UNIVERSITY COLLEGE LONDON
DEPARTMENT OF ECONOMICS
Economics BSc (Econ)
First Year – Term 1
HISTORY OF ECONOMIC
THOUGHT
ECON0008
Rodrigo Antón García
rodrigo.garcia.20@ucl.ac.uk
London, 2020
,History of Economic Thought – ECON0008 Rodrigo Antón García
Contents
Topic 1 - Some Roots of Economic Analysis.
o Topic 1.1 - From the middle ages to an age of mercantilism. 1
o Topic 1.2 - Wealth of nation and balance of trade. 1
o Topic 1.3 - The Quantity Theory of Money. 2
Topic 2 – From Competition for Trade to Efficiency in Production.
o Topic 2.1 – William Petty, the state and compactness . 2
o Topic 2.2 – The Surplus: Petty; the Physiocrats. 5
o Topic 2.3 – Classical themes: surplus, distributions, circulation –
the Physiocrats. 6
Topic 3 – Adam Smith.
o Topic 3.1 – Smith: Division of labour and the extent of the market. 6
o Topic 3.2 – Free competition, natural price, monopoly. 8
o Topic 3.3 – Review of classical themes so far. 9
Topic 4 – Ricardo: machinery, diminishing returns, differential rent.
o Topic 4.1 – Context; mechanisation and unemployment. 11
o Topic 4.2 – Diminishing returns; differential rent. 13
o Topic 4.3 – Malthus and population crisis. 14
Topic 5 – Ricardo: distributive shares; demand in Classical Political Economy.
o Topic 5.1 – Ricardo: distributive shares. 15
o Topic 5.2 – Ricardo, crisis theory and context. 19
o Topic 5.3 – Demand in Classical Political Economy. 21
o Topic 5.4 – From Ricardo to Keynes. 22
,History of Economic Thought – ECON0008 Rodrigo Antón García
Topic 6 – Marginalism: Jevons.
o Topic 6.1 – Utility; Bentham. 23
o Topic 6.2 – The Margin; Jevons. 25
o Topic 6.3 – From value to price; CPE repudiated. 27
o Topic 6.4 – General equilibrium - Walras. 28
o Topic 6.5 – The second generation; Marshall. 31
Topic 7 – Classical Economics .
o Topic 7.1 – Absence of a theory of economic fluctuations. 36
o Topic 7.2 – The Circular flow. 37
Topic 8 – Keynes and Classical Economics .
o Topic 8.1 – The Great Depression and the classical response. 41
o Topic 8.2 – The circular flow revisited. 43
o Topic 8.3 – Keynes challenge to the classical approach. 45
o Topic 8.4 – “The prefix general”. 48
Topic 9 – History of Trade theory.
o Topic 9.1 – English classical political economy and the gains from
trade 49
o Topic 9.2 – Ricardo: comparative advantage. 50
o Topic 9.3 – Late-comers: arguments for protection; List. 53
o Topic 9.4 – From post-war Keynesianism to Washington Consensus and
beyond. 55
,History of Economic Thought – ECON0008 Rodrigo Antón García
ECON0008: HISTORY OF ECONOMIC THOUGHT SUMMARY
Topic 1 - Some Roots of Economic Analysis.
o Topic 1.1 - From the middle ages to an age of mercantilism.
Mercantilism: an economic theory that argues that the wealth and power of a nation-
state was evaluated base on the accumulation of gold and silver (profitable balances).
To achieve wealth and power: promote exports and limit imports in order to generate
trade surplus value.
Mercantilism is based on the principle that the world's wealth was static, and
consequently, many European nations attempted to accumulate the largest possible
share of that wealth by maximizing their exports and by limiting their imports via tariffs.
• Discussions of economic issues began to be taken up by merchants,
particularly merchants travelling internationally.
• Wealth-getting no longer considered sinful.
• Government ( prince ) the principal economic agent.
• Commercial wars between European nation states.
• Increases in nations wealth a ero s m game .
• European colonialism, start of African slave trade. Eurocentric.
• Maritime trade important. Piracy, warfare.
o Topic 1.2 - Wealth of nation and balance of trade.
Bullionism: an economic theory that defines wealth by the amount of precious metals
owned. An early form of mercantilism.
Quest for gold is a zero-sum game: amount of gold is fixed, increase in one nation s
wealth must come in expense of another nation. Prevent money from being exported.
Get gold from Spain & letters of marque. An early estimate of England s national income
(Petty, early 1670s) includes 60,000 pounds taken from the Spaniards .
Thomas Mun. Mercantilist. Believed that wealth can be increased by foreign trade, in
specific a Balance of Trade Surplus.
- Although BOT and BOP distinction was not made yet, Mun included goods and
all aspects of merchants mark-up (merchant gains) in his trade history.
- He believed that export of money can increase a nation s treasure (conflict with
bullionists). Arguing that when gold is used in trade to acquire goods that are
subsequently re-exported, even more gold will be returned that was originally sent out
(inflow of specie).
