B. A.

1st Semester Summer Drive

Subject Name: Economic Theory
Set 1

Q1. Establish whether the following is a topic in macroeconomics or Microeconomics:

a) A consumer must decide how to reallocate spending as a result of a 10% increase in
the price of food and no change in disposal income.
Solution: This is a topic in microeconomics since an individual consumer must restructure
expenditures because of higher food price.
b) Purchases of durable goods fall as a result of deteriorating consumer confidence.
Solution: This is a topic macroeconomics because consumer, as a spending sector, decrease
spending on durable goods as a result of increasing pessimism. This would be a topic in
microeconomics if we analysed how individual As pessimism affects her spending on various
goods and services.
c) Investment spending declines as a result of rising interest rates.
Solution: This is a topic in macroeconomics since we are considering the effect that rising
rates have on total investment spending. This would be a topic in microeconomics if
Corporation a was postponing capital spending plans because of rising interest rates.
d) A firm contemplates the purchase of more technologically efficient equipment as a
result of a 20% increase in wages.
Solution: This is a topic in microeconomics since it concerns one firms decision about
adding technologically efficient equipment.
e) A cut in federal income taxes is expected to increase consumer spending.
Solution: This is a topic in macroeconomics since it considers the effect if lower taxes upon
total consumer spending.

Q2. Contrast cardinal and Ordinal Utility?

Solution:
The indifference curve indicates the various combinations of two goods which yield equal
satisfaction to the consumer. By definition:
"An indifference curve shows all the various combinations of two goods that give an equal
amount of satisfaction to a consumer".
The indifference curve analysis approach was first introduced by Slustsky, a Russian
Economist in 1915. Later it was developed by J.R. Hicks and R.G.D. Allen in the year 1928.
These economists are the of view that it is wrong to base the theory of consumption on two
assumptions:
(i) That there is only one commodity which a person will buy at one time.
(ii) The utility can be measured.
Their point of view is that utility is purely subjective and is immeasurable. Moreover an
individual is interested in a combination of related goods and in the purchase of one
commodity at one time. So they base the theory of consumption on the scale of preference
and the ordinal ranks or orders his preferences.
Assumptions:
The ordinal utility theory or the indifference curve analysis is based on four main
assumptions.
(i) Rational behavior of the consumer: It is assumed that individuals are rational in making
decisions from their expenditures on consumer goods.
(ii) Utility is ordinal: Utility cannot be measured cardinally. It can be, however, expressed
ordinally. In other words, the consumer can rank the basket of goods according to the
satisfaction or utility of each basket.
(iii) Diminishing marginal rate of substitution: In the indifference curve analysis, the
principle of diminishing marginal rate of substitution is assumed.
(iv) Consistency in choice: The consumer, it is assumed, is consistent in his behavior during
a period of time. For insistence, if the consumer prefers combinations of A of good to the
combinations B of goods, he then remains consistent in his choice. His preference, during
another period of time does not change. Symbolically, it can be expressed as:
If A > B, then B > A
(iv) Consumers preference not self-contradictory: The consumers preferences are not
self-contradictory. It means that if combinations A is preferred over combination B is

preferred over C, then combination A is preferred over combination A is preferred over C.

Symbolically it can be expressed:
If A > B and B > C, then A > C
(v) Goods consumed are substitutable: The goods consumed by the consumer are
substitutable. The utility can be maintained at the same level by consuming more of some
goods and less of the other. There are many combinations of the two commodities which are
equally preferred by a consumer and he is indifferent as to which of the two he receives.
Example:
For example, a person has a limited amount of income which he wishes to spend on two
commodities, rice and wheat. Let us suppose that the following commodities are equally
valued by him:
Various Combinations:
a)
b)
c)
d)
e)

16 Kilograms of Rice
12 Kilograms of Rice
11 Kilograms of Rice
10 Kilograms of Rice
9 Kilograms of Rice

Plus
Plus
Plus
Plus
Plus

2 Kilograms of Wheat
5 Kilograms of Wheat
7 Kilograms of Wheat
10 Kilograms of Wheat
15 Kilograms of Wheat

It is matter of indifference for the consumer as to which combination he buys. He may buy 16
kilograms of rice and 2 kilograms of wheat or 9 kilograms of rice and 15 kilograms of wheat.
All these combinations are equally preferred by him.
An indifference curve thus is composed of a set of consumption alternatives each of which
yields the same total amount of satisfaction. These combinations can also be shown by an
indifference curve.

