e s h o r t r u n a n d t r a n s f e r p a y m e n t s i nt h e l o n g r u n a r e c a l l e d Q U A S I - R E N T S .

E c o n o m i c R e n t a n d Transfer Earnings i n t h e P a y m e n t t o L a n dT h e f o r m a l a n a l y s i s i s i d e n t i c a l t o t h a t g i v e n i n t h e c a s e o f l a b o u r . H o wm u c h o f t h e p a y m e n t m a d e t o a g i v e n p i e c e o f l a n d i s a t r a n s f e r p a y m e n td e p e n d s u p o n t h e n a t u r e o f t h e t r a n s f e r . C o n s i d e r , f ir s t, t h e c a s e o f a ni n d i v i d u a l w h e a t f a r m e r . H e m u s t p a y t h e g o i n g p r i c e o f l a n d i n o r d e r t op r e v e n t t h e l a n d f r o m b e i n g transferred to the use of other wheat farmers. F r o mh i s p o i n t o f v i e w , t h e r e f o r e , t h e w h o l e o f t h e p a y m e n t t h a t h e m a k e s i s at r a n s f e r p a y m e n t . N o w c o n s i d e r a p a r t i c u l a r i n d u s t r y w h i c h u s es l a n d . I no r d e r t o s e c u r e l a n d f o r , s a y , w h e a t p r o d u c t i o n , i t w i l l b e n e c e s s a r y t o o f f e ra t le a s t a s m u c h a s t h e l a n d c o u l d e a r n w h e n p u t t o o t h e r u s e s . F r o m t h ep o i n t o f v i e w of t h e w h e a t i n d u s t r y , t h a t p a r t o f t h e p a y m e n t m a d e fo r l a n dw h i c h i s e q u a l t o w h a t it c o u l d e a r n i n i t s n e x t m o s t r e m u n e r a t i v e u s e is at r a n s f e r p a y m e n t . I f t h a t m u c h i s n o t p a i d , t h e n t h e l a n d w i ll i n f a c t b et r a n s f e r r e d t o t h e a l t e r n a t i v e u s e . If, h o w e v e r , l a n d p a r t i c u l a r l y s u i t a b l e f o rw h e a t g r o w i n g is s c a r c e r e l a t i v e t o t h e d e m a n d f o r i t, t h e n t h e a c t u a l p a y m e n t fo r t h e u s e o f t h is l a n d m a y b e a b o v e t h e tr a n s f e r p a y m e n t ; a n y a d d i t i o n a l p a y m e n t is a n e c o n o m i c r e n t A s s u m e , f or e x a m p l e , t h a t t h e m a x i m u m p a y m e n t t h a t c a n b e o f fe r e d b y f a r m e r s w i s h i n g t o u s e l a n d f o r t h ec r o p n e x t m o s t r e m u n e r a t i v e t o w h e a t is 1 0 p e r a c r e . N o w w h e a t f a r m e r sm u s t o ff e r 1 0 p e r a c r e to s e c u r e t h e l a n d . B u t i t m a y b e t h a t t h e p r i c e o fw h e a t is s u c h t h a t t h e p r o f it s o f w h e a t g r o w i n g a r e v e r y h i g h w h e n o n l y 1 0 p e r a c r e is p a i d f or t h e l a n d . A l a r g e n u m b e r o f f a r m e r s w i l l w i s h t o


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A D I G R E S S I O N O N T H E V A L U E O F A S S E T ST h e a b o v e a n a l y s i s l e a d s n a t u r a l l y t o a d i s c u s s i o n o f t h e r e l a t i o n b e t w e e nt h e e a r n i n g p o w e r o f a n a s s e t a n d i ts m a r k e t p r i c e . T h e d i s c u s s i o n a p p l i e st o a n y a s s e t t h a t c a n e a r n a r e v e n u e w h e t h e r it i s a f a c t o r o f p r o d u c t i o n( s u c h a s l a n d ) o r a s t o c k o r a b o n d . C o n s i d e r f irs t a n e x a m p l e o f t w o p i e c e so f l a n d o f e q u a l s i z e , o n e g r o w i n g w h e a t a n d r e t u r n i n g , a ft e r c o s t s , a p r o f i t

