work, and his wages must at least be sufficient to maintain him. They must even
upon most occasions be somewhat more; otherwise it would be impossible for him
to bring up a family, and the race of such workmen could not last beyond the
first generation. The Wealth of Nations, Book 1, Chapter 8 It is difficult for
wages to rise much above this minimum. Smith partially attributes this to
inequality of bargaining power. The power of the worker to withhold his labour
is far weaker than the power of the employer to withhold access to employment: A
landlord, a farmer, a master manufacturer, or merchant, though they did not
employ a single workman, could generally live a year or two upon the stocks
[capital] which they have already acquired. Many workmen could not subsist a
week, few could subsist a month, and scarce any a year without employment. In
the long-run the workman may be as necessary to his master as his master is to
him; but the necessity is not so immediate. The Wealth of Nations, Book 1,
Chapter 8 This "natural" inequality was supplemented by legal
inequality. When Smith was writing The Wealth of Nations – and for another fifty
years thereafter – British workers were prohibited from forming unions and
bargaining collectively. There were no similar prohibitions on employers: We
rarely hear, it has been said, of the combinations of masters, though frequently
those of workmen. But whoever imagines, upon this account, that masters rarely
combine, is as ignorant of the world as of the subject. Masters are always and
everywhere in a sort of tacit, but constant and uniform, combination, not to
raise the wages of labour above their actual rate. To violate this combination
is everywhere a most unpopular action, and a sort of reproach to a master among
his neighbors and equals. We seldom, indeed hear of this combination, because it
is the usual, and one may say, the natural state of things which nobody ever
hears of. Masters, too, sometimes enter into particular combinations to sink the
wages of labour even below this rate. The Wealth of Nations, Book 1, Chapter 8
Yet there were sometimes forces leading wages upward. Rapid economic growth can
create a shortage of labour. The reinvestment of profits will lead to
ever-greater employment. However, higher wages, by improving living conditions
and thus reducing infant and child mortality, quickly lead "to the great
multiplication of the species." The race between the demand for labour and
the supply of labour will eventually be won by the supply of labour and wages
will once again fall to the "lowest rate, which is consistent with common
humanity." Additionally, labour of greater skill or difficulty will itself
take on a natural price in terms of common labour: If the one species of labour
should be more severe than the other, some allowance will naturally be made for
this superior hardship; and the produce of one hour’s labour in the one way may
frequently exchange for that of two hours’ labour in the other. Or if the one
species of labour requires an uncommon degree of dexterity and ingenuity, the
esteem which men have for such talents, will naturally give a value to their
produce, superior to what would be due to the time employed about it. Such
talents can seldom be acquired but in consequence of long application, and the
superior value of their produce may frequently be more than a reasonable
compensation for the time and labour which must be spent in acquiring them. The
Wealth of Nations, Book 1, Chapter 6 The Role of Value Value, or "natural
price" is a central concept in Smith’s work. Temporary deviations of market
price from natural price provide his capitalists with their production
directions. When the market price is above the natural price, profits will also
be above their natural rates. New capital will be drawn to such an industry
until increased production brings prices and profits down to their natural
rates. When the market price is below the natural price, profits will also be
below their natural rates. Capital will leave such an industry until decreased
production brings prices and profits up to their natural rates. The natural
price, in turn, is determined by the costs of production. The costs of
production can be broken down into labour costs, rent and profit. Labour has its
natural price, which is the cost of the goods and services the workers need in
order to work and raise families. But how is the natural rate of profit
determined? Or the natural rate of rent? Smith has not provided us with either
an economic or sociological principle which would establish either of these
rates. He leaves us with an incomplete theory of value. Indeed, Smith who
borrowed the water / diamond paradox from Law without acknowledging it, failed
to resolve the riddle and the resulting relationship between use-value and
use-exchange, by mistakenly focusing on total rather than marginal utility. His
confusion is further shown in his experimentation with three value theories. He
provided a labour cost and a labour command theory of value for a primitive
society and finally a cost of production theory for an advanced one. In his
"Nation of hunters" analogy, Smith’s notion of labour cost of value is
determined by the quantity of labour which is measured by wages which is also
extended to his labour command theory- "Value of any commodity…….to the
person who processes it and who means not to use or consume it himself, but to
exchange it for other commodities, is equal to the quantity of labour which
enables him to purchase or command" . However, when he perceived that if
wages were not the same proportionate part of final prices of all goods, he then
realised that his labour theory of value for an advanced economy would not hold.
