ricardian land rent model-ppt

Urban Economics

Prof. J. M. PogodzinskiLecture 11

Ricardian Land Rent Model Corn prices determined in national

market; taken as given by farmers.Price the same everywhere.

Zero economic profit. Free entry intofarming.

Land varies in fertility Landowners rent land to the highest

bidder Zero transport cost

Higher Fertility Lowers Cost of Production

Bushels

£

AC-High Fertility

MC – High Fertility

AC - Low

MC - low

Higher Prices = Higher Land Rent

Bushels

£

AC – High Fertility

MC – High Fertility

Q0

P0

AC0

P1

Q1

AC1

Higher Prices = More Land Used in Production

Bushels

£

AC – Low Fertility

MC – Low Fertility

P0

P1

Q1

Leftover Principle• In equilibrium, land rent equals the

excess of total revenue over non-landcosts – landowner gets the leftover

• Increase in price of corn increases landrent to the point where farmers againhave zero profits

• Increase in price of corn brings moreland into production

• Price of land is high because price ofcorn is high; high land prices don’tcause high corn prices

Who Gains from Tariffs? Not farmers – zero profits before and

after Not consumers – they pay higher

price for corn Landowners – paid higher rents; land

increases in value

Von Thünen – Land Rent andAccessibility

Corn is transported by farmer tocentral market town, farmer paysshipping cost

All land is equally productive Price of corn and inputs is determined

in national markets, so farmers takeprices as given. Prices are the samein all locations.

Free entry; zero profits in equilibrium.

No substitution between land andother inputs in production• Fixed inputs [fixed proportions

production function] – one acre of landwith fixed number of other inputsproduce Q bushels of corn

• PQ = Revenue• C = costs of non-land inputs• R = land rent per acre (use one acre)• x = distance to market• t = cost of shipping one bushel one mile• tQx = transport cost

Bid-Rent Function The bid-rent function shows the

maximum amount that will be paidfor a unit of land at a given location

Profit = PQ – C – tQx – R = 0 Bid-Rent Function: R = PQ – C – tQx Land rent declines with distance to

marketplace because farmers arewilling to pay more for land withlower shipping costs.

Market Area = x*

$

x = distance to market

PQ = totalrevenue

C = non-land costs

C + tQx = non-landcosts + shipping cost

R = Land Rent

x*0

Bid-Rent Function Interpretation

R

x = distance from market1 mile 2 miles0

Bid-Rent Function with Substitutionbetween Land and Other Inputs

L = Acres of Land Profit = PQ – C – tQx – RL Bid-Rent Function =

xLtQ

LCPQ

LtQxCPQR

Substitution between Land and OtherInputs in Production

Land

OtherInputs

Fixed Proportions

Standard Isoquant

PerfectSubstitutes

Effect of Substitution Possibilities onBid-Rent Function

R

x = Distance to marketx*

Effect of Substitution Possibilities onBid-Rent Function

R

x = Distance to market

Increase in Output Price (P) or Declinein Other Input Cost (C)

R

x = Distance to market

Decrease in Shipping Cost (t)

R

x = Distance to market

Land Rent or Land Value? Most models are static. Rents do not

change over time.

In general,

In equilibrium: t is infinite

n

tt

tiRValue

0 1

iR

iRValue

n

tt

0 1∞