Ricardian Theorien and Model of Development

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His father was a successful stockbroker. At the age of fourteen, when he entered his father’s office, he showed much aptitude for business He made a fortune as a stockbroker and loan broker, after his family disinherited him for marrying, Priscilla Anne Wilkinson at the age of 1, who was outside his Jewish faith. Then he disconnected from Judaism and became a Unitarian, at the time of his marriage. He had eight children including three sons who also have achieved fame in their respective workplace.

At the age of 25, he was already rich and began to occupy himself with scientific pursuits, and gave some attention to mathematics as well as to chemistry and mineralogy. Arcade’s curiosity in economics was sparked by a chance reading of Adam Smith’s Wealth of Nations (1776) when he was in his late twenties. At the age of 37, he wrote his first book on economics, The High Price of Bullion a Proof of the Depreciation of Bank Notes (1810), which stated that England’s inflation was the consequence of the Bank of England’s propensity to issue excess banknotes.

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In short, Richard was an early advocate in the quantity theory of money, or what is recognized today as monetarism. His other writings included: Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), which argued that repealing the Corn Laws would distribute more wealth to the productive members of society. There he introduced the differential theory of rent and the law of diminishing returns to land cultivation. On the Principles of Political Economy and Taxation (1 81 7), an analysis that concluded that land rent grows as population increases.

It also clearly laid out the theory of comparative advantage, which argued that all nations could benefit from free trade, even if a nation was less efficient at producing all kinds of goods than its trading partners. In 1811 , made the acquaintance of James Mill, whose introduction to him arose out of the publication of Mill’s tract entitled Commerce Defended. Richard was elected into the British parliament in 1819 and he was very much interested in various areas of policy making: repayment of public debt, capital taxation ND the Corn Laws.

He was very much against protectionism and campaigned for repealing Corn Law. At last in 1846, his nephew John Lewis Richard, PM for Stoke-on-Trend, advocated free trade and the repeal of the Corn Laws. He had considerable debate with his notable friends included Jeremy Beneath and Thomas Malthusian, over many issues, such as, the role of landowners in the society. Richard was also influenced by Jean-Baptists Say who was French economist and businessmen, famous for his often misinterpreted “Says Law and whose work sparks numerous debates among economists at his time. When

Richard died on 11 September 1823, in Catacomb Park, Clotheshorse, England, his estate was worth more than $100 million in today’s dollars. Functional Distribution of Income: At first Richard assumes that The whole economy is like a giant landlord’s estate, the management of which can be given over to a tenant farmer (capitalist) who hires labor. There is only one output (corn) which serves as the I-good and C- good. There are diminishing returns (infertile land). Wage rate is institutionally determined at subsistence level in terms of corn. So, there are three factors of production: Land, Labor and Capital goods.

And there are three classes of people: Landlords who earns rents, Workers who earns wages and Capitalists who receives profits. Distribution is the fundamental question posed by Richard. Richard wanted to show how the total output of a society is distributed among wages, rent, and profits. Labor Theory of Value: Smith, Richard and Marx each used the labor theory of value in their own ways and to their own principles. Adam Smith’s (1776) great theme was that the prosperity and wealth of nations occur from the energy, cleverness and pragmatism of their people.

According to him the primary function of the labor hero of value was to put the source of wealth in the productive activity of the population rather than in the god-given fertility of land or its stores of treasure. For Smith the labor theory of value is a return to fundamental realities of human existence, a way of transmitting the attention of his audience from ways to take already produced wealth away from others through interest or rent, toward projects for generating wealth through the organization of productive labor.

Richard started his book on “On the Principles of Political Economy and Taxation” (1817) with a whole-hearted endorsement of Smith’s work. He raised en criticism, that Smith’s account of natural price as the adding up of natural levels of wages, profits, and rents is inconsistent with the labor theory of value itself. This observation guides Richard to the explanation of the labor theory of value as a logically consistent framework for the analysis of the distribution of the value of the product between wages, profit and rent.