Instead, it appears that he opted for a cost of production value theory
consisting of land, labour and capital value theory. Up to this part, I have
tried to give a brief history of Theory of Value before David ricardo. Now, I
will try to explain Ricardian Theory of Value in detail. First of all, I would
like to give some information about David Ricardo. His Life and Times David
Ricardo was born 4 years before the publication The Wealth of Nations. His world
was the world of the industrial revolution, his England the nexus of world trade
and finance. He was the third child of a well-to-do family of Sephardic Jews,
from whom he was astringed at the age of 21, on the occasion of his conversion
and marriage to Quaker. His success as a stockbroker allowed him to devote his
attention to questions of public policy, which in turn led to a successful carer
as a Member of Parliament. His writings also led to a correspondence with Thomas
Malhus, a correspondence into a personal friendship, although they disagreed on
many of the fundamental economic issues of their they. He died in 1823 at the
age of 51. Contibutions One of Ricardo’s fundamental contributions is the
comparative advantage theory of trade, which explains international trade as the
result of relative rather than absolute differences in productivity across
countries. This implies that countries can benefit by specializing in the
production of goods that they produce most efficiently, relative to the rest of
world, and trading them for goods that are most efficiently produced elsewhere
in the world. The theory of comparative advantage suggests that trade is
beneficial to all trading partners and provides a formal rationale for free
trade policy. It discredits the merchantilist view of trade, which sees the
accumulation of export surpluses as the means to benefit from rate. Also of
particular interest to industrial economists is the Ricardian notion of rent.
Ricardo developed his theory of rent in his analysis of the returns to
agricultural land, when such land differs in location or degrees of fertility.
In the long run, the price of grain will be just sufficient to cover the cost of
production (including a normal rate of return on investment, the opportunity
cost of inducing the farmer to retain in the market) and transportation to
market of the least productive (or most distant) farm the output of which is
needed to balance supply and demand. But if the least advantaged farmer earns
only a normal rate of return, then those who work more fertile farms, or farms
from which the transportation cost is less, will earn an above-normal rate of
return. This excess return, an income that cannot be competed away that is a
return a unique asset(fertility, location) is an example of an economic rent.
Ricardo’s Labor Theory of Value In the preface of The Principles of Political
Economy and Taxation (1817), David Ricardo laid out the goal of his work. He was
setting out to uncover the laws that regulate the distribution of the produce of
the earth – all that is derived from its surface by the united application of
labour, machinery, and capital … among [the] three classes of the community,
namely, the proprietor of the land, the owner of the stock or capital necessary
for its cultivation, and the labourers by whose industry it is cultivated. The
Principles of Political Economy and Taxation [Preface]. The first step of this
project was to understand the laws of value. As the heading of Chapter 1, he
gives us the foundation of what came to be called the labor theory of value: The
value of a commodity, or the quantity of any other commodity for which it will
exchange, depends on the relative quantity of labour which is necessary for its
production… The Principles of Political Economy and Taxation, Chapter 1,
Section 1 Ricardo planned to develop a rigorous theory of value. Rather than
make his theory fuzzy enough to encompass the value of all goods, he would
exclude goods such as "rare statues and pictures, scarce books and coins,
wines of a peculiar quality, which can be made only from grapes grown on a
particular soil," since their value is wholly independent of the quantity
of labour originally necessary to produce them, and varies with the varying
wealth and inclinations of those who are desirous to possess them. These
commodities, however, form a very small part of the mass of commodities daily
exchanged in the market. The Principles of Political Economy and Taxation,
Chapter 1, Section 1 This theory of value would be limited to the goods and
services that were typical products of competitive capitalism: In speaking,
then, of commodities, of their exchangeable value, and of the laws which
regulate their relative prices, we mean always such commodities only as can be
increased in quantity by the exertion of human industry, and on the production
of which competition operates without restraint. The Principles of Political
Economy and Taxation, Chapter 1, Section 1 Ricardo was much more consistent than
Smith. Smith had identified labour as the major factor responsible for natural
price. But Smith’s measure of labour itself varied from chapter to chapter.