Q3. What do you mean by the term Elasticity? Classify various demand curves under
different elasticity categories.
Solution:
In economics, elasticity is the measurement of how changing one economic variable affects
others. For example:

"If I lower the price of my product, how much more will I sell?"
"If I raise the price, how much less will I sell?"

"If we learn that a resource is becoming scarce, will people scramble to acquire it?"

In more technical terms, it is the ratio of the percentage change in one variable to the
percentage change in another variable. It is a tool for measuring the responsiveness of a
function to changes in parameters in a unitless way. Frequently used elasticities include price
elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of
substitution between factors of production and elasticity of intertemporal substitution.
Elasticity is one of the most important concepts in neoclassical economic theory. It is useful
in understanding the incidence of indirect taxation, marginal concepts as they relate to the
theory of the firm, and distribution of wealth and different types of goods as they relate to the
theory of consumer choice. Elasticity is also crucially important in any discussion of welfare
distribution, in particular consumer surplus, producer surplus, or government surplus.

We may distinguish between the tree types of elasticitys, viz., Price Elasticity, Income
Elasticity and Cross Elasticity.

PRICE ELASTICITY

Price elasticity measures responsiveness of potential buyers to changes in price. It is the

ratio of percentage change in quantity demanded in response to a percentage change in
price.

Price Elasticity =

Proportionate change in amount demanded

---------------------------------------------------------------------------------------Proportionate change in price

Change in demand
---------------------------------------------

Change in price
+

Amount demanded

---------------------------Price

Suppose the price of a particular brand of a radio set falls from Rs. 500 to Rs. 400 each, i.e.,
20 per cent fall. As a result of this fall in price, suppose further that the demand for the radio
sets has gone up from Rs. 400 to 600, i.e., 50 per cent. Elasticity of demand will be 50/20 or
2.5 percent.
The concept of price elasticity can be used in comparing the sensitivity of the different types
of goods (e.g., luxuries and necessaries) to change in their prices. For example, by this
means we may find that the price elasticity for food grains, in general, is 0.5, whereas for
fruit it may be 1.5. This means that the demand for food grains is less sensitive to price
changes than demand for fruit. Food is a necessary of life and people must buy almost the
same quantity, even if its price has risen. The consumer can, however, economize in fruit or
any other commodity included in the family budget.
The elasticity of demand is always negative, although by convention it is taken to be
positive. It is negative because change in quantity demanded is in opposite direction to the
change in price. That is a fall in price is followed by rise in demand, and vice versa. Hence,
elasticity is always less than zero, unless of course the demand curve is abnormal, i.e.,
sloping upward from right to left. Strictly speaking, in mathematical terms, there should be
minus sign (-) before figure indicating price elasticity. But by convention, for the sake of
simplicity, the minus sign is dropped in economics.

INCOME ELASTICITY

Income Elasticity is a measure of responsiveness of potential buyers to change in income. It

shows how the quantity demanded will change when the income of the purchaser changes,
the price of the commodity remaining the same. It may be defined thus: The Income
Elasticity of demand for a good is the ratio of the percentage change in the amount spent on
the commodity to a percentage change in the consumers income, price of commodity
remaining constant. Thus, while prices remain constant

Income Elasticity =

Proportionate change in the quantity purchased

---------------------------------------------------------------------------------------Proportionate change in Income

.It is equal to unity or one when the proportion of income spent on good remains the same
even though income has increased.
It is said to be greater than unity when the proportion of income spent on a good increases as
income increases.
It is said to be less than unity when the proportion of income spent on a good decreases as
income increases.
Generally speaking, when our income increases, we desire to purchase more of the things
than we were previously purchasing unless the commodity happens to be an inferior good.
Normally, then, since the income effect is positive, income elasticity of demand is also
positive.
It is zero income elasticity of demand when change in income makes no change in our
purchases, and it is negative when with an increase in income, the consumer purchases less,
e.g., in the case of inferior goods.
It may be carefully noted that for any individual seller or firm, the demand for the product as
a whole may be inelastic. By lowering the price, as compared with his rivals, the seller can
infinitely increase the demand for his product. The demand curve will thus be a horizontal
line.
Elasticity, viz., price elasticity and income elasticity, are valuable aids in the measurement of
demand for different commodities. As such they are also helpful in measuring the incidence
of taxation.

