IGNOU : M.COM : IBO 1 : UNIT 2 : Q - 1. Critically examine Ricardian Theory of Trade.

Ans.  Classical economists, such as David Ricardo, believed that labour is the only Source of value of goods in the economy. This does not mean that no other inputs are required in production, but since the other inputs such as raw materials and capital goods are also  produced by labour, ultimately it is the labour which determines the relative valuation of goods. , Among other inputs, not produced by labour, land is given by nature in a fixed quantity. Landowners earn rent which does not determine price, rather it is the price which determines how much rent the landowners will earn. Such an explanation of value is known as the labour theory of value. Let us understand it with the help of an example. Assume that it takes 3 hours of labour to make one yard of  cloth and 5 hours of labour to 10 kilogram of wheat.  The wheat and cloth markets are perfectly competitive and labour is free to move from wheat production to cloth production and vice versa. This implies that  the wage rate will be same in the cloth and wheat industries. Let be this wage rate then the average cost [ cost per unit, one unit of cloth is one yard, and one unit of wheat is 10kg ] in cloth and wheat production will be respectively 3W and 5W. These will  also be the price of cloth and wheat respectively, because under private competition price is equal to average. Thus the relative price of cloth in term of wheat is 3W/5W or 3/5 which simply means that 3/5 th of a unit of wheat will buy one unit of cloth, or 6 kg. wheat will exchange for one yard of cloth. In the terminology of classical economists this exchange ratio is known as value which is determined only by labour and nothing else.