Sometimes it was the amount of labour needed to produce the product; sometimes
it was the amount of labour that could be hired for an amount of money equal to
the value of the product; sometimes it was the value of the goods and services
that the worker could purchase with his wages. A Measure of Value But Ricardo
was searching for an "invariable measure of value." This is truly an
impossible goal. When the technology of production of a good or service changes,
its value will change. All theories of value are in agreement on this. Even gold
and wheat, two candidates for such a measure that were rejected by Ricardo, will
alter in value as the technology of production changes. The same is true, in a
more roundabout way, of labor itself. If new farming and/or baking technology
reduce the value of bread, then the value of labor will also fall since the
worker’s capacity to work can be "produced" at a lower cost. (The
Principles of Political Economy and Taxation, Chapter 1, Section 1.) It might be
possible, Ricardo thought, to find a measure of value which would not vary as
the distribution of income changed, even thought it would certainly vary with
technological change. Ricardo’s project was to discover which economic forces
determined the distribution of income. The best candidate for such a measure was
labour. If profits rose and wages fell, or if profits fell and rents increased,
it would still require the same amount of labour to weave a bolt of cloth or to
build a ship. The Level of Wages Ricardo’s theory of wages was similar to
Smith’s, but much more severe. Thomas Malthus, Ricardo’s good friend, had
published his famous Essay on the Principle of Population in 1798. While Adam
Smith had noted a tendency for population to increase when wages were high,
Ricardo (and Malthus) turned this tendency into a ruthless certainty: The
natural price of labour…depends on the price of the food, necessaries, and
conveniences required for the support of the labourer and his family. With a
rise in the price of food and necessaries, the natural price of labour will
rise; with the fall in their price, the natural price of labour will fall. …
It is when the market price of labour exceeds its natural price that the
condition of the labourer is flourishing and happy, that he has it in his power
to command a greater proportion of the necessaries and enjoyments of life, and
therefore to rear a healthy and numerous family. When, however, by the
encouragement which high wages give to the increase of population, the number of
labourers is increased, wages again fall to their natural price, and indeed from
a reaction sometimes fall below it. When the market price of labour is below its
natural price, the condition of the labourers is most wretched: then poverty
deprives them of those comforts which custom renders absolute necessaries. It is
only after their privations have reduced their number, or the demand for labour
has increased, that the market price of labour will rise to its natural price,
and that the labourer will have the moderate comforts which the natural rate of
wages will afford. (The Principles of Political Economy and Taxation, Chapter 5)
The Theory of Rent Agricultural products presented a particular difficulty.
Smith’s solution had been to make land rent one of the components of natural
price and simply add it onto labour costs and profits to get value. Ricardo
started by examining how agriculture was different from manufacturing. When the
demand for shovels increases, manufacturers can build more factories. There is
no reason that these new factories cannot be as productive as the existing
factories. That is, the amount of labour needed to produce a shovel will not
change when we double or triple shovel production by building new shovel
factories. When the factory is a farm, however, we have a different problem.
Land varies greatly in its productive qualities. It is usually the best land
that is first drawn into agricultural production. Therefore, when the demand for
wheat increases, it will take more than the average amount of labour to produce
and transport the additional wheat. Ricardo’s example supposes that there are
three grades of land. On the best land it costs ?3 to produce 10 bushels of
wheat and deliver it to the town market. This cost includes the necessary amount
of profit to get someone to farm the land. On the middle grade of land it costs
?4 to produce the same amount of wheat and transport it to the town market. On
the poorest land, it costs ?5 to produce and transport 10 bushels of wheat. The
differences in costs reflect differences in the amount of labour required. With
a small population, the demand for wheat can be met by farming only the best
land. The price of wheat will be ?3 per 10 bushels. But as population grows,
some of the middle grade land will be brought into cultivation. Now the price of
wheat will rise to ?4 per 10 bushels. If I own some of the best land and you
farm that land, I can charge you a rent of ?1 per 10 bushels of wheat. If I own
some of the middle grade land, I cannot collect any rent since the cost of
production on that land is the same as the price of the wheat. As population
continues to grow, cultivation is extended even to the poorest land and the
price of wheat rises to ?5 per 10 bushels. Now the owners of the best land will
enjoy a rent of ?2 per 10 bushels and the owners of the middle grade land can