CROSS ELASTICITY

Here, a change in the price of one good causes a change in the demand for another. Cross
elasticity of Demand for X and Y

Proportionate change in purchases of commodity X

-------------------------------------------------------------------------------------------------------Proportionate change in the price of commodity Y

This type of elasticity arises in the case of inter-related goods such as substitutes and
complementary goods.
The two commodities will be complementary, if a fall in the price of Y increases the demand
for X and conversely, if a rise in the price of one commodity decreases the demand for the

other. They will be substitute or rival goods if a reduction in the price of Y decreases the
demand for X, and also if a rise in price of one commodity (say tea) increases the demand
for the other commodity (say coffee). The cross elasticity of complementary goods is
positive and that between substitutes, it is negative.
It should, however, be remembered that cross elasticity will indicate complementarities or
rivalry only if the commodities in question figure in the family budget in small proportions.
Cross elasticity of demand can be used to indicate boundaries between industries. Goods with
high cross elasticity constitute one industry, whereas goods with low cross elasticity
constitute different industries. It is not to be supposed that cross elasticity represents
reciprocal relationship. It is not a two-way street. The cross elasticity of a tea with respect to
coffee is not the same as that of coffee with respect to tea. The tastes of the consumer, his
money income and all prices except of the commodity Y are assumed to remain constant.

Q4. State the factors that affect supply of a commodity. Show the effect
diagrammatically.
Solution:
It is also known as the determinants of supply. The Important determinants of supply can be
grouped together in a supply function as follows:
SN=f (PN,PR,F,T,G )
Supply function describes the functional relationship between supply of a commodity (say N)
and other determinants of supp1y, i.e., price of the commodity (P N), price of a related
commodity (PR), prices of the factors of production (F), technical know-ho" (T) and goals or
general objectives of the Producer. Each of the_ factors influences supply in a different' way.
To isolate the effect of other factors we take these other factors as constant while considering
the relationship between supply and one of the above variables. For example, if we want to
study the relationship between price and supply of commodity, N, we shall assume other
factors PR, F, T and G to remain constant or unchanged. We study below these relationships:
(i) Price of the commodity, expressed as SN ft PN), i. e. other things being equal, supply of
commodity N depends upon the price of commodity N. This sort of relationship is studied in
what has' come to be popularly known as the Law of Supply'. It implies that if the price of a
commodity goes up, its supply shall expand and vice versa.
(ii) Prices of related goods, expressed as SN = f(P R), 'j e., other things being equal, supply of
commodity N depends upon the prices of the related goods. If the price of a substitute goes
up, producers would, be tempted to divert their available resources to the production of that
substitute.
(iii) Prices of factors of production, expressed as SN f(F), i, e, other things being equal,
supply of a commodity depends upon the prices of factors of production. A rise in the price of
one factor of production, will cause a consequent increase in the cost of producing those
commodities which use a great deal of that factor and only a small increase in the costs of
producing those commodities that use a small amount of the factor.
(iv) State of technology, expressed as SN=f(T), i,e., the supply of a commodity depends upon
the state of technology. Over the the time the technical know-how changes. Goals of firms,
expressed as SN 1(6), j e., other things being equal the supply of a commodity depends upon
the, goals of firms producing that commodity. Ordinarily; every firm tries to attain. Maximum
profits. Natural factors. The supply of the agricultural' goods to a great extent depends upon
the natural conditions. Adequate rain, fertility of land irrigation facilities, favorable climatic
conditions etc., help in raising the supply of agricultural produce., Contrary to that, heavy
rains, floods, drought conditions, etc., adversely affect the agricultural production.
(v) Means of transportation and communication. Proper development of means of
transportation and communication helps in maintaining adequate supply of the commodities.
In case of short Supply, goods can be rushed from the, surplus areas to the deficient areas.
But if the developed means of transportation are used to export goods, it will create scarcity
of goods .In the domestic market.

(vi) Taxation Policy. Imposition of heavy taxes on a commodity discourages its production,
and as a remit its supply diminishes. On the other, hand, tax concessions of various kinds
induce producers to raise the supply.
1
(vii) Future expectations of rise in prices. If the producers expect, an increase in the price in
the near future, then they will curtail the current supply, so as to offer more goods in future at
higher prices.
Law of Supply
Its different from law of demand. Law of supply explains the relationship between price of a
commodity and its quantity supplied. Price and supply are directly related. A rise in price induces
producers to supply more quantity or the commodity and a fall Prices, makes them reduce the supply.
The higher is the price of the commodity the larger is the profit that can be earned, and, thus the
greater is the incentive to the producer' to produce more of the commodity and offer It in the Market.
Likewise at lower prices, profit margin shrinks and hence producers reduce the sale .
Supply schedule and supply curve
Law of supply can be illustrated with the help of a, schedule and supply curve. A supply schedule is a
tabular statement that gives a full account of supply of any given commodity in a given market at a
given time
It states what the volume of goods offered for sale would be at each of a series of prices.
Market Equilibrium

The operation of the market depends on the interaction between buyers and sellers.
Equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.
At equilibrium, there is no tendency for the market price to change.

