Ricardo’s Model Ricardo Economic Theory

There are three main groups in the Ricardian model: capitalists, laborers, and landlords. The capitalists perform the essential roles in the economic play; they are the producers, the directors, and the most important actors. They perform two essential functions for the economy. First, they contribute to an efficient allocation of resources, because they move their capital to the areas of highest return, where, if perfectly competitive markets prevail, consumer demands are met at the lowest possible social cost. Second, they initiate economic growth by saving and investing.

Although Ricardo held to a labor cost theory to explain changes in relative prices over time, labor is essentially passive in his model. He used the wages fund doctrine and Malthusian population theory to explain the real wage of labor: real wage = wages fund/labor force. The wages fund depends upon capital accumulation, and the size of the labor force is governed by the Malthusian population principle. If the wages fund increases as a result of capital accumu­lation, then real wages will rise in the short run. Increasing real wages will result in an increase in population and, hence, in the labor force. Long-run equilibrium will exist when the labor force has increased sufficiently to return real wages to the cultural subsistence level.

One could define "subsistence level of living" in terms of a minimum caloric intake that would sustain an individual and permit normal work and play activities plus an income sufficient to clothe, house, etc., the individual at some minimum level of well-being. It seems clear that ideas of what is "subsistence" vary with time and among cultures. For example, the U.S. federal government has a definition of poverty that is used to judge the need for certain federal assistance programs and also to measure the performance of the economy. Families whose income is judged to be below the poverty level in the United States would be considered quite well off in the less well developed countries of the world. If the United States opened its borders to free immigration, many people would choose to come here and live in "poverty," as they would be much better off than in their home country. Ricardo's subsistence level of wages, then, is not an objective, unchanging level of well-being, but one compatible with a particular time and culture.

Landlords are mere parasites in the Ricardian system. We will see this more clearly after examining his theory of land rent. For Ricardo, the supply curve for land is perfectly inelastic and the social opportunity cost of land is zero. Landlords receive an income, rent, merely for holding a factor of production without serving any socially useful function. The classical economists were particularly critical of the spending habits of landlords. Instead of saving and accumulating capital—so as to increase the supply of capital goods in the economy—the landlords engaged in consumption spending. The classical econo­mists considered the activities of the landowning class to be harmful to the growth and development of the emerging industrial society.

Ricardo's model presents the following relationship between the growth of the wealth of the nation and the three major economic groups. The total output, or gross revenue of the economy, is distributed to the laborers, capitalists, and landlords. The part of total output not used to pay labor its cultural subsistence wage and to replace the capital goods worn out in the production process can be called net revenue or economic surplus: Gross revenue - (subsistence wages + depreciation) = net revenue. Net revenue will thus consist of profits, rents, and wages over the subsistence level. In long-run equilibrium, wages will be at a subsistence level and net revenue will equal profits and rents. The workers and landlords will always spend their entire income on consumption, so profits are the only source of saving, or capital accumulation. Using his theory of land rent, Ricardo concluded that a redistribution of income favoring the landlord takes place over time as profits decrease and rents rise, with a consequent reduction in the rate of economic growth.

The Problem of the Times: The Corn Laws

What were the Corn Laws

Some of the most interesting economic questions of the early 1800s centered on the consequences of the Corn Laws, regulations placing tariffs on the importation of grain (not American Indian corn) into England. Coupled with this interest in the Corn Laws was growing concern over the pressure of population on the food supply. Food prices, rents, and investment in land were rising steadily. The most dramatic index of the growing concern about tariffs, land rents, and food prices is the price of wheat during the period. Edwin Cannan reported the following average prices (shillings per quarter of a ton) in his History of the Theories of Production and Distribution:

1770-1779 45 shillings
1780-1789 45 shillings
1790-1799 55 shillings
1800-1809 82 shillings
1810-1813 106 shillings

