Land rent has several sources. One origin, which few people know about, is the declining marginal product of labor. This means that as one adds more workers to an operation, each extra worker adds less to output than the previous worker.

An example is a kitchen. Suppose you are preparing food for a party of 20 persons. If you had one helper, that would be very helpful. A third person working in the kitchen may also be useful. But then each extra worker will be less and less productive. After there are several persons doing the food preparation, an extra person would get in the way and make the process less productive.

As numerical example, suppose there is a restaurant with four waiters. To simplify, we will ignore the cooks and the other jobs. During the day, the number of customers fluctuates, but the firm needs to have four servers on hand to handle the times when the place is full. One waiter can serve at most 4 persons per hour and works 8 hours. Each meal sells for \$50, and his wage is \$200 per day. The server at most produces revenue of \$1,600. The daily cost of the capital goods is \$200 (including a \$50 return on the investment), so the owner has \$1,600 minus \$200 minus \$200 = \$1,200 of net revenue, profit beyond the costs of labor and capital goods.

When the restaurant is less busy, a second waiter would on average increase the total service to 7 per hour for gross revenue of \$2,800. Subtracting \$200 and wages of \$400, the net revenue is \$2,200, and the extra or marginal revenue is \$1,000. With even fewer customers, a third waiter increases the service to 9 per hour for gross revenue of \$3,600. Subtract \$200 + \$600 for net revenue of \$2800. The marginal revenue is \$600.

The extra revenue is still greater than the extra labor cost of \$200, so the entrepreneur hires the fourth worker. With even fewer customers, that waiter would increase the service to 10 per hour. The gross revenue is now \$4000. Subtract \$200 + \$800 for net revenue of \$3,000. The marginal revenue is \$200, equal to the marginal cost of labor. The firm therefore does not hire any more labor. Note that the marginal revenue product of labor, the extra revenue from an extra worker, declines with each extra worker. The firm hires servers until the marginal product of labor equals the wage.

However, we forgot about land. The restaurant pays \$200 per day for the capital goods—the equipment, tables, building, and inventory. But it also pays rent for the space. Moreover, all the enterprises in the neighborhood have the same cost and revenue structure. They all have a net revenue of \$3,000.

Here comes the landlord, the owner of just the space, and says, “this \$3,000 of revenue is a surplus, and I can capture it, because workers would still get paid, and the owner’s \$200 per day is covering his normal return and cost of the capital goods.”

Conventional economists call this a “producer surplus” even though it neither comes from nor goes to the producers—the workers and the capitalist—but instead is rent which today is paid to the landowner—even though he produces neither the product nor the land. Karl Marx wrote that this surplus is created by labor and should go to the workers instead of to the greedy capitalist. But we see here that the surplus is really land rent captured by the landlord. The Marxist-socialist view is that it is wages unjustly taken by capitalist profit. We see that this is false, since the capitalist does not keep it, but pays it to the landlord.

The average revenue product of labor is the total net revenue plus wages,  \$3,000 + \$800 = \$3,800, divided by the 4 workers, thus \$950. Each worker produces \$950 of revenue, but gets a wage of \$200. The surplus from each worker is \$750. Conventional economists call this a “producer surplus” even though it neither comes from nor goes to the producers—the workers and the capitalist—but instead is rent which today is paid to the landowner—even though he produces neither the product nor the land.

Karl Marx wrote that this surplus is created by labor and should go to the workers instead of to the greedy capitalist. But we see here that the surplus is really land rent captured by the landlord.

Rent serves an economic purpose. The land rent reflects the scarcity of the space. It the rent were set to zero, everybody would want to use that space, and it would have to be allocated by bureaucrats, perhaps to an official’s cousin. No, best to have an auction where the highest bidder rents the space, as he will make the best use of the location.

Perhaps a state-socialist would by law set the rent at zero, and distribute the surplus to the workers. But the rent serves an economic purpose. The land rent reflects the scarcity of the space. It the rent were set to zero, everybody would want to use that space, and it would have to be allocated by bureaucrats, perhaps to an official’s cousin. No, best to have an auction where the highest bidder rents the space, as he will make the best use of the location.

Therefore the efficient and equitable solution is to collect the rent, and then divided it equally among the four waiters and the capitalist, since the owner of the capital goods is a human being and resident also. That’s a net revenue of \$3,000 divided by 5, for \$600 each. (The landlord lives elsewhere.) Therefore each server gets an income of \$800 per day. The surplus is land rent, efficiently and equitably divided among the people involved.

There are three views of the difference between the average product and the marginal product. The Marxist-socialist view is that it is wages unjustly taken by capitalist profit. We see that this is false, since the capitalist does not keep it, but pays it to the landlord. The conventional view is the same as the Marxist, as mainstream theory ignored land and rent, and so puts the revenue as profit, but without any judgments. Third is the reality that the surplus is land rent. That difference is where much of land rent comes from. The question then is, who should get the rent?

The question is, who should get the rent?