Unit 2 Distribution

Rent

Definition :

1) Economic Rent

Economic rent refers to the amount paid to the owner of a factor of production over the
cost that is to be necessarily incurred on utilizing such elements in the production process.
These factors of production could include land, labor, capital, etc. It represents the amount
earned by the owner over and above his expectations or what he would have made in the
normal market scenario.

Key takeaway

 Economic rent refers to the payment made to the owner of factors of production above the
necessary cost of using those elements in the production process.
 Factors of production include land, labor, capital, etc., and economic rent represents the
surplus earned by the owner over their expectations or what they would earn in a regular
market scenario.
 Economic rent is a surplus amount that exceeds the factor market price.
 Economic rent can arise due to scarcity of resources or a producer group having a
competitive edge over others because of advanced technology or other factors.
 Equation for economic rent = marginal product – opportunity cost
 It is payment of for the use of land. It does not include interest on capital invested.

OR economic rent = Agreed price – Free market price

eg economic rent = Rs 700 –rs 600 = rs 100

2. Contract Rent:
Contract rent refers to that rent which is agreed upon between the landowner and the
user of the land. On the basis of some contract, which may be verbal or written,
contract rent may be more or less than the economic rent. Eg. Party A wish to rent
out his property to party B in exchange of money for period of 2 years as per
agreement.

3. Quesi rent theory

 The concept of quasi rent was given by Alfred marshal. He define earning or
income generated by factor of production except land.
 The earning from machines & instrument are termed as quasi rent.
 Quasi rent refers to income produced when the demand for products increases
suddenly.
 Quasi rent is temporarily in nature therefore it can be increased or decreased after
some time eg. Machine
 Quasi rent = Total revenue – Total variable cost

4. Classical vs Neo classical theory of rent

Classical rent ( Also known as Differential Rent by David Ricardo)

 Classical rent concept of land rent is also termed as David Ricardo’s theory of rent.
  As per classical theory rent paid for land is not determined by cost of production
but as per usage of land. This means that rent is paid as part of using people of
land & not what is being produced in the land.
 The theory assumes that land is fixed resources which various levels of production.
Some land be fertile while other least fertile.
 The theory states land of owned privatively & that aim of the owner is to earn
maximum profit only.
 The theory states that demand of agricultural goods is always high even are the
land infertile. It’s simply means that when demand of food is low then only most
fertile land will be required & there is no requirement of fertile land.
 This theory ignores the role of technology in increasing the productivity which is
very relevant today.

Neo Classical theory of rent or Modern theory of rent

Classical theory states rent is determined by the productivity of land but modern economist
rent of land is determined by the location of the land & demand of land.

1. Location is the most significant factor in determining rent. The value of land is mainly

determined by its proximity to economic and social centers. For example, a piece of land

in the city center is worth more than a piece of land in a rural area. The demand for land

in the city center is higher, leading to an increase in its value.

2. The demand for land is influenced by various factors such as population growth,

economic development, and changes in the housing market. For example, if a city

experiences an increase in population due to migration or natural growth, the demand for

land will also increase, leading to an increase in rent.

3. The concept of rent is not limited to land only but also applies to other assets such as

buildings, machinery, and intellectual property. The rent on these assets is determined by

the demand for them and their scarcity.

4. The modern view on rent theory has significant implications for the housing market. It

suggests that affordable housing can only be achieved by increasing the supply of land in

desirable locations. However, this is not always possible due to zoning laws and

regulations that limit the development of land in certain areas.

Wages

Concept & meaning of wages

A wage is monetary compensation (or remuneration, personnel expenses, labor) paid by

an employer to an employee in exchange for work done. Payment may be calculated as a
fixed amount for each task completed (a task wage or piece rate), or at an hourly or daily
rate (wage labour), or based on an easily measured quantity of work done.