1 Thus the old examination question, 'Discuss the view that the price of cinema seats is highin central L ondo n beca use the price of land is high', should be answ ered in the affirmative, notin the negative as examiners often seemed to expect.

h i r e l a n d a t t h is p r i c e in o r d e r t o g r o w w h e a t : t h e d e m a n d f o r w h e a t l a n dw i l l e x c e e d it s s u p p l y . C o m p e t i t i o n w i l l b i d u p t h e r e n t o ff e r e d u n t i l t h ed e m a n d is e q u a l t o t h e s u p p l y . T h e r e n t a l fin ally e s t a b l i s h e d m i g h t b e , s a y , 1 3 p e r a c r e . I n t h i s c a s e , fr o m t h e p o i n t o f v i e w o f t h e w h e a t i n d u s t r y a s aw h o l e , 1 0 is t r a n s f e r e a r n i n g s a n d t h e r e m a i n i n g 3 is e c o n o m i c r e n t . I ft h e p r i c e o f w h e a t fa ll s a n d , a s a r e s u l t , t h e d e m a n d f o r w h e a t l a n d f a ll s ,t h e n t h e r e n t p a i d f o r w h e a t l a n d w i l l a l s o f a ll . T h i s w i ll c o n t i n u e u n t i l t h er e n t o f f e re d f a l ls t o 1 0 a n d t h e n l a n d w i ll b e g i n t o b e t r a n s f e r r e d o u t o fw h e a t i n t o o t h e r u s e s. T h i s t ra n s f e r w i ll c o n t i n u e a n d t h e s u p p l y o f w h e a tw i l l d i m i n i s h u n t i l t h e p r i c e o f w h e a t ri s e s s u f f i c ie n t l y s o t h a t t h e r e m a i n i n gw h e a t f a r m e r s c a n o ff e r t o p a y t h e 1 0 t r a n s f e r c o s t t o k e e p t h e l a n d o u t o fo t h e r u s e s .L a n d i s v e r y m o b i l e b e t w e e n a g r i c u l t u r a l u s e s b e c a u s e t h e l o c a t i o n i su s u a l l y o f l i tt l e i m p o r t a n c e . I n t h e c a s e o f u r b a n u s e s , h o w e v e r , l o c a t i o n o ft h e l a n d is c r i t i c a l a n d , f r o m t h i s p o i n t o f v i e w , l a n d i s o f c o u r s e c o m p l e t e l yi m m o b i l e . I f t h e r e i s a s h o r t a g e o f l a n d i n c e n t r a l L o n d o n , s u c h l a n d a s isa v a i l a b l e w i ll c o m m a n d a h i g h p r i c e b u t , n o m a t t e r w h a t t h e p r i c e p a i d ,t h i s w i ll n o t c a u s e l a n d i n r u r a l a r e a s t o m o v e i n t o c e n t r a l L o n d o n . T h ev e r y h i g h p a y m e n t s m a d e t o u r b a n l a n d a r e i n t h e n a t u r e o f e c o n o m i c r e n t s .T h e l a n d is s c a r c e r e l a t i v e to d e m a n d f or i t a n d i t c o m m a n d s a p r i c e v e r ym u c h a b o v e w h a t i t c o u l d e a r n i n a g r i c u l t u r a l u s e s . T h e p a y m e n t w h i c h i tr e c e i v e s is t h u s w e l l i n e x c e s s o f w h a t is n e c e s s a r y t o p r e v e n t i t f r o m t r a n s f e r r i n g f r o m u r b a n b a c k t o a g r i c u l t u r a l u s e s . F r o m t h e p o i n t o f v i e w , h o w e v e r , o f o n e p a r t i c u l a r t y p e o f u r b a n u s e , h i g h r e n t s a r e a tr a n s f e r p a y m e n tw h i c h m u s t b e p a i d t o k e e p th e l a n d f ro m t r a n s f e r r i n g t o o t h e r u r b a n u s e s .M o t i o n p i c t u r e c i n e m a s , f or e x a m p l e , p r o v i d e b u t a s m a l l p o r t i o n o f t h et o t a l d e m a n d f o r l a n d i n c e n t r a l L o n d o n ; if t h e r e w e r e n o c i n e m a s a t a l l,

