David Ricardo

“The modern economist, reading Ricardo’s Principles, feels rather as a member of

one of the Mount Everest expeditions would feel. If arriving at the top of the
mountain, he encountered a hiker clad in T-shirt and tennis shoes.” In other
words, economics came very easy to Ricardo—as easy climbing a mountain in a t-
shirt and shoes… which is not very easy.”

Ricardo’s Major Contributions

(1) Free trade (2) Hard money (3) Laws of comparative advantage (4) Labor
theory of value (5) Rent theory (6) Theory of taxation (7) Rule of investment
and speculation (8) Quantity theory of money (9) Theory of distribution.
Publications
1. The High Price of Bullion, a Proof of Deprecation of Bank Notes (1810)
2. Essay on the Influence of a Low Price of Corn on The Profits of Stock (1815)
3. Principles of Political Economy and Taxation (1817)
The Salient features of Ricardo’s method and assumptions
1. Ricardo was a deductive thinker and he did not use the inductive method.
He believed in abstract logic. He did not use historical facts to support his
conclusions.
2. He believed in the doctrine of laissez-faire. He looked at the problems not
promises and uncertainty not progress.
3. Ricardo considered money as a veil. But he believed in the quantity theory
of money: the level of prices in the economy is proportional to the quantity
of money.
4. Ricardo approached (exchange) value from the cost of production side. He
emphasized labor theory of value.
5. Ricardo incorporated the pessimistic views of Malthus with respect to
population and supply.
6. His theory of rent is based on the law of diminishing returns.

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 7. Ricardo believes that the principal problem in the political economy is to
determine the laws which regulate the distribution of the produce (as rent,
wages and profits).
David Ricardo (April 18, 1772-September 11, 1823), is a British political
economist, who systematized economics, and was one of the most influential of
the classical economists. He was one of greatest theoretical economists of all
time. At age twenty-seven, after reading Adam Smith’s The Wealth of Nations,
Ricardo got excited about economics. He wrote his first economics article at age
thirty-seven. He achieved speculator, and amassed a considerable fortune.
He was born in London and he was the third of seventeen children in a Sephardic
Jewish family (from Portugal) immigrated from the Netherlands to England just
prior to his birth. His formal education ended at the age of 13 and he was largely
self-educated. At age14 Ricardo joined his father at the London Stock Exchange,
where he began to learn about the working of finance. This beginning set the
stage for Ricardo’s later success in the stock market and real estate.
In 1819 he was elected to the British Parliament, where he was an outspoken
opponent of trade protectionism and advocate for unfettered labor and capital
markets. Illness forced Ricardo to retire from Parliament in 1823 and he died on
11 September at Gatcombe Park (which is now the home of the Princess of Royal
and her Family). When he died, his estate was worth over $100 million in today’s
dollars.
Ricardo made friends with James Mill, the Utilitarian philosopher Jeremy
Bentham and Thomas Malthus.
Sound Money
Ricardo first gained notice among economists over the “bullion controversy,” In
1809 he wrote that England’s inflation was the result of the Bank of England’s
propensity to issue excess that bank notes. In short, Ricardo was an early believer
in the quantity theory of money, or what is known today as monetarism. As a
strong advocate of ‘sound money’, Ricardo persuaded Britishparliament to
establish a strict anti-inflation standard. This is the same goal world’s central
banker have today.

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Law of Diminishing returns
Ricardo articulated one of the most famous laws of economics, the law of
diminishing returns. It holds that as more and more resources are combined in
production with a fixed resource-for example, as more labor and machinery are
used on a fixed amount of land-the additions to output will diminish.

3. Ricardian Theory of Rent

One of Ricardo’s chief contribution is his theory of rents. Borrowing from
Malthus, Ricardo explained that as more land was cultivated, farmers would
have to start using less productive land. But because a bushel of corn from less
productive land sells for the same price as a bushelfrom highly productive
land, tenant farmers would be willing to pay more to rent the highly
productive land. Rent per acre is the highest on the most fertile land and
declines to zero on the worst quality soil. Result: the landowners, not the
tenant farmers, are the ones who gain from productive land. This finding has
withstood the test of time. Economists use Ricardian reasoning today to
explain why agricultural price supports do not help farmers per se but do
makes of farmland wealthier.
“Rent is that portion of the produce of earth which is paid to the landlord for
the use of the original and indestructible powers of the soil.”
Assumptrions:
1. Rent is a differential surplus. Rent arises because of the peculiar
characteristics of land, namely, that its supply is inelastic and it differs in
fertility. Only those lands which are more fertile than others will get rent.
2. Land has more original and indestructible powers.
3. Land is subject to the law of diminishing returns.
4. There exists perfect competition.
The second grade lands have to be cultivated in order to meet the needs of the
growing population. If the second grade lands are to be brought under cultivation
the price of grain prevailing in the market must be sufficient enough to meet the

