Fred Foldvary on Ricardo and Marshall are Brothers
|January 5, 2003||Posted by Fred Foldvary under Archive, Progress Report, The Progress Report|
Fred Foldvary’s Editorial
Ricardo and Marshall are Brothers
by Fred E. Foldvary, Senior Editor
David Ricardo (1772-1823) was one of the great classical British economists. His main work is Principles of Political Economy and Taxation. The economic model Ricardo developed was the heart of classical theory until classical economics was overturned by the neoclassical revolution at the end of the 1800s.
Ricardo sought to determine how the output or wealth of an economy is divided into the owners of the three input-factors, land, labor, and capital goods. When settlers come to a new land, they first use the most productive land, and later settlers go to ever less productive land. On free land, all the product goes to labor and capital goods. But since there is one common wage level and a common costs of capital goods, the output of the superior land all goes to the owners as rent.
Ricardo’s theory therefore has a triangle sloping down from the best to the worst land in use, the flat bottom side being the production that goes to labor and capital goods, the sloping down top side being the total product. The triangle is the portion of wealth going to land rent. That triangle gets bigger and bigger as production moves to ever less productive land.
Alfred Marshall (1842-1924) was the great British economist who developed the supply and demand curves of neoclassical economics. The neoclassical turn emphasizes supply and demand rather than the factors of production, and it simplified economics to two factors, land and capital goods, folding in land into capital goods.
In the neoclassical school of thought, the supply curve of goods being produced slopes up, since it represents the costs of production. The lowest-costs producers are able to sell goods at a low price, and as the market price goes up, producers with ever higher costs are able to sell their goods profitably. Meanwhile there is a downward sloping demand curve, with folks buying ever more as the price goes down.
Imagine the supply curve sloping up as the demand curve slopes down. Somewhere they cross, and that is the market-clearing point that determines the market price and the market quantity sold.
The revenue from production is represented by the rectangle starting at the origin and going to the market price and the market quantity, revenue being price times quantity. That revenue rectangle is cut into two parts by the upward-sloping supply curve.
If the supply curve is drawn as a straight line, the two parts are triangles. The bottom triangle is the revenue or output that goes to pay for labor and capital goods, since these determine the supply. Where does the rest of the revenue and output, represented by the upper triangle, go?
Neoclassical economists call the upper triangle, between the supply curve and the price line, the “producer surplus.” It is the extra revenue left over after paying for labor and capital goods, which is surplus because the producers would supply the good if they just got a return for their labor and capital goods.
So who gets this producer surplus? The producers don’t receive it, because the surplus is not due to having better labor or capital goods tools, but because of locational advantages. Therefore, the surplus goes to the landlords as rent. Landlords are able to charge more rent in the more productive areas, because the more productive areas sell at the same price as the less productive areas, and the difference in revenues can be captured by the landlords as rent.
We can see that Marshall’s triangle of the producer surplus is the very same thing as Ricardo’s triangle that represents the land rent of superior lands. Marshall’s producer-surplus triangle is Ricardo’s rent triangle turned upside down. But the classical economists clearly labeled it “land rent,” while the neoclassical economists, having only “producers” in their model, call it a “producers’ surplus” even though the producers are not getting the surplus, but rather the landowners.
Karl Marx (1818-1883) recognized there was a surplus from production, but mistakenly thought it was that part of wages that was taken away by producers as profit. Henry George (1839-1897) clearly saw it as a social surplus that was being taken by the landowners, but that should instead go to society as public revenue, replacing taxes on labor and capital.
Marshall and Ricardo recognized the surplus that arises from production, and thus they are brothers in economic theory. But today’s neoclassical textbooks don’t bother to ask who gets this so-called “producer surplus”. They don’t tell students that this surplus is paid as land rent.
Millions of students are learning neoclassical economics today and read about the producer surplus. The implicit conclusion is that the producers are getting this surplus as profit. They don’t stop to think about what factor owner of production – of land, labor, or capital goods – gets the profit.
Henry George had it right. The producer surplus is really a social surplus that belongs to the people. If labor and capital are taxed, it hurts production, while if rent is used for public revenue, this has no ill effect, since the rent is a surplus rather than an economic cost of production. Once it is recognized that the producer surplus is rent, it becomes clear that this rent should be public revenue, rather than taxing labor and capital.
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Copyright 2001 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.