1. What is meant by rent in economics? Explain the Ricardian theory of rent.

     Economic rent is defines as the payment made to a factor of production which is in excess of its supply price, that is, the minimum amount which is necessary to keep the factor in its present use.

     Ricardo has defined rent as "that portion of the produce of the earth which is paid to the landlord for the use of original and indestructible powers of the soil".

     The Ricardian theory of rent is based on the following assumptions:

• The theory assumes that the supply of land from the view point of the entire society is absolutely fixed.
• Ricardo assumes that the land can be used for the production of only one product or crop (that is corn or wheat).
• Ricardo also assumes that the land differs in quantity.
• The theory assumes perfect competition in the market for land.
• The theory is based on the assumption of the law of diminishing returns in agriculture.
• The theory explains the emergence of rent by assuming the existence of the marginal land. Marginal land is no-rent land, that is it fetches no rent.
• According to Ricardo, lands of different grade of fertility are cultivated strictly in descending order of fertility.

Ricardo has shown that rent would arise under two situations:

Extensive cultivation, Intensive cultivation.

     Rent arising in case of extensive cultivation: Extensive cultivation refers to production of more additional output by bringing additional land of different grades into cultivation. As long as the best grade of land is available in plenty, every farmer can have it free and no rent would arise. But as the population of the country increases there would arise the need of cultivating the second grade. When the land of the second grade is brought under cultivation, rent on first grade would rise. Therefore, the first grade land would earn a surplus over and above the output produced on the second grade with the use of same quantity of labour and capital. The surplus would be equal to the excess of produce of first grade land over the produce of second grade land. Economic rent is equal to this surplus. If we stop at cultivating second grade land, then second grade land is the marginal land as its cost of production is first covered by the market price of the product and according to Ricardo marginal land earns no rent. We can illustrate this by taking a numerical example. Suppose there are four grades of land A, B, C and D, where A is the most fertile land and B, C and D are 2nd, 3rd and 4th grades of land. It we assume that 'D' grade of land is the marginal land, that is the most inferior land, the other degree grades of land would earn rent as follows:

  Economic rent = Produce on intra-marginal land - Produce on marginal land.

We can show the same fact graphically on the following page:

     Rent under intensive cultivation: Intensive cultivation o land refers to a situation when additional doses of labour and capital are employed on a given piece of land in order to increase production. Rent in this case rises because of the application of the law of diminishing returns. Here the last dose of labour and capital employed, that is the marginal dose pays no rent since the price equals the per unit cost of this land. Intra marginal dose of labour and capital earn rent to the extent of excess of price over the cost of production, that is difference between their produce and the produce of the marginal dose. This is shown with the help of the following example:

     Here the 4th dose of labour and capital is the marginal dose and it earns no rent. The above situation can be illustrated graphically on the following page:

     Ricardian theory of rent has taken rent in the sense of 'differential rent'. In case of extensive cultivation, more productive land will earn rent as compared to inferior land because of difference in fertility between them. In case of intensive cultivation rent arises because of difference in productivity of different doses of labour and capital due to operation of diminishing marginal productivity.

2. Explain the modern theory of wages

     Neo-classical or modern theory of wages explains the determination of wages by the forces of demand and supply. This is sometimes known as demand and supply theory of factor pricing. According to this theory ,

     wages are determined by the demand and supply forces in the same way as commodity prices are determined in a product market.

     According to modern theory of factor pricing,under conditions of perfect competition in both labour and product markets, wages are determined by the forces of demand and supply.

     Demand for labour:  Demand for labour of a firm sows different quantities of labour which will be employed by the firm at different wage rates. The demand for labour by a firm depends upon its marginal productivity in value terms that is MRP (or VMP in case of perfect competition). The profit of the firm will be maximised at that level of employment where wage rate equals MRP. MRP curve is inverted U shaped because of the law of variable proportions, indicating that as more and more units of labour are employed on a given amount of fixed factors, MRP increases initially and decreases eventually. If we assume that the price of the product does not change as the industry produces more by employing more labour, then the market demand curve for labour can be obtained by taking horizontal summation of MRP curves of all the firms in the industry. Since MRP curve of every firm is downward sloping, the market demand curve for labour must also be downward sloping.

     Supply of labour: By supply of labour, we mean the total number of man-hours which will be offered at different wage rates. Supply of labour force depends upon (1) average working hours and (2) the number of labour.

     Average working hours: Every worker has a limited number of hours at his disposal , which he divides between work and leisure. An increase in wage rate will lead to increase in number of hours worked and thereby increase in the labour supply. But beyond a point, he may not be tempted to work more. Instead, he may like to have more leisure because he has earned lot of income with which he may like to enjoy life by having more leisure. Thus the individual supply of labour is backward bending curve.

 If the wage rate increases beyond OW₂, the supply of labour will decrease.

     It may be difficult to ascertain the nature of the slope of the supply curve because with the increase in wage rate, some workers may be induced to work more and some may be induced to work less.

