Classsical School of Thought

Chapter-3; Lecture-2
Recommended Books: (i) An outline of
the history of economic thought,
Screpanti & Zamagni (ii) A history of
Economic Thought, V. Lokanathan

In this lecture we will know:

1.Ricardo’s corn laws 2. Theory of Rent
3. Labor theory of Value 4. Theory of
comparative advantage
 David Ricardo (1772-1823)
• Although Adam Smith was the founder of the classical
school, David Ricardo became the leader of the school.

• He was born in 1772 in a Jewish family in England.

• Ricardo had no formal schooling beyond the age of

fourteen. He turned to the systematic study of political
economy rather late in life.

• When he was twenty-seven, he became across Adam

Smith’s “wealth of Nations”. That book kindled his
interest in economics.

• Ricardo’s chief work “On the principle of Political

Economy” was published in 1810.
 The Corn Laws

• The Corn Laws were tariffs and other trade

restrictions on imported food and grain ("corn")
enforced in the United Kingdom between 1816
and 1846.

• The word 'corn' in British English denotes all

cereal grains, including wheat, oats and barley.

• They were designed to keep grain prices high to

favour domestic producers, and represented
British mercantilism.
• The Corn Laws blocked the import.
•The Corn Laws enhanced the profits and
political power associated with land
ownership.

•The laws became the focus of opposition from

urban groups who had far less political power
than rural areas.

•In England, ‘the Age of Ricardo’ (1816) to

their repeal (1846) .

•The protectionist barriers allowed the

maintenance of high land rents to the
detriment of profits, given the rigidity of real
wages.
 The Theory of Rent

In 1815, at the climax of the debate on the Corn Laws, five

pamphlets were published: two by Malthus, one by Edward West,
one by Robert Torrens 92 from Ricardo to Mill and, finally, one by
Ricardo.

The common ground these five papers had at the analytical level, in
spite of their theoretical and political differences, was the use of
the theory of differential rent—a theory that seems to have been
formulated independently by the first three of these economists.

Ricardo himself had no hesitation in acknowledging Malthus as the

founding father.

The theory of differential rent had already been proposed by James

Anderson in 1777.

In order to understand the gist of Ricardo’s theoretical system, it is

useful to begin with an extremely simple model of an economy in
one good, let us say corn and labour.
The levels of net corn production, Ga, Gb, Gc, Gd, Ge that
can be obtained from five types of land, A, B, C, D, E, scaled
in decreasing order of fertility.
• Let us assume that a fixed quantity of seeds and a fixed
quantity of labour, say, one worker, are used on each
acre of land. If we begin from a situation in which only
one kind of land, A, is cultivated, production of corn net
of seeds will be Ga.

• If the cultivation is extended to land B, the net

production will increase to Ga+Gb, and if land C is also
cultivated the production will be Ga+Gb+Gc and so
forth.

• A movement to the right along the horizontal axis

implies an increase in production and an increase in the
plots of land cultivated.
Let us assume that on the least fertile of the cultivated
plots there is no rent; and that the real wage wr is fixed.

• If the plots of land of types A, B, C, D, and E are the only

ones to be cultivated, the capitalist who works on the
least fertile plot, E, will produce an amount of corn (net
of seeds) equal to Ge and will make profits equal to (Ge –
wr).

• The other capitalists, working on the more fertile land,

would obtain higher profits if they didn’t have to pay
rent. For example, on land D the profits would be (Gd –
wr) > (Ge – wr).

• On land C they would be greater than on D, and so

In this case, however, competition will raise
the demand for the more fertile plots; and this
will allow the owners to extract higher rents
the more fertile the land, the higher the rent.

In competitive equilibrium all the capitalists

will earn the same profit rate since the
product that can be obtained from intra-
marginal lands over and above that of the
marginal land will be entirely swallowed up in
rent.

In Fig. 1 the rents are represented by the

shaded area, the total wages by the area 0
wrwre, and the profits by the area wrπ πwr.
This is the theory of extensive differential
• The theory was criticized as it seemed to imply, against the evidence,

• That are no rent is paid on marginal lands and try to resolve the problem
by using the concept of ‘absolute rent’

• In order to understand why differential rent is also paid on the marginal

pieces of land, we only have to reinterpret it as ‘intensive rent’.

