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Classicals After Smith

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Gold price rose from the official government price of 3.17 pounds to 5.10 per ounce. The 'question' was 'Why is the market price of gold was rising? ... – PowerPoint PPT presentation

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Title: Classicals After Smith


1
Classicals After Smith
  • ECON 205W
  • Summer 2006
  • Prof. Cunningham

2
Jean Baptiste Say(1767-1832)
  • Background
  • In 1788, at the age of 21, read Smiths Wealth of
    Nations
  • In 1803 (1814, 1821) wrote Traite dEconomie
    (Treatise on Political Economy)
  • Became a popular textbook of economics in Europe
    and the U.S.
  • Used at Harvard as late as 1850,Dartmouth as
    late as 1870
  • Jefferson liked the book

3
Say (Continued)
  • Emphasized that labor, land, and capital are all
    involved in production.
  • Thought that counties are rich and powerful in
    proportion to the lowness of prices.
  • Equated value with utility

4
Says Law
  • it is production which opens a demand for
    product.
  • Supply creates its own demand
  • No one sells without an intent to buy
  • Endorsed by Ricardo, attacked by Malthus.

5
William Nassau Senior(1790-1864)
  • 1825, became the first professor of political
    economy at Oxford.
  • Believed we should separate the science of
    political economy from value judgments, leading
    to the modern notion of positive economics.

6
Senior (2)
  • Seniors four propositions
  • People wish to maximize wealth at the lowest
    sacrifice. (Principle of income or utility
    maximization)
  • The population is limited only by moral or
    physical evil, or by the fear of a deficiency of
    wealth that each class of inhabitants thinks they
    need. (Principle of population.)
  • Labor productivity is not limited, but increases
    as capital is brought to bear. (Theory of capital
    accumulation.)
  • Principle of diminishing returns to agriculture.

7
Senior (3)
  • Abstinence Theory
  • Cost is subjective
  • The costs of production are the labor of workers
    and the abstinence of capitalists. (People have
    to be paid to abstain from consumption to give up
    their buying power to purchase capital.)
  • This makes saving a function of interest.

8
Senior (4)
  • Policies
  • Favored the Poor Laws of 1834.
  • Thought that the living conditions of those
    receiving welfare ought to be worse than those of
    the lowest paid workers.
  • Should discourage able-bodied workers from
    applying for welfare.
  • Opposed to trade unions because they interfered
    with the market process and the mobility of
    labor.
  • Factory Acts.
  • Favored child labor laws, but did not favor laws
    restricting the hours of adults.

9
Thomas Robert Malthus (1766-1834)
  • Background
  • An Essay on the Principle of Population, 1798
  • Considered the plight of the poor and unemployed
  • Recessions caused by deficient demand.
    (Anticipates Keynes)
  • Principles of Political Economy, 1820.

10
Malthus (2)
  • Setting
  • An Essay on the Principle of Population
  • The population, left unchecked, will grow at an
    exponential rate.(e.g., 1,2,4,8,16,32, )
  • The food supply will grow at an arithmetic
    rate.(e.g., 1,2,3,4,5, )
  • Argued that the population, unchecked, doubles
    every 25 years.

11
Malthus (3)
  • Offers two different types of checks to
    population growth
  • Preventive checks (reduce the birth rate)
  • Positive checks (increase the death rate)
  • Argued that poverty and misery are the natural
    punishment for the failure of the lower classes
    to exercise moral restraint.
  • Did not advocate govt relief for the poor.
  • Aid would increase the population growth rate,
    making matters worse.

12
Malthus (4)
  • Some of Mathus ideas found their way into the
    harsh Poor Law Amendment of 1834.
  • Abolished all relief for able-bodied people.
  • Thomas Carlyle, after reading Mathus book,
    called political economy the dismal science.

13
Malthus (5)
  • Theory of General Gluts
  • Workers receive a subsistence wage
  • Their marginal product is more than their wage,
    so that their employer makes a profit.
  • This means, he says, that workers do not have the
    buying power to buy the goods they produce.
  • Capitalists have more income (profits) than they
    can spend on consumption goods. The capitalists
    also spend some of the income on capital goods.
    All in all, the capitalists do not spend all
    their income.
  • This leads to insufficient demand, inventories
    build up, lay-offs follow ? unemployment.

14
Malthus (6)
  • Policy Recommendation
  • Force spending by landlords to make up for
    deficient demand.
  • Tariffs promote domestic consumption.
  • Keep taxes low.
  • Maintain low government debt since high govt
    debt causes inflation.
  • (Opposed to redistribution of income)

15
Malthus (7)
  • Summary
  • Absolves the wealthy and the government for
    responsibility for the poor.
  • Focused on rents and spending by landlords.
  • Diminishing returns in agriculture.
  • No forethought for technological improvements.
  • There is still a Malthusian problem in
    developing nations.
  • Anticipated Keynes in assuming that the
    difference in employment levels in the
    macroeconomy was due to insufficient demand.
    Keynes referred to Malthus as his predecessor.

