EID MUBARAK TO ALL

Theory of Free Trade:

Definition and Explanation:

"A policy of unrestricted international exchange of goods is known as the policy of Free Trade".

Adam Smith like the Physocratics of France, was a staunch advocate of free trade. He was of the view that state should not interfere in the internal economic life of the citizens of a country as it hampers economic progress. He was against putting any kind of restrictions on the imports and exports of commodities. In the words of Adam Smith:

"After all why the protection in needed just to save the gold from going into the other country. I do not give much importance to it. It is a kind of commodity which is less important than other commodities because goods can serve many other purposes besides purchasing money but money can serve many other purposes besides purchasing goods. If protection is levied, it will divert industries from more advantageous trade to less advantageous trade".

The other English classical economists also believed in the doctrine of laissez-faire.
The policy of free trade has not been carried out completely by any country of the world. Some degree of state regulations has always been there on the international exchange of goods. England was the only country in the world which had maintained free trade for a long period. It was mainly due to the fact that it was more industrially advanced than the other countries and so it suited her interest.

In the late nineteenth century, there was a reaction in favor of protection from U.S.A. and Germany and they set up the industries by erecting, tariff walls. England abandoned her free trade policy during the Great Depression of 1930's. In recent years, some attempts have been made to establish free trade areas on regional basis.

In 1957, six countries of Europe comprising France, Germany, Italy, Netherlands, Belgium, Luxembourg formed a European Common Market. A second area of regional free trade is established by Great Britain. Norway, Sweden, Denmark, Portugal, Australia and Switzerland and is known as E.F.T.A.

Advantages of Free Trade:

The main advantages which are claimed for free trade are as follows:

(1) If the policy of free trade is adopted by all the countries of the world, it promotes a mutually profitable international division of labor which leads lo specialization in the production of those commodities in which they have the greatest relative advantage. The diversification of human and material resources of the country into remunerative channels results in increasing the real national product of all the countries. The standard of living of the people all over the world goes up.

(2) Free trade is undoubtedly the best from the point of view of the consumers, because they can get wider range of goods and commodities at lower prices. When protection is levied, the choice is reduced and the prices of commodities go up. The consumers then stand at a disadvantage.

(3) Free trade has the merit that it prevents the establishment of injurious monopolies.

(4) Under free trade, the home producers try to put forth their best because they are faced with foreign competition They quickly adopt the changes which are made in the designs of the commodities or in methods of production.

(5) The factors of production are freely able to move from one place to another or from one occupation to another occupation and thus are able to secure high rewards for their services.

Disadvantages of Free Trade:

Disadvantages. The main arguments which are advanced against free trade are as Under:

(1) One of the most captivating argument put forth against free trade is that it leads to over-dependence upon other countries. In time of war or any other emergency, the over-specialized countries may not be able to supply the required goods to the non-specialized ones.

(2) It is pointed out that under system of free trade, the economically backward country remains always at a disadvantage with the economically advanced country. So in order to build up industries, the backward nations must erect tariff walls USA. and Germany in the late 19th century abandoned free trade, because they were late in entering the industrial field. They developed the industries behind tariff barriers. So is also the case with India.

(3) When trade is unrestricted, the import of injurious and harmful goods cannot be hindered.

(4) Under free trade, if a country resorts to dumping with a view to capturing foreign markets, the home industries cannot be protected.

(5) Another argument advanced against free trade is that international specialization leads to an unbalanced economy of the country.

In the past, all the countries of the world have abandoned free trade and have turned protectionist In the last few years, there is again, a reaction in favor of free trade on regional basis. It has been experienced by the member of the ECM that the reduction of tariffs has greatly increased their trade with one another and the consumers have been able to get goods at cheaper prices.

Monopsony:

Monopsony:

Definition of Monopsony:

"When there is a single firm hiring the labor in the market, it is called monopsony in economics".

Under perfect competition, the labor gets wages equal to its marginal revenue product. There is no exploitation of labor. However, when the market of labor is imperfect, there emerges the phenomenon of exploitation of labor. How the wages are determined under imperfect competition and their exploitation by the monopnist firm is explained in brief as under.

Characteristics/Features of Monopsony:

Monopsony in the labor market, is said to exist when there is a single buyer of labor. The main characteristics of monopsony are as under:

(i) The firm or employer hires a large portion of the total employment of a certain type of labor.

(ii) The mobility of labor is very much limited either geographically or in terms of skills of offer.

(iii) The monopnist faces imperfect competition in the labor market but perfect competition in the product market.

(iv) The single buyer faces a large number of workers who are unorganized or non-unionized.

Ricardian Theory of Rent/Ricardian Model of Rent:

Definition:

The theory of economic rent was first propounded by the English Classical Economist David Ricardo (1773 -1823). David Ricardo in his book. "Principles of Political Economy and Taxation", defined rent as that:

"Portion of the produce of the earth which is paid to a landlord on account of the original and indestructible powers of the soil, Ricardo in his theory of rent has emphasized that rent is a reward for the services of land which is fixed in supply. Secondly, it arises due to original qualities of land which are indestructible". (The original indestructible powers of the soil include natural soil, fertility, mineral deposits, climatic conditions etc., etc.).

Assumptions:

(i) Rent Under Extensive Cultivation.

(ii) Rent Under Intensive Cultivation.

Explanation and Example of Ricardian Theory of Rent:

Rent Under Extensive Cultivation:

According to Ricardo:

"All the units of land are not of the same grade. They differ in fertility and location. The application of the same amount of labor, capital and other cooperating resources give rise to difference in productivity. This difference in productivity or the surplus which arises on the superior units of land over the inferior units is an economic rent".