: r e n t a l s o f l a n d w o u l d b e a b o u t w h a t t h e y a r e n o w . T h u s t h e c i n e m a i n d u s -! t r y f a c es a p e r f e c t l y e l a s t i c s u p p l y o f l a n d i n c e n t r a l L o n d o n , a n d t h e w h o l eJ o f t h e p r i c e t h a t it p a y s f o r i ts l a n d is a t r a n s f e r p a y m e n t w h i c h m u s t b e

p a i d t o k e e p t h e l a n d f r o m t r a n s f e r r i n g t o o t h e r u s e s . 1


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o f 1 , 0 0 0 p e r a n n u m ; t h e o t h e r g r o w i n g o a t s a n d r e t u r n i n g , a f te r a ll c o s t s ,a p ro f it o f 5 0 0 p e r a n n u m . A s s u m i n g t h a t t h e s e c o n d p i e c e o f l a n d i s a sg o o d a s t h e f ir s t , t h e p e r s o n f a r m i n g i t w o u l d b e li k e l y to t r a n s f e r it f r o mo a t s t o w h e a t p r o d u c t i o n . A s s u m e , h o w e v e r , t h a t t h is c a n n o t b e d o n e o rt h a t t h e firs t p i e c e o f l a n d i s s u i t a b l e o n l y f o r g r o w i n g w h e a t a n d t h a t t h es e c o n d p i e c e is s u i t a b l e o n l y f o r g r o w i n g o a t s . U n d e r t h e s e c i r c u m s t a n c e s ,t h e firs t p i e c e o f l a n d is c l e a r l y w o r t h t w i c e a s m u c h a s t h e s e c o n d p i e c e o fl a n d . I f, f or e x a m p l e , t h e t w o p i e c e s w e r e o f fe r e d f o r s a l e a t p r i c e s o f 1 0 , 0 0 0a n d 7 , 5 0 0 , n o o n e w o u l d b u y t h e s e c o n d p i e c e i n p r e f e r e n c e t o t h e firs to n e . T e n t h o u s a n d p o u n d s i n v e s t e d i n b u y i n g t h e firs t p i e c e o f l a n d y i e l d s 1 , 0 0 0 p e r y e a r , w h e r e a s t h r e e - q u a r t e r s a s m u c h m o n e y , i .e ., 7 , 5 0 0 , i n v e s t e d i n t h e s e c o n d p i e c e y ie l d s o n l y h a l f a s m u c h i n c o m e , i . e ., 5 0 0 p e ry e a r . C l e a r l y , t h e f irs t p i e c e o f l a n d is a b e t t e r i n v e s t m e n t t h a n t h e s e c o n do n e , a n d n o o n e w o u l d b e p r e p a r e d t o b u y t h e s e c o n d p i e c e . If, h o w e v e r ,t h e firs t p i e c e w e r e o f fe r e d f o r 1 0 , 0 0 0 a n d t h e s e c o n d p i e c e f o r 5 , 0 0 0 ,t h e n b o t h p i e c e s w o u l d r e p r e s e n t e q u a l l y g o o d i n v e s t m e n t s . T h e r a t e o fr e t u r n p e r p o u n d i n v e s t e d w o u l d t h e n b e th e s a m e fo r e a c h p i e c e o f l a n d .