16
David Ricardo(1772-1823)
  • Background
  • 1817, Principles of Political Economy and
    Taxation
  • At 27, read Wealth of Nations
  • Argued for tax on capital, even though it would
    have cost him personally.
  • Always focused on gain vs. loss was able to
    reduce everything quickly to its essence thought
    in terms of rational, economic, profit-maximizing
    consumers
  • Used abstract, deductive analysis.

17
Ricardo (2)
  • Staunch supporter of the classical system.
  • Recognizes flaws in Smith, but still sees it as
    the best available theory.
  • It is clear in his writing that he has different
    purposes and motivations than does Smith.

18
Ricardo (3)
  • Smith was a moral philosopher
  • Ricardo was not a philosopher at all.
  • In his Principles he uses an abstract
    presentation to make these key contributions
  • Labor Theory of Value
  • Differential Rent Theory
  • Falling Rate of Profits
  • International Trade (Comparative Advantage)
  • Modifications of Says Law
  • Theory of Employment

19
Ricardo (4)
  • Currency Question
  • 1797, in the midst of a panic during a war
    between England and France, the government
    suspended the gold standard.
  • Gold price rose from the official government
    price of 3.17 pounds to 5.10 per ounce.
  • The question was Why is the market price of
    gold was rising?
  • Ricardo argues that it is a result of the
    quantity theoryover-issuance of money.
  • Paper money had changed value, not gold.
  • Seigniorage was driving over-issue.
  • Argued that if the Bank of England reduced its
    issuance of paper money and moved to a bullion
    standard, it could resume the gold standard at a
    favorable rates.

20
Ricardo (5)
  • Diminishing Returns and Theory of (Differential)
    Rents (land rent)
  • First economist to use the marginal principle.
  • Price of rents related to marginal productivity
    of the soil.

21
Ricardo (6)
  • Labor Theory of Value
  • For a commodity to have exchange value, it must
    have use value. Possessing utility or use value,
    commodities derive their exchange value from (1)
    scarcity and (2) quantity of labor required to
    produce them.
  • Argues that raw materials and capital gods used
    up in the process of production are embodied
    labor.
  • Recognized that differing capital-labor ratios in
    industries could result in different returns to
    capital if goods were sold at prices related to
    labor cost.
  • This could not happen in a market economy because
    capital would flow toward the higher return and
    therefore equalize.
  • Labor time accounts for 93 of the value of a
    commodity?
  • Also allows for differential labor productivity.

22
Ricardo (7)
  • Distribution of Income
  • His major concern was understanding the forces
    that determine the shares of the national income
    accruing as wages, profits, rents (functional
    distribution of income). Thought this was more
    important than understanding the nature and
    causes of wealth.
  • All things have a natural price and a market
    price.
  • The natural price of labor is that price which
    allows workers to subsist and perpetuate
    themselves without a change in their numbers.
  • Market prices depend upon supply and demand.

23
Ricardo (8)
  • In the long run, the natural price of labor rises
    because diminishing returns will make food more
    and more expensive.
  • In the long run, workers will only make a
    subsistence wagethis is called the iron law of
    wages
  • Fertility rises and falls with wages, related to
    customs and habits, not just biology.
  • Because of declining fertility of soil, rents
    will fall.
  • Profits equalize across industries by attracting
    capital and labor, but will fall because profit
    is the residual claimant to revenue.

24
Ricardo (9)
  • International Economics
  • Smith and Cantillon argued that absolute
    advantage was the explanation for trade.
  • After the industrial revolution in the UK, the UK
    arguably had an absolute advantage in every
    manufactured commodity.
  • Ricardo argues the law of comparative advantage.
  • Smith had trouble with trade in services, which
    Ricardo did not suffer.

25
Ricardo (10)
  • Says Law
  • In the main, Ricardo agreed with Says Law.
  • In his arguments with Malthus, he did back-track
    on Says Law, or at least allowed that Says Law
    might not guarantee full employment equilibrium.
  • Ricardian Equivalence Theorem.

26
Jeremy Bentham(1748-1832)
  • Studied history and Latin at age 4. Entered
    Queens College at 12 and graduated at 15. Then
    he studied law. Moved on to study more broadly.
  • Left his estate to University College, London.
    Still present at all board meetings

27
Bentham (2)
  • The greatest good for the greatest number.
  • Individuals are hedonistic. They seek to maximize
    pleasure and minimize pain.
  • In seeking individual happiness, they may not
    necessarily cause the greatest collective
    happiness.
  • Govt and law, moral and social sanctions, are
    designed to direct individual pursuit into
    maximum social utility.
  • Wealth is a measure of happiness, but has
    diminishing marginal utility.

