David Ricardo
(1772-1823)

 Biography:

      Son of orthodox Jewish immigrants; 3rd of 17 children; converted to Christianity at marriage.

      Became wealthy as stockbroker; retired as country gentleman in his 40s, left a large inheritance (partly to Malthus)

      1817—published On The Principles of Political Economy and Taxation, with urging from James Mill

      1819-1823 (death)—served in House of Commons, calling for free trade.

Methodology:

      A businessman with a love of abstraction.

      See letter to Malthus in Buchholz, pp. 88-89.

      The "Ricardian Vice"

      Use of assumptions:

On an invariable measure of value 

When commodities varied in relative value, it would be desirable to have the means of ascertaining which of them fell and which rose in real value, and this could be effected only by comparing them one after another with some invariable standard measure of value, which should itself be subject to none of the fluctuations to which other commodities are exposed. Of such a measure it is impossible to be possessed, because there is no commodity which is not itself exposed to the same variations as the things, the value of which is to be ascertained; that is, there is none which is not subject to require more or less labor for its production. . .

 To facilitate, then, the object of this enquiry, although I fully allow that money made of gold is subject to most of the variations of other things, I shall suppose it to be invariable, and therefore all alterations in price to be occasioned by some alteration in the value of the commodity of which I may be speaking.

 

On The Principles of Political
Economy and Taxation

by David Ricardo, 1817

(third edition 1821)

PREFACE

     The produce of the earth - all that is derived from its surface by the united application of labor, machinery, and capital, is divided among three classes of the community; namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the laborers by whose industry it is cultivated.
     But in different
stages of society, the proportions of the whole produce of the earth which will be allotted to each of these classes, under the names of rent, profit, and wages, will be essentially different; depending mainly on the actual fertility of the soil, on the accumulation of capital and population, and on the skill, ingenuity, and instruments employed in agriculture.
    
To determine the laws which regulate this distribution, is the principal problem in Political Economy: much as the science has been improved by the writings of Turgot, Stuart, Smith, Say, Sismondi, and others, they afford very little satisfactory information respecting the natural course of rent, profit, and wages.
     In 1815, Mr Malthus, in his 'Inquiry into the Nature and Progress of Rent,' and a Fellow of University College, Oxford'. in his 'Essay on the Application of Capital to Land,' presented to the world, nearly at the same moment, the true doctrine of rent; without a knowledge of which, it is impossible to understand the effect of the progress of wealth on profits and wages, or to trace satisfactorily the influence of taxation on different classes of the community; particularly when the commodities taxed are the productions immediately derived from the surface of the earth. Adam Smith, and the other able writers to whom I have alluded, not having viewed correctly the principles of rent, have, it appears to me, overlooked many important truths, which can only be discovered after the subject of rent is thoroughly understood. . . .

Chapter 1  On Value

    It has been observed by Adam Smith, that 'the word Value has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called value in use; the other value in exchange. The things,' he continues, 'which have the greatest value in use, have frequently little or  no value in exchange; and, on the contrary, those which have the greatest value in exchange, have little or no value in use; Water and air are abundantly useful; they are indeed indispensable to existence, yet, under ordinary circumstances, nothing can be obtained in exchange for them. Gold, on the contrary, though of little use compared with air or water, will exchange for a great quantity of other goods.
    
Utility then is not the measure of exchangeable value, although it is absolutely essential to it. If a commodity were in no way useful, - in other words, if it could in no way contribute to our gratification, - it would be destitute of exchangeable value, however scarce it might be, or whatever quantity of labor might be necessary to procure it.
     Possessing utility, commodities derive their exchangeable value from two sources: from their scarcity, and from the quantity of labor required to obtain them.
     There are some commodities, the value of which is determined by their scarcity alone. No labor can increase the quantity of such goods, and therefore their value cannot be lowered by an increased supply. Some rare statues and pictures, scarce books and coins, wines of a peculiar quality, which can be made only from grapes grown on a particular soil, of which there is a very limited quantity, are all of this description. Their value is wholly independent of the quantity of labor originally necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them.
     These commodities, however, form a very small part of the mass of commodities daily exchanged in the market. By far the greatest part of those goods which are the objects of desire, are procured by labor,. and they may be multiplied, not in one country alone, but in many, almost without any assignable limit, if we are disposed to bestow the labor necessary to obtain them…

     That this [labor theory of value] is really the foundation of the exchangeable value of all things, excepting those which cannot be increased by human industry, is a doctrine of the utmost importance in political economy; for from no source do so many errors, and so much difference of opinion in that science proceed, as from the vague ideas which are attached to the word value.

