David Ricardo



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David Ricardo: Lecture Notes

David Ricardo (1772 – 1823)
- London stockbroker in his father’s firm from age 14.

- left an estate of £615,000 (@ $3 million) => very skilled in stock business

- lively debate with his close friend, Thomas Malthus, from 1811
Method:

- criticized for deduction without apparent empirical or historical derivation
-> “the Ricardian Vice”


- interested primarily in distribution (wages, profits, and rent) rather than market price

- profits are a residual after payment of wages

- differential rent -> no rent on marginal land

- labour theory of value in the Principles
The High Price of Bullion (1810)

- offers an undeveloped theory of value
“Gold and silver, like other commodities, have an intrinsic value, which is not arbitrary, but is dependent on their scarcity, the quantity of labour bestowed in procuring them, and the value of the capital employed the mines which produces them”


Essay on Profits (1815)

Essay on the Influence of a Low Price of Corn on the Profits of Stock”



Corn Model

- analyses a model of an economy with agricultural and industrial sectors

supposes that corn is the only input (wages and seed) and output of the agricultural sector



- industrial sector uses both manufactured inputs and corn (wages)

-> profit in agriculture is the residual between corn output and corn input net of rent

-> rate of profit in agriculture is ratio of corn surplus to corn input

=> agricultural profit rate is independent of changes in relative prices
-> agricultural profit rate sets industrial profit rate through competition of capitals


- Malthus criticized this distribution approach for lack of a theory of value

- Malthus and James Mill badgered Ricardo to write the Principles
Principles of Political Economy and Taxation” (1817)

- few changes in the 2cd edition but substantial changes in the 1820 3rd edition

- Preface: “the principal problem in Political Economy” (and the purpose of this book) is “To determine the laws which regulate th[e] distribution” of produce between wages, profits, and rent, i.e., the revenues of labour, capital, and land

Value of Commodities

- Utility is necessary for exchange value but is “not the measure of exchange value”
– approvingly cites Smith’s distinction between use value and exchange value


- Assuming Utility, exchange value is determined by

1) Scarcity
– for commodities which labour cannot increase in quantity
(e.g., rare paintings, books)
– only a small part of the market


2) “Quantity of Labour required to obtain them”
– assuming a) labour can increase quantity


b) “competition operates without restraint”

Labour Theory of Value

- criticizes Smith for “labour commanded” theory because ‘labour value’ (wages) is variable

- exchange value determined by
“comparative quantity of commodities which labour can produce”
not “comparative quantities of commodities given to labour”


e.g. Smith (Malthus) argue that a decrease in the value of commodities purchased by wages
=> an increase in the real value of wages
Ricardo argues that a decrease in the value of commodities purchased by labour
=> a decrease in the real value of wages
(decrease in labour required to produce wage goods)


- labour is comparable because the market adjusts for different qualities of labour
Wages [from Chapter V: On Wages]

- determined by the ‘real value’ of the commodities in the wage basket
– “quantity of capital and labour employed in producing them”


- “natural price of labour”
– “price which is necessary to enable the labourer …. to subsist and perpetuate their race without either increase or diminution”
=> no change in the labour force (population)
– depends not on money wages but on the “quantity of food, necessaries, and conveniences become essential … through habit, which that money can purchase”
– “It essentially depends on the habits and customs of the people”
– changes with changes in the value of necessaries


Capital [from Chapter V: On Wages]

- “Capital is that part of the wealth of a country which is employed in production and consists of food, clothing, tools, raw materials, machinery, etc., necessary to give effect to labour.”)
Determinants of labour value

1) Quantity of Labour

- “labour applied immediately to commodities” plus “labour bestowed in the implements, tools, and buildings with which labour is assisted”

- e.g. stockings: value is the sum of new labour, labour in raw materials, and the portion of the labour in the machinery and buildings necessary for production

- relative value doesn’t change if wages change for commodities with the same K/L (Fixed/Circulating Capital) ratios

=> increase of wages -> decrease of profit

2) Change in Wages

- the value of commodities “is divided into two portions: one of which constitutes the profits of stock, the other the wages of labour” [Chapter VI: On Profits]

-> change relative value if capitals differ in

a) in durability [depreciation]

b) the proportion of fixed and circulating
“Accordingly as capital is rapidly perishable, and requires to be frequently reproduced, or is of slow consumption, it is classed under the headings of circulating or of fixed capital.”
“In one trade very little capital may be employed as circulating capital, that is to say in the support or labour –it may be principally invested in machinery, implements, buildings, etc., capital of a comparatively fixed and durable character.”
– definitions of fixed and circulating capital depend on turnover period
- circulating capital turns over [is recovered] in the sale of the commodity
- fixed capital requires more than one period of production and sale to turn over


c) time required to bring the commodity to market

d) turnover of circulating capital

- the importance of this variation of value is relatively minor
“The degree of alteration in the relative value of goods, on account of a rise or fall in labour, is not of much importance” and “could not exceed 6 or 7% for profits could not, under any circumstances, admit of a greater general and permanent depreciation than to that amount”


- “There can be no rise in the value of labour without a fall of profits”

Example (simplifying Ricardo’s examples)

- K = value(/value price) of fixed capital W = value/(value price) of wages
Value = labour time necessary to reproduce the commodity
 = rate of profit = Profit/(K + W) P = K + W + (K + W) = (1 + )(K + W)
[Ricardo uses the term value for both pure labour value and (1 + )(K + W) but I use P and the term value/price to distinguish (1 + )(K + W) from pure labour value]






K

W

K + W

Value

Profit



P

P/Q




























Iron (150 tons)

80

20

100

150

50

50%

150

1

Gold (150 oz.)

