There is a certain fixed supply of land. Regardless of whether a person is willing and able to work or not, the total amount of land available at any point in time is limited. If there is a demand for a product, a specific quantity of land will be needed to meet the demand. In the short term, this can lead to the law of diminishing returns. The greater the demand, the greater the price of land.
Despite the fact that land is free and already available, it has some special characteristics. One of these is that it has a relatively low factor substitution potential. For instance, a similar plot of land can be used to grow wheat, a stadium, or a sugarcane. However, this does not mean that the plot of land has the same productivity. It also does not mean that the land is homogeneous. This is because it differs in climate, fertility, and locational advantages.
Another characteristic of land is that it is a pure economic rent. A landowner receives the return to his land – that is, the total income that a productive factor has earned – in exchange for the use of that land. These returns are often called differential rent.
When a landowner earns a differential rent, the result is a surplus for the owner. He or she receives a total profit for the land as a whole. Using a simple formula, this can be measured in terms of the difference between the return to land and the real supply price of that land.
The law of diminishing returns applies to other factors of production as well. For example, a person can earn more in an opera than the average singer. However, that person’s wages are not necessarily higher than the average opera singer’s. Similarly, it is possible for an increase in the value of a natural resource to be a windfall gain for the owner.
Other factors, including labour, are more responsive to changes in price than land. For instance, a decrease in the wage rate for city workers will depress the demand for X. However, it is important to note that a smaller decrease will counteract that effect. Hence, the return to land will increase more in the long run than the relative decline in the wage rate.
Unlike capital, a supply of land is a fixed supply. Therefore, the amount of land that is available is not subject to human effort. Moreover, the value of the land is determined by the demand for the product, and not by the costs of the factor. Hence, a tax on the value of land is not going to change the behavior of the demander.
Moreover, land has a relatively high price sensitivity to changes in consumer demand. This is why a tax on the price of land will not affect the economic performance of the economy. Besides, the tax will not cause distortions or create economic inefficiencies.