ECS3705 Exam Preparation November 2021.

ECS3705 Exam Preparation November 2021. History Of Economic Thought. Functional distribution of income according to Ricardo Ricardo wanted to understand the force that determine the shares of the national income accruing as wages, profits & rents (interest was combined with profit). Wages – natural price is given the habits & customs of the people, enables workers to subsist and to perpetuate themselves without a change in their numbers. Market price depends on supply & demand. Ricardo felt that the rates f profits in different fields of enterprise within a country tend to equalize. Entrepreneurs want the highest profits and move money to obtain this. Due to increase demand for food poorer land will come into cultivation and will cause better land to be worked more intensively. Rent will therefore rise. Nominal wages will also rise to maintain the natural wage. Thus profit rates and profit share of national income will fall.  Wage fund doctrine Mill, like many before him, accepted the wage fund doctrine. Wages according to him depend mainly upon labour demand & supply. Wages cannot rise except by an increase of the aggregate funds employed in hiring labourers or by a decrease in the numbers of workers employed. Wages cannot fall except by a decline of the funds devoted to paying for labour or by an increase in the numbers of labourers to be paid. According to Mill, government cannot increase total wage payments by fixing a minimum wage about the equilibrium level. The higher wages that some workers would receive will be offset by the loss of employment others will face. This doctrine provided a basis for opposing unionism but Mill did not use it for this purpose. Workers cannot raise their income through collective action – if wages rise in one place it falls in another.  Institutions An institution is not merely an organization or establishment for the promotion of a particular objective, like a school/prisons/union. It is also an organized pattern of group behaviors, well established and accepted as a fundamental part of the culture. It includes customs, social habits, laws, modes of thinking and ways of living.  Institutions and their role in Institutionalist economics An institution is not merely an organization or establishment for the promotion of a particular objective, like a school/prisons/union. It is also an organized pattern of group behaviors, well established and accepted as a fundamental part of the culture. It includes customs, social habits, laws, modes of thinking and ways of living. Economic life, according to institutionalist, is regulated by economic institutions, not by economic laws. Institutionalists were especially interested in analyzing and reforming the institutions of credit, monopoly, absentee ownership, labour management relations, social security and the distribution of income. They advocate economic planning & the mitigation of the swings of the business cycle.  Soviet of technicians according to Veblen There is constant conflict between two sides – industries and business, big and small... Veblen was critical & friendly towards socialism but was not a socialist himself. Veblen though engineers – the technicians of society – might eventually lead the social revolution and operate industry for the common good. They are the ones to object ownership, finance, sabotage, credit and unearned income because these interfere with technological efficiency and progress. Engineers are the best representation of the community at large, because capital and labour, bargaining over prices have become a loose knit vested interest that seeks its own benefit to the detriment of society. The outcome has been business like concessions and compromise between them. The two sides play a game of chance and skill, with the industrial system becoming a victim of interference on both sides. Material welfare of the community depends on the smooth working of the industrial system without interference. Engineers can achieve this as unlike owners and workers they are not motivated by self interest. Because they are more homogeneous and unified they are natural leaders and people with spirit of tangible performance and the most highly developed instinct of workmanship. Veblen believed technicians could solve the nation’s problems but the chances of this happening was remote.  Quasi-rent according to Marshall In the short run land and manufactured capital goods are similar because the supply of both is fixed. The return to old capital investments is something akin to rent: Marshall called it Quasi-rent. Quasi-rent is the earning on previous capital investments in the short run. In the long run quasi-rent disappears because a normal return to the fixed capital investment is essential if the investment isto be renewed and business perpetuated.  Why, according to Keynes, the economy is inherently unstable According to Keynes the economy is given to recurring booms & busts because the level of planned investment spending is erratic. Changes in investment plans cause national income and output to change by amounts greater than the initial changes in investments. Equilibrium levels of investment and saving – those that are applicable after the adjustment has occurred – are achieved through changes in national income as opposed to changes in the rate of interest. Investment spending is determined jointly by the rate of interest and the marginal efficiency of capital. Interest rate depends on people’s preference for liquidity and the quantity of money. Marginal efficiency of capital depends on the expected future profits and the supply price of capital. The expected rate of profit from new investment is unstable and therefore one of the most important causes of business fluctuation.  