Scribd
Upload
25 views

Chapter 4 Tutorial Notes-1

Uploaded by

oloratomaneedi25
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
25 views

Chapter 4 Tutorial Notes-1

Uploaded by

oloratomaneedi25
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

TUTORIAL NOTES FOR CHAPTER 4

TRICKY RICARDO TAKES ECONOMICS DOWN A DANGEROUS ROAD

• If we recap back chapter one, we can clearly summarize that Adam Smith was
the father of Classical school of thought, David Ricardo expanded on Adam
Smith’s classical economics.
• Economics during Adam Smith and before him was more of a theoretical subject
and did not include mathematics or science.
• David Ricardo changed economics from a theoretical subject to a social science
which Included mathematical precision.
• David Ricardo supported Adam Smith view of Free Trade, hard money and
added a new principle of The Law of Comparative Advantage.
• His Laissez faire policies were in strict accordance with those of Adam Smith.

DAVID RICARDO’S INFLUENCE FOR GOOD

• He pushed his for a case for Sound Money in the economy which led to a Peel
Act of 1844, sometimes referred to as the Peel banking act of 1844.
 This act was there to restrict the powers of British banks and gave
exclusive issuing powers to the central bank of England. The Peel Act led
to a strict anti-inflation monetary standard.
• Sound Money:
 refers to stable money specifically, is not liable to sudden appreciation or
depreciation in purchasing power over the long term, it is aided by self-
correcting mechanisms inherent in a free market system.
• Appreciation:
 represents an increase in the value of one currency in relation to another,
for example when comparing rand against the US dollar let’s say in 2019
the rand against dollar was R19 per dollar and in 2020 the rand against
dollar is R15. We can now conclude that the currency has appreciated
because now its is cheaper to buy US goods and services.
• Depreciation:
 represents a decrease in the value of one currency in relation to another,
for example when comparing rand against dollar. In 2019 the rand was
R15 per each dollar and in 2020 it was R19 per each dollar, we can now
conclude that it expensive to trade with the US and thus the currency had
depreciated.

RICARDO POSITIVE CONTRIBUTIONS

• A hard money monetarist


 Ricardo favored a strict anti-inflation monetary policy.
 He invented the Quantity Theory Of Money: MV=PQ
M = Total amount of money in the economy
V = Velocity of Circulation of money
P = General price level in the economy
Q = Quantity of goods and services

 The quantity Theory of money is the very essence of the true definition of
inflation and deflation.
 In plain it is the amount of money in the economy multiplied by the number
of times the money is used, equals the price of goods bought multiplied by
the amount of goods bought.
 In other words, MV presents expenditure and PQ represents income
which then means that income must equal expenditure.

• For example:
 If the economy has R1000 in total and that money is turned over 3 times
during a month, total spending equals R1000 x 3 = R3000 that month.
 If the amount of goods bought was 100 items, then the average price of
each would be R3000 divided by 100 which equals R30.
 The Quantity Theory of money is an identity which states that expenditure
must equal income: MV = PQ
 Meaning: R1000 * 3 = R30 * 100
 Ricardo assumptions were that velocity of money (the rate at which
money changes hands) remained the same and the amount of goods
bought remained the same.
 Ricardo believed that by targeting money supply growth, the level of
goods and serviced prices in an economy could be controlled.
 He argued that there is a link between the general level of prices in an
economy and the amount of money.
 One of the main criticisms of the Quantity Theory Of Money is that the
velocity of money does not remain constant and changes due to notions
of spending impulses.
• In summary
 Ricardo’s view was that more money in an economy tends to lead to
higher prices (inflation) and less money tends to lead to lower prices
(deflation), but money has no impact on the economic activities and is just
a veil.

THE LAW OF DIMINISHING RETURNS

 Ricardo developed the law of diminishing returns.


 His law of diminishing returns is based on 3 assumptions of his Corn
model:
1. One giant farm producing corn(land)
2. Constant real wage
3. Fixed capital (1 spade per worker)
• In this model
 As labor increases in the farm producing corn, there is going to be a need
to increase corn farmland which requires additional land. Land is fixed we
cannot expand land in this given scenario.
 Also, as we employ more and more labor in the corn farm given that the
land is fixed, the production or output will increase up to a certain point
whereby there the marginal output by additional worker starts to decline till
reach zero.
• In summary
 The law of diminishing returns is the decrease in the marginal output a
production process as the amount of a single factor of production is
incrementally increased, while the amounts of all other factors of
production stay constant.
 The law of diminishing predicts that after some optimal level of capacity is
reached, adding an additional factor of production will result in smaller
increases in output.

RICARDO REVEALS A LAW THAT REVOLUTIONIZES WORLD TRADE

• The law of comparative advantage


 Comparative advantage is the ability of one country to produce goods and
services at lower opportunity cost than another country given the same
resources.
 Comparative advantage is what you do best while also giving up the least.

• Example:
SOUTH AFRICA CANADA
1 bag of wheat 3 hours 2 hours
1 bottled water 6 hours 2 hours

 Canada has an absolute advantage in the production of both


commodities with respect to South Africa.
 Absolute advantage is when a country can produce goods and services
using fewer resources or inputs.
 Does this mean Canada should product both goods (not specialise in
just one of the products) and export them to South Africa? According
to Ricardo the answer is NO!

Ricardo’s comparative advantage theory tells us:

 If Canada took 2 hours from the wheat and employed them to make
bottled water, it would result in 1 extra unit of bottled water and 1 less bag
of wheat.
 If South Africa took 6 hours away from bottled water and employed them
to make wheat, it would result in 2 extra bags of wheat and 1 units less of
bottled water.
 If you add up the total production of both countries after specialisation, you
see that here is one more unit of bottled water and two extra bags of
wheat produced in the aggregate because of trade.

You might also like