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David Ricardo was born in 1772 and made a fortune as a stockbroker and loan broker.[1] At the age of 27, he read An Inquiry into the Nature and Causes of Wealth of Nations by Adam Smith and was energized by the theories of economics. His main economic ideas are contained in Principles of Political Economy and Taxation (1817)). This set out a series of theories which would later become theoretical underpinnings of both Marx's Das Capital and Marshallian economics, including the theory of rent, the labour theory of value and above all the theory of comparative advantage.

Ricardo wrote his first economic article ten years after reading Adam Smith and ultimately, the "bullion controversy" gave him fame in the economic community for his theory on inflation in 19th century England. This theory became known as monetarism, the theory that excess currency leads to inflation.[2] He was also a factor in creating classical economics,[3] which meant he fought for Free trade[4] and free competition without government interference by enforcing laws or restrictions.[5]

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Diminishing returns

Another idea Ricardo is known for in his Essay on the Influence of a Low Price of Corn on the Profits of Stock is the Law of Diminishing Returns[6] (Ricardo, Economic Essays, Henderson 826). The law of diminishing returns states that if you add more units to one of the factors of production and keep the rest constant, the quantity or output created by the extra units will eventually get smaller to a point where it will begin to fall ("Diminishing Returns").

For example, one man is working as a cashier. He is doing everything: bagging, price checking, and cashiering all at once. Since his labor or input is a part of the production process by giving service to customers, he raises the production possibility frontier (PPF) curve of the business. If the owner decided to hire someone else to help and split up the work, they would also raise the PPF, but not as much as the previous employee. This creates a diminishing effect of one factor of production (labor) where in this case, workers could specialize in certain tasks to break up the work load. If you add too many workers, they might get in each other's way or serve as distractions. These instances would be examples where diminishing returns would happen.

Comparative advantage

Ricardo was opposed to tariffs and other restrictions on international trade. Ricardo devised an idea that is well known as the theory of comparative advantage (Henderson 827, Fesfeld 325). According to the Washington Council on International Trade, comparative advantage is the ability to produce a good at a lower cost, relative to other goods, compared to another country. In the Principles of Economics, Ricardo states that comparative advantage is a specialization technique used to create more efficient production (52) and describes opportunity cost between producers (53). With perfect competition [1] and undistorted markets, countries tend to export goods in which they have a comparative advantage ("Comparative Advantage").

For example, we should think of two countries that both make cards and pencils and use the same amount of time to make one unit of items (please see table). Country one can make 4 pencils if they specialize just in pencils at the expense of one card, but this country can also make ¼ of a card at the expense of one pencil. The same logic goes for country two: if country two makes only pencils, it will make 2 pencils at the expense of 1 card. If country two specializes only in cards, it will make ½ of a card at the expense of a pencil. For this example, country one has a comparative advantage in pencils over country two (4 pencils to 2 pencils), whereas, country two has a comparative advantage in cards over country one (½ of a card to ¼ of a card). In Ricardo's idea of comparative advantage, these two countries should specialize in what they do best. According to The Fortune Encyclopedia of Economics, Ricardo's idea of comparative advantage is "the main basis for most economists' belief in free trade today" (827).

1 Card 1 Pencil
Country One 4 Pencils 1/4 of a Card
Country Two 2 Pencils 1/2 of a Card

How Ricardian economics are used today

Though David Ricardo was of the 19th century, many people use his work in everyday economics, such as rent. Ricardo's theory on rent consisted mostly of an agricultural model featuring farmers and landowners. Since highly productive land was desired for more crops and the market would pay the same price for crops grown on both favorable and unfavorable land, farmers were eager to pay more for highly productive land to grow more crops for the extra money (Henderson 827). By this example, we can see Ricardian Economics affect agricultural life today as well as the 19th century.

Ricardo also had another influential theory: minimum wages. He knew that once the population rose more greatly, the demand for jobs would increase, making the wages decrease to a level that would not support people because many were willing to take the low-paying jobs to survive (St. Clair 9, Fusfeld 325). This observation of minimum wage work is especially true today when looking at the controversy with the enforcement of a minimum wage law. In Ricardo's book, On the Principles of Political Economy and Taxation, he is saying that the jobs we give more value to are paid better than those we do not value as much (11-2). To Ricardo, value had much to do with the cost of production, which included wages and profit (St. Clair 27) and how much you paid a worker affected the price you put on the item. He also believed the value of a product was related to the quality of labor necessary for the production (Principles of Political 5). An example of this would be paying a slightly higher price for an item that is handmade, rather than being manufactured. Though this is true, Ricardo also thought the labor or machine itself should be considered when selling an item and that a little of every item should be priced to include this factor of labor (St. Claire 24). Ricardo addressed many of the issues we face today in our economic world, such as minimum wage and rent (Fusfeld 325). These issues are perhaps as important to us today as they were in the 19th century, which is why David Ricardo's economic theories are still an important part of modern economics.

Works cited

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Bhagwati, Jagdish N., Arvind Panagariya, and T. N. Srinivasin. Lectures on International Trade. Cambridge: MIT P, 1998.

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"Diminishing Returns." Def. 1. Encarta. 2006. MSN. 27 Nov. 2006 <http://encarta.msn.com/encnet/features/dictionary/DictionaryResults.aspx?refid=1861604748>.

Dornbusch, Rudiger, Stanley Fischer, and Paul A. Samuelson. "Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods." American Economic Review 67.5 (Dec. 1977). 7 Nov. 2006 <http://www.jstor.org/cgi-bin/jstor/printpage/00028282/di950096/95p0011d/0.pdf?backcontext=page&dowhat=Acrobat&config=jstor&userID=891ccadb@uwec.edu/01cce4406900501b0da5d&0.pdf>.

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Henderson, David R. "David Ricardo." The Fortune Encyclopedia of Economics. 1993.

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References

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