Ricardian economics
Encyclopedia
David Ricardo
was born in 1772 and made a fortune as a stockbroker
and loan broker. At the age of 27, he read An Inquiry into the Nature and Causes of Wealth of Nations
by Adam Smith
and was energized by the theories of economics. His main economic ideas are contained in Principles of Political Economy and Taxation (1817). This set out a series of theories which would later become theoretical underpinnings of both Marx's Das Kapital
and Marshallian economics, including the theory of rent, the labour theory of value and above all the theory of comparative advantage
.
Ricardo wrote his first economic article ten years after reading Adam Smith and ultimately, the "bullion
controversy" gave him fame in the economic community for his theory on inflation
in 19th century England. This theory became known as monetarism
, the theory that excess currency
leads to inflation. He was also a factor in creating classical economics
, which meant he fought for Free trade
and free competition without government interference by enforcing laws or restrictions
.
(Ricardo, Economic Essays, Henderson 826). The law of diminishing returns states that if you add more units to one of the factors of production and keep the rest constant, the quantity or output created by the extra units will eventually get smaller to a point where overall output will begin to fall ("Diminishing Returns").
For example, consider a simple farm that has two inputs: labor and land. Suppose the farm has 100 hectares of land and one worker (the labor input). This land-labor combination produces some level of output. If we increase the amount of land, and the amount of labor stays the same, the worker will have to give less attention to each acre of land (if everything else stays the same). So, output might go up, but the additional (marginal) output from adding an acre of land may decrease. If we continue to add more and more land that must be tended by our one worker, we will eventually add so much land that output actually starts to decrease as our worker becomes overwhelmed (that is, less labor time, on average, is devoted to each acre). This is the typical stylized result of increasing one productive input while holding the others constant (versus increasing all inputs, generating economies of scale
).
s and other restrictions on international trade
. Ricardo devised an idea that is well known as the theory of comparative advantage
(Henderson 827, Fesfeld 325). According to the Washington Council on International Trade, comparative advantage is the ability to produce a good at a lower cost, relative to other good
s, compared to another country. In the Principles of Economics, Ricardo states that comparative advantage is a specialization technique used to create more efficient production (52) and describes opportunity cost
between producers (53). With perfect competition http://www.uncc.edu/hscampbe/landuse/e-support/Glossary.html and undistorted markets, countries tend to export goods in which they have a comparative advantage ("Comparative Advantage").
For example, we should think of two countries that both make cards and pencils and use the same amount of time to make one unit of items (please see table). Country one can make 4 pencils if they specialize just in pencils at the expense of one card, but this country can also make ¼ of a card at the expense of one pencil. The same logic goes for country two: if country two makes only pencils, it will make 2 pencils at the expense of 1 card. If country two specializes only in cards, it will make ½ of a card at the expense of a pencil. For this example, country one has a comparative advantage in pencils over country two (4 pencils to 2 pencils), whereas, country two has a comparative advantage in cards over country one (½ of a card to ¼ of a card). In Ricardo's idea of comparative advantage, these two countries should specialize in what they do best. According to The Fortune Encyclopedia of Economics, Ricardo's idea of comparative advantage is "the main basis for most economists' belief in free trade today" (827).
consisted mostly of an agricultural model featuring farmers and landowners. Since highly productive land was desired for more crops and the market would pay the same price for crops grown on both favorable and unfavorable land, farmers were eager to pay more for highly productive land to grow more crops for the extra money (Henderson 827).
