The principle of political economy and taxation

taxation (1817) developed by Ricardo was one of his greatest achievement and contributed much to economic theories at that time and to economist who came after him. His analysis mainly focused on how a fixed amount of wealth is distributed among the three classes namely land owners who receive rent, labourer whose reward is wage and entrepreneurs or capital owners who receive profit. He then set out some laws which regulated the distribution of income and from his work the following economic laws can be extracted (Cunningham, 1994).

The first law is that cost of production is determined by prices in addition the amount of labour used in production of goods and services determines their value. Further more cost of production also influences value of items. His third law i. e. the theory of rent was based on prediction of population increase. Where there is increase in population then more food is required to feed the growing number of people this in turn will necessitate the cultivation of less fertile land.

Therefore according to Ricardo rent for land was determined as the difference between the most and least productive piece of land as measured by price of wheat per acre. The growth in population leads to increase in rent at the expense of wages and profit. The 4th and 5th laws were concerned with natural price of labour and wage fund (amount of capital in circulation). According to these laws the price of labour, as any 2 other market price is determined through the forces of demand and supply. In addition he proposed that there was available fixed supply of money (at any given time) for payment of wage.

Through increase in both capital and population, less fertile land was cultivated this in return lead to increase in rent but on the other hand both profit and wages decreased. In his view increase in population constantly surpasses the rise in wage fund which causes the standard of living of working man to fall. The next law dealt with diminishing returns of profit. Where more inferior land is put into use both food prices and rent increases on the other hand profit decreases since higher wages are extracted from the existing circulating capital (Cunningham, 1994).

Ricardo’s concept of rent Rent is the reward of land owners and is determined as the difference between the incomes generated by the most and the least fertile land in cultivation. His theory of rent was closely related to marginal productivity of land and the theory of value which is directly related to labour cost. In his opinion economic development leads to increased utilization of less fertile land and the first people to benefit are the land owners as they receive rent payment in product or money.

Variation in land scarcity leads to some land paying higher monopoly vale than others. Therefore the return of investment on such land is usually higher than expected based on scarcity and value of produce. This give land owners premium over real social value but in situation where there is increased/prolonged scarcity of land then the principle of free market cannot correctly measure or convey value and create a gap between social value and personal value which is regarded as Ricardian rent. 3 Therefore according to Ricardo rent constitutes a loss to society above maximum production.

Therefore Ricardo proposed tax on land value as such tax does lead to increase in prices. Ricardo’s concept of wages According to Ricardo the cost of production affects prices in the long run (natural prices). Where natural prices correspond with wages then wages are described to be at subsistence level. Therefore the rise and fall in natural prices correspond to fluctuation in cost of living. In his view an economic system which is constantly improving will support wage above subsistence level.

During period of economic prosperity the growth in population leads to increase in work force and this tend to push wages back to subsistence level. Productivity increase, recognized as natural phenomenon by Ricardo, is essential for capital expansion and this can support both higher wages and population growth. However in the long run the combined impact of increase in population and the law of diminishing return will ultimately push wages back to subsistence levels.

Ricardo’s concept of profit

Profit is the reward to entrepreneurs or providers of capital and it is the residual after paying rents and wages. Rent is an add-on to cost of profit and wages but do not reduce any of them however it is passed on to consumer cost. In addition an increase in wages will lead to reduction of profit. Profit as ordinary and necessary cost of production are allowed to decline up to a certain natural limit beyond which economic progress will come to a stand still.

Reference

Cunningham, J. W. (1994). David Ricardo: Critical assessments, London: routledge.