     If the quantity of labor realized in commodities, regulate their exchangeable value, every increase of the quantity of labor must augment the value of that commodity on which it is exercised, as every diminution must lower it...

Section IV

The principle that the quantity of labor bestowed on the production of commodities regulates their relative value, considerably modified by the employment of machinery and other fixed and durable capital.

In the former section we have supposed the implements and weapons necessary to kill the deer and salmon, to be equally durable, and to be the result of the same quantity of labor, and we have seen that the variations in the relative value of deer and salmon depended solely on the varying quantities of labor necessary to obtain them,—but in every state of society, the tools, implements, buildings, and machinery employed in different trades may be of various degrees of durability, and may require different portions of labor to produce them. The proportions, too, in which the capital that is to support labor, and the capital that is invested in tools, machinery and buildings, may be variously combined. This difference in the degree of durability of fixed capital, and this variety in the proportions in which the two sorts of capital may be combined, introduce another cause, besides the greater or less quantity of labor necessary to produce commodities, for the variations in their relative value—this cause is the rise or fall in the value of labor.

Chapter 2

On Rent

Rent is that 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. It is often, however, confounded with the interest and profit of capital, and, in popular language, the term is applied to whatever is annually paid by a farmer to his landlord. . . .
     On the first settling of a country, in which there is an abundance of rich and fertile land, a very small proportion of which is required to be cultivated for the support of the actual population, or indeed can be cultivated with the capital which the population can command, there will be no rent; for no one would pay for the use of land, when there was an abundant quantity not yet appropriated, and, therefore, at the disposal of whosoever might choose to cultivate it.
     On the common principles of supply and demand, no rent could be paid for such land, for the reason stated why nothing is given for the use of air and water, or for any other of the gifts of nature which exist in boundless quantity... If all land had the same properties, if it were unlimited in quantity, and uniform in quality, no charge could be made for its use, unless where it possessed peculiar advantages of situation. It is only, then, because land is not unlimited in quantity and uniform in quality, and because in the progress of population, land of an inferior quality, or less advantageously situated, is called into cultivation, that rent is ever paid for the use of it. When in the progress of society, land of the second degree of fertility is taken into cultivation, rent immediately commences on that of the first quality, and the amount of that rent will depend on the difference in the quality of these two portions of land.
     When land of the third quality is taken into cultivation, rent immediately commences on the second, and it is regulated as before, by the difference in their productive powers. At the same time, the rent of the first quality will rise, for that must always be above the rent of the second, by the difference between the produce which they yield with a given quantity of capital and labor. With every step in the progress of population, which shall oblige a country to have recourse to land of a worse quality, to enable it to raise its supply of food, rent, on all the more fertile land, will rise.
     Thus suppose land - No. 1, 2, 3, - to yield, with an equal employment of capital and labor, a net produce of 100, 90, and 80 quarters of corn. In a new country, where there is an abundance of fertile land compared with the population, and where therefore it is only necessary to cultivate No. 1, the whole net produce will belong to the cultivator, and will be the profits of the stock which he advances. As soon as population had so far increased as to make it necessary to cultivate No. 2, from which ninety quarters only can be obtained after supporting the laborers, rent would commence on No. 1; for either there must be two rates of profit on agricultural capital, or ten quarters, or the value of ten quarters must be withdrawn from the produce of No. 1, for some other purpose. Whether the proprietor of the land, or any other person, cultivated No. 1, these ten quarters would equally constitute rent; for the cultivator of No. 2 would get the same result with his capital, whether he cultivated No. 1, paying ten quarters for rent, or continued to cultivate No. 2, paying no rent. In the same manner it might be shown that when No. 3 is brought into cultivation, the rent of No. 2 must be ten quarters, or the value of ten quarters, whilst the rent of No. 1 would rise to twenty quarters; for the cultivator of No. 3 would have the same profits whether he paid twenty quarters for the rent of No. 1, ten quarters for the rent of No. 2, or cultivated No. 3 free of all rent.
     It often, and, indeed, commonly happens, that before No. 2, 3, 4, or 5, or the inferior lands are cultivated, capital can be employed more productively on those lands which are already in cultivation. It may perhaps be found, that by doubling the original capital employed on No. 1, though the produce will not be doubled, will not be increased by 100 quarters, it may be increased by eighty-five quarters, and that this quantity exceeds what could be obtained by employing the same capital, on land No. 3.
     In such case, capital will be preferably employed on the old land, and will equally create a rent; for rent is always the difference between the produce obtained by the employment of two equal quantities of capital and labor...