Ricardo also had another influential theory: minimum wage
s. He knew that once the population rose more greatly, the demand for jobs would increase, making the wage
s decrease to a level that would not support people because many were willing to take the low-paying jobs to survive (St. Clair 9, Fusfeld 325). This observation of minimum wage work is especially true today when looking at the controversy with the enforcement of a minimum wage law. In Ricardo's book, On the Principles of Political Economy and Taxation
, he is saying that the jobs we give more value to are paid better than those we do not value as much (11-2). To Ricardo, value had much to do with the cost of production, which included wages and profit
(St. Clair 27) and how much you paid a worker affected the price you put on the item. He also believed the value of a product was related to the quality of labor necessary for the production (Principles of Political 5). An example of this would be paying a slightly higher price for an item that is handmade, rather than being manufactured. Though this is true, Ricardo also thought the labor or machine itself should be considered when selling an item and that a little of every item should be priced to include this factor of labor (St. Claire 24). Ricardo addressed many of the issues we face today in our economic world, such as minimum wage and rent (Fusfeld 325). These issues are perhaps as important to us today as they were in the 19th century, which is why David Ricardo's economic theories are still an important part of modern economics.
.
Bernhofen, Daniel M. "Gottfried Haberler’s 1930 Reformulation of Comparative Advantage in Retrospect." Review of International Economics 13.5 (Nov. 2005). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
Bhagwati, Jagdish N., Arvind Panagariya, and T. N. Srinivasin. Lectures on International Trade. Cambridge: MIT P, 1998.
Caravale, Giovanni. Legacy of Ricardo. New York: B. Blackwell, 1985.
"Classical Economics." Def. 1. Online Learning Center. 2003. McGraw-Hill Higher Education. 4 Dec. 2006.
"Comparative Advantage." Def. 1. Washington Council on International Trade. 2001. International Trade Education Foundation. 14 Nov. 2006.
"David Ricardo." Def. 1. WordNet Search. Princeton U. 7 Nov. 2006.
DeLaval International AB. "Basic Economic Principle." DeLaval. 9 June 2006. DeLaval International AB. 27 Nov. 2006.
"Diminishing Returns." Def. 1. Encarta. 2006. MSN. 27 Nov. 2006.
Dornbusch, Rudiger, Stanley Fischer, and Paul A. Samuelson. "Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods." American Economic Review 67.5 (Dec. 1977). 7 Nov. 2006.
Fonseca, Gonçalo L. "Piero Sraffa, 1898-1983." The History of Economic Thought Website. 14 Nov. 2006.
"Freer Trade." Def. 1. Washington Council on Economic Trade. 2001. International Trade Education Foundation. 4 Dec. 2006.
Fusfeld, Daniel R. "Ricardo, David." The World Book Encyclopedia. 1990 ed. 1990.
Gehrke, Christian, and Heinz D. Kurz. "Find More like This Keynes and Sraffa's 'Difficulties with J. H. Hollander.'" European Journal of the History of Economic Thought 9.4 (Winter 2002). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
Henderson, David R. "David Ricardo." The Fortune Encyclopedia of Economics. 1993.
Jamelske, Eric M. Lecture. University of Wisconsin-Eau Claire Economics Department. Schneider Social Sciences Building. Fall 2006.
Makowski, Louis, and Joseph M. Ostroy. "Perfect Competition and the Creativity of the Market." Journal of Economic Literature 39.2 (June 2001). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
Mankiw, N. Gregory. "Comparative Advantage: The Driving Force of Specialization." Principles of Economics. 4th ed.
Mittelman, James H. "Rethinking the International Division of Labour in the Context of Globalisation." Third World Quarterly 16.2 (June 1995). Academic Search Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
Peach, Terry. Interpreting Ricardo. New York: Cambridge UP, 1993.
"Perfect Competition." Def. 1. On-Line Glossary. U of North Carolina-Charlotte. 3 Dec. 2006.
“Ricardian Model.” Def. 1. Deardorff's Glossary of International Economics. 2006. Michigan U-Ann Arbor. 14 Nov. 2006.
Ricardo, David. Economic Essays: Edited with Introductory Essay and Notes by E. C. K. Gonner. New York: A. M. Kelley, 1966.
- - -. The Principles of Political Economy and Taxation. London: Dent, 1911.
