Home » Eng Finance » R » Ricardo, David (1772-1823)

Ricardo, David (1772-1823)

The son of Jewish parents who were connected with the money market, firstly in the Netherlands, and later in London, Ricardo had little formal education. At the early age of fourteen, however, he was already working in the money market himself. It was James Mill (the father of J. S. Mill) who persuaded Ricardo, himself diffident about his own abilities, to write. Nevertheless, Ricardo succeeded in making a fortune on the stock exchange, sufficient for him to be able to retire at forty-two. Not surprisingly, many of his earlier publications were concerned with money and banking. In 1810 he published a pampbiet on The High Price of Bullion, a Proof of the Depreciation of Bank Nates; in 1811 appeared the Reply to Mr Bosanquet’s Practical Observations on the Report of the Bullion Committee; and in 1816 Proposals for an Economical and Secure Currency. However, his work on monetary economics did not have the originality or exert the influence comparable to his studies in other brammes of economics. In 1815 he published his Essay on the Infiuence of the Low Price of Corn on the Profits of Stock, which was the prototype for his most important work. This first appeared in 1817 under the title of The Principles of Political Economy and Taxation, a work which was to dominate English classical economics for the following half-century. In his Principles Ricardo was basically concerned ‘to determine the laws which regulate the distribution (between the different classes of landowners, capitalists and labour) of the produce of industry’. His approach was to construct a theoretical model which abstracted from the complexities of an actual economy so as to attempt to reveal the major important influences at work within it. His economy was predominantly agricultural. With demand rising as a result of increasing population, and a leve! of subsistence which tended, by custom, to rise also over time, more and more less-fertile land had to be brought into cultivation. The return (in terms of the output of corn) of each further addition of capital and labour to more land fell. This process continued until it was no longer considered sufficiently profitable to bring any additional plots of land under cultivation. However, costs and profits must be the same on all land, whether or not it was marginal. Labour cost the same wherever it was applied. If profits were higher at one place than at another, it would encourage capital to be invested at the place of high return, until by the process of diminishing returns, profit fell into line with profits elsewhere. Therefore, as costs and profits were the same throughout, a surplus was earned on the non-marginal land, and this was rent (shaded in diagram).

David Ricardo

The consequence of this was that, as the population expanded and more less-fertile land was brought into cultivation, profits became squeezed between the increasing proportion of total output which went in rent and the basic minimum leve! of subsistence allocated to the wages of labour. Ricardo assumed that prices were determined principally by the quantity of labour used during production. However, he recognized that capita! costs did nevertheless also have an influence on prices and that the effect of a rise in wages on rel ative prices depended on the proportion of these two factors of production in the various commodities. With a rise in wages, capital-intensive goods became cheaper relative to labour-intensive goods, with a consequent shift in the demand and output in favour of the former. In the theory of international trade Ricardo stated explicitly for the first time the law of comparative costs. This law can best be illustrated by means of the example of two countries (A and B) producing two commodities (say cloth and wine). If the relative east of cloth to wine is the same in both countries, then no trade will take place because there is no gain to be had by exchanging wine (or cloth) for cloth (or wine) produced abroad for that produced at home. Trade will take place where cost differences exist. These can be of two kinds. First, if wine is cheap in A and cloth in B, A will specialize in wine and B in cloth, and exchange will take place to their mutual advantage. Secondly the law of comparative costs states the condition under which trade will take place, even though both commodities may be produced more cheaply in one country than another.

Country Wine Cloth A 120 100 B 80 90

Country B exports one unit of wine to A, and imports in exchange 102/100 units of cloth. If Country B had devoted the eighty man-hours employed in making wine for exports to making cloth instead, it would have produced only 80/90 units of cloth. Country B therefore gains from trade by the difference (120/100 – 80/90) units of cloth. As long as B can exchange wine for cloth at a rate higher than 80/90, it will therefore gain from the trade. If Country A exports a unit of cloth to Country B, it will obtain in exchange 90/80 units of wine. If the hundred man-hours required by A to produce a unit of cloth had been devoted to the home production of wine, only 100/120 units of wine would be obtained. The gain from trade therefore is (90/80 – 100/120) units of wine. Provided therefore A can exchange cloth for wine at a rate higher than 100/120,it will gain from the trade. Within the range of exchange of wine for cloth of 120/100 and 80/90 both countries therefore benefit.

The law of comparative costs survives as an important part of the theory of international trade today. Otherwise Ricardo’s main contribution is the analytical approach of theoretical mode! building which has contributed substantially to economists’ methodological tool-kits.

Reference: The Penguin Dictionary of Economics, 3rd edt.