According to the modern theory of rent, the rent of a factor, from the point of view of any industry, is the difference between its actual earnings and transfer earnings (Rent = Present Earnings minus Transfer Earnings). Transfer earning refers to the amount of money, which a factor of production could earn in its next best-paid use (opportunity cost). Suppose, a hectare of land under cotton cultivation yields an income of Rs.15,000. If the same area is put into its next best use, namely, paddy cultivation, it earns an income of Rs.12,000, then it is its transfer earning(opportunity cost). Then, the rent of that hectare of land is Rs.3,000 (Rs.15,000-12,000). According to the modern theory, rent, in the sense of surplus, arises when the supply of land is less than perfectly elastic. From the point of view of elasticity of supply, there are three possibilities.

a) The supply of land may be perfectly inelastic, i.e., it is represented by a vertical line (Fig.). The demand for land is a derived demand for the products of the land. If the population of the country increases, the demand for food will increases, resulting in increased demand for land and a rise in its rent, and vice versa. It is known that the demand for a factor depends upon its marginal productivity, which is subject to the Law of diminishing marginal returns. Therefore, the demand curve of land slopes downward from left to right as shown in the figure. The supply of land, on the other hand, is fixed so far as the community is concerned, although individuals can increase their land area by acquiring more land from others or reduce it by parting with it. Therefore, the supply of land is perfectly inelastic. The interaction of demand and supply of land determines its rent. If the demand for land increases from D0 to D2, Then, the rent also increases from R0 to R2. Similarly, if the demand for land decreases from D0 to D1, then, the rent decreases to R1. Here, the transfer earnings will be zero, because the land cannot be transferred to any other use; the supply of total land area is also fixed and it has only one use. In this case, the entire income from land is surplus and hence, it is called rent.

Fig: Perfectly inelastic supply of land

b) The supply of land may be perfectly elastic to an individual farmer. In that case, it will be represented by a horizontal straight line (Fig). If any factor has a perfectly elastic supply, it will earn no surplus or reward. Hence, in this case, the actual earnings and the transfer earnings would be the same and there would be no surplus (rent). However, in real life, no factor has a perfectly elastic supply.

Fig: Perfectly elastic supply of land

c) The supply of land may fall between two extremes, i.e., it may be elastic, but not perfectly elastic (Fig). In this case, a part of the income from land is rent (in the sense of surplus over transfer earnings), and the remaining part is not rent. The total earnings are ORPM and transfer earnings are OSPM. Then, SRP (the shaded area in the figure) is the surplus or rent.

Fig: Relatively elastic supply of land