- - -. Works and Correspondence. Cambridge: UP for the Royal Economic Society, 1951.
Ruffin, Roy J. "David Ricardo's Discovery of Comparative Advantage." History of Political Economy 34.4 (Winter 2002). Business Source Alumni Edition. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
Salanti, Andrea. "Pricing & Growth: A Neo-Ricardian Approach." Economic Journal 103.418 (May 1993). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 7 Nov. 2006.
Samuelson, Paul A. "The Classical Classical Fallacy." Journal of Economic Literature 32.2 (June 1994). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
Weatherall, David. David Ricardo: A Biography. The Hague: Martinus Nijhoff, 1976.
St. Clair, Oswald. A Key to Ricardo. New York: Augustus M. Kelly, 1965.
"Tariff." Def. 1. Washington Council on International Trade. 2001. International Trade Education Foundation. 4 Dec. 2006.
Whitaker, John K. "Henry George and Classical Growth Theory: A Significant Contribution to Modeling Scale Economies." American Journal of Economics & Sociology 60.1 (Jan. 2001). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006.
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
was born in 1772 and made a fortune as a stockbroker
Stock broker
A stock broker or stockbroker is a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors...
and loan broker. At the age of 27, he read An Inquiry into the Nature and Causes of Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...
by Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
and was energized by the theories of economics. His main economic ideas are contained in Principles of Political Economy and Taxation (1817). This set out a series of theories which would later become theoretical underpinnings of both Marx's Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...
and Marshallian economics, including the theory of rent, the labour theory of value and above all the theory of comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
.
Ricardo wrote his first economic article ten years after reading Adam Smith and ultimately, the "bullion
Precious metal
A precious metal is a rare, naturally occurring metallic chemical element of high economic value.Chemically, the precious metals are less reactive than most elements, have high lustre, are softer or more ductile, and have higher melting points than other metals...
controversy" gave him fame in the economic community for his theory on inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
in 19th century England. This theory became known as monetarism
Monetarism
Monetarism is a tendency in economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over...
, the theory that excess currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
leads to inflation. He was also a factor in creating classical economics
Classical economics
Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....
, which meant he fought for Free trade
Free trade
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...
and free competition without government interference by enforcing laws or restrictions
Trade barrier
Trade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...
.
Diminishing returns
Another idea Ricardo is known for in his Essay on the Influence of a Low Price of Corn on the Profits of Stock is the Law of Diminishing ReturnsDiminishing returns
In economics, diminishing returns is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant.The law of diminishing returns In economics, diminishing returns (also...
(Ricardo, Economic Essays, Henderson 826). The law of diminishing returns states that if you add more units to one of the factors of production and keep the rest constant, the quantity or output created by the extra units will eventually get smaller to a point where overall output will begin to fall ("Diminishing Returns").
For example, consider a simple farm that has two inputs: labor and land. Suppose the farm has 100 hectares of land and one worker (the labor input). This land-labor combination produces some level of output. If we increase the amount of land, and the amount of labor stays the same, the worker will have to give less attention to each acre of land (if everything else stays the same). So, output might go up, but the additional (marginal) output from adding an acre of land may decrease. If we continue to add more and more land that must be tended by our one worker, we will eventually add so much land that output actually starts to decrease as our worker becomes overwhelmed (that is, less labor time, on average, is devoted to each acre). This is the typical stylized result of increasing one productive input while holding the others constant (versus increasing all inputs, generating economies of scale
Economies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
).
Comparative advantage
Ricardo was opposed to tariffTariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s and other restrictions on international trade
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
. Ricardo devised an idea that is well known as the theory of comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
(Henderson 827, Fesfeld 325). According to the Washington Council on International Trade, comparative advantage is the ability to produce a good at a lower cost, relative to other good
Good (economics and accounting)
In economics, a good is something that is intended to satisfy some wants or needs of a consumer and thus has economic utility. It is normally used in the plural form—goods—to denote tangible commodities such as products and materials....
s, compared to another country. In the Principles of Economics, Ricardo states that comparative advantage is a specialization technique used to create more efficient production (52) and describes opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
between producers (53). With perfect competition http://www.uncc.edu/hscampbe/landuse/e-support/Glossary.html and undistorted markets, countries tend to export goods in which they have a comparative advantage ("Comparative Advantage").