W h e n p e o p l e b u y a n a s s et - a p i e c e o f l a n d , a g o v e r n m e n t b o n d , a c o m m o n s t o c k - th e y a r e i n v e s t i n g t h e i r m o n e y i n r e t u r n f o r s o m e e x p e c t e dy i e l d . S e l f - i n t e r e s t o n t h e p a r t o f i n v e s t o r s e n s u r e s t h a t t h e r e l a t i v e p r i c e s o fv a r i o u s a s s e t s w i l l r e f le c t t h e i r r e l a t i v e e a r n i n g p o w e r s . I f o n e a s s e t b r i n g sa n i n c o m e t w i c e a s b i g a s t h a t b r o u g h t b y a n o t h e r a s s et , ceteris paribus, t h eo n e a ss e t w i ll c o m m a n d t w i c e t h e p r i c e o f t h a t c o m m a n d e d b y t h e o t h e ra s s e t . I f t h i s is t h e c a s e , t h e n a p o u n d i n v e s t e d i n e i t h e r a s s e t w i l l b r i n g t h es a m e r a t e o f r e t u r n . W e r e t h i s n o t t h e c a s e , a p o u n d i n v e s t e d in o n e a s s e tw o u l d b r i n g a h i g h e r r e t u r n t h a n a p o u n d i n v e s t e d in t h e o t h e r a n d a l l i n v e s t o r s w o u l d p r e f e r o n e a s s e t t o t h e o t h e r .

T h i s c o m p a r i s o n b e t w e e n a s s et s c a n b e s t b e m a d e b y e x p r e s s i n g t h e r e t u r no n e a c h a s s e t a s a p e r c e n t a g e o f t h e p u r c h a s e p r i c e . I n t h e a b o v e e x a m p l e ,t h e a n n u a l e a r n i n g s a r e 1 0 p e r c e n t o f t h e p u r c h a s e p r i c e : a n y o n e b u y i n ge i t h e r p i e c e o f l a n d w o u l d h a v e a n a n n u a l i n c o m e e q u a l to 1 0 p e r c e n t o fh i s i n v e s t m e n t .

N o w , a s s u m e t h a t t h e g e n e r a l r a t e of r e t u r n t h a t c a n b e m a d e o n i n v e s t m e n t s o f a g i v e n d e g r e e o f ri s k is X p e r c e n t . I n t h i s c a s e , t h e p r i c e o f a n ys i n g l e a s s e t o f a c o m p a r a b l e d e g r e e o f r is k w i ll b e d e t e r m i n e d i n t h e m a r k e t ,s o t h a t i t a l s o y i e l d s a r e t u r n o f X p e r c e n t . I f t h e p r i c e w e r e l o w e r , e v e r y o n ew o u l d r u s h t o b u y t h is a s s e t r a t h e r t h a n t h e o t h e r s t h a t y i e ld X p e r c e n t ; i ft h e p r i c e w e r e h i g h e r , n o o n e w o u l d w i s h to b u y t h i s p a r t i c u l a r as s e t w h e na l l o t h e r s y i e l d e d X p e r c e n t .

A s s u m e , fo r e x a m p l e , t h a t t h e g o i n g r a t e o f r e t u r n i s 5 p e r c e n t . A p a r t i c u l a r a ss e t y i e l d i n g a n e t i n c o m e o f 2 0 0 p e r y e a r i n d e f in i t e l y w o u l dc o m m a n d a p r i c e o f 4 , 0 0 0 . If t h e p r ic e w e r e l es s , s a y , 2 , 0 0 0 , t h e e a r n i n g s


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A s s u m e t h a t I l o a n 1 , 0 0 0 to t h i s c o m p a n y by p u r c h a s i n g t h i s b o n d at at i m e w h e n the m a r k e t r a t e of i n t e r e s t is 5 per c e n t . N o w a s s u m e t h a t a fewy e a r s l a t e r t h e m a r k e t r a t e o f i n t e r e s t r is e s to 1 0 p e r c e n t so t h a t f i rm s i s s u i n gn e w b o n d s s i m i l a r to the one i l l u s t r a t e d w i l l h a v e to o f fe r 1 0 0 per y e a rb y w a y of i n t e re s t p a y m e n t . N o w , if I s h o u l d w i s h to se l l m y e x i s t i n g 1 , 0 0 0b o n d , p a y i n g 5 0 i n te r e s t per y e a r , I w i l l be u n a b l e to o b t a i n 1 , 0 0 0 for it.