Malthus’s explanation for the failure of Say’s Law Malthus saw the economy as having perfectly synchronized production rounds of equal lengths. Thus all firms start producing at the same time, pay wages at the same time and start selling fished goods at the same time. It would then appear that the finance to buy up the output of the current production round consists of nothing more than the wages paid out during the current production round. Entrepreneurs are thus prevented from making any profit even when workers spend their wages in full (no leakages). Because these wages are a cost of production for the firm, the following must hold for the firm sector as a whole: aggregate demand for goods = cost of producing these goods. Firms can at best earn back what they previously paid in wages and demand is never sufficient for firms to make a profit. As a result of not making a profit, firms will not be inclined to invest and economic activity would stagnate. This was the problem Malthus saw. The only way for firms to make a profit is to find a demand for their goods which is not a cost of production for them.  The commonalities of socialism (ie what all forms of socialism have in common) 1. Rejection of classical view about harmony of interest between classes of society 2. Rejection of classical concept of laissez-faire 3. Rejection of classical idea of Say’s Law (markets are inherently unstable) 4. Perfectibility of people given the right social system; with the right system, people will become good 5. Need for some kind of collective action or state ownership  Consumer & producer surplus Consumer surplus = total utility of a good is the sum of the successive marginal utilities of each added unit. The price a person a person pays for a good never exceeds and seldom equals the price which he or she will be willing to pay for that good. Only at the margin will price generally match a person’s willingness to pay. Total satisfaction a person gets from purchasing successive units of goods exceeds the sacrifices required to pay for the goods. Producer surplus is everything between the equilibrium price and above the supply curve.  Collectivism (or dogmatic state socialism) This type of socialism regards private ownership of business firms as the root of the problem. For that reason, collectivism advocates the complete abolition of private property in the means of production. All business enterprises are to be nationalized. No private businesses will be allowed.  Friedman’s modern quantity theory of money According to Friedman the demand for money is relatively stable in the short run. The FEB (RBSA) system controls the supply of money. An increase in the supply of money will leave people holding cash balances in excess of amounts they want. In an attempt to get rid of the money they spend money on goods (transactions). However now the money on moves in the economy from the one to the other. Due to this the demand for goods, output & prices will increase. In an economy operating at its natural level of employment and output –only prices will rise over the long run. As the prices rise the demand to hold money will rise as more money is needed to buy the same goods. Eventually an equilibrium will be reached between the quantity of money supplied and demanded but this will be at a higher price level. Friedman assumed that the demand for money is highly stable – more stable than functions such as the consumption function that are offered as alternative key relations.  Tableau economique Quesnay, whom formed part of the Physiocratic school, constructed the Tableau economique for the king of France in 1758 and revised it later. It depicted the circular flow of goods and money in an ideals, freely competitive economy. This was the first systematic analysis of the flow of wealth on what later came to be called a macroeconomic basis. Quesnay assumed that land is owned by landlords but is cultivated by tenant farmers, who are therefore the only productive class. The products that the tenant farmers create has to satisfy not only their own needs but also the needs of the landowners. In addition the output of the farms provides for the needs of the sterile class (manufacturers & merchants). The tableau shows how the net product circulates among the three classes and how it is reproduced each year.  The distinction between natural prices and market prices Natural prices: In every society there is average or natural rate (wages, profit and rent). When a good is sold at the natural price there will be exactly enough revenue to pay these natural rates. This is the long run price below which the entrepreneur would no longer continue to sell the goods. Market prices: Actual price at which a good is sold. Depends on the short run supply & demand workings and it will fluctuate around the natural price.  