RECARDIAN THEORYOF

INCOME DISTRIBUTION

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 RICARDIAN MODEL
The economy is divided into two broad sectors agriculture and industry.
Agriculture occupies a crucial place in the Ricardian Model, since the forces working
in the agricultural sector determine the distributive shares in industry.

Ricardos theory is based upon three assumptions:

1) Law of diminishing returns operates in agriculture;

2) The Malthusian law of population, according to which the population will increase.
The wage rate tends to be equal to the subsistence level in the long run.

3) Profits are a necessarily incentive for capital accumulation, which is the key to
economic growth.

The distribution of national output takes place among the three shares of rents,
wages and profits.
According to Prof. Kaldor, the Ricardian theory of income distribution is based upon
two separate principles, the marginal principle and the surplus principle.

a. Based on the marginal principle, the Ricardian theory explains the determination of
the share of rent in the national output.

b. With the surplus principle, the theory explains how the remaining national output (that
is, national output less rent) is divided between wages and profits. 2
 Rent in the Ricardian theory is the difference between the product of labour on
marginal land (i.e., the land that yields output just sufficient to cover cost of
production) and the product on the superior lands.
If both extensive as well as intensive margins of cultivation are taken into account,
then rent of a land is equal to the difference between its total product and the
production costs (of labour) incurred on it.
Since in the Ricardian theory, production cost per unit of labour in equilibrium must
be equal to the marginal productivity of labour, the total costs of production is
marginal product of labour multiplied by the number of units of labour employed.
On the other hand, total product is obtained by multiplying the average productivity
with the amount of labour employed. The difference between total product and
total production costs will represent the rent of land.
That is, the difference between the marginal productivity and the average
productivity of labour on a given land will be equal to the rent earned from land
per unit of labour employed and the total rent will be equal to the difference
between the average product and marginal product multiplied by the number of
units of labour employed.
To quote Prof. Kaldor, Rent is the difference between the product of labour on
marginal land and the product on average land, or (allowing for the intensive as
well as extensive margins), the difference between the average and marginal labour
productivity.
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 Ricardian theory explains the determination of relatives shares of rents,
wages, and profits with the use of the marginal principle and surplus
principle. Figure depicts the situation agricultural sector of the economy.
X-axis measures the amount of labour employed on the agricultural
land, Y-axis measures the agricultural product produced.
AP and MP curves respectively represent the average and marginal
productivity of labour.
They are downward sloping because of the operation of the law of
diminishing returns.
Suppose, OM labour is employed in agriculture, then the marginal
product of labour is ME and the average product of labour is MD.
The difference between the marginal product and average product is
ED. The difference between the average and marginal product of labour
represents the rent earned on land per unit of labour employed.
ED is the rent of land per unit of labour employed. The total rent
earned by land is equal to the area BEDC (that is, ED multiplied by
BE). Thus, out of the total product OMDC, the share of rent is BEDC.

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 The remaining product OMEB is to be divided between labour and capital. The
Ricardian theory of wages rate of labour is not determined by the marginal productivity of
labour, as is generally assumed in neo-classical economics.

In the Ricardian theory, the marginal product is assumed to be equal to the sum of
wages and profits. The wage rate is determined by the minimum subsistence level, a
level which is just sufficient to keep the labour force living at a minimum subsistence
(which in Ricardos analysis is determined both by biological and cultural factors).
Suppose the minimum subsistence level is OW amount of the agricultural output (i.e.,
corn), then the wage rate that will be determined in the long run is OW. Since the marginal
product of labour is the sum of wages and profit in the Ricardian system, the distance KE
(=WB) measures the rate of profit per unit of labour employed.

With OM as the labour employed and OW as the wage rate, the share of wages will
be OMKW.

From the remaining output OMEB (i.e., output less rent), the share of wages (labor's
share) is equal OMKW. The rest of the output, WKEB, will be the share of profits in
the total output. Thus, profits in the Ricardian theory are a residual income after the
payments of wage and rents. In other words, profits are the surplus of total product
over wages and rents.