>w o u l d be in e x c e s s of 5 per c e n t ; in f a c t , t h e y w o u l d be 10 per c e n t , ande v e r y o n e w o u l d r u s h to buy t h i s a s s e t . The c o m p e t i t i o n a m o n g p o t e n t i a lp u r c h a s e r s w o u l d p u s h up the p r i c e . If t h e p r i c e w e r e h i g h e r t h a n 4 , 0 0 0 ,s a y 8 , 0 0 0 , t h e n the y i e l d w o u l d be l e s s t h a n 5 per c e n t - in f a c t , 2 - 5 perc e n t in t h i s c a s e - and no o n e w o u l d w i s h to p u r c h a s e thea s s e t an d its p r i c ew o u l d h a v e to f a l l .

The price of an asset is directly related to its earningcapacity. If there is competition among purchasers ofassets, asset prices will tend to be set at levels thatyield the same rates of return on each asset.

T h e a b o v e d i s c u s s i o n of t h e p r i c i n g of a s s e t s can be a p p l i e d to one p r o b l e m t h a t is e x t r e m e l y i m p o r t a n t in s u b s e q u e n t p a r t s of t h i s b o o k . A b o n di s e v i d e n c e of d e b t . It u s u a l l y t a k e s the f o r m of a p i e c e of p a p e r r e c o r d i n g ap r o m i s e to r e p a y the sum of m o n e y o r i g i n a l l y b o r r o w e d (the p r i n c i p a l ) ats o m e f u t u r e d a t e , and to p a y a s t a t e d s u m ofm o n e y e a c h y e a r in the i n t e r i m( t h e i n t e r e s t on the l o a n ) . A s t y l i s e d p i c t u r e of s u c h a b o n d is p r e s e n t e dh e r e :


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)S i n c e i n v e s t o r s c an p u r c h a s e a new b o n d y i e l d i n g 10 per c e n t , no one w i l lp u r c h a s e m y b o n d s for 1 , 0 0 0 , as t h i s w i l l y i e l d t h e m o n l y 5 per c e n t . T h u sa p u r c h a s e r w o u l d o f fe r m e a p r i c e s u f fi c ie n t ly b e l o w 1 , 0 0 0 so t h a t hew o u l d r e c e i v e 10 per c e n t on his i n v e s t m e n t .

A rise in the current rate of interest entails a fall inthe market price of all existing bonds, the fall beingsufficient so that a purchaser of an existing bond willreceive the same return on his investment as he couldreceive by buying a new bond. Thus the current rateof interest on new loans and the market price of exist-ing bonds vary inversely with each other.

