David Ricardo: Economic Theories & Concept

Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

In the late 1700s, as the Industrial Revolution switched into high gear, economics blossomed as a field of study. In this lesson, you'll learn about David Ricardo, one of the economists of that era whose ideas are still used today.

Introduction to Ricardo

David Ricardo wasn't a trained economist like many of his contemporaries. He did attend school, but to be a stock trader, not an economist. It wasn't until after his successful career in the financial markets that he read Adam Smith's The Wealth of Nations and began contemplating and writing about economics.

Ricardo was born in 1772 to a moderately wealthy family, the third in a family that would eventually include seventeen children. His father was a successful stockbroker who, while disowning David over his choice of a non-Jewish bride, still provided the connections necessary for David's own successful career. After amassing his own fortune, Ricardo passed away at the age of 51, leaving behind three of his own children.

While Ricardo's name may not be used as much as Adam Smith's in our modern economic discussions, his ideas have had a profound impact. He published three books in the early 1800s, and after his death, nine volumes of his letters and essays were published. Of all of his works, two of his theories stand out - economic rent and competitive advantage.

Economic Rent

The first step in understanding economic rent is forgetting what you currently think of as rent. Economic rent has nothing to do with the more common definition of rent, meaning a payment in exchange for the use of something for a certain amount of time. Economic rent is the amount paid for something above that which the owner is expecting. Economic rents exist because markets are imperfect.

For example, imagine you are interviewing for a new job and you decide you will accept the job for $40,000 per year. The hiring manager calls, offers you the job, and then breaks the news - they would like to offer you $45,000. Your economic rent is $5,000. It's not profit, because it doesn't exceed costs; it exceeds your expected revenue.

In a perfect market structure with producers and consumers that have complete information, there is no opportunity for economic rent. All parties know the true value of each input and that's what they pay - no more, no less. But, in an imperfect market, forces like labor unions and incomplete knowledge provide the opportunity for economic rent.

Comparative Advantage

Comparative advantage is an important concept of international free trade. Ricardo's theory on international trade, based largely on Smith's idea of specialization of labor, is that nations should focus on producing whatever they can produce more efficiently, and then trade their excess for goods they can't produce efficiently.

Consider the case of Britain and Portugal, an example Ricardo used. In Ricardo's example, it cost Britain 110 units of inputs to produce one unit of wine, but Britain could produce one unit of cloth for 90 units of input. Portugal, on the other hand, could produce one unit of wine for 90 units of input, but it cost Portugal 110 units of input to produce one unit of cloth. In this example, Portugal has a comparative advantage over Britain in wine production, and Britain has a comparative advantage over Portugal in cloth production.

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