1
AGEC 603
Rents
• Inputs
– Two inputs – land / capital
– No fixed costs
– Land fixed
• Surplus of value
– net returns
• Rent
Setup
• Contract rent – actual payments made for the
use of the property of others
• Land Rent – the theoretical earnings of land for
its use in production
• Economic rent – surplus of income above the
minimum supply price necessary to bring a
factor into production
Three Concepts of Rent
2
Land Rents = Net Returns
Gray area =
TR = P * Q
Red area TC
= AC x Q
Green area
Rents =
TR - TC
MR
5
10
15
20
25
30
5 10 15 20 25 30 35 40 45 0
MC
AC
PR
ICE
Output
Land Rents
Area of insufficient input use Area of too much input use
Intensive margin
Green box = net returns = rents =
Residual economic surplus
Produce at MR = MC
LAND RENT RESULTS
• Rent is excess of revenue over costs
• Rent is determined by output price
• Rent is not output price determining
3
• Land grades - Ricardo
• Location – von Thünen
• Use capacity
What Gives Rise to Rents
• Three operators
• Face the same output price
• Homogenous product
• Different grades of land – fertility differences
– Grades differ in their costs of producing
Land Grades
Rents Due to Fertility
AC
MR
Pri
ce
Output
MC
AC
MR
Pri
ce
Output
MC AC
MR
Pri
ce
Output
MC
A B C
Intensive margins Extensive margin
4
Additional Rent Details
A B C
AC
Pri
ce
Output
MC
2
AC
Output
MC AC
Output
MC AC
Output
MC
D
Four grades of land – price = $2 Notice only grade A produces
Extensive margin
Price increases to $2.5
A B C
AC
Pri
ce
Output
MC
2
AC
Output
MC AC
Output
MC AC
Output
MC
D
• Grade A and B produce – only A has rents
2.5
Extensive margin
• Surplus of $0.50 / output unit – increase in costs
• Rent is not needed to ensure continued
production for grade A
• Surplus exists and will not dissipate goes to the
owners
• Land rent arises because of fertility differences
Aspects of Rents
5
Price increase to $3.33
A B C
AC
Pri
ce
Output
MC
2
AC
Output
MC AC
Output
MC AC
Output
MC
D
• Grade A, B and C produce – A and B have rents
2.5
3.33
Extensive margin
Price increase to $4
A B C
AC
Pri
ce
Output
MC
2
AC
Output
MC AC
Output
MC AC
Output
MC
D
• All grades produce – A, B , and C have rents
2.5
3.33
4
Extensive margin
• Surpluses (Rent) – varies by grade
– Grade A = $2.00
– Grade B = $1.50
– Grade C = $0.77
– Grade D = $0.00
• More fertile the land the larger the rent
• Extensive margin shifts outward as price
increases
• Surplus exist and will not dissipate
Aspects of Rent
Careful – not quite
As price increased so did output
Increase output increases AC
Rent is something less
These are prices changes necessary to
bring the grade to extensive margin.
6
DAVID RICARDO SAYS:
Corn Is Not High Because a Rent Is
Paid, but a Rent Is Paid Because
Corn Is High
• Johann Heinrich von Thünen – rent and a
central market
• Homogenous product
• On market sell at market price = P
• Three locations
• Must pay transportation cost to the market
– Price received = market price – transportation costs
Location
Location Impact on Rents
A B C
AC
Pri
ce
At the market Output
MC
• All grades produce – A, B , and C have rents
P – Trans 250
P
AC
Pri
ce
250 miles Output
MC
AC
Pri
ce
500 miles Output
MC
P – Trans 500
7
• Further from the market the smaller the rents
• Rents arise because of location
• Lower rents farther the distance
– Lower net price received
– Smaller output
Aspects of Rents
• Assumptions
– Further from the market the smaller the rents
– Product value $150 / at the market
– Transportation costs = $0.30 / ton mile
– Cost to produce = $138 / ton
• Example rents at three locations of production
– At the market = 150 – 138 = $12 / ton
– 20 miles = 150 – 138 – (20 * .3) = $6 / ton
– 40 miles = 150 – 138 – (40 * .3) = $0.00
Location Continuum
Example - Graphically
$ Costs
$138
$150
$ Rents
$12
$0
0 20 40
Miles
$144 $6
0 20 40
Miles
$ Rents
$12
$6
$0
8
Land Rent Triangle
$
$ Rents
Distance Miles
Land Rents
Transportation
Costs
Other
Costs
Rents Stop
No Rent
Margin
Distance Miles
$ Rents Market Price
No Rent Margin
Total costs and
value of the product
Production +
transportation costs
• Land rents can reflect
– Amenities
– Convenience of access
– Savings, time – distance
• Use capacity
– Measures the cumulative impact of various factors
that affect land quality
• Fertility, location, accessibility, amenities, convenience, etc.
