David Ricardo

 David Ricardo

David Ricardo was born in London on April 18/19 in 1772, he was the third oldest child in a family of 17 children. His parents were Sephardic Jews who had immigrated to England. His father, Abraham, was a successful stockbroker. Ricardo’s business career started when he began working for his father at age 14, but at 21 he married a Quaker, which created a family rift that sent Ricardo into the world completely on his own. He was a British political economist. He was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and James Mill. At age twenty-seven, Ricardo’s interest in economic questions arose in 1799 when he read Adam Smith’s Wealth of Nations. For 10 years he studied economics, somewhat offhandedly at first and then with greater concentration. His first published work was The High Price of Bullion, a Proof of the Depreciation of Bank Notes (1810), after reading Adam Smith’s The Wealth of Nations, Ricardo got excited about economics. In his Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), Ricardo articulated what came to be known as the law of diminishing marginal returns. One of the most famous laws of economics, it holds that as more and more resources are combined in production with a fixed resource. He nonetheless prospered as a stockbroker and left a vast estate at his death. 11 September 1823 (aged 51) Gatcombe Park, Gloucestershire, England.

David Ricardo Contribution of Economics

A classical economist known for his Iron Law of Wages, labor theory of value, theory of comparative advantage and theory of rents. David Ricardo and several other economists also simultaneously and independently discovered the law of diminishing marginal returns. His most famous work well-known is the “The Principles of Political Economy and Taxation” (1817).

Classical authors such as A. Smith and D. Ricardo believed in the 'Say's law', according to which every supply creates its own demand, since the currency only works as a medium of exchange and is not intended to divert purchasing power. Thus, the necessary condition for the effective demand is equal to the value of all goods produced would be that all social classes (workers, capitalists and landlords) were willing to spend the entire household income to buy these goods (Corazza, 2005).

The Ricardian Rent

Ricardo's notions of rent were one of his major topics. Ricardo defines rent as a payment to the landowners “for the use of the original and indestructible powers of the soil” (Ricardo 1951, p67).

If rent exists or not depends on the question of land scarcity. Ricardo developed his theory in roughly three phases. A first phase without any rent. In the respective country exists a large quantity of the most fertile land? Therefore, no first day settler will be willing to pay any rent. Ricardo also accepted the idea of growing profit for a while because of equally fertile land. But with a growing population the demand for food increases. Therefore, in a second phase, less fertile land must be cultivated.

In the second phase the invested capital increased to 210 quarters of wheat but the outcome decreased to 90 quarters of wheat. Therefore, the profit rate shrank to 43% from 50% in the first phase. In general the profit rate diminished in the second phase.

In the third phase one can observe decreasing absolute profits. These observations proved Ricardo's expected differences between the landowners and the capital owners. Moreover, there is a disappearing incentive to accumulate capital. As did Adam Smith, Ricardo favored the idea of a rational market agent. If there were any possibility in the market of reaching a higher profit, no settler would be willing to pay a rent. However, if a rent exists and the profit rate falls, the general profit rate must fall as well according to Ricardo.

According to Ricardo “rent is that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil”

 The Ricardian theory of rent as base on certain assumption:

1. Rent is peculiar to land alone. Rent arises because of the peculiar characteristics of land namely that its supply is inelastic and it differs in fertility. Rent arises because of differences in the fertility of land. Rent is a differential surplus. All lands which are not of equal fertility. Only those lands which are more fertile than others will get rent.

2. Land has some original and indestructible powers.

3. Land is subject to the law of diminishing returns

4. There is perfect competition. [For details see page no. 109 to 111, History of Eco. Thought by Lokonath]

Ricardo's Labor Theory of Value

The question of how to measure value was the second major topic in Ricardo's work. First of all it should be mentioned that Ricardo had some difficulties in finding a perfect instrument. Hollander showed, in some cases the Ricardian theory of value generates some errors (Hollander 1987, p102). Ricardo relied on his idea that value only depends on real changes. From Ricardo's point of view real changes are changes in the quantity of labor absorbed in the production. If the real wage increases, the profit falls (inverse profit-wage relation). Real wages could increase in four cases:

1.      decreasing wage but more sharply decreasing productivity;

2.      constant wage but decreasing productivity;

3.      increasing wage but constant productivity;

4.      Increasing wage but a less increasing productivity.

Ricardo distinguished the labor embodied value and the labor commanded value. The latter one must be higher because of the included profits. Here, he was again in contrast with Adam Smith. While deriving his theory of value Ricardo introduced the clear differences between fixed capital (used over several periods) and circulated capital (used only once).

The Iron Law of Wages, 1817

David Ricardo was one of the foremost economic theorists of the early nineteenth century. His ideas about free enterprise and wage control were used by the industrial capitalists of Britain who wanted to produce as much profit as possible at the least possible cost. Together with Adam Smith, whose book The Wealth of Nations (1776) laid the foundations of the capitalist doctrine of laissez-faire, and Thomas Malthus (1766-1834), who employed statistics in developing a theory of world population explosion.