Only in equilibrium is quantity supplied equal to quantity demanded.

At any price level other than P0, the wishes of buyers and sellers do not coincide.
Excess demand, or shortage, is the condition that exists when quantity demanded exceeds
quantity supplied at the current price.
When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is
restored.
Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity
demanded at the current price.
When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is
restored.

Shift of Demand versus Movement along a Demand Curve

A change in demand is not the same as a change in quantity demanded.

In this example, a higher price causes lower quantity demanded

Changes in determinants of demand, other than price, cause a change in demand, or a

shift of the entire demand curve, from DA to DB.
A Change in Demand versus a Change in Quantity Demanded

When demand shifts to the right, demand increases. This causes quantity
demanded to be greater than it was prior to the shift, for each and every price level.

A change in Supply versus a change in Quantity Supplied

A change in supply is not the same as a change in quantity supplied.

In this example, a higher price causes higher quantity supplied, and a move along the demand
curve.
In this example, changes in determinants of supply, other than price, cause an increase in supply,
or a shift of the entire supply curve, from SA to SB

When supply shifts to the right, supply increases. This causes quantity supplied to be greater
than it was prior to the shift, for each and every price level

Q5. Suppose that the short run costs for a paintbrush manufacturer are given by the
expression
TC = 100 + 2Q + 0.01 Q2
a) What are the fixed costs of this manufacturer?
b) What are the total costs, average cost, average variable cost and marginal cost at 50
and 100 units of output?
c) At what output is average cost the minimum?

Q6. Given the production function:

Q = 100 + P 0.01P2 + 2N 0.03N2
Determine the marginal rate of technical substitution.

SET 2
Q1. Define monopolistic competition? Explain its unique features.
Solution: A monopolistically competitive industry has features from both a monopoly market
structure and a perfectly competitive market structure.
The features of a monopolistically competitive industry include:
(1) Many firms. Like a perfectly competitive structure, in monopolistic competition there are
a large number of firms. Each firm is small relative to the size of the market.
(2) Entry is easy. Like a perfectly competitive structure, entry into an industry is not blocked.
In the long run, if firms are earning an economic profit, this will attract firms into the
industry. Firms will continue to enter until economic profits are zero.

(3) Firms produce different products. Unlike a perfectly competitive firm which produces a
homogeneous product, a firm that is monopolistically competitive will produce a slightly
different product than their competitors. By producing a unique product that no other firm
provides, a monopolistically competitive firm can act as a monopolist and have some market
power over the price it charges. In other words the firm can raise its prices and not worry
about losing all the demand for their product.

Q2 State the Marginal Productivity Theory. What are its features and assumptions?
Solution:
The marginal productivity theory of distribution determines the prices of factors of
production. This theory states that a factor of production is paid price equal to its marginal
product. For example a labourer gets his wage according its marginal product. He is rewarded
on the basis of contribution he makes the total output.
Factors of production are demanded because they have productivity. Higher the productivity
of a factor, greater will be its price. Marginal product or otherwise called marginal physical
product (MPP) refers to addition to the total physical product by employing one more unit of
a factor.
When MPP is multiplied by price it is called value of marginal product (VMP). Marginal
revenue product (MRP) is the addition made to total revenue by employing an additional unit