Richard opens the first chapter with a statement of the labor theory of value in his book. Arcade’s labor theory of exchange value states that the relative price of two goods is determined by the ratio of the quantities of labor required in heir production. In his words, value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labor which is necessary for its production, and not as the greater or less compensation which is paid for that labor” (Richard 1817).

His labor theory of value, however, required several assumptions: both sectors have the same wage rate and the same profit rate; the capital employed in production is made up of wages only; the period of production has the same length for both goods. As Richard himself realized that the second ND third assumptions were quite unrealistic, he made two exceptions to his labor theory of value: production periods may differ; the two production processes may employ instruments and equipment as capital and not just wages, and in very different proportions.

And he follows Smith in value “in use” and value “in exchange”, focus on value in exchange. Value “in use” is the usefulness of the commodity, its utility. In the words of Adam Smith: “The word VALUE, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the rower 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 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 frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it. Wealth of Nations Book 1, chapter IV) Value “in exchange” is the relative proportion with which the product exchanges for another product (in other words, its price in the case of money). It is relative to labor as explained by Adam Smith: “The value of any commodity to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labor which it enables him to purchase or command. Labor, therefore, is the real measure of the exchangeable value of all commodities. (Wealth of Nations Book 1, chapter V; emphasis added). According to Richard, utility is not a measure of value; it is a necessary but not sufficient condition. Having utility, commodities derive their exchangeable value from two sources: from their scarcity and from the quantity of labor required to obtain them. The quantity of scarce goods can not be increased by any labor and thus their value cannot be lowered by an increased supply, such as, rare paintings, statues, wine of special quality etc.

And the commodities which derive their exchangeable value from the quantity of labor needed to produce them can be increased in quantity by the exertion of human industry, and on the reduction of which competition operates without restraint and for them labor is the foundation of their value. He also mentioned that rent is the result not the cause of value. While Adam Smith applied labor theory of value to the primitive societies, Richard applied it to capitalist society as well. In fact he thought that labor was the foundation of in value in all stages of society.

From the assumptions made by Richard to make this theory consistent, it can be found that Richard realized that when the question of capital comes in, a problem arose: specially, as different industries apply different quantities of capital per laborer, then the rate of profit will also vary across industries. Richard understood that if he then assumed that the rates of profit across different industries were equalized as free competition would imply, then, mathematically, relative prices would now vary with wages – exactly what he had criticized Adam Smith for.

So he realized that the labor theory of value would only work if the degree of capital-intensity was the same across all sectors. Thus, Richard proposed two ways out of this problem. The first was the empirical argument that firms apply capital in a roughly proportional manner to the amount of labor invested. In this case, the resulting prices when profits are equalized would not differ much from the values implied by the LTV. This is what Stiller (1958) has called Arcade’s “93% labor theory of value”.

The second solution was to find a commodity which has the average capital per worker, so that its price would reflect labor-embodied value and thus not vary with changes in distribution. He called this the “invariable standard of value”. If one can find what this “standard” commodity is, Richard argued, then the rest of the analysis is simple. But in reality this “standard commodity” does not exist. Richard has made a difference between natural price and market price.

Market price may differ from the natural price because of temporary fluctuations of supply and demand if market price rises above the normal price, profit will rise and more capital will be applied to produce the commodity. On the other hand, if the market price fall, profits will fall capital will flow out of the industry. In other words, short run price depends on supply and demand and long run price depends on the cost of production.

And the relative costs of production to the respective amounts of labor required producing them. According to Richard labor is the foundation and SOUrce of value, is the cause of changes in absolute value, is the closest approximation to measure of value and inter-relates economic value of technology. For him the labor theory of value provides the crucial image of the determinate totality of economic value production, which then allows for the rigorous deductive analysis of its division into functionally relevant parts.

