EQUILIBRIUM IN THE MARKETS FOR LAND AND CAPITAL

Figure 7 The Markets for Land and Capital

Supply and demand determine the compensation paid to the owners of land, as shown in panel (a), and the compensation paid to the owners of capital, as shown in panel (b). The demand for each factor, in turn, depends on the value of the marginal product of that factor.

Now consider the purchase price of land and capital. The rental price and the purchase price are obviously related: Buyers are willing to pay more for a piece of land or capital if it produces a valuable stream of rental income. And as we have just seen, the equilibrium rental income at any point in time equals the value of that factor’s marginal product. Therefore, the equilibrium purchase price of a piece .of land or capital depends on both the current value of the marginal product and the value of the marginal product expected to prevail in the future.