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cost of production in the second grade lands. Otherwise the second grade lands
will go out of cultivation. Since under perfect competition, there will be only one
price for a commodity, all the produce, whether it is from the first grade lands or
from the second grade lands, will have the same price. When the second grade
lands are cultivated, the first grade lands will yield a surplus over and above their
expenses of cultivation. This is called rent. In our present example, only first grade
lands yield rent. The second grade covers only the expenses of cultivation. But
suppose the demand for food grains further increases, then lands of inferior
fertility (third grade lands) will be brought under cultivation. Then the second
grade lands will yield rent and the rent of the first grade lands will increase
further. The lands that are just able to meet expenses of production is known as a
no-rent land or marginal land. Rent indicates the differential advantage of the
superior land over marginal land.
Besides, rent also arises on account of situational advantage e.g., lands nearer to
market save transport costs. Even if the lands are equally fertile, lands possessing
situational advantage command some superiority over other lands. Thus rent
arises as account of differences in fertility and situation.
To Ricardo rent does not enter price and rent is determined by price. Rent is price
determined but not price determinant. Rent is high because price (of corn) is high,
price is high, not because of rent is high. Rent does not enter the price because
the marginal lands do not get any rent at all.

Limitations of rent theory

1. There is no historical evidence that the best lands are always cultivated
first.
2. Powers of soil is not indestructible. Fertility of land may decline in the
course of time by continuous cultivation. Rent of a single farm enters price.
3. Ricardo’s theory of rent is based on the assumption of perfect competition.
But in practice most of the markets are imperfect.
4. Rent is not peculiar to land. Now the term rent is applied to payments
made for factors of production which are imperfectly elastic supply.

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Physiocrats, Smith and Ricardo- A Comparative Analysis of Rent
All of them considered rent as surplus. But Physiocarts and Smith regarded rent as
a gift of the nature, Ricardo argued that rent arise not because of the bounty of
nature but because of its niggardliness.
While Smith saw harmony of interests between landlords and rest of the society.
Population increase cause increase in demand for food and increased demand for
food raises its price. Lands of inferior quality will be brought into cultivation. Rent
will therefore rise. Wages will also rise to give labor their minimum of
subsistence. And profits will fall. Therefore, with the rise of population, Ricardo
argued, “all classes except the landlords will be injured by the increase in the
price of corn”.
Indirectly Ricardo’s theory of rent suggested that landlords as a class were never
interested in improvements in agriculture. He believed that improvements in
agriculture and imports of cheap grain could prevent the tendency towards rising
rents and falling profits. So as a policy, Ricardo opposed Corn Laws (high tariffs on
food grain imports). The repeal of Corn Laws and other restrictions on the
imported food grains would promote the interests of the society and the rents of
landlords will fall.
Ricardo believed that rent did not enter into price. This fad serious policy
implications. It implied that even if high tax was imposed on rents, it would not
raise the price of corn.

Ricardo’s Theory of Comparative Cost

Ricardo’s greatest legacy was the theorem of comparative advantage, in which he
demonstrated the unambiguous and universal benefits of free trade. His theory of
comparative advantage and his analysis of provide a solid foundation for modern
principles of taxation, regulation, and public finance.
Ricardo also opposed the protectionist Corn Laws, which restricted imports of
wheat. In arguing for free trade, Ricardo formulated the idea of comparative
costs, today called comparative advantage. Comparative advantage –a very subtle