The Ricardian theory of rent is explained by taking an example:

Schedule:

Grades of Land Yield in Quintals per Acre Price per Quintal ($) Total Return ($)
A 50 50 2500
B 35 60 2100
C 20 70 1400
D 15 80 1200

In the above schedule, we assume that there are four grades of land A, B, C and D in an uninhabited country. A grade land is more fertile than B grade land. B grade land is superior to C grade and so is C grade to D grade land.

Following Ricardo let us assume, a batch of settlers migrate to this island. They begin cultivating A grade land which yield 50 quintals of wheat per acre. Let us suppose now that the population of that country increases and A grade land is not sufficient to meet the food requirements of the growing population. The inhabitants of that country shall then have to bring under cultivation B grade land. With the identical amounts of labor and capital. B grade land yields 35 quintals of wheat per acre. A surplus of 15 quintal of wheat {50 - 35 = 15) which arises with the same outlay on A grade land is an economic rent. B grade land being a marginal land gives no rent. When owing to the pressure of growing population and a rise in demand for food, C grade land is brought under cultivation, it yields only 20 quintals of wheat with the identical amount of labor and capital. With the cultivation of C grade land, the economic rent of A grade land is now raised to 30 quintals per acre: (50 - 20 = 30) and that of B grade land 15 quintals of wheat per acre. C grade land is a no rent land as it is cultivated at the margin.

If the expenses of production on A grade of land yielding 50 quintals of wheat are $2500 and the market price of total yield on A grade land is also $2500, then A grade land only will be brought under cultivation. A grade land here is the marginal land. If the price of agricultural produce increases ($60 per quintal) and the expenses of producing wheat on B grade land are equal to the market price of the produce i.e.. $2100, then B grade of land which was hitherto neglected would be brought under cultivation. B grade land then becomes the marginal land. Similarly, D grade land will be the marginal land when it compensates the cultivator by giving a yield of $1200, and enjoys no surplus over cost. Marginal land is thus not fixed. It varies with the changes in the price of agricultural produce. If population increase still further and the demand for food increases, then D grade land will be brought under plough. The surplus or economic rent of A grade land will go up to 35 quintals (50 - 15 = 35), of B grade 20 quintals, of C grade 5 quintals. D grade land being the marginal land yields no rent.

Diagram:

The Ricardian model is now explained with the help of a diagram:



In the figure (19.1), the various grades of land in the descending order of fertility are plotted on OX axis and yield per acre is shown on OY axis. The cultivated area due to pressure of population and the rising demand for food is pushed to D grade of land which is a marginal land. The owner of A grade of land gets a surplus, or economic rent of 35 quintals of wheat, of B, 20 quintals and on C grade, the rent is 5 quintals of wheat.

Rent Under Intensive Cultivation:

The theory of rent which has been discussed above applies to Intensive margin of cultivation. The surplus or economic rent also arises to the land cultivated intensively. This occurs due to the operation of the famous law of diminishing returns.

When the land is cultivated intensively, the application of additional doses of labor and capital brings in less and less of yield. The dose whose cost just equates the value of marginal return is regarded marginal or no rent dose. The rent arises on all the infra-marginal doses.

For example, the application of first unit of labor and capital to a plot of land yields 25 quintals of wheat, the 2nd dose gives 15 quintals of wheat and with third it drops down to 10 quintals only, the farmer applies only 3 doses of labor and capital as the total outlay on the third does equals its return. The rent when measured from the third or marginal dose is 15 quintal (25 - 10 = 15) on first dose and 5 quintal on second dose (15 -10 = 5). The third dose is a no rent dose.

Criticism on Ricardian Theory of Rent:

(i) No Original and Indestructible Power: Ricardo is of the opinion that rent is paid due to the original and indestructible powers of the soil. It is pointed out that there are no powers of the soil which are indestructible. As we go on cultivating a piece of land time and again, its fertility gradually diminishes. To this criticism, it is replied that there are properties of the soil, such as climate situation, sunshine, humidity, soil composition, etc., which are infect original and indestructible.

(ii) Wrong Assumption of 'No Rent Land': Ricardo assumes the existence of no-rent land. A land which just meets the cost of cultivation. The modern economists are of the opinion that if a plot of land can be put to several uses, then it does yield rent.

(iii) Rent Enters Into Price: According to Ricardo, rent does not enter into price. The modern economists are of the opinion that it does eater into price.

(iv) Wrong Assumption of Perfect Competition: Ricardo is of the opinion that perfect competition prevails between the landlord and the tenant, but in the actual world, it is imperfect competition which is the order of the day.

(v) All Lands are Equally Fertile: Ricardo assumes that rent arises due to difference in the fertility of the soil. But the modern economists assert that if all lands are equally fertile, even then the rent will arise. The rent can arise: (a) if the produce is not sufficient to meet the requirements of the people, and (b) due the operation of the law of diminishing returns.

(vi) Historically Wrong: Carey and Roscher have criticized the orders of cultivation assumed by Ricardo. They are of the opinion that it is not necessary that A grade land will be cultivated first, even if it lies far away from the city. To this it is replied by Walker that when Ricardo uses the words 'best land' he means by it the land which is superior both in fertility and in situation.

(vii) Neglect of Scarcity Principle: It is pointed out by the modem economists that the concept of rent can be easily explained with the help of the scarcity principle and so there is no need to have a separate theory of rent.