- Keeping gold in the kingdom does not multiply wealth, it will simply raise prices
and diminish exports.
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,History of Economic Thought – ECON0008 Rodrigo Antón García
- He argued that monarchs should listen to traders and do not rely only on
bullionism and piracy. Munn argued in favour of increasing the merchant shipping fleet.
- Merchant s mark-up far more profitable with remote or far countries such as the
East-Indies. Unequal trade acknowledged.
For example, Munn observed that pepper costs 2s (24d) in England and 20d (1s 8d) if we bought it from the
D tch; gi ing a merchant s mark p of 4d (+167%). B t if e bro ght pepper from the East-Indies it costs
only 3d, giving a merchant s mark p of 21d (+700%). Reference: 12d (penny) = 1s (shilling) 20s = £1.
Policy conclusions:
Bullionists – Get gold from Spain, piracy, etc. Prevent gold exports.
Mercantilists – It is fine to export gold in the course of expanding trade. Buying goods for
re-export.
Summary - The issue of imbalances between surplus and deficit countries is nothing new; on the
contrary, it was the subject of some of the first systematic discussions of economic issues in early
modern times, being a b rning iss e in that period hen mercantilist iss es dominated
discussion of economic affairs.
Initiall , disc ssion held to the traditional standpoint that a co ntr s ealth consists of
precio s metals ( b llionism ), b t it moved forward, as illustrated by the work of Thomas Mun
(written 1621), to prioritise the amassing of a trade surplus.
o Topic 1.3 - The Quantity Theory of Money.
Influx of gold into Europe due to the discovery of America in the 16th century caused a
century-long inflationary process. Relationship between increase in money supply
(precious metals) and increase in prices begun to be noticed.
Navarro (Martin de Azpilicueta) 16th century observed how in Spain, flooded with money
from the Americas, prices were much higher than in other European countries i.e. France.
In countries where there is a great scarcity of money all other saleable goods, and even the hands and
labour of men, are given for less money than where it is abundant. Thus, we see by experience that in
France, where money is scarcer than in Spain, bread, wine, cloth, and labour are worth much less. And even
in Spain, in times when money was scarcer, saleable goods and labour were given for very much less than
after the discovery of the Indies, which flooded the country with gold and silver. Martin de Azpilicueta.
This led to early formulations of the Quantitative Theory of Money QTM which states that
price level changes proportionally with the money supply, this is shown by the equation
of exchange MV PT.
M – Money, P – Price level, V – Velocity of circulation and T – Transactions.
Bullionists argued that the influx of precious metals from the Americas created inflation.
Contrary, mercantilists presumed that this increasing inflationary pressure could be
mitigated through trade. They believed that lack of M is an obstacle to trade. Moreover,
they thought that an increase in M could quicken trade, stimulating an increase in
transactions, T.
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,History of Economic Thought – ECON0008 Rodrigo Antón García
Assuming that the velocity of circulation of money is constant, V V → MV PT. If the
Money Supply increases (M ↑), as a result from an influx of gold/precious metals from
America, this would quicken trade and transactions (T ↑).
M↑
P V
T↑
Therefore, given that V is constant, if as M ↑ so does T ↑, inflationary pressure could be
mitigated. Bullionists did not trade gold/precious metals so T was constant (did not
fluctuate much), so P would rise much more for them.
M1
Going further, if we assume that M and T increase proportionately, ΔM ΔT, then
T1
M M1 M
T
. So, P1 T1
V T
V P . Neutralising the effects of price inflation.
Summary Price inflation associated with the influx of precious metals into Europe from the
Americas in the 16th century led to early formulations of the Quantity Theory of Money, i.e. the
idea that the effect of a change in money supply is limited to a proportionate change in the price
level. This idea appeared to undermine the arguments in favour of a bullionist policy.
Ho e er, mercantilists arg ed that, j st as too little mone as a hindrance to trade, so
also, con ersel , an increase in the mone s ppl co ld q icken trade, i.e., increase the number
of transactions taking place, thus neutralizing inflationary pressure.
Topic 2 – From Competition for Trade to Efficiency in Production.
o Topic 2.1 – William Petty, the state and compactness .
Transition period (from mercantilism focus on trade to classical focus on production)
The mercantilist concept that gold and silver are the wealth of a nation was rapidly
becoming outmoded during the transition period. Mercantilists viewed trade as being
essentially like warfare (one-sum game); one nation gained what the other lost.
Dudley North asserted, on the contrary, that trade is mutually advantageous, as no one
will accept a smaller value for what is given up. Moreover, he asserted it was not trade
that most enriches the nation but production.
Spatial compactness.
William Petty s view on the importance of spatial compactness was derived from his
observations from Holland s success as the most technologically advanced country and
most densely populated country in Europe. A small, but densely populated country, that
dominated much of Europe trade and lead commercially.
