This section is from the "Elementary Principles of Economics" book, by Richard T. Ely and George Ray Wicker. Also available from Amazon: Elementary Principles Of Economics: Together With A Short Sketch Of Economic History
The fact that situation is the factor of special importance in determining the desirability of urban land leads to certain peculiar results that call for separate discussion. We may consider first of all land used for residential purposes. Cities have sections which natural beauty, healthfulness, convenience, and especially fashion have rendered especially desirable. In proportion to demand the supply is sharply limited, and this brings about a keen competition. The height to which this competition will carry rents will depend upon the number having large wealth, and their readiness to spend money for what they regard as desirable sites for homes, fashion in our cities having perhaps more to do with intensity of desire than anything else. Similar considerations will affect the height to which rent for business sites will rise. The higher the average of well-being and the more ready people are to spend money, the higher will such rents go. Fashion enters here, too, particularly in the retail trade. If people spend money readily, they will pay appreciably more for an article in a convenient locality than for the same article in a slightly less convenient situation. This will frequently enable those doing business in desirable locations to secure higher prices with a larger number of sales, or to increase still further the number of sales by keeping the same price which competitors less desirably situated ask. Intensity of traffic is an important consideration in determining the rent, and consequently the value, of retail business property. We must also take into account the quality of the people who make up this traffic, the rent depending upon both numbers and quality. In some cases a high degree of intensity may counterbalance a lack of fashion, or even more than counterbalance it, so that retail business property in a neighborhood which is not fashionable may, on account of the intensity of traffic, have a higher rent than retail business property in a fashionable locality with comparatively little traffic. The influence of fashion, however, can be seen in a very marked manner in a city like New York, where large numbers of rich people would on no account make purchases on an " unfashionable" street. The result is a large surplus gain secured by business sites favorably located. Competition transfers to the landowners this surplus due to location. This explains what has puzzled so many, namely, the high rents in American cities as contrasted with European cities. Our cities are spacious, but other considerations than space govern rents.
Reflection will show that where the two elements of a high degree of scarcity and desirability enter into the location of land on the seashore or in summer resorts on the mountains, similar causes will give high rent. On the other hand, it is commonly a matter of unconcern where the potatoes and beef we eat are produced, and the result is that agricultural rents are less governed by situation, transportation being the chief consideration in this particular.
The Relation of Rent to Value of Product. It is often said that rent has no influence on the value of the product, rent differing herein from wages and interest, which are said to determine price. This at first sight seems paradoxical, inasmuch as the tenant must pay rent to the landowner as well as interest to the capitalist and wages to his laborers. The paradox is explained by saying that prices are fixed by the expenses of production on the poorest land, where wages and interest are paid, but no rent. Hence the rent that is paid for the better laud is the result of the price fixed in this way and not a cause of it.
This doctrine is true in the main, but requires limitations.
To the extent that land is indestructible and does not require any payment to keep its services in production, it is correct to say that rent does not enter into price. On the other hand, to the extent that labor and capital require a remuneration to keep them from perishing, wages and interest clearly do enter into price. But so far as regards the payments which are necessary to keep up the fertility of the land, and so far as regards the surplus above maintenance which labor and capital receive, the statement is not true.
The Relation of Rent to the Value of Land. The value of land, however, is determined by its rent. The value of the product determines rent, and rent in turn determines the value of the natural agent. If any piece of land is so much more desirable than the poorest piece of land in cultivation that it will return a rent of $5 per acre, and if at the same time and place capital regularly commands 5 per cent interest, then the owners of the land and others will regard each acre of this land as equal in value to an amount of capital that returns $5 per year, or $100. Hence we may say that the value of land is its rent capitalized at the current rate of interest.
Definitions of Rent. We are now prepared to define rent more accurately and completely than was possible before, and to see that different definitions which may be given really describe the thing from different points of view. Thus the definition " rent is that which is paid for the use of land or other natural agents," conveys no idea of the power by which it is secured nor of the way in which its amount is determined. Hence, we may add the following definition: Rent is the amount produced by land or other natural agents in excess of a normal return to the labor and capital devoted to its cultivation. In this definition, however, there is no direct indication of those differences in desirability from which rent arises. We may, therefore, give as our final definition, the following: Rent is a differential return received by the owners of superior natural agents, the amount being determined by the extent to which the given natural agent or the given use of the agent surpasses in productiveness the poorest natural agent of the same sort or the least profitable use of such a natural agent that society requires to satisfy its need for the product. In all this, we have assumed that cultivators are of equal efficiency. Differences of product due, not to differences in the natural agent, but to differences in the ability of those who use the natural agent, do not require explanation at this point.
1.Rent is the return paid for the use of a natural agent, and is equal to that part of the product of the natural agent which is in excess of the product of the poorest agent of the same sort that is cultivated.
2.So long as land exists in excess of all demand, rent is determined by the excess of product over that of the poorest free land.
3.When land is all taken, and all is cultivated that will repay cost, rent is determined by the excess of product over the necessities of laborers,as determined by the law of wages,and the necessary reward to the capital invested in cultivation.
4.Increased demand for the products of the soil regularly results in the cultivation of more land (extensive cultivation) and in the application of more labor and capital to that already in cultivation (intensive cultivation).
5.In a given stage of the arts of production a point is reached in the application of economic energy to any natural agent, beyond which the return to further applications of energy is proportionately less. (The Law of Diminishing Returns.)
6.Special importance attaches to situation in the determination of urban rents.
7.The value of any natural agent is determined by its rent capitalized at the current rate of interest on free capital
1.On what is rent based ? Why would rent disappear if land were unlimited in amount and all of equal quality ?
2.Discuss the differences in desirability of land.
3.How is the amount of rent determined when free land exists ?
4.What is the extensive margin of cultivation? The intensive? What is intensive cultivation? What determines how far intensive cultivation may profitably be carried ? State the law of diminishing returns. Show how it applies to land used for manufacturing. For commercial buildings. For city residences.
5.What effect does a lowering of the margin of cultivation have upon rent? Why?
6.What is the effect of improvements in the arts of production? Of consumption? Of transportation ? What are the forces in society that tend to raise agricultural rents ? Urban rents ?
7.Why does not rent determine price ?
8.How is the value of any natural agent measured?
Clark, J. B.: Distribution of Wealth, Ch. XIII, pp. 188-193. Commons, J. R.: The Distribution of Wealth, Ch. III, pp. 159-170. George, Henry: Progress and Poverty, Bk. III, Ch. II (seven pages). Hobson, J. A.: The Economics of Distribution, Ch. IV, §§ 1 and 2. Mill, J. S.: Principles of Political Economy, Bk. II, Ch. XVI, §§ 2 and 3. Patten, S. N.: Dynamic Economics, pp. 144-147. Taylor, H. C.: "The Differential Rent of Farm Land," Quarterly Journal
of Economics, August, 1903, Vol. XVII, p. 598. Walker, F. A.: Land and its Rent.