Theory of Rent: Richard wanted to understand the questions of who gets what in an economy, and why. To do this, he required a theory of rent. At that time, in 19th century Britain the issue of land rent was especially significant. In Arcade’s words: “Economic rent on land is the value of the difference in productivity between a given piece of land and the poorest [and/or most distant], most costly piece of land producing the same goods (e. G. Bushels of wheat) under the same conditions (of labor, capital, technology, etc. ). [l] Here the productivity is defined in terms of the natural fertility of the soil; and the productivity of the existing technology in utilizing currently available labor and capital, also the relative distance from the same market in terms of regional economics with one market and it is noted that the closer a piece of land was to the urban core the higher was its market rent. Thus productivity differences reflect the cost differences in supplying grain to that one market from that piece of land. The concept of economic rent requires some assumptions.

At first it is assumed that at the initial stage of development with a stable and low level of population, only the very best lands which are the most fertile, the most easily worked, the closest to the market and the lowest cost lands for producing grain are cultivated. With the population growth, diminishing returns on land because f the fixed quantity of land forces to cultivate new but inferior and marginal lands which are less fertile, more difficult to work, and further from the market, involving higher production and transportation costs.

Thus the necessary result of adding on more and more inferior or marginal land is the increasing cost of producing those extra bushels of grain to feed that growing population. Here it is assumed that all people were fed. It is also assumed that there is only one price for any given region, for any one given market zone, which clears the market in that region. The final or equilibrium market price for grain will thus equal the cost of producing that last bushel of grain under diminishing returns on that last unit of land forced into production to feed that larger population.

Nobody is going to produce grain for very long at a cost higher than the market price; and nobody will be silly enough to sell grain at lower price than the existing market price. In fact the level of population and of demand has really determined the market price of grain; for without that increased demand, that last unit of land would not be producing grain for the market. On that last piece of land put under cultivation, total sales revenue equals total costs, with no surplus or profit. The farmer earns just enough to keep him in production, without looking for alternative employment.

On the more productive and lower cost lands that were put into cultivation earlier, total sales revenues exceed total costs, because costs on those better lands are lower. That difference generates a surplus or a profit called “economic rent”, which can be seen on the graph by the difference between production costs and the market price. According to Arcade’s theory, the rent to a landowner for a certain piece of land is equal the surplus revenue that remains after paying all other costs, including the tenant farmer’s normal profit.

From the graph we can see, as we are putting more land on cultivation, the production cost is getting higher due to diminishing return and the rent is getting lower. At last, the last unit of marginal land has been brought into production with a rent of zero, since here the market price equals the cost of production. So, Richard argued that all of that surplus, or profit, or ‘economic rent’ was captured or expropriated by the landlord.

As a result, the landlord could expel those tenants that refused to hand over the surplus, and replace them with those working marginal lands or with landless peasants. We can see this idea has influenced Karl Marx. Rent can also be understood in terms of opportunity cost. The opportunity cost of doing A is the value of any benefit foregone, or given up, by not doing B; i. E. , the value that would have been produced by using that factor of production in the next best alternative ‘opportunity. Thus, in order to secure the use of that factor, the employer has to pay something more than its opportunity cost. So the term ‘rent’ became the term for payment of any such a ‘surplus’ to a factor of production over and above what was necessary to maintain that factor in its present use or form of production, above its opportunity cost. Rent and Price Theory: There is a controversy in the Arcadian theory of rent whether rent determines the price or not. Richard is of the view that rent does not form a part of the price of agricultural production.

It is the result of price. As price rises, more and more units of the inferior kind of land are brought under cultivation. This enables the owner of superior kind of land to earn a differential surplus. Rent is, thus, not a price, determining factor but it is price which determines rent. Example: For instance, the cost of production of wheat per quintal in A, B, C and D grades of land is $30, $40, $50 and $60 respectively. Let us suppose that the price of wheat in the market is $40 per quintal. At this price only A and B grades of land will be brought under cultivation.

The owner of A grade land will earn a surplus of $10 per quintal. If due to greater demand of wheat, price rises to $50 per quintal in the market, the owner of A grade land will earn $20 as rent and the owner of B $10, and the C grade land will be no-rent-land. If price happens to rise to $60, then D grade land will be cultivated and the rent per quintal of wheat for A, B and C grades of land will be $30, $20 and $10. Thus, we conclude that higher the rice, the higher is the rent and the lower the price, the lower is the rent.