He came to the conclusion that this depended not only on being clever , but it was about
natural advantages and a densely populated country that benefited from spatial
compactness. An early observation to the theory of productivity.
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According to Petty, spatial compactness provides favourable conditions for economies
of scale, technological progress and division of labour.
i) Economies of scale. The charge on administration of justice would be easier (less
administrative costs). Social overheads better organized. Saved time to travel to work.
(Not EOS in production process).
ii) Technological Progress. Compactness is a prominent theme in Petty s writings
on o r metropolis London . (London is the supreme example). It gives a favourable
condition for propagation and improvement of useful learning (Bacon): ideas and
innovation spread rapidly, more people interact, produce more ideas and there is a
higher chance of innovation.
iii) Division of labour. Specialization. Petty places this at the heart of economic
issues of central concern such as ships, textiles and watches. For example: in the making
of a watch, tasks can be divided into many parts (wheel, spring, cases…). “The watch
would be better and much cheaper than if the whole work be put upon one man”.
Petty observed that Holland also benefited from natural advantages including the
abundant natural waterways, which provided the opportunity to construct a dense canal
network. This offered an important reduction in transportation costs. On the contrary,
Britain s roads iced during winter and wheels became useless to an extent.
Petty s policy proposal illustrates characteristics of mercantilist policy combined with
beginnings of transition towards focus on production over trade.
- War aims. Raising finance for war still a dominant concern: 90% state revenue
for war.
- State policies to increase pop lation ( m ltipl the people ). Objective to give
England same advantages of population compactness as Holland. State action and
forced inward migration to England from Ireland ( transplantation ).
- Bank of ar . Raising population increases tax revenues, being able to have
money to finance war every 3 years.
Petty was profoundly mercantilist, reflecting the state-oriented and emphatically military-
fiscal orientation of this age, but also shows characteristics of subsequent classical
political economy, introducing ideas of a surplus product and its distribution, along with
discussions of how to increase it. In fact, Petty s proposal to increase population was the
first example of economic policy.
Summary - An early attempt to analyse efficiency in production was made by William Petty (1623-
87), ho identified li ing compactl , or pop lation densit , as a so rce of Holland s remarkable
economic advance. Such spatial compactness, he argued, provides conditions for economies of
scale, division of labour and technological progress.
In an age when the state was the principal economic agent and the market viewed with
suspicion, his ideas were put forward to underpin proposals for state action. These proposals
included policies to increase population, and a programme of forces inward immigration from
Ireland to England to compact the latter s pop lation and so gi e it eq i alent ad antages to those
of Holland.
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, History of Economic Thought – ECON0008 Rodrigo Antón García
o Topic 2.2 – The Surplus: Petty; the Physiocrats.
Petty represents the first stage of the classical tradition and its subsequent school of
thought. However, there is an important distinction to be made, as at this point, he was
only an individual, not a school of thought as such.
Still, he managed to distinctly classify three great social classes, each of which with its
own revenue, being the first one to put an idea of national income accounts. These three
classes where: Rent of Land (land), Yield on Money and other Personal States (capital)
and The Labour of People (labour).
Petty observed how the labour of people , corresponding to the factor of production of
labour, produced a surplus (labourer produces more through productive activity than it
consumes). This surplus value was distributed to landowners as rent and to capitalists
through profits.
- Petty therefore argued for state action and policies to increase and compact the
population to obtain a surplus value, particularly transplantation from Ireland.
The Physiocrats were a group of 18th-century Age of Enlightenment French economists
who believed that the wealth of nations derived solely from the al e of land agric lt re
and land de elopment and that agricultural products should hence be highly priced.
This movement reflected the interest of landowners and the rising capitalist agricultural
sector in France, which acted against the French state s attempts to foster manufactures
and their export through intervention and regulation (Colbertism).
Physiocrats thought that labour only created a net product (surplus value) when
combined with the powers of nature, this was mainly primary land although also fisheries
and mines to a lesser extent. This was a decisive enlightened move away from a focus
on trade (mercantilism) to a focus on production (classical). However, this focus was only
on the agricultural or productive sector, which was seen more efficient than the
manufacturing or sterile sector.
- Physiocrats therefore argued for a raise in production in the proportion of the
productive sector with regard to that of the sterile sector.
Expenditure on Agriculture Expenditure on Manufacture
Surplus ( net) product and its distribution among social classes.
- Petty: Rent, Wages and Yield on money, etc. (Surplus as rent and a vague category).
- Physiocrats: Revenue (Rent) and Wages-and-profit. (Surplus all effectively as rent).
Summary Pett s ritings represent a transitional phase, reflecting both the state-oriented and
emphatically military-fiscal orientation of the age of mercantilism , hile also introd cing the
classical idea of a s rpl s prod ct and its distrib tion, along ith discussions of how to increase
it. These no became central themes of classical political econom , hich came to dominate
much of economic thought for over a century.
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