LECTURE 6: 19 MARCH 2017 ECONOMIC RETURN TO LAND RESOURCES BPE 23302 LAND ECONOMY LECTURE 6: 19 MARCH 2017 ECONOMIC RETURN TO LAND RESOURCES

ECONOMIC RETURN TO LAND RESOURCES Concept of rent Method of appraising land rent Classical theory of rent Significant of land rent

ECONOMIC RETURN TO LAND RESOURCES Land of economic value consists of natural resources, Including underground mineral, metals, and oil; Including forest; the generic variety of life; oceans, lakes, and rivers; The atmosphere; The electromagnetic spectrum (for transmitting radio and television); and The three-dimensional surface area of the earth as sites for living and working.

ECONOMIC RETURN TO LAND RESOURCES Land other than natural resources has no value; otherwise it would be in the category of produced “wealth” . “Land” will refer to natural resources unless otherwise stated. Land is limited and scarce. Land obtains a market value due to its usefulness over time and the scarcity of land of good qualities. This value is called “land rent”.

ECONOMIC RETURN TO LAND RESOURCES Concept of land

Concept of Rent What is rent? The word rent has several meaning. First, means a payment for use of property, which includes the use of land as well as produced wealth, such as building, cars and computers. Classical economic, means as the amount that one pays solely for use of land. Layman, means as payments made to property owners for the use of their lands and buildings.

Concept of Rent The Concept of Rent All rents are based on scarcity. A monopoly rent is created when supply is artificially constrained- restricting taxi licenses. A scarcity rent is created when there is a limited or fixed supply of resource operating at infra-marginal efficiency. A Ricardian rent initially referred to the fixed supply of arable (or productive) land. There are three different concept of rent; Contract rent Land rent and Economic rent

Actual payments tenants make for their use of the property and others. Concept of Rent Contract rent (Rc) Actual payments tenants make for their use of the property and others. The amount of these payments is normally agreed to by the landlord and tenant in advance of the period of property use and thus stems from mutual contractual agreements. These concept is more or less synonymous with the popular meaning ascribes to the term “rent”.

Theoretical earnings of land resources. Concept of Rent Land rent (Ri) Theoretical earnings of land resources. Economic return that accrues or should accrue to land for its use in production. Applies to combined earnings of raw land and other improvements on the land. These distinctions are made with respect to: Different classes of land Fertility or site quality of land Location effects.

Over time economic rent disappears as supply rises. Concept of Rent Economic Rent Defined as the surplus of income above the minimum supply price it takes to bring a factor into production. A short run phenomenon A surplus that a productive factor can earn because of unexpected demand or supply conditions. Example, a real estate can earn an economic rent above its normal land and contract rents under a short term supply deficits, enabling the owner to raise rental rates. Over time economic rent disappears as supply rises.

Concept of Rent Land rents and contract rents are more important concept in land economics. These concepts differ from each other in one significant respect. Contract rent involves an actual payment to the property owner. This payment may either exceed or fall below the amount of land rent. Contract rent may exceed/fall below the theoretical land rent. If ( Rc) > (Ri) : Tenant must contribute the difference by reducing returns to other inputs. If (Rc) < (Ri) : Tenant will pocket the difference.

Concept of Rent How Does Rent Arise? The value of land is due to a variety of sources. There are three types of land; Fixed material resources Renewable resources Space.

Method of appraising land rent Land rent as an economics surplus Land rent as residual economic surplus Total value product or of the total returns that remains after payments is made for the factor costs, respectively.

Value of product per output unit Figure 2: Illustration of the effects differences in land quality have upon the amounts of land rent that accurate to three grade of land Value of product per output unit Grade A land AC MC Production Costs Cost and Return Land rent Grade B land Grade C land The units of output secured from three different grades of land can be assumed to have the same market value. The average cost of production per output unit lower on the grade A tract than on the Grade B and C tracts because of the total cost of production is appear over more units. With these differences in average unit production costs, the grade A tract yields considerable land rent, the grade B tract a smaller amount of rent and the grade C tract produce barely enough to pay is production costs. With higher prices or lower costs, rents rise along line- even on the grade C land. Lower prices or higher costs, in turn, would lower the rents secured on the A and B tracts and force the grade C land out of use.

Figure 3: Illustration of the effects of differences in accessibility upon the amounts of land rent that occur to three tracts of land of comparable quality located at differences distances from market. Net value of price per unit of output ( after deduction of shipping costs) at point of production Site of Market AC MC Production Costs Cost and Return Land rent Units of Output Site 250 miles from market Site 500 miles from market The first diagram indicates the amount of land rent that can be expected on a site located at the market. Lands located at greater distances must pay a shipping cost to get their products to market. The lower net price received by producers located 250 and 500 miles from market has considerable effect in reducing the amount of land rent received at these locations. These area are just as productive as those located at the market; but with a transportation-cost handicap , the operators located at these distances must gear their production to a lower net price level. The lower land rents associated with the received by the operators at these locations and to the effect of this lower price level in cutting back the number of variable inputs operators can profitably employ in production.

Classical Formulation of Rent Theory 1662 - Sir William Petty made some pertinent observations concerning land rent. The classical rent theory with group of English economist at the Napoleonic Wars. The British Parliament- Controversial Corn Law and to publish their views regarding the nature of rent and certain related subjects. Thomas Robert Malthus, David Ricardo & Johann Heinrich Von Thunen made significant contributions to present land rent theory. Malthus – residual surplus concept Ricardo – attributes rent to differences in fertility as basic for classical concept of rent. Von Thunen - explained rent in terms of differences in location with respect to a central market.

