PRESENTATIONS DONE IN PARTIALFULFILLMENT OF THE COURSEECONOMICS FOR DEVELOPMENT AGEC 470TOPIC PRESENTED: RICARDIAN THEORY OFECONOMICS DEVELOPMENT. PRESENTER: MULAMA KENNEDY MASINDE LECTURE: MR. CLIVE MAIRURA. DATE 12TH OCT 2012
DAVID RICARDO THEORY OF REDISTRIBUTION OF RESOURCES. David Ricardo (18 April 1772 – 11 September 1823) was a British political economist and stock trader. He was often credited with systematizing economics, and was one of the most influential of the classical economist, along with Thomas Malthus, Adam Smith, and John Stuart Mill. Perhaps his most important contribution was the law of comparative advantage, a fundamental argument in favor of free trade among countries and of specialization among individuals.
• Like Smith David also produced his views on economy development in his book Principles of Political Economy and taxation. The book concludes that land rent grows as population increases. It also clearly lays out the theory of comparative advantage, which shows that all nations can benefit from free trade, even if a nation lacks an absolute advantage in all sectors of its economy.
Ricardo’s theory• He never propounded any theory of development. He simply discussed the theory of distribution. The theory is based on marginal principle explains the surplus principles, the division of the remaining shares between the wages and profits
ASSUMPTIONS OF THE THEORYRicardian theory is based on the following assumptions:-• That all land is used for production of corn and the working forces in agriculture help in distribution in the industry.• That the law of diminishing returns operates on land, that the supply of land is fixed• Demand of corn is perfectly inelastic• That labor and capital are variable inputs• That there is capital homogeneity• That capital consist of the circulating capital
• State of technical knowledge is given• All workers are paid a subsistence wages• Supply price of labor is given and constant• Demand for labor depends upon the accumulation of capital and that both demand and supply prices are independent of marginal productivity of labor• There is perfect competition capital• Accumulation results from profits
• In the Ricardian system the whole economy consists of one large huge farm fixed in supply which is engaged in producing only corn by applying homogenous units of labor and capital. It grows on the basis of interrelations of these groups in the economy. They are landlords, capitalist and laborers, among who the entire production of land is distributed.• Total national output is distributed among these three groups as rent, profits and wages respectively
Division of rents, profits and wages.• Given the total output of corn the share of each group can be attained and determined. Rent per unit of labour is the difference between the Average and marginal product of labour. i.e. total rent= the difference between the Average productivity of labor (APL) and marginal productivity of labour (MPL) multiplied by quantity of labour and capital applied on land• Thus output of total corn produced and sold rent has the first right and the residual is distributes between wages and profits, while interest is included in profits.
Corn Model TP TP Ws x L TP-Rent TP’ Rent Stationary stateProfitsWages L’ L” L At L’ profits are high. Capital accumulation occurs and the wage fund grows, raising wages above Ws. Population grows gradually pushing wages back toward Ws. But real cost of Ws rises due to diminishing returns and profits are squeezed out.
Rent.• He defined rent as "the difference between the produce obtained by the employment of two equal quantities of capital and labor." The model for this theory basically said that while only one grade of land is being used for cultivation, rent will not exist, but when multiple grades of land are being utilized, rent will be charged on the higher grades and will increase with the ascension of the grade. As such, Ricardo believed that the process of economic development, which increased land utilization and eventually led to the cultivation of poorer land, benefited first and foremost the landowners because they would receive the rent payments either in money or in product.
Malthuss criticism and Extrapolation of the problem of Ricardian Rent• In demonstrating that Ricardian Rent constitutes value for nothing (Ricardo was momentarily neglecting Says Law that all savings by-definition-equals investment), Ricardo overlooks that such value-for-nothing doesnt necessarily disappear upon "mis- payment" to a landlord.
Capital accumulation.• According to Ricardo, capital accumulation is the outcome of profits because profits leads to saving of wealth which is used for capital formulation. Capital accumulation depends on two factors:- a.) the capacity to save and b.) the will to save. The capacity to save is more important in capital formulation and accumulation.
• This depends upon the net total output after meeting the cost of workers subsistence. The larger the surplus, the larger the will to save. Ricardo tried to show that it is only under different conditions that capital accumulation will reduce profits. In this system wages plays an important role in determining income between capital and labour.