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 Given the OM amount of labour employment, in the Ricardian analysis,
the number of labour employed depends upon the capital accumulation
in the economy. With an increase in the capital accumulation, demand
for labour employment rises. Therefore, the level of employment in the
agricultural sector is determined by the available capital stock.
With OM amount of labour employment, the share of profits in the
agricultural output is equal to WKEB and the share of wages is
OMKW. The resulting profits/wages ratio represents the percentage
rate of profits on capital investment. At equilibrium, the percentage rate of
profits on capital investment must be the same in agriculture and in industry.
This is so because, given their mobility, capital funds would move from one
sector to the other until the rate of profit becomes equal in both the sectors.
But, in the agricultural sector the money rate of profit cannot be
different from that measured in terms of its own product, i.e., corn rate
of profit. This is because in the agricultural sector, both the input (wage
fund used for payment to labour) and output are the same commodity.

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 But in the manufacturing industry, the input and output are
different commodities. Whereas, the input in manufacturing
industry is wages paid to labour and the output is in terms of
manufacturing goods.
The input (corn-wage) is a fixed quantity determined by the
minimum subsistence level, given the state of technical
knowledge.
The output per worker in terms of manufactured goods is also
fixed.
The money rate of profit in the industry cannot change through
variations either in corn-wage or in output per worker because
both of these are fixed.
The only way in which the money rate of profit in the industry can
change and can become equal to the money rate of profit in
agriculture (in equilibrium) is through changes in the relative
prices of industrial goods in terms of agricultural product. Thus,
the money rate of profit in industry must become equal to the corn-
rate of profit in agriculture and not the other way around.
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 Therefore, in the Ricardian scheme, money rate of profit in manufacturing
industry depends upon the corn-rate of profit in agriculture. The fall in the
corn-rate of profit in agriculture will bring about a fall in the money rate of profit
in the manufacturing industry also.
As regards the relative distributive share as economic growth takes place,
labour employment and output increases in agriculture with capital
accumulation. As a result of increase in labour employment and output, the
demand for labour will increase.
Increase in the demand for labour will cause the rate of wages to rise above
the minimum subsistence or the natural level. This will bring about the
increase in population. The increase in population will bring down the wage
rate to the minimum subsistence level through the increase in the supply of
labour, but it will also lead to the increase in demand for agricultural output.
As the agricultural output is increased to meet the increase in demand by
employing more labour, the average and marginal products of labour will
decline due to the operation of the principle of diminishing returns. As
average and marginal products of labour increases, agricultural output expands
and the rent will increase, because rent is the difference between the average and
marginal products of labour.

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 The vertical distance between the AP L and MPL curves increases with the
increase in the number of labour employed. With OM labour employed, the
difference between average product (AP L) and marginal product (MPL),
that is, rent on land per unit of labour is ED. To the right of M, the
difference between the two goes on rising, given the state of technical
knowledge.
As a result of the rise in cost of production, the prices of agricultural output will
increase. With the higher price of corn or agricultural output, higher money
wage will have to be paid to the labourers so that they can maintain the
subsistence standard of living. But it should be noted that while wages in terms
of money would rise, the wages in terms of corn will not change and will
remain fixed at the minimum subsistence level (OW) in the long run.
An important thing to note is that, though the real wage rate will remain fixed
at OW in the long run, the share of wages in the total product will increase
with the increase of output and employment in agriculture.
When labour employment in agriculture increases up to ON, the total
wages share rises to the area OWTN, which is greater than the wages share
OWKM at OM level of employment. Both the absolute and the relative
share of wages in the total product have increased.