L A N D R E N T S , L A N D V A L U E S A N D L A N D T A X E S : The relation between thee a r n i n g s of l a n d and thev a l u e of l a n d i s j u s t a s p e c i a l c a s e of h o w the v a l u eo f a s s e t s is d e t e r m i n e d . Q u i t e c l e a r ly , the l a r g e r the y i e l d t h a t c an beo b t a i n e d for any g i v e n p i e c e of l a n d , the h i g h e r the r e n t (in the e v e r y d a ys e n s e of the w o r d ) t h a t c an be o b t a i n e d for the l a n d ' s s e r v i c e s , and theh i g h e r the p r i c e t h a t c an be o b t a i n e d f r o m s e l l i n g the l a n d . The s a l e v a l u eof a p i e c e of l a n d is t h e r e f o r e d i r e c t l y r e l a t e d to the r e n t t h a t c an be a s k e dfo r the l a n d ; b o t h of t h e s e r e f l e c t the s a m e t h i n g , e a r n i n g p o w e r . T h i s is allv e r y o b v i o u s but it is s u r p r i s i n g l y e a s y to f o r g e t it in p r a c t i c e . C o n s i d e rt w o s e p a r a t e q u e s t i o n s : (1) W h a t w o u l d be the ef f ec t s of a 10 per c e n t taxo n all r e n t s p a i d for the u s e of l a n d ? 1 and (2) W h a t w o u l d T ie the ef f ec t s ofa 10 per c e n t tax on t h e v a l u e of a l l l a n d in a c o u n t r y ? M o s t s t u d e n t s w o u l dh a v e l i t t l e t r o u b l e w i t h the f i r s t q u e s t i o n . T h e y w o u l d a n s w e r s o m e w h a t asf o l l o w s : s i n c e the tax is l e v i e d on all r e n t s the r e l a t i v e p r o f i t a b i l i t y ofd i f f e r e n t u s e s w i l l be u n a f f e c t e d and t h u s t h e r e w i l l be no a l l o c a t i v e e f f e c t s .L a n d w i l l not be f o r c e d out of u s e b e c a u s e l a n d w h i c h is v e r y u n p r o f i t a b l ew i ll c o m m a n d l i tt l e r e n t an d so pay l i t t l e t a x . T h u s t h e r e w i l l be no c h a n g ei n the s u p p l y of g o o d s w h i c h are p r o d u c e d w i t h the aid of l a n d a n d , s i n c et h e r e is no c h a n g e in s u p p l y , t h e r e c an be no c h a n g e in p r i c e s . Thus the taxcannot be passed on to consumers. F a r m e r s w i l l be w i l l i n g to p a y j u s t as m u c h( a n d no m o r e ) as t h e y w o u l d h a v e o f fe r e d p r e v i o u s l y for the use of l a n d .A g r i c u l t u r a l p r i c e s and r e n t s w i l l be u n c h a n g e d and the w h o l e of t h e taxw i l l be b o r n e by the l a n d l o r d . Th e net r e n t s e a r n e d by l a n d l o r d s w i l l f a l lb y 10 per c e n t and the s a l e v a l u e of l a n d w i l l f al l c o r r e s p o n d i n g l y .

B u t n o w c o n s i d e r the s e c o n d q u e s t i o n . A tax on l a n d v a l u e s w i l l h a v e ani d e n t i c a l e f f e c t to t h o s e a n a l y s e d a b o v e ! T h e r e is no way in w h i c h l a n d l o r d s c an p a s s the tax on to t e n a n t s . The tax w i l l be b o r n e w h o l l y by l a n d l o r d s and the s a m e l a n d l o r d s w i l l pay the h e a v i e s t t a x e s as in the c a s e of a

1 Assuming that persons using their own land would have a market rental assessed by thetax department and the tax then levied on this assessed re ntal.


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t a x o n r e n t s ; t h is i s b e c a u s e t h e l a n d s w h i c h e a r n t h e h i g h e s t r e n t s w i ll a l s ob e t h o s e w i t h t h e h i g h e s t v a l u e s . P r e s e n t e d o n l y w i t h t h e s e c o n d q u e s t i o n ,h o w e v e r , i t i s e a s y t o f o r g e t t h a t e a r n i n g s a n d s a l e v a l u e s a r e j u s t t w o w a y so f e x p r e s s i n g t h e s a m e t h i n g a n d t h a t t h e re s u l t s o f a t a x o n l a n d v a l u e sw o u l d b e t h e s a m e a s a t a x o n r e n t s .