     Total number of labour: Total number of labour depends on (a) size of the population and () age composition.

     These factors influence the potential labour supply to the entire economy. As far as the supply of labour to a particular industry is concerned, it is generally believed that the supply curve is positively sloped. This is because of the fact that an increase in wage rate induces the workers to shift from low-paid industries to comparatively high-paid industries.

     Equilibrium wage rate: Given the market demand and supply curves for labour, wage rate in the perfectly competitive industry can be determined by combining negatively sloped demand curve and positively sloped supply curve.

     As shown in the above diagram, the demand curve and the supply curve of labour, D and S respectively, intersect each other at E. This is the equilibrium point. Equilibrium wage rate is OW because at this wage rate demand for labour is equal to supply of labour.

     When the wage rate is OW₂, there is excess supply of labour which causes the wage to fall. At the wage rate OW₁ there is excess demand for labour which causes the wage to rise. It should be noted that though the wage rate is determined in the entire industry by demand for and supply of labour, it is equal to MRP (or VMP) of labour. This is because given the wage rate as determined in the industry, each firm will maximise its profit by equating the wage rate with its MRP such as the point 'E' where MRP intersects the wage level OW so as to give OL number of labour employed. Horizontal straight line AW = MW shows the supply curve of labour to the individual firm.

3. Explain briefly estimation of national income by expenditure method.

     The expenditure method measures national income at the disposition stage, that is the disposition of final products. It estimates national income by measuring the final expenditure on gross domestic product. In other works, it measures national income by estimating expenditure on final products. Estimation of national income by expenditure method involves the following steps:

All the economic units which incur expenditure on final products are divided into four groups:

• Households
• Business sector
• Government sector
• Rest of the world

Final expenditure on final goods and services in the economy is divided into four broad categories:

• Consumption expenditure
• Investment expenditure
• Government expenditure
• Net exports

     The third step involves the measurement of the components of final expenditure.

     Different components of final expenditure are measured as follows:

      Estimation of private final consumption expenditure: Private final consumption expenditure comprises expenditure on the purchase of consumer good and services by households and private non-profit institutions serving households like schools, clubs, charitable hospitals. It is divided into three major sub-categories:

• Expenditure on non-durable goods.
• Expenditure on durable goods.
• Expenditure on services like transport service, medical service etc.

     We calculate the final consumption expenditure by the households and private non-profit institutions serving the households on the domestically produced consumer goods and services by multiplying the volume of sale of these goods and services in the market with their retail prices.

     Estimation of investment expenditure: Investment expenditure is the expenditure on capital goods. Capital goods are produced by firms and they may be bought by firms, by households or by governments.

Investment expenditure are divided in to three broad categories:

• Expenditure on business fixed investment, that is expenditure on the purchase of new plants, machinery, equipments, factories.
• Inventory investment that is change in inventories of the firm which are in the ware houses, goods on store shelves, on showroom floors which have not yet been sold.
• Expenditure on residential investment, that is expenditure on the purchase of new houses by households and landlords.

     Thus expenditure on machinery and equipment, change in inventories and expenditure on residential housing gives us total investment expenditure or gross investment. However, a part of this expenditure is incurred to replace the worn-out capital. The amount necessary for replacement is called depreciation. by deducting depreciation from gross investment we get net investment.

Net domestic investment = Gross fixed business investment + Inventory investment + Gross residential investment - Depreciation.

Estimation of government expenditure: The government expenditure are of two types:

Current expenditure on goods and services, that is government final consumption expenditure.

Capital Expenditure

     Government final consumption expenditure is valued in terms of cost to the government since government services have no market price. The transfer payments like social security schemes, unemployment compensation and welfare payments are excluded from national income as they do not generate any output in the current period.

     Estimation of net exports: Net exports are the difference between the value of goods and services exported to other countries and the value of goods and services imported from other countries. Net exports account for domestic spending on foreign goods and foreign spending on domestic goods.

     The sum total of four items - Consumption, investment, government spending n net exports - is the total final expenditure which gives us Net Domestic Product at factor cost.

     In the last stage, net factor income earned from abroad is added to net domestic product at factor cost to arrive at Net National Product at factor cost or national income.

Y = C + In + G+ (X - M) - NIT + NYA

where,

        Y : National income

        C : Stands for consumption expenditure

        I_n : Represents net investment

        G : Stands for government expenditure.

(X - M) : Represents net exports.

     NIT : stands for net indirect taxes.

   NYA : Represents net income from abroad.

Explain the following equations:

1) GNP = NNP + Depreciation

2) NNP = NDP + Net factor income earned from abroad

3) GDP_MP = GDP_FC + Net indirect taxes

4) GDP = NDP + Depreciation

5) National income at factor cost = National income at market price - Net indirect taxes.

6) D.P.I = P.I - Personal taxes and miscellaneous receipts of government administrative departments.