Ricardo was one of the principal economic theorists used by industrialists in reaction to calls for reform of working conditions in Britain. Ricardo's theory, which eventually became known as the 'Iron Law of Wages, maintained that the wages of laborers should be kept at the lowest possible level because their high rate of reproduction ensured surplus supply of labor. He also advocated a restriction of the Poor Laws. These had originally been passed by the British Parliament in the early nineteenth century to bring relief to the poorer classes in British society. The industrialists of Britain were therefore able to use the Ricardian theory of wage control to refute the calls of the reformers

Wages: wages are the price of labor. Like all other things. Labor has its natural price and market price. The market price of labor depends on supply and demand. If there is an abundant supply of labor, market price of labor will be low and if there is scarcity of labor market price will rise. But, we must note that the market price will fluctuate around the natural price.

The natural price of labor depends on the price of necessities of life required by the laborer and his family. According to Ricardo, “The natural price of labor is that which is necessary to enable the laborers one with another, to subsist and to perpetuate their race, without either to increase or decrease” If the price of food and other necessaries rise, wage will rise and when the prices of food and other necessaries fall, wage will fall.

Ricardo believed that, in the long- run both the natural price of labor and money wage would tend rise because of the increase in the cost of producing food for increasing population. Improvements in agriculture and imports of food grains would lower the cost of living only temporality. But ultimately money wages will rise in order to meet the increasing costs of food grains.

Iron Law of Wages

Ø  Ricardo’s idea that in the long run, the wages of workers will enable them to live only a “Subsistence level” is sometimes referred to as the “Iron Law of Wages”.

Ø  When the market price of labor raises above the natural price, there will be expansion in the families of workers. As population increases, wages will come down to their natural price.

Ø  When the market price of labor is below the natural price, poverty and misery will reduce the working population and wages rate will rise. Thus in the long run, workers will receive wages at minimum subsistence level.

Ø  The principles of Political Economy and Taxation (1817). In that book presented most of his important theories, especially those concerned with the determination of wages and value. For the problem of wages he proposed the iron law of wages, According to him (Ricardo) wages tend to stabilize round the subsistence level. Any rise in wage rate above subsistence will cause the working population to increase to the point that heightened competition among the glut of labor will merely causes their wages to fall back to the subsistence level.

Ø  The iron law of wages is of little importance to- day. Nobody pays any serious attention to the theory except in the text books on the history of economic thought.

Ricardo’s Law of Comparative Advantage

David Ricardo probably discovered the law of comparative advantage around the first two weeks of October 1816. The date itself is not important, but his letters at the time reveal how Ricardo’s mind worked when he discovered the law. If my hypothesis is correct, the letters show his mind ranged over much of the terrain of trade theory—from factor price equalization conditions to the Ricardian model. I also conjecture that the hard part of his discovery was coming up with the key assumption of factor immobility. The logical nature of his proof is re-examined. Given the importance comparative advantage, how it was discovered may give economists some insight into the process of highly creative thinking.

Ricardo’s discussion of comparative advantage is preceded by a general discussion of the links between trade and welfare:

“Foreign trade, then, though highly beneficial to a country, as it increases the amount and variety of the objects on which revenue may be expended, and affords, by the abundance and cheapness of commodities, incentives to saving, and to the accumulation of capital, has no tendency to raise the profits of stock, unless the commodities imported be of that description on which the wages of labor are expended (Ricardo, I, p. 133).”

The first part of the above statement, that trade increases “the amount and variety” of the mass of commodities, is an illusion to the static effects of trade. The second part of the statement suggests trade is related to economic growth, though not necessarily to profits unless imports cheapen the goods purchased by workers and, thus, lower wages and raise profit, as in the familiar Ricardian refrain about income distribution. After a paragraph describing Ricardo’s general views on profits, he then makes his famous statement that

“The same rule which regulates the relative value of commodities in one country, does not regulate the relative value of the commodities exchanged between two or more countries.”

The most reasonable assumption is that when he wrote Chapter 1 he had not worked out the law of comparative advantage because of his statement about relative prices and relative wages. He certainly was aware in Chapter 7 that his theory applied to this case as well; for we have the tremendous footnote in which he applied the theory:

“Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats he can only exceed his competitor by one-fifth or 20 per cent; and in making shows he can excel him by one-third or 33 per cent: will it not be in the interest of both that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats (Ricardo, I, p. 136).”

In October 1816, Ricardo sent the first seven chapters of his Principles to James Mill. On November 18th, 1816 James Mill wrote Ricardo: “that it may be good for a country to import commodities from a country where the production of those commodities costs more, than it would cost at home: that a change in manufacturing skill in one country, produces a new distribution of the precious metals, are new propositions of the highest importance, and which you fully prove (Ricardo, VII, p. 99).”