David Ricardo

Lecture # 12

Ms Salma Shaheen

David Ricardo(1772-1823)• Biography

– Son of a Jewish immigrant stockbroker

– 3rd of 17 children

– Read Wealth of Nation in 1799

– Encouraged by James Mill

– Principles of Political Economy 1817

– Member of Parliament 1819-1823

• Ricardian System differs from Smith’s in method and analysis

• Deductive method— “strong case”

• Importance of diminishing returns in agriculture

The Ricardian System

• Labour theory of exchange value (relative prices)

• Theory of rent and diminishing returns in agriculture

• Theory of wages and Malthusian population theory

• These three combined in the “Corn Model” of the growth process

• Related themes--international trade, machinery, taxation and banking policy

Social background of Ricardian Theories:

• Ricardo and Malthus are known as pessimists in the history of economic thought.

• During the life of Ricardo , industrial revolution had already take place with all its attendant evil.

• There was factory system and growth of population and poverty of working masses increases.

• There was increase in price of grains, caused by depreciation of money and increased urban population.

• Lands of inferior quality were brought into cultivation and lands rent were increases.

• The economy of the day were known as capital economy because use of capital were increases.

• The rising prices for food made ‘corn laws’ a tropic of great controversy.

• The landowner were interested in the continual of corn law, because they get high prices of corn and consequently high prices of rent.

• The Ricardian system:

• The salient features of ricardian system are as follows

1)First of all , Ricardo had an analytical genus. He was deductive thinker. He did not give statistical or historical facts to support his conclusion.

2)He was firm believer of Laissez fair.

3)He consider money as evil. Ricardo believe on the quantity theory of money in which the level of prices in the economy is proportional to quantity of money in the economy.

4)He incorporate the pessimistic views of Malthus with respect to population and food supply.

• 5) Ricardian analysis of rent based on the law of diminishing return.

• On the scope of political economy:

• Ricardo considered political Economy as “an inquiry into laws which determine the division of the produced of the industry among the classes who occur in its formation.”

• In his preface (introduction) to his ‘principles of political economy and taxation’ Ricardo stated that the produce of the earth was divided into rent , profit and wage and that ‘to determine the laws which regulate this distribution, is the principle problem in the political economy’

• Value:

• Ricardo theory of value is essentially a labour theory of value.

• According to Ricardo, the value of commodities depend upon two things,

1)Scarcity

2)The quantity of labour required to obtain them.

• Ricardo agree with Smith that value of most things depend on the amount of labour required to produce them.

• But there are another group of things, whose supply cannot be increased by labour.

• Smith applied labour theory of value to primitive society, Ricardo applied it to the capitalist society as well.

• Ricardo has made a distinction between the natural price and market price.

• Market price may deviate from natural price because of temporary fluctuations of supply and demand.

• If market price rises above the normal price, profits will rise and more capital will be used to produce the commodity and vice versa.

• In other words short run price depend upon the supply and demand and long run price depend on the cost of production.

• And the relative cost of production of two commodities are proportional to the relative amount of labour required to produce it.

• Ricardo theory of Rent

• In the beginning of 19th century between 1814 and 1816,there arose a political debate in England which led to so many theoretical discussions in the economic history of Europe

• In fact in the period of 1711 to 1794 the prices of corn (a general name of all kinds of grains in UK) remain very stable. But during the period of 1795 to 1800 there was three fold increases in the prices of corn, and it went on increases in the coming two decades. As the corn was basic food items, the increase in the prices create trouble to the labors.

• This creates political instability, thousand of people die due to starvation, and the employers unwillingly increase the wages as the prices of corn increases.

• Among the economist of that time there was a group which thought that prices of corn went up due to collusive behavior of landlord so they could earned higher rent.

• At that time most of the corn production made with the help of land avail on rent

• The other group headed by David Ricardo who wrote his book, “Principle of Political economy and taxation”, in 1827 was quite opposite to that of above group.

• According to Ricardo, the corn prices increases due to Napoleonic war in the Europe from 1804 to 1815. These wars created the shortage of corn in Europe leading to increase its prices. This made more profitable to produce corns. As the result the demand for the land increases pushing the use of piece of land, so the price or rent of land increases.

