UNIT 4
THEORIES OF RENT, INTEREST, WAGE & PROFIT
The quantity of land is limited, and so is its productiveness, and it is not uniform in quality. If the superior land will not support the population, recourse must be made to inferior lands and the produce is, thus, raised at different costs. The differential advantage of the superior land over the inferior gives rise to Economic Rent. It is plain that the farmer may just as well pay for the superior land as get the inferior land rent free.
Thus, rent arises out of the difference existing in the productiveness of different soils under cultivation at the time for the purpose of supplying the same market, and the amount of rent is determined by the degree of those differences. This is known as Ricardo’s Theory of Rent.
According to Ricardo, rent is that portion of the produce of the earth, which is paid to the landlord for the original and indestructible powers of the soil. It is a surplus enjoyed by the super marginal land over the marginal land arising due to the operation of the law of diminishing returns.
Productiveness depends on fertility and convenience of situation. Therefore, Economic Rent in its simplest form is the differential profit that arises in the case of production, owing to differences in natural conditions due to:
(1) Fertility of the soil,
(2) Advantages of situation.
Take, for simplicity, a new country dependent on its own supplies and occupied by a body of settlers. At first we may suppose that there is an abundance of the best land and that it is practically free. In this case only the best land will be used, and the produce will sell so as to just cover (with current wages and profits) the expenses of production. So far, there is no differential profit and, thus, no economic rent.
1. The classical theory of interest is a special theory because it presumes full employment of resources.
On the other hand, Keynes theory of interest is a general theory, as it is based on the assumption that income and employment fluctuate constantly.
2. Classical regard rate of interest to be equilibrating mechanism between saving and investment. Keynes regards changes in income to be the equilibrating mechanism between them. According to Keynes, savings depend on income. Classicals regarded savings as fixed corresponding to full employment income, whereas for Keynes for every level of employment, there will be a different level of income and for different levels of income there will be corresponding savings (curves).
3. According to classicals, more savings will flow at a higher rate of interest, but according to Keynes savings will fall because the level of income will fall, for the investment will be less when the rate of interest goes up, leading to a decline in income and hence savings.
4. The element of hoarding occupies a central position in Keynes’ liquidity preference theory of interest because he considers money as a store of value also; whereas the classicals gave little importance to the element of hoarding and considered money only as a medium of exchange.
5. Classicals gave more attention to interest on bank loans, whereas Keynes was concerned with the entire loan and interest rate structure in the market and the complex of rates of interest that exist. In his theory, long-term rate of interest on loans, bonds and securities occupy greater significance as they influence long-term investment.
6. Classicals always held that savings automatically flow into investment. Keynes held just the reverse, that is, it is investment that automatically leads to saving out of current income. Further, classicals held that investment could be increased by saving more but Keynes held that investment could increase income and out of the increased income, increased savings flow.
7. An increase in thrift, which according to classicals, was a great virtue, may according to Keynes, cause income to fall reducing the volume of savings. Hence, the classical position is falsified. It is one of the great merits of “General Theory” and the Keynesian approach of liquidity preference that it once for all cleared the thinking which confused the amount saved with the propensity to save. Thus, whereas classicals were keen to retain saving to investment as determining factors, Keynes omitted them completely from his theory of interest.
The following points highlight the four important features of Schumpeter’s theory of economic development.
They are: 1. Circular Flow 2. Role of Entrepreneur 3. Cyclical Process or Business Cycle and 4. End of Capitalism.
Feature # 1. Circular Flow:
Schumpeter starts his analysis of development process with the concept of circular flow.It implies a condition where economic activity produces itself continuously at constant rate through time.
Thus, it means a continuous activity and no destruction. It is the characteristic of an economy in stationary state.
The circular flow is similar to circulation in blood in an animal organism. Circular flow is based upon a state of perfect competitive equilibrium in which coasts are equal to receipts and prices to average costs. The Schumpeter, “The circular flow is a stream that is fed from the continually flowing springs of labour power and land and flow in every economic period into the reservoir which we call income, in order to be transformed into satisfaction of wants”.
The main features of circular flow are as under:(a) All economic activities are essentially repetitive and follow a familiar routine course.
(b) All the producers know the aggregate demand for goods and adjust the supply of output accordingly. This means demand and supply are in equilibrium at each point of time.
(c) The economic system has the optimum level of output and its maximum use and there is no possibility of wastage of resources.
(d) The firms working in a system are in a state of competitive equilibrium.
(e) Under the stationary equilibrium, the prices are equal to the average cost.
According to the modern theory of wages, wages are the price of services rendered by a labor to the employer.
As products the prices are determined with the help of demand and supply curve. Similarly, the wages (prices of services rendered by labor) is also obtained with the help of demand and supply of labor.
Therefore, for the determination of wage level, it is necessary to study the demand for labor, supply of labor, and the interaction between them.
i. Demand for a product:
Refers to one of the important determinant of demand for labor. The demand for labor is derived from the demand of the product it produces. In case, the demand for the product increases, the demand for labor would also increase However, this is the expected demand of the product and not the current demand. Therefore, the expected demand of the product determines the demand for labor. Moreover, along with the magnitude of demand, the elasticity of demand for labor is also need to be determined. The elasticity of output helps in determining the elasticity of labor.
a. Condition 1:
Labor would be inelastic if their wages contribute only a small amount to the total wages of industry
b. Condition 2:
Labor would be elastic if the product produced by him is elastic
c. Condition 3:
Labor would be elastic if cheaper substitutes of products are available
Elasticity of demand of labor depends on two factors, which are technical aspects of production and elasticity of demand for the product. The long-term demand for labor is more elastic than the short-term demand of labor.
Ii. Other factors of production:
Helps in determining the demand of labor. The price and amount of other factors of production employed affects the demand for labor. For example, if other factors of production are expensive then the demand for labor would be high. However, if other factors are available at cheaper quantity, then the demand for labor would reduce. Similarly, an increase in the demand of technology would reduce the demand for labor.
Supply of Labor:
Supply of labor refers to the number of hours spent by labor in the factor market. In an economy, there are several factors that influence the supply of labor. Some of the factors are wage rate, population size, age structure, availability of education and training employment opportunities for women, and social security programs.
On the other hand, in an industry, the supply of labour is less elastic in the short-run. In this case, the supply of labor is dependent on the accessibility of workers in the nearby areas and their willingness for overtime work. However, the supply of labor becomes more elastic in the long-run. Industries attract labor by providing higher wages, training facilities, and good working conditions. Therefore, the supply curve of labor for an industry is upward sloping.