1. Wages are part of the expenses that are involved in running a business.
2. Payment by wage contrasts with salaried work, in which the employer pays an
arranged amount at steady intervals (such as a week or month) regardless of hours
worked, with commission which conditions pay on individual performance, and with
compensation based on the performance of the company as a whole. Waged
employees may also receive tips or gratuity paid directly by clients and employee
benefits which are non-monetary forms of compensation. Since wage labour is the
predominant form of work, the term "wage" sometimes refers to all forms (or all
monetary forms) of employee compensation.
3. Wages are also a means of providing income for employees and as a cost of doing
business to the employer. In a wider sense, wages mean any economic premium
paid by the employer under some contract to his workers for the services delivered
 by them. In this way wages constitute of financial support, family allowance, relief
pay and other benefits. Whereas in the narrow sense, wages are the price paid for
the services of labour in the process of production and it count only the wages
proper or performance wages.

Nominal wages/money wages & Real wages

The following are the two main concepts of wages:

A. Nominal Wage:

B. Real Wage:

A. Money Wages or Nominal Wages:

 The total amount of money received by the labourer in the process of

production is called the money wages or nominal wages.

 it means refers to the amount of wages which worker receives in the

terms of money
 Nominal wages in actual sense does not give us idea of economic
position of the workers.

B. Real Wages:

 Real wages mean translation of money wages into real terms or in

terms of commodities and services that money can buy. They refer to
the advantages of worker’s occupation, i.e. the amount of the
necessaries, comforts and luxuries of life which the worker can
command in return for his services.

 Real wages refers amount of goods & service which worker can buy
with his nominal wages or money wages .
 Real wages actually measure actual purchasing power of the person .
 Real wages includes the inflation or deflation prevalent in the
economy
 Example of nominal wages & Real wages :
The labour is earning the rs 6000 a month is nominal wages & from
rs 6000 what he can actually purchase or buy is the real income.

Factors Affecting Real Wages

1. Price Level or Purchasing Power - the purchasing power of money, has a significant impact
on real earnings. When the general price level rises, the purchasing power of money falls,
resulting in a decrease in real wages, and vice versa.

2. Job Nature-Some activities are dangerous, while others are exhausting, such as piloting or
mining. Some occupations are very exhausting (such as blacksmithing) and lower the
laborer’s working life, while others are dangerous (such as lead working) and shorten the
earning duration. Then there are certain vocations that are filthy and despised, such as
sweeping or butchering.

3. Extra Earnings: —Real wages are also affected by the availability of additional sources of
income. In a five-star hotel, a porter has the possibility to augment his pay. with the help of
consumer suggestions A college peon does not have this option. The real wage of the whole
bearer is higher. Similarly, teachers might supplement their income by answering books,
establishing question papers, tuition fees, writing books, and so on.

4. Working Hours— The number of hours worked and holidays are taken to have an impact on
real wages. We can compare a bank manager who has to go to his bank at 9.00 a.m. and
returns at 6.00 p.m. with someone who has to go to his bank at 9.00 a.m. and returns at 6.00
p.m. With a college lecturer who only has a few periods per day, he gets a lot of vacation
time. As a result, the professor’s real salaries are higher than the manager’s. So, Working
Hours is one of the important Factors Affecting Real Wages.

5. Training Costs—Some professionals, such as technicians, computer scientists, and doctors,

invest a significant amount of money and time in their education. As a result, we must
subtract the cost of their training from their money wages when calculating their real wages.

6. Other Facilities—If a person works in a profession, they are provided with a variety of other
benefits. Medical and Housing Benefits, Provident Fund, Gratuity, Pension, and Bonuses are
all examples of monetary earnings. The real earnings are higher in LTC.
7. Possibilities for Future Promotion—Money salaries in a given career may be low at first,
but they will rise over time. It’s possible that you’ll be promoted in the future. These jobs pay
more in real terms.

8. Employment of Dependents—Wardens and dependents of individuals serving in the army,

railways, banks, and other government agencies are given priority when applying for jobs. As
a result, they have more economic security. Adult boys can easily obtain jobs in some
industrial areas, although such assistance is not available in other areas. As a result, actual
earnings for workers in previous types of firms will be higher.
 9. Professional Expenses—In order to carry on one’s profession, one must incur some
expenses from time to time. For example, a college professor must hire a vehicle and spend
money on books and publications in order to attend classes. Similarly, a lawyer must have a
conveyance, keep a clerk, and pay dues to the attorneys association. To accurately calculate
real earnings, all such expenses must be deducted from wages.