• The wage rate increases when the prices of commodity forming the subsistence of the workers income increase. the commodities consumed by the workers are primarily agricultural based and as demand for food increases, less fertile land is brought to use. For this purpose, to produce unit of the product more workers are needed.
• Demand for labour starts to rise which raises wages. Thus wages increase with the rise in price of corn and price of corn decline, in such situation rent also increases which absorbs the rise in the prices of corn, since wages also increase profits declines.
The Ricardian theory of international trade• He favors free trade as an important factor of economic development. Profit rate can be saved from declining by importing corn. The capital accumulation will therefore continue to be high, but importing of corn leads to fall in the demand of labour. on the other hand landlords and capitalist do not think it fit to import cheap corn from foreign as a result their profits declines
It follows that Home will export Cheese to Foreign. Therefore, Foreign will exportThis is how the worldwide free trade Wine to Home.price is determined. Note that the freetrade price ( ) must lie between the two Thus, Ricardian trade follows the Principalcountries’ autarky prices ( ). of Comparative Advantage: each country exports the good that it can produce at a lower opportunity cost. PriceCheese/Wine 2 1/2 Foreign + Home = World Quantity
Comparative Advantage• Each country exports the good that it had been producing at a cheaper relative price in autarky• Relative Price = Opportunity Cost• Therefore, each country exports the good for which its opportunity cost is lower• This is called the Principle of Comparative Advantage
Misconceptions AboutComparative Advantage (cont.)2. Free trade with countries that pay low wages hurts high wage countries. – While trade may reduce wages for some workers, thereby affecting the distribution of income within a country, trade benefits consumers and other workers. – Consumers benefit because they can purchase goods more cheaply (more wine in exchange for cheese). – Producers/workers benefit by earning a higher income (by using resources more efficiently and through higher prices/wages).
Misconceptions AboutComparative Advantage 1. Free trade is beneficial only if a country is more productive than foreign countries. – But even an unproductive country benefits from free trade by avoiding the high costs for goods that it would otherwise have to produce domestically. – High costs derive from inefficient use of resources. – The benefits of free trade do not depend on absolute advantage, rather they depend on comparative advantage: specializing in industries that use resources most efficiently.
Misconceptions AboutComparative Advantage (cont.)3. Free trade exploits less productive countries. – While labor standards in some countries are less than exemplary compared to Western standards, they are so with or without trade. – Are high wages and safe labor practices alternatives to trade? Deeper poverty and exploitation (e.g., involuntary prostitution) may result without export production. – Consumers benefit from free trade by having access to cheaply (efficiently) produced goods. – Producers/workers benefit from having higher profits/wages—higher compared to the alternative.
Criticism of the Ricardian theory of trade• Neglects the input of technological- He pointed out that improved technology in the industrial fields leads to the displacement of labour and other adverse consequences. I in the beginning technological progress might counteract the action of diminishing returns, but ultimately when the impact of technological impact progress is exhausted diminishing returns sets in, and economy moves towards stationary state• Wrong notion of the stationary state- the Ricardian view that the state reaches the stationary state automatically is baseless, because no economy reaches that state where profits are increasing, production rising and capital accumulation taking place
• Impracticable laissez fair policy- the theory is based on the impracticable laissez faire• Neglects institution factors – one of the principle defects of the Ricardian theory is that it neglects the role of industrial and institutional factors. They have been assumed, though very important in economic development.• Distribution rather than growth theory- according to Schumer, the Ricardian theory is not growth theory but distribution which distributes the shares of workers, landlords and capitalist. Even in this, he regards the share of land as a primary and residual share of labour and capital.
CONCLUSION• Despite these weakens the theory points towards importance of capital accumulation through agricultural development and increase in the various sources of savings and profits rates. The two basic assumptions of the theory of diminishing returns to land and Malthusian principle on population are of particular significance for under developing nation• In an underdeveloped country population increases faster than increase in food production . there is the absence of technical improvement on land. As a result the law of diminishing returns works with full force and productivity falls. The supply of available land being scare in relation to its demand, rents are high, but wages are low because labour supply is in excess of its demand and has little tendency to substitute capital for labour.
Any Questions?, comment? – Thank you! DAVID RICARDO