Bullionism Bullion is another word for plain bars of precious metals. These bars have not been minted or coined. The idea that wealth is equal to precious metal money and that a nation’s wealth is therefore consists of the total amount of gold and silver within its borders is called Bullionism.  The credit system according to Veblen According to Veblen credit plays an important role in modern business. Borrowing money can increase profits as long as the current rate of business earnings exceeds the rate of interest. Those who take advantage of the opportunities offered by credit will be in a position to undersell the other firms who do not take advantage of this. Thus credit becomes wide spread & typical. The use of credit gives a firm a differential advantage against other firms but the credit expansion has no aggregate effect on earnings or on total industrial output. Aggregate net profits in fact reduce because firms have to pay back the loan + interest.  Endogenous money according to the Post Keynesians Post Keynesians regard the stock of money as being essentially endogenous to the economy, changing in response to changes in the level of wages. The need of trade dictates the supply of money. Keynes himself pointed out that money “comes into existence along with debt”. Inflation arises from the fight over the shares of the distribution of income. Wage increases cause production costs to rise, creating a greater demand on the part of firms for working capital to finance their more expensive goods in progress and inventories. Hence, business borrowing rises and the money stock increase.  Why a fall in the nominal wage rate need not raise the level of employment according to Keynes A single firm can increase sales & employment through wage cuts because the demand for its products will remain unchanged. A whole economy, can however not easily increase sales buy cutting nominal wages (assuming it is isolated from international trade) because wages are a source of demand for goods as well as a cost of production. If wages begin to fall, people may come to expect them to fall further – which may cause firms to postpone investment spending, making the depression worse. If these falling wages result in falling prices, this again worsens matters as the real burden of debts increases, transferring wealth from the entrepreneurs to the rentier. Profit margins also become smaller thus reducing incentive for new investments. Because wage cuts hurts wage earners who have a high propensity to consumer (spend) and helps employers who have a low propensity to consumer (spend) the overall propensity to consume is diminished and this again makes matters worse. Less spending and less investment means that the growth of firms is standing still – thus no new jobs created.  The distinctions between rational expectations & adaptive expectations Rational expectations: Market participants reflect on their past errors, use and process all available information, and succeed in eliminating regularities in errors in predicting future price level changes. Because people understand that expansionary fiscal & monetary policies produce inflation they immediately adjust their inflation expectations upward when government undertakes these policies. Adaptive expectations: People determine their expectations about the future inflation on the basis of past and present inflation and change their expectations only as new events unfold.  The Physiocrats on land and taxation of landowners Physiocrats thought that industry, trade and other professions were sterile and only agriculture was productive. Land is therefore equal to rent. Physiocrats thought that because only agriculture produced a surplus, which the landowner received in the form of rent, only the landowner should be taxed. All taxes imposed on others would be passed on to the landowners anyway. A direct tax on landowners was preferable to indirect taxes, which increase as they were passed along to others.  Smith on self-interest Smith’s self-interest refers to the desire to meet one’s own needs – earn your own money, pay your own food. This type of self-interest is entirely moral and can even go a step further where one is concerned with the interests of others. Self-interest as the dire to meet one’s own needs is thus not inherently immoral, selfish or greedy. It only becomes theses when done at the exclusion of a concern for the interests of others, when it is pushed so far that it squeezes out any generosity or any desire to see others get a fair deal to.  Malthus on the Poor Laws Malthus believed poverty and misery are natural punishments for the failure by the “lower classes” to restrain their reproduction. He felt that their must be no government relief for the poor. He believed that by giving them aid would cause more children to survive thus ultimately worsening the problem of hunger. Some of his ideas were adopted into the Poor Laws. This law abolished all relief for able-bodied people outside workhouses. A man applying for the relief had to pawn all his possessions and then enter a workhouse before assistance was granted; his family either entered a workhouse or was sent to work in the cotton mills. Either way, the family was broken up and treated harshly to discourage it from becoming a public charge. These workhouses were invested with a social stigma and entering them can at a high physiological cost. The law aimed at making public assistance so unbearable that most people would rather starve quietly than submit to its indignities.  