 

Chapter 5

Of Wages

     Labor, like all other things which are purchased and sold, and which may be increased or diminished in quantity, has its natural and its market price. 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.
     The power of the laborer to support himself, and the family which may be necessary to keep up the number of laborers, does not depend on the quantity of money which he may receive for wages, but on the quantity of food, necessaries, and conveniences become essential to him from habit, which that money will purchase. The natural price of labor, therefore, depends on the price of the food, necessaries, and conveniences required for the support of the laborer and his family. With a rise in the price of food and necessaries, the natural price of labor will rise; with the fall in their price, the natural price of labor will fall.
     With the progress of society the natural price of labor has always a tendency to rise, because one of the principal commodities by which its natural price is regulated, has a tendency to become dearer, from the greater difficulty of producing it. As, however, the improvements in agriculture, the discovery of new markets, whence provisions may be imported, may for a time counteract the tendency to a rise in the price of necessaries, and may even occasion their natural price to fall, so will the same causes produce the correspondent effects on the natural price of labor. . . .


 Chapter 6

On Profits

     The profits of stock, in different employments, having been shown to bear a proportion to each other, and to have a tendency to vary all in the same degree and in the same direction, it remains for us to consider what is the cause of the permanent variations in the rate of profit, and the consequent permanent alterations in the rate of interest.
     We have seen that the price of corn is regulated by the quantity of labor necessary to produce it, with that portion of capital which pays no rent. We have seen, too, that all manufactured commodities rise and fall in price, in proportion as more or less labor becomes necessary to their production. Neither the farmer who cultivates that quantity of land, which regulates price, nor the manufacturer, who manufactures goods, sacrifice any portion of the produce for rent. The whole value of their commodities is divided into two portions only: one constitutes the profits of stock, the other the wages of labor. . . .
     We have shown that in early stages of society, both the landlord's and the laborer's share of the value of the produce of the earth, would be but small; and that it would increase in proportion to the progress of wealth, and the difficulty of procuring food. We have shown, too, that although the value of the laborer's portion will be increased by the high value of food, his real share will be diminished; whilst that of the landlord will not only be raised in value, but will also be increased in quantity.
     The remaining quantity of the produce of the land, after the landlord and laborer are paid, necessarily belongs to the farmer, and constitutes the profits of his stock. But it may be alleged, that though as society advances, his proportion of the whole produce will be diminished, yet as it will rise in value, he, as well as the landlord and laborer, may, notwithstanding, receive a greater value... END

Hypothetical Ricardian Example

When only Land 1 is used:
       In one week, one worker produces either:
                 90 bushels of corn
             or 90 ounces of silver
If $1 is defined to be 1 ounce of silver, the labor theory of value suggests the price of corn will be $1 per bushel.

Now, suppose the subsistence wage is 10 bushels of corn, valued at $10

If Farmer 1 hires 3 workers:

Sales Revenue = 3 x 90 x $1 = $270
Total Wages = 3 x $10 =   30
Profit     = 240
Rent     = 0

Now, if Land 1 and Land 2 are both used, the price of food is determined by production costs on Land 2 (half as fertile as Land 1).

       On Land 2, in one week, one worker produces either:
                 45 bushels of corn
             or 90 ounces of silver
       Therefore, the price of corn rises to $2 per bushel

    -----Land 2-----  

-----Land 1-----

Sales Rev. = 3 x 45 x $2 = $270      3 x 90 x $2 = $540
Total Wages = 3 x 10 x $2 =   60      3 x 10 x $2 =

  60

Profit     = 210     = 210
Rent     = 0     = 270

 

Comparative Advantage Example:

United States Production Possibilities

Coffee 30 20 10 0
Steel 0 10 20 30

 

Brazil's Production Possibilities

Coffee 18 12 6 0
Steel 0 3 6 9

 

  Production before specialization
  Production after specialization

Now, suppose after specialization, suppose that Brazil exports 10 tons of coffee and imports 9 tons of steel.

Brazilian Consumption

  Before Trade After Trade
Coffee 6 18 - 10 = 8
Steel 6 0 + 9 = 9

 

U.S. Consumption

  Before Trade After Trade
Coffee 10 0 + 10 = 10
Steel 20 30 - 9 = 21