Use Capacity
Rent – Use Capacity
$
$ Rents
No Rent
Margin
$ Rents
Use Capacity
0 B C
M
L
K
T
T
S
W
U
R R
Use Capacity
0 B C
Land Rents
Costs
U
W
S
Triangle KLR = WRS
Triangle KTM = UCS
Total costs
9
• Rent as a return on investment
– Real estate a type of capital
– Land rents are the return to the market value of land
resources
• Rent as an unearned increment
– Unearned return to landowners
– Unearned increments capitalized into selling price
• No real conflict between the three views
Other Views of Rents
• Effects on rental arrangements
• Relation to land values
• Resource development decisions
• Effects on land use allocations
Significance of Land Rents
• Idea situation – contract rates approximate land
rents
• Why deviates
– Inadequate information
– Economic conditions
• Short run demand and supply conditions
• Recessions and booms
– Bargaining Power of landlords and tenants
• Tenants – opportunities
– Share tenants
Rental Arrangements
10
• Assume share as 10% to owner 90% tenant
Share Tenants - details
MFC
MVP
90% MVP
$
Input Level R S
• Theoretical – real estate current market value =
PV (expected future rents)
• Capitalization value
𝑐𝑎𝑝 𝑣𝑎𝑙𝑢𝑒 = 𝑙𝑎𝑛𝑑 𝑟𝑒𝑛𝑡 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
• Review cap value / cap rate / discounting
Relation to Land Values
Question
A B C
AC
Pri
ce
Output
MC
AC
Output
MC AC
Output
MC
Which land plot would you expect to have the largest market value if the following is expected to continue into the long run? Why?
P
11
Question
A B C
AC
Pri
ce
Output
MC
AC
Output
MC AC
Output
MC
A – largest land rent – something such as fertility, location, use capacity is causing parcel A to have the largest rent.
P
• Expectations of future flows of land rents are an
investment guide
• Invest only if future flows of land rents are
satisfactory
Resource Development Decisions
• Single land use to this point
• Reality – number of alternatives
• Recall – can get a land rent triangle for each
different enterprises
• Assume three types of land use
Land Use Allocations
12
Three Rent Triangles
Land
Rents
Agriculture
Commercial
Residential
c-r
r-a
Use Capacity
E
F
G
O
P R T
Three Rent Triangles
Land
Rents
Agriculture
Commercial
Residential
c-r
r-a
Use Capacity
E
F
G
O
P R T
Intensive Margins
Three Rent Triangles
Land
Rents
Agriculture
Commercial
Residential
c-r
r-a
Use Capacity
E
F
G
O
P R T
Extensive Margins =
no rent margins
13
Three Rent Triangles
Land
Rents
Agriculture
Commercial
Residential
c-r
r-a
Use Capacity
E
F
G
O
P R T
Rent – bid gradient = envelope curve
Three Rent Triangles
Land
Rents
Agriculture
Commercial
Residential
c-r
r-a
Use Capacity
E
F
G
O
P R T
Rent – bid gradient = envelope curve
Three Rent Triangles Land
Rents
Agriculture
Commercial
Residential
c-r
r-a
Use Capacity
E
F
G
O
P’ P R’ R T
Margins of transference
Zones of transference
14
Three Rent Triangles
Land
Rents
cr
Use Capacity
E
F
G
O
P P’ R R’ T
Urban growth
commercial and residential shifts to dotted lines
cr’
ra ra’
J K
