Transcript Classicals After Smith - Central Web Server 2

Classicals After Smith
ECON 205W
Summer 2006
Prof. Cunningham
1
Jean Baptiste Say
(1767-1832)



Background
In 1788, at the age of 21, read Smith’s
Wealth of Nations
In 1803 (1814, 1821) wrote Traite
d’Economie (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
2
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

3
Say’s 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.
4
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.

5
Senior (2)

Senior’s 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.
6
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.
7
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.
8
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.
9
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.
10
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 gov’t relief for the poor.
Aid would increase the population growth
rate, making matters worse.
11
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”.
12
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.
13
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 gov’t debt causes inflation.
 (Opposed to redistribution of income)

14
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.
15
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, profitmaximizing consumers
Used abstract, deductive analysis.
16
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.

17
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 Say’s Law
Theory of Employment
18
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 theory—
over-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.
19
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.

20
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.
21
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.
22
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
wage—this 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.
23
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.
24
Ricardo (10)

Say’s Law
In the main, Ricardo agreed with
Say’s Law.
 In his arguments with Malthus, he did
back-track on Say’s Law, or at least
allowed that Say’s Law might not
guarantee full employment
equilibrium.


Ricardian Equivalence Theorem.
25
Jeremy Bentham
(1748-1832)
Studied history and Latin at age 4.
Entered Queen’s 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…

26
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.


Gov’t 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.
27
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.
28
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 behavior—
Freudian psychology, cultural anthropology, etc.
• Should government make the pursuit of happiness its
guiding principle?

Utility theory did become a foundation of
microeconomic theory.
29
John Stuart Mill
(1806-73)


Made contributions to economics, philosophy,
logic, political science
Broad concerns:







Mankind’s position in the cosmos
Each person’s 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
30
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?
31
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

32
Mill (4)

Utilitarianism (1861, 1863)
Generally supported Bentham’s
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.”
33
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
34
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 taxes—who winds up
paying a tax (in his example, an import duty)
35
Mill (7)

On Say’s 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 transactions—”you need not buy
when you sell.”
Therefore, a general over-supply may be
possible.
Builds a theory of business cycles based on
expectations.
36
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

37
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. Smith’s 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
38
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.
39
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.
40