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idea- is the main basis for most economists’ belief in free trade today. The idea is
this: a country that trades for products that it can get at lower cost from another
country is better off than if it had made the products at home.
Ricardo believed in the doctrine of laissez-faire or free trade. His free trade is
based on the theory of comparative cost. Ricardo believed that trade benefits
both trading countries, even one of the countries is more efficient in producing
both the commodities exchanged. Comparative advantage theory reveals that
two countries will gain by specialization and trade, provided that each has a
comparative advantage of lower costs in the commodities it exports.
Ricardo advocated that the more efficient country should export whose
comparative cost is lowest and it should import those whose comparative cost is
highest. The theory of cost was the theoretical basis on which Ricardo advocated
free trade policy. The theory of comparative costs is based on two fundamental
assumptions:
1. Capital and labor did not flow between countries.
2. Law of constant costs rather than increasing costs as output expanded.
Say, for example, that Poorland can produce one bottle of coke with five hours of
labor and one loaf of bread with ten hours. Richland’s workers, on the other
hand, are more productive. They produce a bottle of coke with three hours of
labor and a loaf of bread with one hour. One might think at first that because
richland requires fewer labor hours to produce either good, it has nothing to gain
from trade.
Think again, Poorland’s cost of producing coke, although higher than Richland’s in
terms of hours of labor, is lower in terms of bread. For every bottle produced,
Poorland gives up half of a loaf, while Richland has to give up three loaves to
make a bottle of coke. Therefore, Poorland has a comparative advantage in
producing coke. Similarly, for every loaf of bread it produces, Poorland gives up
two bottles of coke, but Richland gives up only a third of a bottle. Therefore,
Richland has a comparative advantage in producing bread.
If they exchange coke and bread one-for-one, Poorland can specialize in
producing coke and trading some of it to Richland, and Richland specializes in
producing bread. Both Richland and Poorland will be better off than if they hadn’t

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traded. By shifting, say, ten hours of labor out of producing bread, Poorland gives
up the one loaf that this labor could have produced. But the reallocated labor
produces two bottles of coke, which will trade for two loaves of bread. Result:
trade nets poorland one additional loaf of bread. Nor does Poorland’s gain come
at Richland gains also, or else it would not have traded. By shifting three hours
out of producing coke, Richland cuts coke production by one bottle but increases
bread production by three loaves. It trades two of these loaves for poorland’s two
bottles of coke. Richland has one more bottle of coke than it had before, and an
extra of bread.
These gains come, Ricardo observed, because each country specializes in
producing the good for which its comparative cost is lower.
Ricardo’s Theory of Value
Ricardian theory of value is essentially a labor theory of value and he was
concerned with relative values, not with the absolute values. Like Smith he
recognized two forms of value: (1) value in use and (2) value in exchange. To
Ricardo, for a commodity to have value in exchange must have utility but utility
cannot be the measure of exchange value. The value of commodities depends
upon (1) scarcity and (2) the quantity of labor required to produce them. Like
Smith Ricardo believed that the value of most things depended on the amount of
labor required to produce them. But there are some goods whose supply cannot
be increased by labor. The exchange value of such non-reproducible commodities
depended upon their scarcity (e.g., art works, rare statues and pictures etc.). The
supply of goods in the first category can be increased “almost without any
assignable limit”. For this category of goods, labor is the foundation of their value
in all stages of society. Ricardian theory of value has been sometimes described as
93 percent labor theory of value.
Ricardo made a distinction between natural price and market price. Market price
may deviate from normal price (or value) because of temporary fluctuation of
supply and demand. If market price rises above the normal price, profits will rise
and more capital will be used to produce commodity. On the other hand, if
market price falls profits will fall and capital will flow out of the industry. In other
words, short-run price depends on supply and demand and long-run price depend

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on the cost of production. And the relative cost of production of two commodities
is proportional to the respective amounts of labor required to produce them.
Limitation of labor theory of value
(1) It ignores the influence of demand.
(2) It is difficult to measure labor or cost of production. If we take time as the
measuring rod, difficulty remains there too because all workmen are not of
equal efficiency.
(3) Labor may be misdirected. A commodity which cannot fulfil the purpose
gone to its manufacture.
Taxation
Ricardo endorsed Smith’s four tax ‘maxims”—equity, convenience, transparency,
and efficiency. He agreed that broadly based taxes are more efficient and fair than
taxes aimed at specific lines of business or imposed on specific commodities. Like
Smith, he denounced all taxes on capital, including inheritance taxes and taxes on
capital gains, as “cruel and oppressive.
Wrote Ricardo; “It should [never] be the policy of governments… to lay such taxes
as will inevitably fall on capital,” since such taxes prevent capital from finding “its
way into the hands of those who will best employ it” and “since, by so doing, they
impair the funds for the maintenance of labor, and thereby diminish the future
production of the country.”
Ricardo agreed that taxes on rents from unimproved land provided the one
exception to the principle that “broader is better.” However, he summarily
rejected taxes levied disproportionately on landowners because he believed such
taxes violate Smith’s equity maxim. Ricardo noted “ landlords” often invested “
may years of toil” into “the purchase of land or house” and it would certainly be
an infringement of that principle which should ever be held sacred, the security of
property, to subject [them] to unequal taxation.
Ricardo agreed that consumers, not sellers or manufacturers, ultimately and
invariable pay the entire amount of any tax on commodities, thought he disputed
Smith’s conclusion that sometimes consumers will be required to pay ‘a
considerable overcharge.” Said Ricardo: “[I]t is impossible to conceive that more

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can be paid by the public upon whomsoever the tax may fall ..[I]f more is paid,
Adam Smith should have stated by whom it is received …” “Like Smith, he
denounced all taxes on capital, including inheritance taxes and taxes on capital
gains, as ‘cruel and oppressive.”