Interest

Meaning of Interest

 Interest is a payment made by a borrower to the lender for the

money borrowed and is expressed as a rate percent per year.

 It is usually expressed as an annual rate in terms of money and

is calculated on the principal of the loan. It is the price paid for
the use of other’s capital fund for a certain period of time.
 According to Seligman – “ Interest is the return from the fund
of capital
 In simple language interest refers to payment made by the
borrower to the lender of capital.

Gross interest & Net interest

There are two types or kinds of Interest:

(a) Net Interest,

(b) Gross Interest.

a) Net Interest:
The payment made exclusively for the use of capital is regarded as
net Interest or pure Interest. According to Prof. Chapman—“Net
Interest is the payment for the loan of capital when no risk, no
inconveniences apart from that involved in saving and no work is
entailed on the lender.”
According to Prof. Marshall, “Net Interest is the earnings of
capital simply or the reward of waiting simply.”

Thus, Net Interest = Gross Interest – (payment for risk + payment

for inconvenience + cost of administering credit)

i.e., Net Interest = Net Payment for the use of capital.

(b) Gross Interest:

Gross Interest according to Briggs and Jordan has said—“Gross
Interest is the payment made by the borrowers to the lenders is
called Gross Interest or Composite Interest.”

It includes payments for the loan of capital payment to

cover risks for loss which may be:

(i) A personal risks or

(ii) Business risks, payment for inconveniences of the investment

and payment for the work and worry involved in watching—
investments, calling them in and investing.

Thus, Gross Interest = Net Interest + payment of risk + payment for

inconvenience + cost of administrating credit

Liquidity preference theory of interest

 Liquidity preference theory argues that people prefer to keep assets in a

liquid form, such as cash, over less liquid assets like bonds, stocks, or
real estate. This is done to avoid any unforeseen event or to manage any
crisis eg ( Earth quake , Covid like crisis , recession etc). The investor
feel safe to keep the money in liquid form.

KEY TAKEAWAYS

 Liquidity preference theory describes the supply and demand for money
as measured through liquidity.
  John Maynard Keynes mentioned the concept concerning the
connection between interest rates and the supply and demand for
money.
 In real-world terms, the more quickly an asset can be converted into
currency, the more liquid it becomes.

How Does Liquidity Preference Theory Work?

 Liquidity preference theory, developed by John Maynard Keynes, aims
to explain how interest rates are determined.

 People naturally prefer holding assets in liquid form—that is, in a

manner that it can be quickly converted into cash at little cost. The
most liquid asset is money.

 Economic conditions like recessions that create uncertainty raise

liquidity preference as people wish to remain more liquid.

 This requires higher interest rates to induce a shift to illiquid assets.

 The liquidity preference theory thus views interest rates as emerging

from people's desire for liquidity versus illiquid, interest-earning
assets. The more liquidity is preferred, the higher the rate required to
overcome that preference.

 According to the theory, interest rates provide an incentive for people

to overcome their liquidity preference and hold less liquid assets like
bonds.

 Bonds provide interest income but are less liquid than cash since they
cannot be immediately converted to money. Thus, the more illiquid a
bond, the more incentive people will need in terms of its interest rate.1

 Interest rates are determined by the supply and demand for money,
which depends in part on this preference.
  When liquidity preference is high, people want to hold more cash,
decreasing the money supply and reducing bond prices. Three Motives of
Liquidity Preference

Keynes argued that the desire for liquidity springs from three motives: the
transactions, precautionary, and speculative motives.