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 The increase in wages share occurs at the expense of profits, which
declines continuously with the increase in output and employment.
Profit earned per unit of labour is the difference between the
marginal product of labour and the subsistence wage paid to the
labourers.
The distance between the marginal product (MP) and the
minimum subsistence wage line WL to the right of point of K (or
for output greater than OM) goes on declining till it completely
disappears at point T or at output ON where the marginal product
of labour has become equal to the subsistence wage OW.
That is, profit goes on declining as employment increases beyond
M till it falls to zero at the ON level of employment.
It is thus clear that while the relative share of wages increases, the
share of profits declines and becomes zero, as output and
employment are expanded in agriculture because of the
diminishing returns in agriculture (i.e., falling marginal product of
labour), which is responsible for the decline in profits.

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 In the Ricardian model, as the output and employment
expand in agriculture, the profit would decline even in the
manufacturing industry sector.
This is because with the rise in prices of agricultural
output, the money cost of the subsistence level will increase
and therefore the industries would have to pay higher wage
to their workers. The rise in wages of the workers means
that profits of the manufacturers would decline.
Thus, profits in the manufacturing industry would decline
because of the operation of diminishing returns in
agriculture, and the consequent rise in cost and prices of
agricultural output, even though industries themselves
may not be subject to diminishing returns.

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 If capital becomes mobile, the profit rate in the industry must fall
too when the profit rate in agriculture declines, or else capital would
move from one sector to the other. The reason behind this is that the
profit in the industry will decline when the profit in agriculture falls
because the prices of agricultural output will rise (or the industrial prices
will fall relative to the agricultural prices), forcing the industrialists to
pay high wages.
In the Ricardian macro-economic model, there is continuous tendency
towards a declining rate of profit both in the agricultural and
industrial sectors of the economy.
The Ricardian theory regards profit as a necessary incentive for
capital accumulation in the economy. When profit rate declines, the
rate of capital accumulation falls.
Ultimately, when the rate of profit is reduced to zero, investment and
capital accumulation would cease to exist and the economy would
reach the state of stagnation where further growth will completely
stop. This is the conclusion of Ricardos theory.

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 Summing up the Ricardian theory of aggregate income distribution and the
development in the economy in the words of Prof. Patterson, given the assumption of
a constant technology and a constant natural wage in real terms, the relative share of
wages in the total output will increase with a rising level of output and employment.
The relative share of profit will decline and ultimately fall to zero. This is the
point at which the economy reaches the infamous Stationary state of classical
theory, a gloomy situation in which all accumulation, population growth and
technical progress cease. The basic casual force in this scheme is the fact of
diminishing returns in agriculture, a grim tendency which can only by postponed
temporarily by technical progress. Technical progress cannot in other words, prevent
the ultimately disappearance of profit and the onset of a stationary state.
Mr. Paul Davidson opined that whereas Ricardian theory is quite clear about the
increase in the relative share of wages in the total product in course of economic
growth at the expenses of profits, Ricardo was not so much certain and definite about
the change in relative share of rent in the total product during the course of
development. But, if with the growth in output and employment the economic system
behaves as has been depicted in Figure, the relative share of rent will increase along
with the rise in the total share of wages. This is because the gap between the average
product and marginal product (which is equal to rent) goes on widening with the
successive increases in the employment of labour.

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 Criticism of Ricardian Macro- Theory of Distribution

Ricardos theory is the First bold and imaginative attempt to explain the crucial
problem of income distribution into relative functional shares of rent, wages and
profits. But, the theory suffers from various weaknesses.

First actual events in the course of development have been quite contrary to what
Ricardo had predicted on the basis of his theory. Contrary to Ricardos contention,
the relative share of wages in the total product has not increased. Empirical research
has reveals that the relative labour share (wages) in national income remained constant
till the end of the Second World War in the Western capitalists countries.

Even the tendency of to declining rate of profit, as had been predicted by Ricardo
on the basis of diminishing returns, has not been actually found. The share of
profits in the total product has also remained more or less constant.

Further, there has been rapid economic progress in the capitalist countries,
contrary to Ricardos gloomy prognosis that the economies would inevitably move
towards the stationary state.

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