The highest price was reached during 1801, when wheat was selling for 177 shillings a quarter.
For a full understanding of the Corn Law controversy, it is important to remember that this was the period of the Napoleonic wars. The wars had artificially protected British agriculture from continental grain, and this, coupled with Britain's inability to be agriculturally self-sufficient after 1790, resulted in rising grain prices and rents. When the Treaty of Amiens was signed in 1802, English landlords and farmers were apprehensive about the effects of peace on grain prices, so they went to Parliament to get increased protection. The Corn Laws then in effect had been passed in 1791; they placed a floor on the price of grain at 50 shillings per quarter, which was raised in 1803 to 63 shillings per quarter with very little controversy or discussion of the issues. After a year of peace, the war resumed until 1813, when Napoleon was captured. At that time the question of the proper level of tariffs was again raised in Parliament by the agricultural interests.

The landlords were now asking for a floor of 80 shillings per quarter. This time their request prompted an extensive controversy, during which Ricardo, Malthus, Torrens, and West introduced new economic ideas into the debate.
There was much public discussion of these issues, and strong opposition to the agricultural interests developed both inside and outside of Parliament. Study commissions were appointed by both houses of Parliament, and in 1814 a celebrated report entitled Parliamentary Reports Respecting Grain and the Corn Laws was published. As a result of commission hearings, many groups were drawn into the controversy. A common method of reaching the public at this time was to publish pamphlets, and the most significant pamphlets explaining the rising prices of grain and rising rents were those of Ricardo, West, Torrens, and Malthus.

A number of the arguments disturbed Ricardo. One was that higher tariffs would result in lower grain prices. The argument was that higher tariffs would encourage greater investment in British agriculture, and when the resultant increased output or supply came to the market, the price of grain would fall. Ricardo did not agree with these conclusions. Another argument was that the high price of grain was the result of high rents. Rents, under this reasoning, were price-determining. Ricardo disagreed, arguing that rents were price-determined. The fundamental question of the Corn Laws, clearly perceived by Ricardo, concerned the distribution of income. Higher tariffs would shift the distribution of income in favor of the landlords. Because Adam Smith's discussion of the forces determining the distribution of income had not been satisfactory, Ricardo redirected economics toward this question.

Analytical Tools and Assumptions

In his attempt to deal with the many policy issues arising from the Corn Law controversy, Ricardo developed a sophisticated and extensive model, making use of a number of analytical tools and assumptions. Before examining his theories, we should become familiar with these tools and assumptions. (1) Labor cost theory. Changes in relative prices over time are explained by changes in labor cost measured in hours. (2) Neutral money. A change in money supply might result in changes in both the absolute level of prices and relative prices. Ricardo, however, was interested in changes in relative prices over time other than those caused by changes in the money supply, so he assumed in his model that changes in the money supply would not cause changes in relative prices. (3) Fixed coefficients of production for labor and capital. Only one combination of labor and capital inputs can be used to produce a given output. Three cubic yards of dirt can be dug in a day by one person using one spade. To increase output per day, as additional labor is added, additional capital (spades) must be added in a fixed proportion. In other words, the labor-capital ratio is fixed by technological considerations for each type of economic produc­tion and does not vary with changing output. (4) Constant returns in manufac­turing and diminishing returns in agriculture. Supply curves in manufacturing are horizontal, or perfectly elastic (marginal costs are constant as output increases); supply curves in agriculture slope upward (marginal costs increase as output expands). (5) Full employment. The economy tends to operate automatically at full employment of its resources in the long run. (6) Perfect competition. The market contains many independent producers whose products are homogene­ous, and no single seller is able to influence the market price. (7) Economic actors. Individuals are rational and calculating in their economic activities. Capitalists strive to achieve the highest rates of profits, workers the highest wages, and landlords the highest rents. The interactions of such a society in perfectly competitive markets will lead to a uniform rate of profits for investments of comparable risk, to uniform levels of wages for laborers of the same skills and training, and to common levels of rent for land of the same fertility. (8) Malthusian population thesis. Population tends to increase at a faster rate than the food supply. (9) Wages fund doctrine. The wage rate equals the wages fund divided by the size of the labor force.