I t s h o u l d b e n o t e d t h a t t h e g e n e r a l a r g u m e n t t h a t t h e ta x o n r e n t s ( o r o nl a n d v a lu e s ) is b o r n e w h o l l y b y l a n d l o r d s d e p e n d s o n t h e c o n d i t i o n t \ a tt h e f a ll i n t h e p r i c e o f l a n d w i l l n o t i n d u c e l a n d l o r d s t o w i t h d r a w l a n d f r o mt h e m a r k e t . U n d e r c o m p e t i t i v e c o n d i t i o n s , t a x e s a r e p a s s e d o n w h e n e a c hi n d i v i d u a l p r o d u c e r is i n d u c e d b y t h e t a x to r e d u c e t h e q u a n t i t y o f t h ep r o d u c t w h i c h h e o f fe r s f o r s a l e . T h e r e w i l l t h u s b e a r e d u c t i o n i n t o t a ls u p p l y , w h i c h w i l l c a u s e t h e p r i c e t o r i s e . O f c o u r s e , a t a x p l a c e d o n l y o nl a n d u s e d t o g r o w w h e a t w o u l d c a u s e l a n d l o r d s t o t r a n s f e r l a n d f r o m w h e a tp r o d u c t i o n t o o t h e r u s e s ; t h e s u p p l y of w h e a t w o u l d b e r e d u c e d ; t h e p r i c eo f w h e a t w o u l d ris e; a n d t h e t a x w o u l d b e p a s s e d o n , a t le a s t i n p a r t , t oc o n s u m e r s . T h e s u p p l y o f l a n d t o w h e a t p r o d u c t i o n i s v a r i a b l e , b u t if t h et o t a l s u p p l y o f l a n d t o a l l u s e s d o e s n o t r e s p o n d t o t h e t a x o n r e n t a l s , t h e nt h e ta x c a n n o t b e s h i ft e d b y l a n d l o r d s . W e h a v e a l r e a d y w a r n e d a g a i n s tt h e a s s u m p t i o n t h a t t h e t o t a l s u p p l y o f a r a b l e l a n d c a n n o t b e r e d u c e d i n

" s u p p l y . S o m e t a x e s o n l a n d m i g h t d i s c o u r a g e l o n g - r u n c o n s e r v a t i o n p o l i c i e ss o t h a t t h e t o t a l s u p p l y o f c u l t i v a b l e l a n d w o u l d d i m i n i s h . I f t h i s w e r e t r u e ,t h e p r i c e s o f a g r i c u l t u r a l c o m m o d i t i e s w o u l d r i s e a n d p a r t o f t h e e ff e ct o f t h et a x w o u l d b e p a s s e d o n t o t h e c o n s u m e r s o f a g r i c u l t u r a l p r o d u c e .

T HE S I N G L E - T A X M O V E M E N TT a x a t i o n o f l a n d v a l u e s h a s h a d e n o r m o u s a p p e a l b o t h i n t e l le c t u a l l y a n dp o l i t i c a ll y . T h e p e a k o f i ts a p p e a l w a s 8 0 y e a r s a g o . T h e ' s i n g l e - t a x m o v e m e n t ' o f w h i c h H e n r y G e o r g e ( 1 8 3 9 - 1 8 9 7 ) , a n A m e r i c a n p r i n t e r , 1 w a s t h eg u i d i n g g e n i u s , c a u g h t t h e i m a g i n a t i o n o f h u n d r e d s o f t h o u s a n d s o f p e o p l eo n b o t h s id e s o f t h e A t l a n t i c . T h e p o l i c y w a s t o t a x a w a y t h e ' u n e a r n e di n c r e m e n t ' t h a t a c c r u e d t o l a n d o w n e r s . W h a t w a s t h e a p p e a l ?

' T h e t o t a l s u p p l y o f l a n d i n a c o u n t r y t e n d s t o b e p r e t t y w e l l f i x e d. A sb o t h p o p u l a t i o n a n d i n c o m e s ri s e , t h e r e w i ll b e a n i n c r e a s e in t h e d e m a n d

, f o r l a n d . T h i s r is e i n d e m a n d w i l l c a u s e a n i n c r e a s e i n t h e r e n t s , a n d , s i n c ev a l u e s d e p e n d o n w h a t c a n b e e a r n e d , it w i l l a l s o c a u s e a n i n c r e a s e in t h e

; v a l u e s o f l a n d . 2 T h u s t h e o w n e r s o f l a n d g a i n f r o m t h e n a t u r a l p r o g r e s s o fi s o c i e ty w i t h o u t th e i r h a v i n g t o c o n t r i b u t e a n y t h i n g .

