Question

Ricardo's theory of distribution assumed that the supply of land was fixed, while the country's population and capital stock were constantly increasing. On the basis of these assumptions, he predicted eventual stagnation of the economy. How would this happen according to Ricardo?

Short answer

According to Ricardo's theory of distribution, with a fixed supply of land and constantly increasing capital stock and population, the law of diminishing returns would cause each additional worker or unit of capital to contribute less to the total output. This would lead to increased demand for food, higher production costs, and rising prices of agricultural products. As a result, rents and wages would increase while profits for business owners and capitalists decrease. This combination of factors would ultimately cause the rate of return on investments to fall, leading to a slowdown in economic growth and the eventual stagnation of the economy. However, Ricardo's theory does not account for potential technological advancements that could increase land productivity and offset this stagnation.

Step-by-step solution

Understanding the Assumptions

According to Ricardo's theory of distribution, the supply of land is fixed, meaning it cannot be increased. This is important because land is a key factor of production, and with a fixed supply, its scarcity becomes a central issue as the economy grows. On the other hand, the country's population and capital stock, resources such as machinery and tools that aid in the production process, are assumed to be constantly increasing. This means that there will be more people and more capital competing for the same limited amount of land as time goes on.

The Law of Diminishing Returns

As population and capital stock increase, the law of diminishing returns comes into play. This law states that as more and more units of a variable input (e.g., labor or capital) are added to a fixed input (e.g., land), the marginal product of that variable input will eventually decrease. In other words, each additional worker or unit of capital will contribute less to the total output than the previous one. This is due to the limited availability of land in Ricardo's model.

Increased Demand for Food

With a growing population comes increased demand for food and other basic necessities. As more people and capital are employed in agriculture to meet this demand, the productivity of land is stretched, leading to less efficient use of the land and higher costs of production. As a consequence, the prices of agricultural products rise.

Rising Rents and Wages, and Falling Profits

As the prices of agricultural products rise, landowners can charge higher rents for the land, increasing their share of the national income. This increase in rent contributes to higher costs of production for both agriculture and other industries that use land as an input. Additionally, a growing population creates competition among laborers for jobs, leading to higher wages, which also contribute to higher production costs. As a result, profits for business owners and capitalists decrease.

Stagnation of the Economy

The combination of rising rents, wages, and falling profits causes the rate of return on investments to fall. With lower returns, capitalists become less willing to invest in new production, leading to a slowdown in economic growth. This stagnation of the economy is the ultimate outcome of Ricardo's theory of distribution. It should be noted, however, that Ricardo's theory does not consider the possibility of technological advancements or other factors that could potentially increase the productivity of land and offset some of the predicted stagnation.

Key concepts

Law of Diminishing Returns

Ricardo's theory heavily relies on the law of diminishing returns to explain economic constraints. Imagine you're a farmer with a fixed area of land, say an acre. When you first start using the land, each new worker or piece of machinery significantly increases the amount of food you can grow.
However, as more workers and machines are added, each additional one contributes less to the overall food production. This is because there's only so much land to use, and eventually, it gets crowded.

• The first few workers can utilize the space effectively.
• As more join, they have to share resources, and efficiency drops.
• Ultimately, adding further resources just results in minimal additional output.

This phenomenon is a pillar of Ricardo’s distribution theory. It implies that any increase in outputs becomes harder to achieve once the capacity of the fixed input, which is the land, has been reached.

Fixed Supply of Land

The assumption of a fixed supply of land is central to Ricardo's prediction of economic stagnation. Land, unlike other resources such as labor or capital, cannot be expanded to meet demand. As the population and available capital grow, they stretch the available land resources further.
Land's limited availability means it becomes a bottleneck in production processes. Over time, this scarcity becomes more pronounced as:

• Populations increase, adding more pressure to existing land.
• Economic activities expand, requiring more use of land.

Since the amount of land cannot grow in tandem with other resources, its scarcity causes rising rents, which in turn increases overall production costs across sectors.

Economic Stagnation

Economic stagnation, according to Ricardo, occurs when growth slows down significantly. When rising land rents and costs diminish profits, entrepreneurs and businesses find less motivation to invest in new ventures or improve productivity.
Stagnation manifests due to:

• Increased costs without proportional returns from investments.
• Declining profits reducing incentives for innovation and expansion.

When investment doesn’t flow into the economy as it should, economic growth naturally runs out of steam. It's like a train slowing down because fuel (profits and investments) runs low.

Increased Demand for Food

As populations grow, so does the demand for food. Farming must expand to meet these needs, but since the land supply is fixed, this expansion faces natural limits. More people require more food, leading to:

• Heightened pressure on existing agricultural land.
• Increased food prices due to limited supply capabilities.

Higher costs of production mean consumers have to pay more for their food, reflecting an economy stretched to its limits. This stretch is exacerbated as technological solutions to increase food production are not part of Ricardo's original consideration.

Rising Rents and Wages

In Ricardo's framework, as food prices grow due to scarcity, landowners increase rents. These higher rents represent a larger share of national income being diverted to landowners.
At the same time, wages rise because more workers compete for the same amount of jobs. This competition also stems from growing population levels.

• Higher rents cut into the profitability of businesses.
• Elevated wages, while beneficial to workers in the short term, add to production costs.

The combination of these forces results in decreasing profits for capitalists, dampening their appetite to invest further in the economy. Consequently, the conditions are set for a stagnant economic environment.