50

50

100

150

50

50%

150

1

Corn (150 quar.)

20

80

100

150

50

50%

150

1

Total

150

150

300

450

150

50%

450





- All numbers are in value terms, i.e., units of labour time necessary for the production of the commodity. Profit is the difference (residual) between labour time necessary to reproduce the commodity and the labour time necessary to reproduce the capital and wages. The table also is in terms of money measure in ounces of gold since 1 ounce of gold is equivalent to one labour unit. Hence 1 ton of iron exchanges for one ounce of gold. Here the money measure and the labour time measure are the same for both value and value price (1 + )(K + W).
Suppose that wages rise by 25%





K

W

K + W

Value

Profit



P

P/Q




























Iron (150 tons)

80

25

105

150

45

43%

150

1

Gold (150 oz.)

50

62.5

112.5

150

37.5

33.3%

150

1

Corn (150 quar.)

20

100

120

150

30

25%

150

1

Total

150

187.5

337.5

450

150

50%

450





Here we see that commodities cannot sell at their values after the wage change without generating unequal rates of profits. This will cause movement of capital into the higher profit rate industries and out of the lower profit rate industries. The change in supply (Ricardo doesn’t explicitly say relative to demand here but he does accept Smith’s demand and supply mechanism elsewhere) causes a change in prices





K

W

K + W

Value

Profit

(%)

P

P/Q




























Iron (150 tons)

80

25

105

150

35

33 1/3

140

14/15

Gold (150 oz.)

50

62.5

112.5

150

37.5

33 1/3

150

1

Corn (150 quar.)

20

100

120

150

40

33 1/3

160

16/15

Total

150

187.5

337.5

450

112.5

33 1/3

450





- Here the increase in the wage rate (e.g., a rise in the cost (labour time necessary for) of subsistence raises the cost of the advanced W and thus of K + W. No change occurs in the value of the commodities since this is determined by labour time, which has not changed. This change means that at the value/price (P) of each commodity at 150, the producer of corn would receive a lower rate of profit and the producer of iron a higher rate of profit. Competition of capitals will produce an average rate of profit for all the commodities, however.

This means that the actual value (/price) (1 + )(K + W) no longer equals labour value. Note that P falls relatively for the commodity with a high K/L ratio and rises relatively for a commodity with a low K/L ratio but does not change for a commodity with the average K/L ration (50/62.5 = 150/187.5). Note also that the unit of measure in our second example remains both labour time and ounces of gold because the labour time in an ounce of gold still remains at 1. Further note that the reason for differences between labour time in the commodity and the value/price is the tendency of profit to an average. However, Ricardo speaks of the effects of a change in wages because profit is always a residual.



- an increase in wages
-> decrease in value-price of commodities where “fixed capital preponderates” relative to capital “where circulating capital preponderates” due to the average rate of profit. [Note that wages are part of circulating capital]


- “It appears then that the division of capital into different proportions of fixed and circulating capital, employed in different trades, introduces a considerable modification in the rule [labour determines value], which is of universal application when labour is almost exclusively employed in production.”
The Invariant Measure of Value

- a measure of value that does not change if wages (or the profit rate) changes
– valuable, if available, because the relationship between labour time and value and the fact of profit as a residual will not be obscured by a change in wages since the value/price of this commodity will always equal its value. Secondly, this commodity allows us to see whether or not a change in value/price for any commodity is due to a change in necessary labour time or to a mere change in wages (or circulating capital).


- a commodity will be an invariant measure if
a) there is no change in the labour quantity necessary for reproduction
b) the proportion of fixed and circulating capital is such that a change in wages does
not change relative value
=> must have the average fixed/circulating capital ratio (turnover periods, etc.)


- Ricardo merely assumes that gold is an invariant measure of value for simplicity. Note that commodities will rise in price generally (relative to the measure) if the measure of value has a relatively high K/L ratio and fall in price generally if the measure of value has a relatively low K/L ratio.

Rent

- “Rent is the 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.”

