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In an economical meaning land as factor of production is not just land itself but all natural resources. Land belongs to the passive factors of production meaning that land simply exists. From the point of view of the economist most essential feature of the land is still the same. While land can be created by drainage or landfill usually cannot be augmented in response to higher price or diminished in response to lower price. Will Rogers said: “Land is a good investment they ain’t making it no more. The price of land is determined by the demand and supply of land. As with capital, the price of land can be expressed in two ways: The purchase value of land.

The rental value of land

Both land and capital belongs to durable assets which can be bought or sold in the market or they can be rented out for period of time. Two hundred years ago land was primarily used for agriculture; now it is used mainly for residences, offices and store. The price of using a piece of land for a period of time is called its rent, or more formally, pure economic rent.

The supply curve for land is completely inelastic (vertical) because the supply of land is fixed. The demand and supply curves intersect at equilibrium. If rent rose about equilibrium price the amount of land demanded by all firms would be less than the existing amount that would be supplied. Some property owners would be unable to rent their land at all, they would have to offer their land and thus bid down its rent. By similar reasoning, the rent could not remain below the equilibrium intersection for long. If it did, the bidding of unsatisfied firms would force the factor price back up toward the equilibrium level. Only at the competitive price where the total amount of land demanded exactly equals the fixed supply will the market be in equilibrium. Since the supply of land is fixed the rent for the land depends totally on the demand curve for the land. Because the supply of land is inelastic, land will always work for whatever competition gives it. Thus the value of the land derives entirely from the value of the product, and not vice versa.

The fact that the supply of land is fixed has a very important consequence. Suppose the government introduce the 50% tax on all land rents. What is being taxed is the income or rent on the fixed supply of agricultural and urban land sites. After the tax the total demand for the land’s services will not have changed. At a price of 200 dollars people will continue to demand the same amount as before. Hence, with land fixed in supply, the market price of land services will be unchanged and must be at the original market equilibrium. Demand and quantity supplied are unchanged so the market price will be unaffected by the tax.

Therefore, the tax must have been completely paid out of the landowner’s income. What the farmer pays and what the landlord receives are now two different things. As far as the landlord are concerned, once the government steps in to take its 50% share, the effect is just the same as it would be if the net demand to the owners have shifted down from DD to D’D’(see the graph bellow). Land owners returns after taxes is now only E’, or only half as much as E. The whole of the tax has been shifted backward onto the owners of the factor in inelastic supply. Land owner will surely complain. But under perfect competition there is nothing they can do about it, since they cannot alter the total supply and land must work for whatever it can get. Half of loaf is better than none.

The striking result is that tax on rent will lead to no distortions or economic inefficiencies. A tax on pure economic rent doesn’t change anyone’s economic behavior. Demanders are unaffected because their price is unchanged. The Behavior of suppliers is unaffected because the supply of land is fixed and cannot react. Hence, the economy operates after the tax exactly as it did before the tax – with no distortions or inefficiencies arising as a result of a land tax. We see that the supply and demand for factors of production determine the distribution of income and solve the for whom problem.

We might or might not like the wages and rents determined in the marketplace. But whether or not we like the competitive distribution of income, we must recongise that competitive pricing helps to solve the question of how goods are to be produced in an efficient manner. It plays a role in the choice of the most efficient combination of factors of production. Labour-land ratios don’t result from careful government planning and allocation. In a market economy, the signals transmitted by factor prices ensure that the efficient land-labour combinations are used. Land has to be auctioned off at a high price. So the American farmer, seeking the least cost combination, substitute land for labour. In Hong Kong, by contrast, the high land price means that the land is used largely for industry rather than for land-intensive agriculture. Prices serve as indicators of scarcity: they provide signals to producers about the relative scarcity of different inputs, thereby helping producers select the combination of inputs most appropriate for the society’s factor endowments.

Although, there is only finite amount of land on this planet, the supply of land can be increased through land reclamation, for instance, but the resulting addition to the stock of land can only be very small. However, there are many markets for land and the land can be switched from one use to another. In that case the supply of land is not as inelastic as it seems to be. On the graph we can see demand and supply curves for land used for housing. An increase in the population will increase the demand for housing land. The result will be a rise in price of housebuilding land and an increase in quantity supplied. In some countries, this extra land is likely to be found by taking agricultural land and using it for house building. Using agricultural land for housing purposes is controversial in some countries.

The government limits the supply of land for housing. This has the effect of making the supply of land for housing far more inelastic. As an example we can use UK, where they use for regulations Green Belt policies. The market is in equilibrium with price OE and quantity bought and sold OA. An increase in population, leading to the shift of demand curve from D1 to D2, would lead to an increase in the price of land by EF. However, if the government has imposed limits on the sale of agricultural land for building purposes, the supply curve is not S1 but S2. The result is that the increase in the price of land is not EF but EG. Moreover, instead of an extra AC land being released for building purposes, only AB more is sold. Fewer houses are likely to be built, resulting in either homelessness or overcrowding in the existing stock of houses.

Economics Second edition, Alain Anderton -
Economics, Samuelsson and Nordhohaus -

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