Distribution
He analyzed the distribution of money among the landlords, workers, and owners
of capital. He found the relative domestic values of commodities were dominated
by the quantities of labor required in their production. Rent being eliminated
from the costs of production. He concluded that profits vary inversely with wages,
which move with the cost of necessaries, and that rent tends to increase as
population grows, rising as the costs of cultivation rise. He was concerned about
the population growing too rapidly, in case it depressed wages to the subsistence
level, reduce profits and checked capital formation.
David Ricardo maintained that the economy generally moves towards a standstill.
His analysis is rooted in a modified version of the labor theory of value. He
believed that the rate of profit for society depends on the amount of labor
necessary to support the workers who farm “the most barren land that can still
maintain agriculture’’. This model breaks land down into categories based on
average fertility rates .The most fertile land naturally produces more food than
land of poorer quality. As a result it commands a higher rent. The poorest land
utilized for agriculture receives no rent. With all of its earnings going to cover
labor and capital costs. The difference between the output from the least fertile
land which can still be farmed and that of a higher quality land constitutes the
source of rent on the better land. As the population grows, poorer land must be
cultivated in order to meet the growing demand. The cost of rent for good land
then increases. This with the fact that poor land necessitates increased labor
input to maintain minimal output results in falling profit levels. As rents rise,
profits fall. Essentially, rent costs gobble up profits as the population increases.
Since profits lead to reinvestment and thus growth of rising rent costs indirectly
prevent economic progress.

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He argued that raising the duties on imported grain had the effect of increasing
the price of corn and hence increasing the incomes of landowners and the
aristocracy at the expense of the working classes and the rising industrial class. He
said that the abolition of the Corn Laws would help to distribute the national
income towards the more productive groups in society.
Stationary state
When population is small, only the best land are used for producing food. This, in
turn, means rents are small and there will be a good deal of income to be shared
between profits and wages. Everybody except the landlord is happy. In the next
stage of society since profits are high, capitalists will begin accumulation more
capital. There will be more demand for laborers. The increased demand for labor
will raise wages above the subsistence level, population will expand. When
population expands, the society is forced to cultivate lands of inferior quality to
produce the necessary increase in food supply. This, in turn, diminishing returns
and increased rents. The relative shares of wages and profits fall.
In the third stage, rent rise further and wages and profits fall. The process goes on
until population so large, the pressure on land is so great and rents are so high
that the wages at the subsistence level and profits are so low that capitalists do
not wish to accumulate more capital. The society is said to have reached the
stationary state at this point. That means the system has come to a halt.
The Ricardian theory of stationary state is a brilliant analysis because it brings
together under one head the problems of production, growth and distribution of
income which, in fact, remain the major economic problem even today.
Wages
Labor has its natural price and market price. The market price of labor depend on
the supply of and demand for labor. Excess supply reduces wages and excess
demand raises wages. But the market price fluctuates around the natural price.
To Ricardo, the natural price of labor is that price which is necessary to enable the
laborers, one with another, to subsist and to perpetuate their race, without either
increase or diminution’’. If the prices of food and other necessaries rise, wages
rise and if the prices of food and other necessaries fall, wages fall. Ricardo

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believed that in the long-run both the natural price of labor and money wage
would tend to rise because of the increase in the cost of producing for increasing
population. Improvements in agriculture and imports of food grains would lower
the cost of living only temporarily. But ultimately wages will rise in order to meet
the increasing costs of food grains.
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 “lron Law of Wages”.
When the market price of labor rises above the natural price , there will be
expansion in the families of workers. As population increases, wages will come
down to their natural price. When the market price of labor is below the natural
price, poverty and misery will reduce the working population and wage rates will
rise. Thus in the long-run, workers will receive wages at minimum subsistence –
level.
Profits
Ricardo has not given a clear-cut theory of profits. He has treated profits and
interests as one and same. But Ricardo was emphatic about one thing. He firmly
believed wages increased at the expense of profits i.e., whenever there was an
increase in wages, profits would fall. Thus according to Ricardo, wages and profits
are diametrically opposed to each other. It implied that the employer and worker
are eternally opposed. Ricardo believed that in the long-run, many wages would
rise and the rat of profits would tend to fall. Ricardo believed that the interest of
the landlord is always opposed to that of the consumer and manufacturer and the
interest of worker and employer are always opposed.

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