There is no Room: The Role of Net Reciprocal Effectual Demands in Ricardo’s Theory of Foreign Trade

The paper aims to contribute to the Sraffian interpretation of Ricardo’s theory of foreign trade in his Principles, following the recent reappraisal of Sraffa’s 1930 paper. We argue that Ricardo assumed that trade happened at natural relative prices in each country, and that those prices are determined by taking as given the real wage, the available methods of production and the set of sectoral effectual demands. We show that gravitation towards natural prices ensures that: (i) Ricardo’s theory is not incomplete, so there is no need for price elastic demand functions, contrary to what John Stuart Mill argued; (ii) the quantities imported of a particular commodity will correspond to the domestic effectual demand for that commodity, net of what is produced locally by lands of superior quality, which we call ‘net effectual demands’; (iii) the terms of trade are fully determined by the ratio of the total (absolute) quantity of labor embodied in the imported commodities relative to the total quantity of labor contained in the exported commodity; and (iv) in the simple examples in chapter 7, gravitation also implies that the terms of trade are determined directly by the ratio of the given levels of reciprocal net effectual demands.