of a factor. Average revenue product (ARP) is the average revenue per unit of a factor of
production.
xplanation of the Theory:
Marginal productivity theory explains the following facts,
(a) Reward of each factor is equal to its marginal productivity:
Under perfect competition a firm employs various units of a factor up to that point where the
price paid to the factor is equal to. Its marginal productivity. Every producer compares the
price with its productivity. The price paid to a factor is income to it while it is cost to the
producer. The point of equilibrium reaches at that point where MPP=price. If the producer
employs less units of factors the productivity will be more and the cost will be less. Thus in
such a case the producer will increase his profit by employing more units of factors and
reaches the equilibrium point. On the other hand if the number of factor employed is more
than the equilibrium level, the cost will be more than the productivity. The producer will
lower the units of factors so long he reaches equilibrium. Thus his profit is maximized at the
point of equilibrium
(MRP=MW). In other words a producer will employ the factors only up to the point where
the cost of an additional factor unit equals its marginal revenue.
(b) Reward for each factor is same in every use.
Marginal productivity theory assumes that productivity of a factor is equal in all its uses. If
the factor cost in two different uses is not uniform i.e. of the factor cost in one use is greater
than other use, factors will move to that use where the factor cost is high.
This price will continue so long as the productivity of a factor becomes equal in all its uses.
Besides this the marginal productivity of, all factors is the same in a particular use and thus
they are the perfect substitutes of each other. The producer goes on substituting dearer factors
by the cheaper factors so long as the marginal productivity of the factor becomes proportional
to their prices. This condition for achieving equilibrium is stated as follows.
When a producer employees more and more of a factor unit, the marginal physical
productivity of additional factor will start diminishing. That is why Marginal Productivity
Curve diminishes after a particular point of employment of a factor. Since the objective of a
firm is to maximize profit, he will always compare the cost of employing (MR) an additional
laborer with the contribution (MP) made by that additional laborer.
He will go on employing additional factor so long as Marginal factor cost is equal to
Marginal Productivity. The moment the productivity of an additional factor equals the
marginal factor cost, he will stop employing additional factors and thereby his profit is
maximized. The equilibrium situation is explained by the following diagram.
As there is perfect competition in factor market, AFC and MFC are the same. At point Q,
AFC (MFC) is equal to MRP. The number of laborers employed is ON. At point Q the
producer attains equilibrium. At point Q, MFC=MRP. If the producer employees ON1 of
factors, the MRP is P1N1, but factor cost is Q" N r as Q1N1, < P1N1, the producer will

increase additional factors. It he employees ON 2 laborers, MRP is P2N2 and MFC is Q2N2. As
Q2N2 > P2N2 he will incur loss. He will reduce the number of laborers. Thus it is concluded
that a producer will get maximum profits in production only if the different factors are so
employed by him that their prices equal their marginal productivity.
Assumptions of the theory,
1. Prevalence of perfect competition in factor as well as product market.
2. All factors are identical.
3. Factors are perfect substitute for each other.
4. Factors are perfectly mobile.
5. Perfect divisibility of factors.
6. The theory operates in the long-run.
7. The theory is based on full employment.
Criticism:
(1) Unrealistic assumptions:
The theory is founded on certain unrealistic assumptions like prevalence of perfect
competition and they are perfectly mobile. In reality there assumptions are not found.
(2) Difficulty in the measurement of MRP:
It is difficult to measure marginal revenue productivity of a factor. Marginal revenue
productivity is the addition made to total revenue by employing an additional unit of a factor.
But actually it is difficult to get it. In a large-scale industry if the work of a labourer is
decreased, it will have no fall in total production.
(3) Factors are not perfectly identical:
In reality, different units of a factor are not identical. They are heterogeneous and hence
cannot be substituted by one another. Land and capital cannot be substituted for each other.
Labour as a factor cannot be equal in health and efficiency. They are not equally productive.
(4) Reward determines productivity:
The reward of a factor is determined by the factor's marginal productivity. Hence MRP is the
cause and reward is the effect. When a laborer is given higher wages, his living standard will
develop and his health and efficiency will increase. Hence reward is the cause and not the
wage.
Q3 Discuss Subsistence Theory and Wage Fund Theory of Wage Determination.

