The Theories of David Ricardo [Virtual Economy]

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David Ricardo - Theories

David Ricardo

Ricardo developed two key theories, that are still important in economics courses today. They are:

  • Distribution theory
  • International trade theory (comparative advantage)

Distribution theory

Along with Malthus, Ricardo was very concerned about the impact that rising populations would have on the economy. He argued that with more people, more land would have to be cultivated - nothing controversial so far! However, the return from this land would not be constant as the amount of capital available would not grow at the same rate. In fact the land would suffer from diminishing returns. Extra land that was brought into cultivation would become more and more marginal in terms of profitability, and eventually returns would not be enough to attract any further capital. At this point the maximum level of economic rent Look up Economic Rent in glossary would have been earned.

The allocation of each factor of production to each area of economic activity would therefore be determined by the level of economic rent that could be earned. As this gradually fell due to diminishing returns, capital would shift to more profitable activities.

International trade theory

Ricardo's theory on international trade focused on comparative costs and looked at how a country could gain from trade when it had relatively lower costs (i.e. a comparative advantage). The original example focused on the trade in wine and cloth between England and Portugal. Ricardo showed that if one country produced a good at a lower opportunity cost than another country, then it should specialise in that good. The other country would therefore specialise in the other good, and the two countries could then trade. It's not too difficult to work out which good Portugal should specialise in - wine or cloth?! The same would almost certainly be true today.

If all countries specialised where they had a comparative advantage, then the level of world welfare should increase.

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