• On the other hand if prices decrease, it will be less profitable to produce corn. Accordingly the rent of the land and demand for the land decreases.

• Thus according to Ricardo rent is determine by prices, not the prices of corn which is determined by rent .

• Ricardo and his associates have had a long struggle to abolish English corn law and (tariff) 1815 with the purpose of importing more quantities of corn, in the country so that their prices will decreases and the supply of corn increases.

• Land of inferior quality will be brought into cultivation,rent will there fore rise.

• Wages will also rise to give labour their minimum of subsistence. And profit will fall.

• Ricardo said that rent did not enter into price.

• This had serious policy implications. It implied that even if high tax was imposed on rent , it would not raise the price of corn.

• Implication of the Ricardo theory of Rent:

• The Physiocrats, Smith and Ricardo considered rent as surplus.

• But there is one difference While the Physiocrats and Smith considered rent as gift of the nature,

• Smith believed on the harmony of interest between landlord and rest of society, Ricardo was conflict of interest between the land lord and the rest of society.

• As population increases the increase demandfor food will rise its price.

• Wages:

• Wages are the price of labour. Like all other things , labour has its natural price and market price.

• The market price of labour depend on the supply and demand.

• If there is abundant supply of labour , wages will be low and vise versa.

• The natural price of the labour depend upon the prices of necessities of life.

• If the prices of food and other necessaries rise, wage will rise and when the price of food fall, wage fall.

• Ricardo believed that in the long run , both the natural price of labour and money wage tend to rise because of the increase in the cost of producing food for increasing population.

• Ricardo idea that in the long run the wages of the workers will enable them to live only at the subsistence level, is sometime referred as ‘Iron law of wages’.

• When the market price of labour rises above the natural price, there will be expansion in the families of worker.

• As population rises wages will come down to the natural level.

• When the market price of labour below the natural price, poverty and misery will reduce the working population and wages will rise.

• Thus in the long run labour will receive the wages at minimum subsistence level.

• Ricardo has not given a clear cut theory of profit but he was emphatic about one thing.

• He firmly believed wages increased at the expense of profits.

• In other words, whenever there was an increasing in wages, profits would fall.

• Thus according to him, wage and profit are opposed to each other

• Money:

• On the question of money, we should remember that Ricardo was interested in the urgent currency problems of this day.

• Ricardo wrote on currency problems at the time when the market price of gold was increasing because of the introduction of irredeemable (inconvertible ) paper standard by the bank of England.

• He maintained that printing of bank notes was the main cause of rising prices of gold and other commodities.

• Ricardo advocates that Bank of England should restore gold standard. He believed the gold standard by acting as a check on the over-issue of currency would curb inflation.

• He advocated the economy in the use of gold and silver. Ricardo’ currency reforms was adopted by the parliament in 1819 and gold standard was introduced in 1821.

• And the gold standard remained the dominant monetary standard in Britain and many other countries for over a century, except during the major wars.

The theory of Comparative advantage.

• It is the major contribution of Ricardo to the theory of foreign trade.

• Smith advocated free competition in foreign trade and his theory of trade was based on the difference of absolute cost.

• According to Smith every country would buy in the cheapest market.

• But Ricardo develops the theory of comparative cost.

• According to him ‘trade might take place of the advantages of both trading partner’ even one of them was more efficient in the production of both commodities produced.

• Ricardo advocate that the more efficient country should export those commodities whose comparative cost is lowest and it should import those commodities whose comparative cost is highest.

• The theory of comparative cost was the theoretical basis on which Ricardo advocated free trade policy.

• We can illustrate the theory of comparative cost by the famous example given by Ricardo himself.

• Let us assume that Portugal is more efficient than England in both lines of production. Portugal can produce a certain quantity of wine by the labour of 80 men and a certain quantity of cloth by labour of 90 men. But in England, the production of the same quantities of wine and cloth takes, respectively, the labour of 120 and 100 men.

Portugal England

Wine 80 120

Cloth 90 100

• Under these circumstances it would be of mutual advantages for both countries if Portugal specialized in wine and imported cloth, while England specialized in cloth and imported wine.