For example, we should think of two countries that both make cards and pencils and use the same amount of time to make one unit of items (please see table). Country one can make 4 pencils if they specialize just in pencils at the expense of one card, but this country can also make ¼ of a card at the expense of one pencil. The same logic goes for country two: if country two makes only pencils, it will make 2 pencils at the expense of 1 card. If country two specializes only in cards, it will make ½ of a card at the expense of a pencil. For this example, country one has a comparative advantage in pencils over country two (4 pencils to 2 pencils), whereas, country two has a comparative advantage in cards over country one (½ of a card to ¼ of a card). In Ricardo's idea of comparative advantage, these two countries should specialize in what they do best. According to The Fortune Encyclopedia of Economics, Ricardo's idea of comparative advantage is "the main basis for most economists' belief in free trade today" (827).
| 1 Card | 1 Pencil | |
|---|---|---|
| Country One | 4 Pencils | 1/4 of a Card |
| Country Two | 2 Pencils | 1/2 of a Card |
How Ricardian economics is used today
Though David Ricardo was of the 19th century, many people use his work in everyday economics. Ricardo's theory on rentRenting
Renting is an agreement where a payment is made for the temporary use of a good, service or property owned by another. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from landowners...
consisted mostly of an agricultural model featuring farmers and landowners. Since highly productive land was desired for more crops and the market would pay the same price for crops grown on both favorable and unfavorable land, farmers were eager to pay more for highly productive land to grow more crops for the extra money (Henderson 827).
Ricardo also had another influential theory: minimum wage
Minimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...
s. He knew that once the population rose more greatly, the demand for jobs would increase, making the wage
Wage
A wage is a compensation, usually financial, received by workers in exchange for their labor.Compensation in terms of wages is given to workers and compensation in terms of salary is given to employees...
s decrease to a level that would not support people because many were willing to take the low-paying jobs to survive (St. Clair 9, Fusfeld 325). This observation of minimum wage work is especially true today when looking at the controversy with the enforcement of a minimum wage law. In Ricardo's book, On the Principles of Political Economy and Taxation
On the Principles of Political Economy and Taxation
On the Principles of Political Economy and Taxation is a book by David Ricardo on economics. The book concludes that land rent grows as population increases...
, he is saying that the jobs we give more value to are paid better than those we do not value as much (11-2). To Ricardo, value had much to do with the cost of production, which included wages and profit
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
(St. Clair 27) and how much you paid a worker affected the price you put on the item. He also believed the value of a product was related to the quality of labor necessary for the production (Principles of Political 5). An example of this would be paying a slightly higher price for an item that is handmade, rather than being manufactured. Though this is true, Ricardo also thought the labor or machine itself should be considered when selling an item and that a little of every item should be priced to include this factor of labor (St. Claire 24). Ricardo addressed many of the issues we face today in our economic world, such as minimum wage and rent (Fusfeld 325). These issues are perhaps as important to us today as they were in the 19th century, which is why David Ricardo's economic theories are still an important part of modern economics.
Works cited
“Adam Smith.” Def. 1. WordNet Search. Princeton U. 7 Nov. 2006Bernhofen, Daniel M. "Gottfried Haberler’s 1930 Reformulation of Comparative Advantage in Retrospect." Review of International Economics 13.5 (Nov. 2005). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006
Bhagwati, Jagdish N., Arvind Panagariya, and T. N. Srinivasin. Lectures on International Trade. Cambridge: MIT P, 1998.
