Have you ever taken the time to think about the uniqueness of each factor of production? What did you think about land? Imagine how any business activity would be possible in the absence of land. Land is necessary for business, and due to this, economists pay particular attention to the land market as the market where land is traded. Let’s learn about the land market in this article. What are you waiting for? Read on!
Meaning of land market
We’ll be discussing land markets, and the land market has to do with land as a factor of production. So, let’s quickly explain land so the definition of land market will be easier.
Land refers to any resources that are found in nature. This means that land as a factor of production is not created as a result of human effort. This includes land and anything that comes naturally from the land such as gold, diamonds, water, and other raw materials.
Land refers to the resources that are found in nature and used by firms as factors of production.
Now that we have defined land, we will know exactly what economists mean by the land market. So, what do they mean? The land market is simply the market where land is traded. Since firms need land and other raw materials to use as production inputs, they need a market where they can rent or purchase them, and this is where the land market comes in.
The land market is the market where land is traded.
Marginal analysis in the land market
In a perfectly competitive market, firms, being price takers, will always compare the marginal benefit and marginal cost of adding an extra unit of land. Since the firm wants to maximize its profit, it will keep adding extra units of land for as long as the marginal cost does not exceed the marginal benefit.
Every decision in economics considers benefits and costs.
Let’s look at an example below involving a coffee processing firm.
A coffee processing firm operates in a perfectly competitive market. It currently owns a plot of land on which it plants a bag of coffee seeds. However, after planting this bag of coffee on the only available plot of land, there are three bags of coffee seeds remaining. The manager sees the opportunity to plant more coffee by acquiring more land, therefore, the company adds an extra plot of land for each extra bag of coffee. Since the firm has matched the bags of coffee seeds with plots of land, it has reached efficiency. Any extra land added will be unnecessary, making the added benefit less than the added cost. This example describes the law of diminishing marginal returns in terms of land.
The law of diminishing marginal returns in the case of land states that the continued addition of extra units of land leads to smaller increases in additional output, and eventually, decreases in additional output.
Perhaps you’re wondering about a different coffee company that owns five plots of land and four bags of coffee seeds. Technically, the firm does not need to acquire an extra unit of land. However, opportunity cost applies here! What is this coffee firm forgoing by owning an extra plot of land it is not using? So, there is still a cost involved.
Demand in the land market
First, we will look at demand in the land market. But first, take note of the following.
Usually, land is rented, so the factor price of land is referred to as the rental rate, denoted by R. The quantity of land, on the other hand, is denoted by Q.
So what is demand in the land market? This is also known as land demand or the demand for land and refers to the willingness and ability of firms to purchase or rent land at any given time.
Demand in the land market refers to the willingness and ability of firms to purchase or rent land at any given time.
We mentioned the rental rate and quantity earlier, these may be self-explanatory, but let’s provide simple and accurate definitions for them.
The rental rate of land is the price at which land is sold or rented at any given time.
The quantity of land demanded is the quantity of land firms are willing to purchase or rent at a given price at a given time.
Economists illustrate the land market with the land market graph, and demand in the land market is seen in the land market graph as the land demand curve. With the rental rate (R) on the vertical axis and the quantity of land demanded (Q) on the horizontal axis, the land demand curve slopes downward from the left to the right as the rental rate has a negative relationship with the quantity of land demanded. This is shown in Figure 1 below.
Fig. 1 - Land Demand Curve
Supply in the Market for Land
Similar to the explanation for demand in the land market, supply in the land market involves land supply, the quantity of land supplied, and the rental rate. The rental rate of land is the price at which land is sold or rented at any given time. Let’s define land supply and the quantity of land supplied.
Land supply is the availability of land for purchase or rental by firms at any given time.
The quantity of land supplied is the quantity of land made available for firms to purchase or rent at a given price at a given time.
Same as we did for demand in the land market, the land market graph is used, with the rental rate (R) on the vertical axis and the quantity of land supplied (Q) on the horizontal axis. Supply in the land market is illustrated using the land supply curve. This curve slopes upward from the left to the right since the rental rate has a positive relationship with the quantity of land supplied. Take a look at Figure 2 below.
Fig. 2 - Land Supply Curve
Fixed Supply in the Land Market
The concept of economic rent applies to the land market. A factor of production earns economic rent when the payment for that factor exceeds the needed payment to use it.
Economic rent is earned when the payment for a factor of production exceeds the needed payment to use it.
In a scenario where land remains available (in supply) irrespective of its price, any payment for it is economic rent. Let's simplify this with an example.
Consider 5 acres of land in an area with extreme weather, making it unusable. This land is in fixed supply, and it would still be available even if no rental rate was being paid. This means the needed payment for the land is $0, and any payment for using the land is economic rent. Since the land is in fixed supply, its supply curve is a straight vertical line as shown in Figure 3.
At D1, all 5 acres of land remain available at $0. At D2, the rental rate of an acre of land is $100, and this means the economic rent is:
At D2 the economic rent increases to:
Fig. 3 - Economic rent of land in fixed supply
Equilibrium in the Land market
Equilibrium in the land market simply refers to the point where the supply of land meets the demand for land. Achieving an equilibrium makes the land market efficient. This is best explained using the land market graph.
The equilibrium graph shows both the land supply curve and the land demand curve. The intersection of these two curves is referred to as the equilibrium point, and the rental rate at this point is denoted by R* whereas the quantity at this point is denoted by Q*. Let's take a look at Figure 4 below.
The supply of land is inelastic compared to the other factors of production. This is because the cost of increasing the quantity of useful land is very high compared to the other factors of production. Figure 4 shows equilibrium in the land market alongside the capital market. The steeper and more inelastic supply curve for land means that any small increase in the quantity of land demanded would lead to a much higher price as opposed to the capital market where the supply is relatively more elastic.
Fig. 4 - Equilibrium in the land market
Equilibrium in the land market is where the demand and supply curves intersect.
Land market examples
Let us provide some examples of land markets. Remember, land refers to any natural resource, so the examples are the markets for different natural resources. Here are five examples of land markets.
- The market for timber
- The market for copper
- The market for aluminum
- The market for water
- The market for limestone
Go ahead and add more examples for any natural resource you can think of. Remember, if it’s used as an input, it qualifies!
Now that you have reached the end of this topic, you should check out our article on the Market for Capital. It is very similar to this one and you should understand it very easily!
Land Market - Key takeaways
- Land refers to the resources that are found in nature and used by firms as factors of production.
- The land market is the market where land is traded.
- The law of diminishing marginal returns of land states that the continued addition of extra units of land leads to smaller increases in additional output, and eventually, decreases in additional output.
- Demand in the land market refers to the willingness and ability of firms to purchase or rent land at any given time.
- The rental rate of land is the price at which land is sold or rented at any given time.
- The quantity of land demanded is the quantity of land firms are willing to purchase or rent at a given price at a given time.
- Land supply is the availability of land for purchase or rental by firms at any given time.
- The quantity of land supplied is the quantity of land made available for firms to purchase or rent at a given price at a given time.
- Equilibrium in the land market is where the demand and supply curves intersect.
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