David Ricardo - History of Economic Thought - Lecture Slides, Slides of Economics

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David Ricardo

David Ricardo (1772-1823)

• Important sources:

– On the Principles of Political

Economy and Taxation (1817)

– Wikipedia

– EconLib

Functional Distribution of Income

• There are
  • three factors of production
    • land ,
    • labor , and
    • capital goods (such as shovels)
  • three classes of people:
    • landlords ,
    • workers , and
    • capitalists.
• Ricardo focused on income distribution

among the three classes

Functional Distribution of Income

• Landlords earn rent ,
• workers earn wages , and
• capitalists earn profits.
• Ricardo wanted to show how the total output

of a society is distributed among wages, rent,

and profits.

Diminishing Returns

• Following Turgot and others, Ricardo assumed

that the increase in output from each

additional worker decreases as the number of

workers increases.

– This is the assumption of diminishing returns

Wages

• Ricardo used the Iron Law of Wages

– This idea argued that the wage would in the long

run equal the subsistence wage, which is the bare

minimum necessary for survival.

– This assumption was also made by Cantillon,

Smith and Malthus

• I will assume the subsistence wage per worker is 25

pounds of corn per week.

Case 1: One Worker

• Suppose there is only one worker and

one shovel in the economy.

• The worker’s wage is 25 pounds of corn

per week, the subsistence wage.

• What is the profit earned by the shovel’s

owner?

• The profit earned by each shovel is 65
• Why?
• The landlord of Plot A will offer to pay 65

pounds of corn to the owner of the shovel

• Had he offered to pay, say, 64, the landlord

of Plot B would be able to lure the worker

and the shovel away from Plot A by offering

to pay 25 for the worker and 64.5 for the

shovel

Table 1: Increases in output workers A B C 1 100 90 80 2 90 80 70 3 80 70 60

Case 1: One Worker

• The profit earned by each shovel is 65
  • Note that at this profit rate, one shovel-and-

worker combo is demanded and supplied

• The owner of Plot A will employ the

worker and the shovel.

• All other plots of land will remain

uncultivated.

• Total output = 100.
• After paying wages = 25 and profit = 65 ,

the residual rent = 10.

Table 1: Increases in output workers A B C 1 100 90 80 2 90 80 70 3 80 70 60

Note that Ricardo has precisely determined the level of output and its distribution.

Profits

• Profits per shovel = output producible on

zero-rent land by one worker and one shovel

minus the worker’s subsistence wage.

– In Case 1, profits per shovel = 90 – 25 = 65

Profits

• Profits are the main source of capital

accumulation.

• If the current rate of profit is higher than the

minimum rate of profit that is acceptable to

capitalists, more capital will be accumulated.

Extensive Margin Rent

• When the rent earned by a landlord is due solely to superior

fertility of the land, that rent is called rent on the extensive

margin.

• More precisely, this rent is the output that could be produced

with one worker on this landlord’s land minus what one

worker could produce on zero-rent land.

• In the one-worker case (Case 1), zero-rent land is Plot B.

Therefore, extensive-margin rent on Plot A = 100 – 90 = 10.

Therefore, in this case, all of rent is extensive margin rent.

• In this way, Ricardo ended up with the same theory of rent that James

Anderson had earlier proposed.

Case 2: Three Workers

• Suppose now that there are 3 workers

and 3 shovels.

• Wage is 25 per worker, as before.
• Profit per shovel is 55
  • This will ensure that the landlords will

demand exactly 3 workers and 3 shovels,

as is required for equilibrium.

• Plot A will employ 2 workers and 2 shovels

and Plot B will employ 1 worker and 1

shovel.

• Plot C will be uncultivated, zero-rent land.

Table 1: Increases in output workers A B C 1 100 90 80 2 90 80 70 3 80 70 60

Why is profit = 55? Were

the shovel paid 54, the

owner of Plot C would lure

away a worker and a shovel

by paying them 25 and

54.5, respectively.

Case 2: Three Workers

• The owner of Plot A will

produce 190 and, after

paying 50 as wage and 110

as profit, will collect a

residual rent of 30.

– Of this, only 20 is rent on

extensive margin.

– The remaining rent, 10, is

called rent on the intensive

margin.

Table 1: Increases in output workers A B C 1 100 90 80 2 90 80 70 3 80 70 60

Intensive Margin Rent

• Rent earned from the intensive use of land is called

rent on the intensive margin.

• Using this concept, Ricardo is able to explain why

rent would be paid even when all land is of the same

quality, as long as the amount of available land is not

infinite.

• This follows from the application of Turgot’s idea of

diminishing returns to shovel-equipped labor on a

fixed amount of land.