History of Economic Thought; A Critical Account of the Origin and Development of the Economic Theories of the Leading Thinkers in the Leading Nations
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Compare the value theories and policy prescriptions of mercantilists and physiocrats
- Value theory mercantilist
o Value of a nation = amount of silver and gold in an economy
o Zero sum game one person’s gain is another person’s loss
o Achieving positive trade balance
- Policy prescriptions mercantilist
o Imposing taxes on imported manufactured goods to minimize import
o Only import raw materials to use for export
o Preference for export of manufactured goods over raw materials
o Hard-working and poor population as to keep prices low
o Strong central government
o Low wages
- Value theory physiocrats
o Value comes from nature, so source of wealth = agriculture
Only nature creates new value, capital and labor con only reprocess
Wealth accumulates (new crops can be used again to restart process)
- Policy prescriptions physiocrats (centered around natural order)
o Laissez-faire minimal government intervention
o Taxation of the land owner, since it is the only source of wealth
Describe the major contributions and shortcomings of the physiocratic doctrine
- Contributions
o Examined society as whole
o Analyzed circulation of wealth and goods
o Founded economics as a social science
o Invented idea of tax shifting to specific sectors
o Advocated laissez faire
o Introduced law of diminishing returns
- Shortcomings
o They said industry and trade were not important, only agriculture could make a surplus
Explain the idea of laissez faire and why the physiocrats supported this idea
- Laissez-faire
o people should be left to do as they please
o minimum government interference
only things absolutely essential like protect life and property and to maintain freedom of contract
o goal: economy reaching maximal growth rate
- Physiocrats supported laissez-faire
o As reaction to mercantilism and feudal French ancient regime There was huge government interference
(tariffs, production methods, internal trade, taxes). There was no incentive for individuals to accumulate
wealth
o The physiocrats, however, vouched that all human activities should be bright into harmony with natural laws
(hence the name physiocrat). They believed that individuals have the right to enjoy fruits of their labor,
provided such enjoyment was consistent with the right of others. They extended this idea by stating that rules
of nature would make for markets to thrive. Their emphasis on natural laws was partly triggered by the
scientific discoveries in the natural sciences around that period.
o Based on the description of the idea of laissez-faire and the physiocratic ideology, it can be concluded that the
two are aligned. The idea of Laissez-faire opposed the strong government regulation just like the physiocrats,
and it also is in line with the physiocratic idea that rules of nature would rule society, with minimal
government interference.
What were the main elements and intuitions of the classical approach to political economy?
- Main elements
o Minimal government involvement
The forces of a free and competitive market would guide production exchange and distribution. The
economy would tend towards full employment without government intervention. The government
activity should be very minimal, only protection property rights, providing national defense and
providing public education.
o Self-interested economic behavior
= basic to human nature
Producers and merchants merely provide their goods out of a desire to make profit, just as workers
only offer their labor services to obtain a wage.
, o Harmony of interests (except for Ricardo)
Pursuing own individual interest interest of society is pursued (=invisible hand)
o Importance of all economic resources and activities and laws
Land, labor, capital and entrepreneurship – as well as economic activities - contribute to a nation’s
wealth. Whereas the mercantilists said wealth came only from commerce, and the physiocrats
believed land and agriculture to be the only source of wealth.
o Long run perspective Value theory (not price theory), natural prices (not market prices)
o At last, the classical school tried to focus their analysis on explicit economic theories or laws. For example, the
theory of comparative advantages, Malthus’ population theory, Say’s law. They believed their laws of
economics to be universal and immutable.
Explain the idea and the advantages of the division of labor. What is the role of this concept in Smith's work? What could be
the shortcoming of the division of labor, according to Smith, and the possible remedy?
- Division of labor has a positive effect on efficiency and quantity produced for 3 reasons
o Increase of dexterity of the worker because a task is done over and over
o Time would be saved because workers do not have to go from one operation to the other continuously
o Once tasks have been simplified, new machinery can be invested to increase productivity.
- Disadvantages
o Bad for moral and mental health due to repetitiveness
o Loss of motivation due to boredom
o Division of labor is limited to the extent of the market due to constant pressure on the factories,
- Solution disadvantages education
What, according to Smith, determines exchange value in a primitive and in an advanced economy?
- Primitive economy Exchange value is based on the amount of labor necessary to produce a product
o Because land is free, and there is no technology or capital
- Advanced economy labor, technology and capital are included in the price
o Therefore, the exchange value can be summarized as that goods are exchanged for other goods, money, or
labor at a figure high enough to cover wages, rents, and profits.
Explain the meaning of Smith’s ‘invisible hand’ doctrine and discuss the analytical and normative significance of the ‘invisible
hand’
- Meaning
o The invisible hand describes the unobservable market force that helps the demand and supply of goods in a
free-market reach equilibrium automatically through social harmony of self interest
Self-interest traders will compete with each other which leads to a positive market output
o The invisible hand tries to solve the problem of social order It tries to describe a way to achieve stability and
optimality of society for all of its members
o Start point: all individuals are self-interested and intend only on personal gain
These individuals, who interact on the markets, are guided by an invisible hand to somehow promote
the interest of others as well
The pursuit of self-interest by each individual in society tends to produce the optimal society. Thus, an
unintended consequence of self-interested behavior is social harmony. Interestingly, this all happens
spontaneously, without government intervention.
- Implication
o it demonstrates one of the key economic ideas: that the interest of self-interested individuals can be socially
optimal for all.
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