Ricardo on technological unemployment (that is, unemployment due to machines replacing workers) Ricardo believed that the introduction of machinery would help all 3 major classes of income receivers. Their money incomes would remain the same, while their real incomes would rise – because goods could be produced cheaper with machines. Even workers would gain because the same labour would be demanded as before mechanizations and therefore their nominal wage would not fall. He believed that even if the number of workers in one industry became excessive, capital would shift to another industry and thus workers would be needed there. The only temporary problem would be maladjustment that occurs when capital and labour move from one employment to the other. He later revised his arguments and said that the capital now invested in machinery was deducted from the capital available to pay wages. The long run effect was definitely more favorable than the short run effect. Even if the money profit of the capitalist remains the same after an increase in investment in machinery, more could be saved due to the reduction of costs of production. Thus the capitalist can invest more, ultimately reemploying the redundant workers. Thus technological unemployment is more likely to be a short term problem but a problem nevertheless for workers.  Marx’s theory of history For Marx, history is a process through which the static relations of production (the thesis) come into eventual conflict with the dynamic forces of prodcution (the antithesis) . The static forces are rules, social relations among people and property relations which are all reinforced by the superstructure. The dynamic forces include the technology, types of capital, skill level of labour and these all are constantly changing. The result of this conflict revolutionized the system so that new relations of prodcution permit the higher development of the forces of production. The mechanism for overthrowing old societies is the class struggle and Marx saw society evolving through 6 stages. The first stage had no classes or exploitations and so the society gradualy moved to a stage where classes and exploitation were very common.  The Chicago school on the role of government This school believed in a limited governemt. Government is inherently inefficient as an agent for achieving objectives that can be satifsied through private exchange. Government officials have their own objectives that they seek to optimize and therefore inevitable divert a portion of the resouerces at their disposal to purpose other than those that benefit taxpapers. Rather than being in the public interest, government regulation normally benefit those who seek the regulation or those who learn to marshal it to their private advantage.  Smith on the role of government Adam Smith believed in an invisible hand that channels self-interested behaviour in such a way that the social good emerges. The pursuit of self-interest, restrained by competition, thus tends to produce Smith’s social good – max output & economic growth. This harmony of interests implies that intrusion by Government into the economy is unneeded & undesirable. According to Smith governments are wasteful, corrupt, and inefficient and the grantors of monopoly privileges to the detriment of the society as a whole. He also argued that governments should not interfere in international trade. He did however see 3 major roles of government – 1 to protect society from foreign attack, 2 – to establish the administration of justice and 3 – to erect & maintain public works and institutions that private entrepreneurs cannot undertake profitable.  Mill on production Mills analyzed 3 productive factors – land, labour & capital. Productive labour includes only those kinds of exertions that produce utilities embodied in material objects. Labour that yields a material product only indirectly is also held to be productive thus including educators & government officials. Unproductive labour is that which does not terminate in the creation of material wealth. Capital is the result of saving and is the accumulated stock of the produce of labour, and its aggregate amounts limits the extent of industry. Everything that is not spent is saved and everything saved is invested. Thus the rich by use of their savings (investments) can give employment to the poor. If the rich spend less o luxury goods and more on investments then the wage fund & demand for labour would rise. If the population increase, the increase in demand by wage earners would offset the decrease in demand for luxury goods by capitalists. If the population does not increase in proportion to the growth of capital, wages would rise and luxury consumption by workers would supplant luxury consumption by their employers. This is the optimistic world of full employment. Population is limited by the fear of want rather than by want itself (people do not reproduce above a point where they can support their wants/needs). Increase of capital depends on two things – the surplus product after the necessities are supplied to all engaged in production and the disposition to save. The greater the products that can be made from capital the stronger the motive for its accumulations. Land is limited and Mill applied the short run law of diminishing returns and the long run concept of returns to scale to land.