Ricardo's Theory

Topics: Economics, Capital accumulation, Economic growth Pages: 5 (1624 words) Published: October 27, 2010

Ricardo’s theory is basically a theory of distribution. The theory is based on the marginal and surplus principles. The marginal principle explains the share of rent in national output, while surplus principle explains how the remaining is shared between wages and profit. Assumptions of Ricardo Theory

* That all land is used for corn production
* That the law of diminishing returns operates on land
* That the supply of land is fixed
* That the demand for corn is perfectly inelastic
* That the labour and capital are variable inputs
* That the capital consist of circulating capital
* That there is capital homogenity
* That the state of tehnical knowlege is given
* That the supply price of labour is given and onstant
* That there is perfect competition
* That capital accumulation results from profits
Ricardo postulated the whole economy consists of one huge farm fixed in supply which is engaged in producing only corn by applying homogenous units in labour and capital. It grows on the basis of interrelations of three groups in the economy. They are landlords, capitalist and labourers among whom the entire produce of land is distributed. The total national output is distributed among three groups as rent, profits and wages respectively. Division of Rent, Profit and Wage

Ricardo explained that given the total output of corn, the share of each group can be determined. Rent per unit of labour is the difference between the average and marginal product. The wage rate is determined by wage fund divided by the number of workers employed at the subsistence level. Thus out of total corn produced and sold, rent has the first right and the residual is distributed between wages and profits, whole interest is included in profits. Process of Capital Accumulation

According to Ricardo, capital accumulation is the outcome of profits, because profits lead to saving of wealth which is used for capital formation. Capital accumulation depends on two factors: 1) the capacity to save ii) the will to save. The capacity to save is reckoned as more important in capital accumulation. This depends upon the net income of society which is a surplus out of total output after meeting the cost of various workers’ subsistence. The large the surplus, the larger will be the capacity to save. As Ricardo said, out of two loaves, i may save one out of four i may save three. Landlords and capitalists invest through this surplus. Falling Rate of Profit: An important conclusion is that as an econmomy develops, only landlords benefit. As population increases, less and less fertile land is gradually brought into cultivation. This enables landlords to collect more rent on both the extensive and intensive margins. The workers do not gain; they continue to receive the subsistence wage. As the zero-rent gets worse, the output producible on it decreases. But wages remain unchanged. Therefore, less is left as profit for the capitalist. Steady State: The falling rate of profit leads to slowdown in capital accumulation. Ultimately growth stops altogether; a steady state is reached. ( Ricardo assumed that only the profit of the capitalist is used for the accumulation of new capital goods. The landlords are parasites who blow their earnings on consumer goods.) Subsistence Wage level: If the wage is always at subsistence level, initially, the profit rate is high. This induces an increase in saving by capitalists. This tend to temporarily raise wages above the subsistence level. (According to Ricardo, the rise in saving also leads to an increase in the wages fund, which is a fund out of which the capitalists pay wages to workers. This leads to higher wages) This leads to population growth,...
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