In the words of Richard: “Corn is high, not because rent is paid, but rent is paid because corn is high” Or, in other, words, we can say that the prices of commodities are not high because the rents are high. The correct statement would be that rents are high because prices are high. Rent in brief is price determined and not price determining. On the other hand population growth forces higher cost marginal lands into production, so that the market price of grain is determined by the marginal cost of producing the last unit of grain on that last unit of land called onto production.

Message from the Rent Theory: When the number of farm laborers goes up, the ones who benefit are not the workers themselves, but the land owners. This finding has withstood the test of time. Economists use Arcadian reasoning today to explain why agricultural price supports do not help farm laborers per SE but do make owners o farmland wealthier. Limitations of Rent Theory: In historical reality, however, landlords rarely had such powers of expropriation; and instead that surplus was more usually shared between peasant farmer and his landlord, according to the bargaining power of each, ND according to any contract between them. Rent less marginal land is unimaginable Arcadian theory is based on the assumption of perfect competition. Only under conditions of perfect competition, all units of goods will be homogeneous and there will be only one price for a good at a time. But in the real world, imperfect competition is the rule. Diminishing return of land can be avoided by the technological revolution. Due to use of technology the productivity has increased remarkably that proves Richard wrong. He did not take into account the possibility of technological progress and economic growth. Therefore, he focused primarily on how fixed income is distributed among classes. Thomas Robert Malthusian has satisfactorily explained the principles of rent, and showed that it rises and falls in proportion to relative advantage, either fertility or situation, of the different land in cultivation and has there by thrown much light on many difficult point connected with subject of rent, which were before either unknown to very imperfectly understood.

Malthusian commented that “In this view it (rent) can form no general addition to the stock of the community, s the neat surplus in question is nothing more than revenue transferred from one class to another; and from the mere circumstances of its thus changing lands, it is clear that no fund can arise, out of which to pay taxes. The revenue which pays for the produce of the land, exist already in the hand of those, who purchase that produce, and, if the price of subsistence were lower, it would be just as available for taxation as when, by a higher price it is transferred to the landed proprietor. [2] Carrey and Roaches[3] point out, it is historically wrong to assume that, in a new century, the best lands are cultivated first. In fact, lands that are first cultivated are not usually the best; they are only the most easily accessible. Taxation: Richard defined taxes “As the portion of the produce of the land and labor of a country placed at the disposal of the government. ” When the additional taxes are paid out of an increased production or by diminished consumption, the burden will fall upon revenue.

If not, the burden will fall upon capital, then capital accumulation of that country will be limited. There are taxes on different sectors: Tax on Raw materials: Any taxes which were imposed on the raw materials loud increase the cost of production; consequently increase in its price. If the price of the produce didn’t rise to compensate the cultivator, he would stop cultivating lands. Tax on Rent: According to Richard, “A tax on rent would effect rent only’. The effect of such tax would discourage the cultivation because tax will fall on rent.

He concludes that a tax on land value, equivalent to a tax on the land rent, was the only form of taxation that would not lead to price increase and it is paid by the landlord who is not able to pass it on a tenant. Tax on Gold: Richard mentioned two kinds of taxes on gold- Tax on the actual quantity of gold in circulation Tax on the annual production of gold. Tax on houses: The incidents of this tax, is a type of additional rent which tenant is required to pay. Then the demand for house would decline.

As a result the rent of the house will decline in proportion to the tax imposed. So, the whole tax would be paid, immediately and finally, by the occupier of the house. Tax on Profits: The effects of taxes on the profits of farmers, landlords and manufacturers will finally and eventually cause the price of commodities to rise. After examining the whole procedures Richard concluded in this regard that, well regulated prices of all commodities would ultimately come to the level which was obtaining in the country before taxes were imposed.

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