1 George ran for Mayor of New York City in 1886, and very near ly won. He campaignedon the issue of the single tax. His book Progress an d Poverty (Apple to n , 1880) is probably theall-time best seller on an economic issue.

2 See page 4 87 for a discussion of the validity of this prediction that was m ade by theClassical economists of the early nineteenth century.


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W e c a n n o t , o n t h e b a s i s o f p o s i t i v e e c o n o m i c s , m a k e a m o r a l j u d g m e n to n t h i s s i t u a t i o n . I t is s u f f ic i e n t t o p o i n t o u t t h a t m a n y p e o p l e h a v e b e e ni n c e n s e d a t t h is ' u n e a r n e d i n c r e m e n t ' a n d , w a t c h i n g t h e h u g e f o r t u n e sa c c r u i n g t o l a n d l o r d s i n a r a p i d l y g r o w i n g s o c i e t y , t h e y h a v e p r o p o s e dv a r i o u s m e a s u r e s f or r e m o v i n g t h is ' u n e a r n e d w e a l t h ' fr o m t h e l a n d o w n e r .

I t s h o u l d b e n o t e d t h a t t h e n o r m a t i v e i s s u e h e r e i s n o t n e c e s s a r i l y o n e o ft h e ' r i c h l a n d o w n e r ' v e r s u s t h e ' p o o r w o r k e r ' . M a n y l a n d o w n e r s ( f a r m e r sa n d o w n e r s o f f a m i l y r e s id e n c e s ) m a y b e r e l a t i v e l y p o o r , w h e r e a s a m i l l i o n a i r e m a y i n v e s t i n c e r t a i n a s s e ts w h o s e v a l u e s d o n o t ri s e a u t o m a t i c a l l y w i t ht h e p r o g r e s s o f s o c i e t y .

T h e le ss e m o t i v e , b u t m o r e e n d u r i n g a p p e a l o f t a x e s o n l a n d v a l u e s a r i s e sf r o m t h e f a c t t h a t e c o n o m i c r e n t c a n b e t a x e d a w a y w i t h o u t a ff e c t i n g t h ea l l o c a t i o n o f r e s o u r c e s . T h u s , f or s o m e o n e w h o d o e s n o t w i s h t o i n t e r f e r ew i t h t h e a l l o c a t i o n r e s u l t i n g f r o m t h e f r e e p l a y o f t h e m a r k e t , t h e t a x a t i o no f e c o n o m i c r e n t i s a t t r a c t i v e . 1 I t s h o u l d b e n o t e d , h o w e v e r , t h a t e c o n o m i cr e n t i s n o t u n i q u e t o l a n d l o r d s ; i t a c c r u e s t o t h e o w n e r s o f a n y f a c t o r t h a tis f i xe d i n s u p p l y a n d t h a t f a c e s a r i s i n g d e m a n d . I f t h e r e is , f o r e x a m p l e , afix ed s u p p l y o f f i rs t - c la s s o p e r a s i n g e r s i n t h e c o u n t r y , t h e n t h e y w i l l g a i n i ne x a c t l y t h e s a m e w a y a s l a n d l o r d s d o w h e n t h e s o c i e t y b e c o m e s r i c h e r a n dt h e d e m a n d f or o p e r a s i n c re a s e s w i t h o u t t h e r e b e i n g a n y c o r r e s p o n d i n gi n c r e a s e i n t h e s u p p l y o f s i n g e r s .

1 We must be careful not to forget the meaning of our terms. The statement in the textrefers to economic rent as described; it does no t re fer to the paymen t ac tual ly m ade by tenants tolandlords. What is called rent in the world is partly an economic rent and partly a return oncapi tal invested by the landowner . The pol icy impl ications of the s tatement in the text dependon being able to identify economic rent in practice. At best this is a very difficult thing to do; atworst, it may be quite impossible.

0 pricing of factors of production economic rent

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