Solution:
Subsistence Theory of Wages:
According to this theory, the wage in the long run tends to be equal to the level of
subsistence. By minimum level of subsistence means the amount which is just sufficient to
meet the basic necessities of life of the workers and their family. It is argued that if wages
exceed the subsistence level the labour will marry and will produce children. The supply of
labour will increase then the demand and money wages will fall to the level of subsistence. If
wages remain below the subsistence level, the labour will not be able to maintain their
families. The death rate will increase due to hunger and supply of labour will fall than its
demand. Again wages will rise to the subsistence level.
Criticism: - This theory has been criticized on the following grounds:
1. Relation between marriages and wages: - It is incorrect to say that when the money
income of a person increases about the subsistence level, he marriages and increases the birth
rate. While infect when income increases, people improve their standard of living instead of
having the marriage.
2. Demand side ignored: - This theory gives more importance to the supply side and ignores
the demand side labour, for the determination of wages.
3. Difference in wages: - This theory falls to explain that why wages differ from occupation
to occupation and from person to person.
4. Trade unions ignored: - This theory ignores the role of trade unions. But in the present
age these are playing very important role in the determination of wages.
THE WAGES FUND THEORY:This theory is associated with Adam Smith and J.S.Mill. Wage fund is that amount of floating
capital which is set a part by employer for paying wages to the labour. The average wage rate
is determined by dividing the wages fund by the total number of workers employed
Wage rate = Wage Fund / Total no. of workers.
For example if capital of fund is 10,000 and number of workers are 100 then rate of wages
will be 10,000/100 = 100
If we want to increase the rate of wages, there are two methods. We should increase the fund
or we should decrease the supply of labour. We cannot increase the fund quickly, because the
savings increase slowly. Further if any group of labour succeeds in getting higher wages, the
result will be that other workers would get less.
Criticism: - This theory has been criticized on the following grounds:
1. Difference in wages: - According to this theory, all the workers receive the equal
wages while infect wages differ from worker to worker.

2. Demand factor ignored: - In this theory supply of labour has given much importance
while the demand factor has been ignored.
3. Existence of fund: - According to this theory there is a separate fund for the payment
of wages, while in reality there is no special fund which is particularly meant for the
payment of wages to the workers.
4. Objection on homogeneous labour: - This theory assumes that labour is
homogeneous and they should be paid equally but all the units of labour cannot be
homogeneous
Q4 Discuss the modern theory of rent. How is it different from the Ricardian Theory?
Solution:
Modern theory of rent is an improvement or modification over the Ricardian theory of rent.
Economists like Marshall, Mrs. Joan Robinson and Bounding contributed to the ideas of rent
which is called modern theory of rent. Ricardo's theory explains why one land commands
higher rent than another. But it fails to answer who rent arises. The modern economist has
evolved a theory called the scarcity rent.
Scarcity rent is the modified version of the demand and supply applied to land. According to
the modern theory, rent arises due to the relative scarcity of land in relation to its demand.
The greater the demand for land the higher shall be its rent. Thus Rent is the resultant of the
interaction of the forces of demand and supply in relation to land. The modern theory of rent
is also called on the demand and supply theory.
Demand side:
The demand for land is derived demand. It is derived from the demand of the products of
land. If the demand for products increases, there will be a corresponding increase in the
demand for the use of land. The demand for a factor depends upon its marginal productivity
which is subject to the law of diminishing marginal productivity. That is why the demand
curve for a factor slopes downward from the left lo the right. The downward sloping demand
curve expresses that more land will be demanded at lower rent. Hence the demand curve for
land slopes downward from left to right.
Supply side:So far as community is concerned the supply land is fixed. Thus increased rent cannot
increase supply. Nor fall in price of land can decrease its supply. Land has alternative i.e. it
can be used in several ways. For a particular industry. So far a particular industry, or firm, the
supply of land can be changed it is elastic.
Any individual can get more land. Hence the supply curve of land for an individual industry
is having an "upward slope". Supply of land is negligible. Land represents present mobile
land represents a case of perfectly inelastic supply- The rent of d may rise or fall but the
supply of land remains the same.

Rent is determined at the point where demand for and supply land intersect each other. This is
shown in the diagram given
'DD' and 'SS' are the demand as well as supply curves o land respectively. At point E the
demand for and supply of land are equal OW is the rent. If the rent is less than OW, the
demands for land will- increase. Since the supply of land is fixed, rent will rise again to OW.
If rent rises above OW i.e. OW, then the demand for land will decrease and bring the rent
back to OW.
Difference between Ricardian Theory of Rent and Modern Theory of Rent:
1. According to Ricardo, rent is peculiar to land only. But modern economists hold that
rent can be a part of the income of each factor of production.
2. According to Ricardo Theory, rent is a reward of the original and indestructible power
of the soil. Modern theory of rent attributes it to the difference between actual earning
and transfer earning.
3. According to Ricardo, rent does not enter into price rather it is determined by price.
Rent is not price-determining, it is price-determined. But according to modern theory
of rent, relation between rent and price is not so simple, from the point of view of
economy, rent does not enter into price, but from the point of view of a firm it does
enter into price.
4. According to Ricardian, main cause for the emergence of rent is the difference in the
facility of land. On the other hand, modern theory holds that rent arises when either a
factory becomes specific or its supply is less than perfectly elastic.