28
Bentham (3)
  • Argues that the state ought to serve the people
    instead of the people serving the state.
  • Thought the government ought to have monopolies
    on
  • Issuance of currency
  • Retirement plans
  • Life and health insurance
  • Hoped to make morals an exact science.
  • Problems of measuring utility cardinally and
    objectively.

29
Bentham (4)
  • Criticisms
  • Bentham chose money as his cardinal measure. But
    people have different subjective valuations of
    things, which cannot be compared.
  • Many critics claim utilitarianism is deficient as
    a philosophy.
  • Perhaps people are not purely hedonistic.
  • There are other viable theories of human
    behaviorFreudian psychology, cultural
    anthropology, etc.
  • Should government make the pursuit of happiness
    its guiding principle?
  • Utility theory did become a foundation of
    microeconomic theory.

30
John Stuart Mill(1806-73)
  • Made contributions to economics, philosophy,
    logic, political science
  • Broad concerns
  • Mankinds position in the cosmos
  • Each persons relationship to society
  • The rules that govern thought
  • The natural laws of human action
  • Not as interested in the growth of production or
    efficiency as he was interested in the quality of
    life and the full development of the individual.
  • More social philosopher than technical economist.
  • Law of the true classicals

31
Mill (2)
  • The development of society depends upon the
    development of the individual.
  • Optimistic about the economic progress of society
  • No Malthusian argument
  • No declining rate of profits
  • Belief in progress
  • Softer view on social issues
  • Classical economist who was a modern liberal?

32
Mill (3)
  • Autobiography (1873)
  • Driven by his father
  • grew up in the absence of love and the presence
    of fear.
  • Nervous breakdown at age 20.
  • One of the greatest geniuses of all time.
  • Close to Bentham and Ricardo

33
Mill (4)
  • Utilitarianism (1861, 1863)
  • Generally supported Benthams calculus of pain
    and pleasure
  • Modifications
  • Quality of life is also important
  • Recognized that pleasure may be subjective
  • It is better to be a human being dissatisfied,
    than a pig satisfied.

34
Mill (5)
  • Considerations on Representative Government
    (1861)
  • Proposed to give extra votes to individuals
    possessed of mental superiority
  • Mills Market economics was softened by his
    socialist leanings and sensitivity to social
    problems
  • Something of a romantic
  • From Saint Simon, he learned to favor the
    emancipation of women, and did not approve of
    great wealth being inherited.
  • Sought a philosophy of history

35
Mill (6)
  • Harriet Taylor
  • Essays on Some Unsettled Questions of Political
    Economy, written 1829-30, published in 1844.
  • First essay theory of international trade
  • Develops his theory of reciprocal demand, and
    what is now known as the terms of trade
  • Examined losses due to taxeswho winds up paying
    a tax (in his example, an import duty)

36
Mill (7)
  • On Says Law
  • No one sells without an intention to buy
    therefore, by definition, a seller must be a
    buyer.
  • Mill sees this as incontestable
  • Money can divide this operation into two
    different transactionsyou need not buy when you
    sell.
  • Therefore, a general over-supply may be possible.
  • Builds a theory of business cycles based on
    expectations.

37
Mill (8)
  • On Methodology
  • Uses the term economist, and sees political
    economy as something different from economics.
  • Constructs homo economicus
  • Abstract analysis, testable hypotheses
  • Need to examine extreme cases.
  • Preferred a multidisciplinary approach

38
Mill (9)
  • Logic (1843)
  • Principles of Political Economy (1848)
  • Immediately accepted as authoritative
  • An attempt to write a new Wealth of Nations?
  • Divided into 5 books (vs. Smiths 4)
  • Production, Distribution, Exchange, Dynamics,
    Influence of Government
  • The way he distinguishes between production and
    distribution opens the door to socialism.
  • Discusses diminishing returns
  • Views laissez-faire in a different way from Smith

39
Mill (10)
  • Theory of Value
  • There is nothing in the laws of value which
    remains for the present or any future writer to
    clear up the theory of the subject is complete.
  • Divides economics into statics and dynamics.
  • Argued that profits would fall until net capital
    accumulation would not be profitable net
    increases in capital would stop. Growth would
    stop. The economy would reach a stationary state.
  • Thought this might be good, liberating.

40
Mill (11)
  • Considered the future of the labor force
  • On Liberty (1859)
  • Skeptical and unenthusiastic about government
  • Need to safeguard individual freedoms
  • Conscience
  • Thought
  • Discussion
  • Association
  • Persuit of preferences
  • Society has not warrant to protect the
    individual from himself its legitimate function
    is only the protection of others.
  • Strict libertarian in many matters, more of a
    modern liberal in other matters.
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