 Transactions motive: the need to hold cash for day-to-day

transactions like buying goods and services. This demand for liquidity is
fairly predictable and correlates with the income and expenses of
individuals and firms: the demand for liquidity increases with income.
The transaction motive is fundamental and exists regardless of the level
of interest rates, emphasizing the essential role of money as a medium
of exchange in daily economic activities.
 Precautionary motive: the urge to hold onto cash as a buffer against
unexpected expenses or emergencies. Individuals might hold onto
money or easily accessible funds to cover unexpected medical costs, car
repairs, or other financial demands. Similarly, businesses may maintain
a liquidity cushion to weather unexpected operational or market
challenges. The precautionary motive underlines how money is a store
of value that provides a sense of security in the face of uncertainty.
 Speculative motive: holding onto cash to take advantage of future
investment opportunities not yet available. The speculative motive
tends to be more pronounced among investors and financial
institutions, and its intensity can vary with the expectations regarding
the future trajectory of interest rates, economic growth, and market
conditions. When the nominal interest rate is low, people hold onto
money, even if it provides no interest income. But this changes as the
interest rate ticks upward.

Profit
Meaning of profit: is considered as the gain amount from any business activity.
Whenever a shopkeeper sells a product, his motive is to gain some benefit from the
buyer in the name of profit. Basically, when he sells the product more than its cost price,
then he gets the profit on it but if he has to sell it for less than its cost price, then he has
to suffer the loss.

In general, the profit is defined as the amount gained by selling a product, which should
be more than the cost price of the product. It is the gain amount from any kind of
business activity. In short, if the selling price (SP) of the product is more than the cost
price (CP) of a product, then it is considered as a gain or profit.

Types of Profit
There are three types of profit used in business. They are:

1. Gross Profit
2. Net Profit

Gross Profit
Gross profit is the amount gained by any business or company after removing the cost
associated with the making and selling of the product from the selling price. The
revenue yielded in the company’s income after sales of the commodity should be
reduced by the amount or cost it took to make the product or provide any service to the
customer’s, to get the gross percentage of the profit.

The formula to calculate the Gross Profit is:

Gross Profit = Total Sales – COGs

Where COGs represents the cost of goods sold.

Net Profit
Net profit includes all the cost amount generated by the business as revenue. It
represents the actual sum of money made by any business.

The formula to calculate the Net Profit is:

Net Profit = Operating Profit – (Taxes and Interest).

Risk & uncertainty

 What is Risk?
Risk is a concept that refers to the potential for loss, harm, or deviation from expected
outcomes. It involves the analysis and assessment of potential events or situations, their
probabilities, and the impact they may have on objectives or goals. Risk is often
quantifiable and can be evaluated using various techniques, such as probability
assessments and risk models. It plays a significant role in decision-making, as
understanding and managing risks allow individuals and organizations to make
informed choices and allocate resources effectively.

 What is Uncertainty?
Uncertainty refers to a state of not knowing or having limited information about future
events or outcomes. It involves ambiguity, unpredictability, and the absence of clear
probabilities or measures of likelihood. Uncertainty can arise from various factors, such as
incomplete data, complex environments, or situations with multiple possible outcomes.
Unlike risk, uncertainty is not easily quantifiable or manageable through traditional risk
management techniques.

Dynamic & Innovation theory of profit

 The Innovation Theory of Profit was proposed by Joseph. A.
Schumpeter, who believed that an entrepreneur can earn economic
profits by introducing successful innovations.
 In other words, innovation theory of profit says that the main function of
an entrepreneur is to introduce innovations.
 According to Schumpeter, innovation refers to any new policy that an
entrepreneur undertakes to reduce the overall cost of
production or increase the demand for his products.
 Thus, innovation can be classified into two categories; the first
category includes all those activities which reduce the overall cost of
production such as the introduction of a new method or technique of
production, the introduction of new machinery, innovative methods of
organizing the industry, etc.
 The second category of innovation includes all such activities which
increase the demand for a product. Such as the introduction of a new
commodity or new quality goods, the emergence or opening of a new
market, finding new sources of raw material, a new variety or a design
of the product, etc.
 The innovation theory of profit posits that the entrepreneur gains
profit if his innovation is successful either in reducing the overall cost of
production or increasing the demand for his product.
 The profits earned by innovation is for shorter period as the competitors
can copy innovation
 To earn the profit for longer period the entrepreneur need to patent or
copy right is product or service & innovation technique