Ricardian Theory of Development

Course Code: 0311 15 Econ 5103

Course Title: Advanced Development Economics

Presented to Presented by
Dr. Shahnewaz Nazimuddin Ahmed Md. Shifaz Mamur
Professor Student ID: MSS 231519
Economics Discipline Year: MSS 1st; Term:1st
Khulna University Economics Discipline
Khulna Khulna University
Khulna

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 Contents
 Introduction
Assumptions of the Theory
Main Features of the Theory
Illustration of the Theory
Limitations of the Theory
Conclusion
Reference
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 Introduction
 In the year 1817, David Ricardo's ideas about
development, which formed the basis of his
development model, were outlined in his book,
The Principles of Political Economy and
Taxation.
 David Ricardo emphasizes the importance of
high rate of profit for economic development
because capital accumulation depends upon it.
 Saving must be there for higher capital
accumulation.
 He has also given importance to foreign trade.
 He was against colonial trade because it
depresses the industry of all other countries. David Ricardo (18 April, 1772 - 11 September, 1823)

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 Assumptions of the Theory
1. Supply of Land is Fixed 4. Law of Diminishing Returns Operates on
The theory assumes that the supply of land is Land
fixed, which means that there is a limited The theory assumes that as more and more
amount of land available for cultivation. labor and capital are applied to a fixed amount
2. Land is Used for the Production of Crop of land, the marginal productivity of these
(Corn) inputs decreases, leading to the law of
The theory assumes that land is used for the diminishing returns.
production of corn, which is a basic food
5. Labor and Capital are Variable Inputs
3. Demand for Corn is Perfectly Inelastic
The theory assumes that labor and capital are
The theory assumes that the demand for corn the only variable inputs that can be used to
is perfectly inelastic, which means that increase production.
changes in price do not affect the quantity
demanded.

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 Assumptions of the Theory (Cont’d…)

6. Capital Consists of Circulating Capital 9. The State of Technological Knowledge is

The theory assumes that capital consists of Given
circulating capital, which includes raw The theory assumes that the state of
materials, equipment, and other inputs that technological knowledge is given and does
are used up in the production process. not change over time.
7. There is Capital Homogeneity 10. There is Perfect Competition
The theory assumes that all capital is the The theory assumes that there is perfect
same and can be used interchangeably. competition in all markets, which means that
there are many buyers and sellers and no
8. All Workers are Paid Subsistence Wages single participant can influence prices.
The theory assumes that all workers are paid
subsistence wages, which means that they
are paid just enough to survive and continue
working.

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 Assumptions of the Theory (Cont’d…)
11. Demand for Labor Depends upon 13. The Supply Price of Labor is Given and
Accumulation of Capital Constant
 As the level of capital accumulation increases This means that the supply of labor is fixed
in an economy, the demand for labor also and does not change in response to changes
increases. in the wage rate. The supply of labor is not
12. Demand and Supply Price are Independent of influenced by the wage rate, and individuals
the Marginal Productivity of Labor do not enter or exit the labor market based
on changes in the wage rate.
If a worker becomes more productive and
produces more output per hour, it does not 14. Capital Accumulation Results from Profits
mean that their wage rate will increase. Other This means that firms accumulate capital
factors such as the availability of other workers when they generate profits, which can then
with similar skills, the level of demand for the be reinvested in the business to increase its
output produced, and prevailing wage rates production capacity and productivity.
will also influence the market price for labor.

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 Main Features of the Theory
i. The Ricardian model is based on the interrelation of three groups in the
economy. They are landlords, capitalists and laborers.
ii. Ricardo emphasized the rate of capital accumulation as capital acts as an
engine of growth. Capital is the part of the wealth of a country which is
employed in production and consists of food, clothing tools, raw materials,
machinery etc. Capital accumulation depends upon two factors:
Capacity to save
Willingness to save
iii. Ricardo is of the view that economic development depends upon the
difference between production and consumption. He stresses on increasing
production and reducing unproductive consumption.

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 Main Features of the Theory
iv. Rent, Wage Rate and Profit Rate
• Rent: Rent is that portion of the produce of earth which is paid to the landlord
for the use of original and indestructible powers of the soil.
• Wage Rate: The wage rate is determined by wage divided by number of workers
employed at the subsistence level.
Wage Rate = Wage ÷ No. of Workers
• Profit Rate: The rate of profit is the ratio of profits to capital employed.
As long as rate of profit is positive, the process capital accumulation will
continue and the economy will progress.
The labor force will grow proportionately and the total wage fund will increase.

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 Illustration of the Theory
The output is measured along the vertical axis and labor
along the horizontal axis.
The curve AP represents average product of labor and
MP represents the marginal product of labor.
With OE amount of labor, total output produced is
OPQE.
Rent is shown by rectangle PQML, as the difference
between AP and MP.
At subsistence wage rate OW, the supply curve of labor
WN is infinitely elastic and total wage is OWNE.
Total profits WLMN, are the residue after deducting
rent and wages from the total output:
Source: Ricardo, 1817
WLMN = OPQE - (PQML - OWNE)

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 Illustration of the Theory (Cont’d…)
Stationary State
• With the increase in capital accumulation, profits and wages
tend to increase
• The rise in wages brings about a decline in profits
• The decline in profits will continue till a stage comes when
the net product curve intersects the wage line OW at P.
• At this point, wages are equal to net product and the profit is
nil.
• Any disturbance to the right of point P will make the net
product less than wage level which is impossible.
So ‘P’ is the point at which economy is in a stationary state.
Source: Ricardo, 1817

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 Illustration of the Theory (Cont’d…)
Stationary State
Thus, Ricardian system of development
formulated certain interrelations among capital,
labor and output.
It traces the course of rent, wages and profits
every time and finally it concedes with the
celebrated forecast of the eventual advent of a
stationary state.

Source: Ricardo, 1817

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 Limitations of the Theory
1. Neglects the impact of technology
Ricardo pointed out that improved technology in industrial field leads to the displacement of
labor and other adverse consequences. But Ricardo failed to visualize the impact that science
and technology had on the rapid economic development of the new developed nations.
2. Wrong Notion of Stationary State
The Ricardian view that the system reaches the stationary state automatically is baseless
because no economy attains the stationary state is which profits are increasing, production is
rising and capital accumulation is taking place.
3. Baseless Notion of Population
The Ricardian view that wage rate can not be raised above. The subsistence level is wrong. In
western countries there has been rise in wage rate but population has decreased.
4. Unnecessary Importance to the law of Diminishing Returns
Ricardian theory is primarily based on the law of diminishing returns but the rapid increase
of farm produce in advanced nations has proved that Ricardo under-estimated the
potentialities of technological progress is counteracting diminishing returns to land.

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 Conclusion
• David Ricardo believed that a high rate of profit was essential for economic
development because it allowed for greater capital accumulation. He argued
that, in a country, when businesses are making a higher profit, they are able to
invest more in their operations, which leads to economic development.
• Ricardo also emphasized the importance of saving for higher capital
accumulation. When individuals and businesses save more of their money, they
can invest that money into productive activities, which helps to fuel economic
development.
• The model tries to deal with the various problems relating to development. It
determines the relative shares of different agents of production in national
income. The economy in this model is considered to be ever changing with the
passage of time, till it reaches stationary state.

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 Reference
Ricardo, D. (1911). The Principles of Political Economy & Taxation, Dent
and Dutton Publication, New York, pp. 219-260.

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 Thank You!

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