• All the land available in a country is cultivated. For simplicity, let us

assume that all the plots are equally fertile.

• Let us assume that the capital: labour ratio is fixed.

• A movement to the right along the horizontal axis no longer represents

an extension of the cultivation given the labour : capital : land ratios, but
an intensification of the cultivation with increases in the labour: land and
capital : land ratios.
• It is assumed that, with the increase in production and employment, the
productivity of the last employed worker will fall.

• Ga is the productivity of the first worker, Gb that of the second, and so

forth.

• Therefore, the worker employed with the last investment unit, whose net
productivity is Ge, will produce no rent.

• Yet a rent will be paid which will be equal to the difference between the
productivity of the intra-marginal units and the productivity of the
marginal one, as shown by the shaded area.

• This is the substance of the celebrated law of decreasing marginal

productivity of a variable input.
 Labor Theory of Value

• Ricardian theory of value is essentially a labour theory of

value.
• First of all, like Adam Smith, Ricardo has recognized two
forms of value: (i) value-in-use, and (ii) value-in-exchange.
• Then he points out that for a commodity to have value in
exchange, it must have utility. But he asserts that utility cannot
be the measure of exchangeable value.
• According to Ricardo, the value of commodities depends upon
two things, (i) Scarcity, and (ii) the quantity of labor required
to obtain them.
• Ricardo agreed with Adam Smith that the value of most things
depended on the amount of labor required to produce them.
But there was another group of things, whose supply cannot be
increased by labor.
While Adam Smith applied labor theory of value to primitive
societies, Ricardo applied it to capitalistic society as well.

In fact, he believed that labor was the foundation of value in all

stages of society.

Ricardo has made a distinction between natural price and market

price. Market price may deviate from the natural price (or value)
because of temporary fluctuations of supply and demand.

• If market price rises above the normal price, profits will rise
and more capital will be used to produce the commodity.
• On the other hand, if the market price falls, profits will fall
and 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 The labor theory of
value or the cost of production theory of value has been
characterized on the following grounds:

1.There is difficulty in measuring labor or cost of production.

2.Labor may be misdirected. An article which cannot fulfill the

purpose for which it was intended cannot have any value,
however much labor has gone to its manufacture.

3.The main weakness of labor theory of value is that it ignores

the influences of demand.
 The theory of Comparative Advantage

• “A country has a comparative advantage in producing a good if

the opportunity costs of producing that good in terms of other
goods is lower in that country that it is in other countries.”

• Adam Smith advocated free competition in foreign trade and his

theory of trade was based on difference in absolute costs.

• According to Smith every country would buy in the cheapest

market. But Ricardo developed the theory of comparative costs.

• According to Ricardo, “Trade might take place of the advantages

of both trading countries, even when one of them was more
efficient in production of both the commodities exchanged.”
The theory of comparative advantage may be stated as follows:

• “under competitive conditions, a country tends to specialize in those

commodities in the production of which it has the greatest comparative
advantage” (Silverman).

• Let us take two countries, England and Portugal and two commodities
wine and cloth. Portugal can produce a barrel of wine by labor of 80 men
and a yard of cloth by the labor of 90 men.

• But in England, the production of the same quantities of wine and cloth
takes, respectively, the labor of 120 and 100 men.

Wine (1 barrel) Cloth (1 yard)

Portugal 80 men 90 men
England 120 men 100 men
Let us see how this is happening:

Case-1: Portugal Suppose Portugal produce only wine and exports 40 barrels
of wine to England instead of 45 yards of cloth because (90÷80 = 1.125×40 =
45) and its consumption now will be (125 – 40=85 barrels of wine and 45
yards of cloth) So, 85×80 = 6800 LH

45×90 = 4050 LH

= 10850 LH

Case – 2: England England produce only cloth and imports wine. Its
consumption pattern now changed as: 40 barrels of wine and (100 – 45 = 55)
yards of cloth.

So, 40×120 = 4800 LH

55×100 = 5500 LH = 10300 LH

Under these circumstances, it would be of mutual advantage
for both countries if Portugal specialized in wine and
imported cloth, while England specialized in cloth and
imported wine.

The theory of comparative advantage is based on three

fundamental assumptions: 1.Ricardo assumed that capital and
labor did not flow between countries.

2. He assumed law of constant costs rather than increasing

costs as output expanded.

3.The theory ignores transport costs as well.