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David Ricardo (1772-1823)

David Ricardo was one of those rare people who achieved tremendous success and lasting fame. After his family disinherited him for marrying outside his Jewish faith, Ricardo made a fortune as a stockbroker and a loan broker. When he died, his estate was worth over $100 million in today's dollars. At age twenty-seven, after reading Adam Smith's The Wealth of Nations,Ricardo got excited about economics. He wrote his first economics article at age thirty-seven and then spent only fourteen years—his last ones—as a professional economist.

Ricardo first gained notice among economists over the "bullion controversy." In 1809 he wrote that England's inflation was the result of the Bank of England's propensity to issue excess bank notes. In short, Ricardo was anearly believer in the quantity theory of money, or what is known today as monetarism.

In his Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), Ricardo articulated what came to be known as the law of diminishing returns. One of the most famous laws of economics, it holds that as more and more resources are combined in production with a fixed resource—for example, asmore labor and machinery are used on a fixed amount of land—the additions to output will diminish.

Ricardo also opposed the protectionist Corn Laws, which restricted imports of wheat. In arguing for free trade, Ricardo formulated the idea of comparative costs, today called comparative advantage. Comparative advantage—a very subtle idea—is the main basis for most economists' belief in free tradetoday. The idea is this: a country that trades for products that it can get at lower cost from another country is better off than if it had made the products at home.

Say, for example, that Poorland can produce one bottle of wine with five hours of labor and one loaf of bread with ten hours. Richland's workers, on the other hand, are more productive. They produce a bottle of wine with threehours of labor and a loaf of bread with one hour. One might think at first that because Richland requires fewer labor hours to produce either good, it has nothing to gain from trade.

Think again. Poorland's cost of producing wine, although higher than Richland's in terms of hours of labor, is lower in terms of bread. For every bottle produced, Poorland gives up half of a loaf, while Richlandhas to give up three loaves to make a bottle of wine. Therefore, Poorland has a comparative advantage in producing wine. Similarly, for every loaf of bread it produces, Poorland gives up two bottles of wine, but Richland gives up only a third of a bottle. Therefore, Richland has a comparative advantage in producing bread.

If they exchange wine and bread one-for-one, Poorland can specialize inproducing wine and trading some of it to Richland, and Richland can specialize in producing bread. Both Richland and Poorland will be better off than if they hadn't traded. By shifting, say, ten hours of labor out of producing bread, Poorland gives up the one loaf that this labor could have produced. But the reallocated labor produces two bottles of wine, which will trade for two loaves of bread.Result: trade nets Poorland one additional loaf of bread. Nor does Poorland's gain come at Richland's expense. Richland gains also, or else it would not have traded. By shifting three hours out of producing wine, Richland cuts wine production by one bottle but increases bread production by three loaves. It trades two of these loaves for Poorland's two bottles of wine. Richland has one more bottleof wine than it had before, and an extra loaf of bread.

These gains come, Ricardo observed, because each country specializes in producing the good for which its comparative cost is lower.

Writing a century before Paul Samuelson and other modern economists popularized the use of equations, Ricardo is still esteemed for his uncanny ability to arrive at complex conclusions without any of the...