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Home Theories of Economic Growth Ricardo's Model of Economic Growth

 

Ricardo's Model of Economic Growth:

 

Definition and Explanation:

 

The Ricardo's model of economic growth encompasses the production function, natural and human resources, capital accumulation and pattern of development. Now we present them.

 

(i) Production Function:

 

Ricardo's production function is as:

 

Y = f (L, N, K) ......................... (1)

 

However, this production function is subject to diminishing marginal productivity. It means that as more of K, more of L and more of N are employed the marginal productivity of K, L and N falls. Such all is represented as:

 

 

According to equation (9) Ricardo's model depends upon change in capital accumulation with respect to time (dK/dt), change in labor with respect to time (dL/dt), change in land with respect to time (dN/dt) and change in technology with respect to time (dS/dt).

 

(ii) Natural and Human Resources:

 

According to Ricardo land includes the original and indestructible powers of soil. Therefore, he considers land to be fixed m supply, as it is a gift of nature. It is shown as:

 

dN/dt = 0 .................. (10)

 

Regarding population growth (dL/dt), Ricardo says that there is a market wage rate (W) and natural wage rate (W). The natural wage rate is similar to the subsistence wage rate of Smith. According to Ricardo, if the market wages are above the natural wages the population will increase. While if the market wages are below the natural wages the population will decrease. It is stated as:

 

dLs/dt = q [W - W (t)] .......................(11)

 

Ricardo says that the natural wage rate (W) is determined by productivity of land and socio-cultural environment. This is represented as:

 

 

The movement in the market rate of wages are regulated by the relationship of demand and supply. Therefore, it is written as:

 

W = n (Ld/Ls) ................... (13)

 

Where Ld = demand for labor, and Ls = supply labor.

 

If Ld > Ls the market wages will rise. If Ld = Ls the market wages will remain constant and they will fall if Ls > Ld.

 

Ricardo further says that the Ld is directly influenced by the change in stock of capital in the economy. It is shown as:

 

d . Ld/dt = q . dK/dt ..................... (14)

 

Where q is a constant and its value is greater than zero. According to Ricardo in long run the W becomes equal to W and here Ls = Ld. It is as:

 

d . Ld/dt = d . Ls/dt = dL/dt .................. (15)

 

Substituting equation (11) and (14) in equation (15):

 

 

The equation (16) shows that in long run the growth of labor force depends upon capital and the relationship between two variables is proportional. Thus the above discussion shows that the change in labor force or population depends upon comparison between natural wages and market wages, and rate of change of capital formation.

 

(iii) Capital Accumulation:

 

Ricardo includes both fixed and circulating capital in capital. Fixed capital is that part of wealth of country which is employed in production, and it is consisted of food, clothing, tools, machinery and raw material. While circulating capital consists of 'Wage Fund'. This capital grows in constant proportion to fixed capital provided no technical changes are taking place in the economy. According to Ricardo, there are two ways whereby capital is accumulated:

 

(a) Due to increase in revenues and (b) Due to decrease in consumption.

 

As result of both these cases the savings will be generated. And whatsoever is saved is invested. He further says that rate of capital accumulation is regulated by two factors. (a) The ability to save, (b) The will to save.

 

The ability or power to save depends upon the surplus over the total product necessary to maintain labor's subsistence level. Larger this surplus is greater will be the means to save. The will to save depends upon the rate of profit. As he says, "while the profits of stocks are higher, men will have motive to accumulate, if the rate of profit falls men can move towards increased consumption".

 

The capital accumulation in Ricardo's model is presented as:

 

dK/dt = f (r - r, y - WL) ................... (17)

 

Where y - WL represents the net income of the society or the incomes left over meeting the subsistence level of living. While r - r means the difference between the actual and minimum rate of profit.

 

Ricardo says that as community's net income grows, and the difference between actual profit (r) and minimum compensation for risk (r) increases the capital accumulation will grow. Thus it is the net income and the rate of profit which play an important role in the dynamic process of capital accumulation. He further says that the rate of profit would rise and fall depending upon subsistence wages, it is as:

 

r = d (W) ................... (18)

 

Ricardo says that it is a natural tendency amongst the profits to fall. It is because of the reason that as development takes place the labor will be requiring more food. As a result the level of net income will fall. Moreover, because of application of diminishing returns in production the rate of profit will fall in long run. Thus, according to Ricardo in the

beginning capital accumulation increases at an increasing rate, and when the ratio of profit in total output decreases the capital accumulation becomes sluggish. Because of increase in population and cultivation of less fertile lands the level of profit eventually falls to r . Here capital accumulation stops, population becomes stagnant and the economy enters into "Stationary State". It is shown with Fig.

 

 

(iv) Patterns of Development:

 

With the help of equation No. (9), (10) and (16) the economic development can be represented as:

 

 

The equation (19) shows that capital accumulation plays an important role in economic development. With the help of equation (17) and (19) we can find the dynamic path of national income as:

 

Y = f [Ko, No, Lo, a.............aN; U(t); S(t)] ....................... (20)

 

This equation shows that the growth of the economy depends upon initial amounts of K, L and N like Ko, No and Lo; structural parameters like a......aN and U(t) and S(t) which are institutional framework and technology. Regarding U(t) and S(t), Ricardo says that they are exogenously determined.

 

Criticism:

 

 

The neatness and beauty of this model lies in this fact that it stresses upon raising of savings and profits, the most important elements of economic growth. But still this model has following shortcomings:

 

(i) Ricardo's model is based upon diminishing returns. But due to modern scientific knowledge its application can be suspended.

 

(ii) The concept of stationary state advanced by Ricardo is baseless. How that economy can be a stationary one whose output is expanding, whose profits are rising and capital accumulation is taking place.

 

(iii) Ricardian concept of subsistence wages and the concept of increase in population due to rise in wages are misleading. As far as western countries are concerned the wages have never been subsistence and because of rise in wages the population in these countries decreased, rather increasing.

 

(iv) Like Smith, Ricardo also assumes the system of 'Laisseze-Fair'. But it is not applicable in real life and the state does have to interfere with.

 

(v) Ricardo assumes that there are no institutional changes. But the institutional changes highly influence the process of growth.

 

(vi) Ricardian model basically explains the theory of rent determination. Therefore, this model is like a theory of national income distribution.

 

(vii) Ricardian model did not incorporate the role of rate of interest in economic growth. Moreover, according to Hicks it is a static model and fails to analyze the dynamic situation, the important feature of growth theory.

 

Ricardo's Model and UDCs:

 

Ricardo's model is based upon 'diminishing returns' and Malthusian theory of population. If we analyze UDCs we find that here population increases more than food. The use of superior technology on lands is limited. Consequently, there applies diminishing returns. In case of UDCs the supply does not match the demand. Hence rent goes on to increase. Whereas because of abundance of labor the wages remain low leading to low savings and low investment. Such is in accordance with what it has been said by Ricardo in his model.

 

Relevant Articles:

 

Adam Smith's Model of Economic Growth
Ricardo's Model of Economic Growth
Classical Model of Economic Growth
Marxian Model of Economic Growth
J.E. Meade's Model of Economic Growth
Schumpeter Model of Economic Growth
Secular Stagnation - Hansen's Thesis
Kaldor - Mirrlees Model of Economic Growth
Golden Rule of Economic Growth
Neo-Classical Theory of Economic Growth
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

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