Caravale, Giovanni. Legacy of Ricardo. New York: B. Blackwell, 1985.
"Classical Economics." Def. 1. Online Learning Center. 2003. McGraw-Hill Higher Education. 4 Dec. 2006
"Comparative Advantage." Def. 1. Washington Council on International Trade. 2001. International Trade Education Foundation. 14 Nov. 2006
"David Ricardo." Def. 1. WordNet Search. Princeton U. 7 Nov. 2006
DeLaval International AB. "Basic Economic Principle." DeLaval. 9 June 2006. DeLaval International AB. 27 Nov. 2006
"Diminishing Returns." Def. 1. Encarta. 2006. MSN. 27 Nov. 2006
Dornbusch, Rudiger, Stanley Fischer, and Paul A. Samuelson. "Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods." American Economic Review 67.5 (Dec. 1977). 7 Nov. 2006
Fonseca, Gonçalo L. "Piero Sraffa, 1898-1983." The History of Economic Thought Website. 14 Nov. 2006
"Freer Trade." Def. 1. Washington Council on Economic Trade. 2001. International Trade Education Foundation. 4 Dec. 2006
Fusfeld, Daniel R. "Ricardo, David." The World Book Encyclopedia. 1990 ed. 1990.
Gehrke, Christian, and Heinz D. Kurz. "Find More like This Keynes and Sraffa's 'Difficulties with J. H. Hollander.'" European Journal of the History of Economic Thought 9.4 (Winter 2002). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006
Henderson, David R. "David Ricardo." The Fortune Encyclopedia of Economics. 1993.
Jamelske, Eric M. Lecture. University of Wisconsin-Eau Claire Economics Department. Schneider Social Sciences Building. Fall 2006.
Makowski, Louis, and Joseph M. Ostroy. "Perfect Competition and the Creativity of the Market." Journal of Economic Literature 39.2 (June 2001). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006
Mankiw, N. Gregory. "Comparative Advantage: The Driving Force of Specialization." Principles of Economics. 4th ed.
Mittelman, James H. "Rethinking the International Division of Labour in the Context of Globalisation." Third World Quarterly 16.2 (June 1995). Academic Search Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006
Peach, Terry. Interpreting Ricardo. New York: Cambridge UP, 1993.
"Perfect Competition." Def. 1. On-Line Glossary. U of North Carolina-Charlotte. 3 Dec. 2006
“Ricardian Model.” Def. 1. Deardorff's Glossary of International Economics. 2006. Michigan U-Ann Arbor. 14 Nov. 2006
Ricardo, David. Economic Essays: Edited with Introductory Essay and Notes by E. C. K. Gonner. New York: A. M. Kelley, 1966.
- - -. The Principles of Political Economy and Taxation. London: Dent, 1911.
- - -. Works and Correspondence. Cambridge: UP for the Royal Economic Society, 1951.
Ruffin, Roy J. "David Ricardo's Discovery of Comparative Advantage." History of Political Economy 34.4 (Winter 2002). Business Source Alumni Edition. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006
Salanti, Andrea. "Pricing & Growth: A Neo-Ricardian Approach." Economic Journal 103.418 (May 1993). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 7 Nov. 2006
Samuelson, Paul A. "The Classical Classical Fallacy." Journal of Economic Literature 32.2 (June 1994). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006
Weatherall, David. David Ricardo: A Biography. The Hague: Martinus Nijhoff, 1976.
St. Clair, Oswald. A Key to Ricardo. New York: Augustus M. Kelly, 1965.
"Tariff." Def. 1. Washington Council on International Trade. 2001. International Trade Education Foundation. 4 Dec. 2006
Whitaker, John K. "Henry George and Classical Growth Theory: A Significant Contribution to Modeling Scale Economies." American Journal of Economics & Sociology 60.1 (Jan. 2001). Business Source Elite. EBSCO. McIntyre Lib., Eau Claire, WI. 2 Nov. 2006