Classical Formulation of Rent Theory a) David Ricardo Theory p Rent variation due to fertility. Ricardo emphasis upon differences in fertility Basic premise: When land is rich, fertile and abundance; there is no rent on agricultural land Rent arise when there population increase and excess land demand making it necessary to bring less fertile land into use. Hence a price rises to compensate for the higher cost at the new extensive margin of cultivation.

Classical Formulation of Rent Theory Assume: There are 4 types of land Total cost of labor and capital inputs on each tract is RM 100 Owing to varying fertility; Output declined with reducing fertility : 50 units (tract A); 40 units (B); 30 units (C); 25units(D). Average production cost rises : RM 2 (Tract A); RM 2.50 (B); RM 3 (C); RM 4 (D). When there’s enough grade A land providing needed output, market price (P) remains and equal to average production cost AC P = AC = RM 2 : No Rent

Classical Formulation of Rent Theory When output and land demand rise, the rise in production cost at grade B land, necessitates a market prices increase ( RM 2.50) to make farming in grade B land viable. This creates rent for grade A land. This proceeds until all land grades are utilized and prices rose to RM 3 and RM 4

Classical Formulation of Rent Theory Ricardian Theory assume that:- Prices are set by production cost at the extensive margins of cultivation, Rising prices raise the intensive margin in the more fertile land. Production levels and rents increase. Alternatively, Ricardian rent can be illustrated by using cost curves, which shows rising rents as a prices increase.

Classical Formulation of Rent Theory Ricardo was concerned almost entirely with the problem of agricultural rents. Analysis by assuming newly settled with “ an abundance of rich and fertile land, a very small proportion of which is required to be cultivated for the support of the actual population”. He argued that only the most fertile lands would be brought into cultivation and that no payment of rent would be associated with their use. Rents arise on these lands only when increase in population numbers and in the demand for land make it necessary for society to bring less fertile lands into use.

Classical Formulation of Rent Theory Productive capacity of land and amounts of land rent which arise as a successively less and less fertile grades of land are brought under cultivation. 10 10 10 5 5 5 Assume four grades of land with yield capacities of 50, 40, 30 and 25 units of product for given input of capital and labor. A B C D GRADES OF LAND Illustration of Ricardo’s explanation of land rent

Classical Formulation of Rent Theory B C D RM 4.00 Average production Cost average land rent per unit of output produced 3.33 2.50 2.00 50 40 30 25 Units of Output Produced on Four Grades of land Alternate presentation of Ricardo’s explanation of Land Rent

Classical Formulation of Rent Theory Ricardo believed that farm product prices are determined by the product needed by society. The prices are set by production costs at the intensive and extensive margins of cultivation. Product prices must rise with the outward shift of the extensive margin on the more fertile lands and thus favor their intensive use.

Classical Formulation of Rent Theory b) Johann Heinrich von Thunnen- Rent variation due to location. When crops produced for a central market are grown on land of equal fertility, the land located closer the market enjoy a rent advantage than those located further away. The extent of the rent variation corresponds with the difference in transportation costs. Given that market price and average production cost remain fixed, declining rent is contributed by rising transportation cost.

Classical Formulation of Rent Theory Rent drops and production costs exceed total market value of all points beyond this no-rent margin Market Price Land rent Total Cost And Value of product Land rent Transportation costs 12 9 6 3 Other production and marketing costs No-rent margin 0 10 20 30 40 Miles 0 10 20 30 40 50 miles Distance to factory or other market Distance to factory or other market Relation between rent and location

Classical Formulation of Rent Theory Use capacity and rent paying ability; Site Fertility and Location Rent paying ability is influenced by other factors Management efficiency Land quality factors Accessibility to basic and recreational facilities which raises productivity at a cost.

Classical Formulation of Rent Theory Rent Arising From Location Ricardo’s explanation of rent in terms of dife

Classical Formulation of Rent Theory Other views concerning rent Rent as an unearned increment Rent as a return on investment

ECONOMIC RETURN TO LAND RESOURCES Significant of land rent

Significant of land rent To contract rental arrangements To property values To land resource investment Development decisions To the allocation of land resources between types of use.

Significant of land rent B AC MR = AR AC MR=AR MC MC Costs & Return Illustration of effects of high and low tenant bargaining power upon land rental levels 2 tract of land of comparable productivity, same market.

Significant of land rent Tract A, Tenant have wide choice of employment opportunities (other than farming), low competition for land among small number of tenants. Tenants have high bargaining position Can insist upon high return of their labor and management inputs Consequently lower land rent for the landlord

Significant of land rent Tract B, Tenants scarifies part of their returns to labor and management inputs. Landlord obtain short run economic rents on top of land rent components of contracted rent.

Significant of land rent Use of land rent for determining land values Ability to predict future flow of land rents. Enable owners and investors to determine land values used in of the purchase and sales of land resources. Land and real estate have a current market value equal to the present value of their expected future and rents.

Significant of land rent Land resource development decisions Expected future flows of land rents and profit associated with alternative land uses provide a guide for investments in existing and future land resource development. Cost Benefit Analysis (CBA) is a technique used to determined the economic surplus or returns from alternative projects to help make alternative investments decisions. NPV = Net Present Value of alternative land resource development project

Significant of land rent Four land uses may include: Commercial uses Residential uses Arable farming Forestry.

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