Increased Rents from Increased Costs: A Paradox of Value Theory

Abstract

W HAT will be the effects of an increase in the cost of the variable factor of production upon returns to the fixed factor of production? More concretely, what will happen to the incomes of the owners of coal mines as a result of labor unionization resulting in higher labor cost? What will happen to the incomes of farm landowners if there is an increase in the cost of seed and fertilizer that affects all farmers? What will happen to the foreign-trade balance of an economy processing imported raw materials for export as a result of an increase in the cost of imported raw materials? Or, inversely, what will happen to farm incomes as a result of a decline in the cost of seed and fertilizer? What will happen to quasi-rents in an industry using the product of another industry as an input if there is a costand pricereducing innovation in the second industry? Intuition can lead one astray. Increased costs can easily lead to increased rents and decreased costs to decreased rents. The purpose of this article is to analyze the conditions under which quasi-rents rise as a result of increased factor costs and fall as a result of decreased factor costs. The analysis will proceed by means of comparative statics, quasi-rents being examined in industry equilibrium before and after a cost shift. Consider an industry in equilibrium producing a single homogeneous product under conditions of perfect competition. For simplicity assume that all firms in the industry are identical and that each firm uses two factors of production: the first, land or capital, fixed in supply to the industry in the short run; the second, labor or a particular raw material, elastic in supply to the industry in the short run.2 Each firm is producing the product in a quantity such that marginal cost equals price, or W dL/dX = P (where W is the price of the variable factor, L is the quantity of the variable factor, X is the quantity of output, dL/dX is the variable factor requirement for one more unit of output, and P is the price of the product). For each firm marginal cost is increasing, exceeds average variable cost, and equals average total cost including rent. Assume that the supply curve to the industry of the variable factor of production shifts upward by a constant amount over its entire range.3 Now at each level of industry employment, and hence of industry output, the wage of the variable factor is higher than it was. Since the marginal cost curve of each firm in the industry is WdL/ dX(X), the marginal cost curve of each