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"Unlocking the Power of Ricardo's Law: Understanding the Law of 3"




David Ricardo (1772–1823) was a classical economist best known for his theory on wages and profit, the labor theory of value, the theory of comparative advantage, and the theory of rents. David Ricardo and several other economists also simultaneously and independently discovered the law of diminishing marginal returns. His most well-known work is Principles of Political Economy and Taxation (1817).1




Another version as applied to life values...


From Wikipedia, the free encyclopedia

Comparative advantage in an economic model is the advantage over others in producing a particular good. A good can be produced at a lower relative opportunity cost or autarky price, i.e. at a lower relative marginal cost prior to trade.[1] Comparative advantage describes the economic reality of the work gains from trade for individuals, firms, or nations, which arise from differences in their factor endowments or technological progress.[2]

David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country's workers are more efficient at producing every single good than workers in other countries. He demonstrated that if two countries capable of producing two commodities engage in the free market (albeit with the assumption that the capital and labour do not move internationally[3]), then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good, provided that there exist differences in labor productivity between both countries.[4][5] Widely regarded as one of the most powerful[6] yet counter-intuitive[7] insights in economics, Ricardo's theory implies that comparative advantage rather than absolute advantage is responsible for much of international trade.

Classical theory and David Ricardo's formulation


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Adam Smith first alluded to the concept of absolute advantage as the basis for international trade in 1776, in The Wealth of Nations:

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it off them with some part of the produce of our own industry employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not thereby be diminished [...] but only left to find out the way in which it can be employed with the greatest advantage.[8]

Writing several decades after Smith in 1808, Robert Torrens articulated a preliminary definition of comparative advantage as the loss from the closing of trade:

[I]f I wish to know the extent of the advantage, which arises to England, from her giving France a hundred pounds of broadcloth, in exchange for a hundred pounds of lace, I take the quantity of lace which she has acquired by this transaction, and compare it with the quantity which she might, at the same expense of labour and capital, have acquired by manufacturing it at home. The lace that remains, beyond what the labour and capital employed on the cloth, might have fabricated at home, is the amount of the advantage which England derives from the exchange.[9]

In 1814 the anonymously published pamphlet Considerations on the Importation of Foreign Corn featured the earliest recorded formulation of the concept of comparative advantage.[10][11] Torrens would later publish his work External Corn Trade in 1815 acknowledging this pamphlet author's priority.[10]

David Ricardo

In 1817, David Ricardo published what has since become known as the theory of comparative advantage in his book On the Principles of Political Economy and Taxation.

Ricardo's example[edit]

Graph illustrating Ricardo's example:


In case I (diamonds), each country spends 3600 hours to produce a mixture of cloth and wine.


In case II (squares), each country specializes in its comparative advantage, resulting in greater total output.

In a famous example, Ricardo considers a world economy consisting of two countries, Portugal and England, each producing two goods of identical quality. In Portugal, the a priori more efficient country, it is possible to produce wine and cloth with less labor than it would take to produce the same quantities in England. However, the relative costs or ranking of cost of producing those two goods differ between the countries.



Hours of work necessary to produce one unit

Produce

Country

Cloth

Wine

England

100

120

Portugal

90

80

In this illustration, England could commit 100 hours of labor to produce one unit of cloth, or produce 5/6 units of wine. Meanwhile, in comparison, Portugal could commit 100 hours of labor to produce 10/9 units of cloth, or produce 10/8 units of wine. Portugal possesses an absolute advantage in producing both cloth and wine due to more produced per hour (since 10/9 > 1). If the capital and labour were mobile, both wine and cloth should be made in Portugal, with the capital and labour of England removed there.[12] If they were not mobile, as Ricardo believed them to be generally, then England's comparative advantage (due to lower opportunity cost) in producing cloth means that it has an incentive to produce more of that good which is relatively cheaper for them to produce than the other—assuming they have an advantageous opportunity to trade in the marketplace for the other more difficult to produce good.

In the absence of trade, England requires 220 hours of work to both produce and consume one unit each of cloth and wine while Portugal requires 170 hours of work to produce and consume the same quantities. England is more efficient at producing cloth than wine, and Portugal is more efficient at producing wine than cloth. So, if each country specializes in the good for which it has a comparative advantage, then the global production of both goods increases, for England can spend 220 labor hours to produce 2.2 units of cloth while Portugal can spend 170 hours to produce 2.125 units of wine. Moreover, if both countries specialize in the above manner and England trades a unit of its cloth for 5/6 to 9/8 units of Portugal's wine, then both countries can consume at least a unit each of cloth and wine, with 0 to 0.2 units of cloth and 0 to 0.125 units of wine remaining in each respective country to be consumed or exported. Consequently, both England and Portugal can consume more wine and cloth under free trade than in autarky.





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