- no rent is paid for land which is abundant
- this follows from the “common principles of supply and demand” that “if the supply is boundless, they bear no price” (e.g., air)
[Note how this is linked to his scarcity theory of value for non reproducible commodities]


- rent is only paid because “in the progress of population, land of an inferior quality, or less advantageously situated, is called into cultivation”

- e.g. Suppose that three types of land with the same area produce 100, 90, and 80 quarters of corn from the same amount of capital and labour. The price of a quarter of corn must cover the capital and labour expended on the marginal land. There is no rent on this land since price equals the cost of capital and labour. However, the output of the other lands yields a return – a rent - above capital and labour expended since corn sells at the price established by the marginal land. If the population is sufficient that all three types of land will be cultivated, the 80 quarter land will set the price at the cost of capital and labour. The rent will be 20 quarters on the 100 quarter land and 10 quarters on the 90 quarter land. [Suppose that the population was such initially the demand for corn required only cultivation of the 100 quarter land. If capital and labour cost £100, the price per quarter of corn would be £1 and there would be no rent. Now suppose that population increases such that cultivation is necessary from the 90 quarter and 80 quarter land. If the cost of the capital and labour on each of these lands is still £100, the price of corn must rise to cover this cost on the marginal land, i.e., 80 quarters of corn must sell for £100 or £1.25 per quarter. These means that the 100 quarter owner gets 100*£1.25 = £125 for an expenditure of £100 or a money rent of £25 and the 90 quarter owner gets 90*£1.25 = £112.5 or a money rent of *£12.5. Ricardo’s analysis from the point of view of a pure corn surplus rather than monetarily avoids the problem that a rising corn price will change the value of wages and thus cost]

- Ricardo also analyses the case where similar capitals and labour are applied to the same land successively to get the same result. [We call the margin for successive applications of capital and labour on the same land the ‘intensive margin’ and the margin for applications of capital and labour on the different land the ‘extensive margin’]

- “The exchangeable value of commodities [whether manufactured, mined, or from agriculture] … is always regulated [not by the most favourable production but] …by those who continue to produce them under the most unfavourable circumstances; meaning … the most unfavourable under which the quantity of produce required, renders it necessary to carry on production.”

- “Corn is not high because a rent is paid but a rent is paid because corn is high”

- improvements which diminish the qualitative differences between lands decrease rents and those that increase differences increase rent.

- landlords benefit from the increased price of produce by 1) attaining a greater share of the output and 2) by the units of this greater share having relatively increased exchange value

- “The rising rent is always the effect of the increasing wealth of the country, and of the difficulty of providing food for its augmented population.”

Market Price:

- the price of a commodity due to supply and demand

- “it is the cost of production which must ultimately regulate the price of commodities, and not, as has been often said, the proportion between the supply and demand: the proportion between supply and demand may, indeed for a term, affect the market value of a commodity, until it is supplied in greater or less abundance, according as the demand may have increased or diminished: but this effect will be only of temporary duration” [Chapter XXX]

- “Commodities which are monopolized, either by an individual or by a company, vary according to the law which Lord Lauderdale has laid down [Supply and Demand]; they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the buyers to purchase them; their price has no necessary connection to their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production.” [Note the similarity to modern economic long-run equilibrium. Ricardo is not interested in the short-run]

Growth Theory

- “market price of labour”
– “price really paid for it” due to supply and demand
– market price > natural price “in an improving society for an indefinite period”
-> increase in population -> decrease in market price -> natural price


- “natural advance of society”
-> tendency of wages [in terms of labour value) to rise because the value of necessaries (e.g., food) tend to rise)
-> tendency of wages [in terms of commodities] of labour to fall
- since the supply of labour increases at the same rate while the demand for labour [investment] increases at a slower rate


- Capital Accumulation
–the “motive for accumulation will diminish with every diminution of profit, and will cease altogether when their profits are so low as not to afford them an adequate compensation for their trouble, and the risk which they … encounter”


- aggregate profit rises despite decrease in the rate of profit because the magnitude of capital is greater than the previous magnitude
e.g. K = 1000 rate of profit = 20% Profit = 200
K = 1200 rate of profit = 19% Profit = 218


Growth Model (Hicks/Hollander)

- Q = f(L, K) w = real wages r = return on capital MPL = marginal product on land
L* = rate of growth of Labour K* = rate of growth of Capitals


Assuming no fixed capital: w + wr = F’(L) = MPL

(Ignore money for this analysis but can be included)

wmax = maximum wage => K* = 0

Note: K* = 0 at r > 0 (savings a function to some extent of r)
Coupled with the suggestion that K is time -> savings dependent on r (abstinence)
Contrast Smith: K* independent of r > 0 (savings a commercial function)
-> K* = 0 at r = 0


The upper curve is the Marginal Product of Labour which declines (from some point) due to falling productivity of land. Below this is the maximum available wage which is the Marginal Product of Labour minus the minimum profit (wage * min profit rate) necessary for investment.
We begin say at the minimum wage = 0 population growth. Since rw = MPL – w > minimum rw, investment and accumulation occur. Capitalists hire more labour, bidding the actual wage rate above subsistence. Continued investment, however, implies falling marginal product and profit and rising population. Eventually the supply of labour exceeds the demand for labour and the wage rate falls. Accumulation continues until the marginal product falls to merely cover subsistence wages and the minimum profit (w * minimum profit rate). This ushers in the stationary state where population growth is zero at subsistence wages and capital accumulation is zero since the rate of return has fallen to the minimum.



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