Ricardo formulates the “law of rent” around 1809 also known as Ricardo theory of rent . The Law of Rent states that the rent of a land site is equal to the economic advantage obtained by using the site in its most productive use, relative to the advantage obtained by using marginal (the best rent-free) land for the same purpose, given the same inputs of labor and capital.
Ricardo theory of rent shows how competition generates rent and, therefore, determines the magnitudes of the two remaining shares, we follow Ricardo’s original logic. He began by noting that if land is not scarce, then it generates no rent.
As per Ricardo theory of rent If all land had the same properties, if it were unlimited in quantity, and uniform in quality, no charge could be made for its use.
But, of course, land is scarce and of differing qualities. As population increases, it becomes necessary to cultivate less quality land. Given competition among farmers, and assuming, for example, that there is a difference of ten units of corn in profits between the highest quality land and a low quality land, the farmer on the lower quality land would bid up to ten units in order to farm on the highest quality land. As Ricardo tells the story, the landowner of the higher quality land would insist on a ten unit rent and if the original tenant refused, some other person would be found willing to give all which exceeded that rate of profit to the owner of the land from which he derived it.
With this simple theory of rent or model, Ricardo could explain how the two remaining shares, rent and profits were determined. The logic is crystal clear:
- A given population requires a certain amount of food.
- The lowest quality land called into cultivation generates some profit (total revenue—wages).
- This profit becomes the prevailing profit through competition among farmers—any difference between the profit generated by higher quality land and the profit generated by the lowest quality land accrues to the landowner as rent.
Ricardo theory of rent has a number of important implications, perhaps the most important being its implication for wages. The law of rent implies that wages bear no systematic relationship to the productivity of labor, and are instead determined solely by its productivity “on marginal land,” as all production in excess of that amount will be appropriated by landowners in rent.
Ricardo theory of rent makes it clear that the landowner has no role in setting land rents: he simply appropriates the additional production his more advantageous site makes possible, compared to marginal sites. The law also implies that the landowner cannot pass on the burden of any cost such as land taxes to his tenants, as long as such costs do not affect the relative productivity of his land and marginal land.
Read about: Theory of Comparative advantage