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Summary History of Economics 2019/2020
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History Exam Questions 2019-20201. Compare the value theories and policy prescriptions of mercantilists and physiocrats
Mercantilists believed that the source of value was to exchange products for more money
than the products had previously been worth. Their policy prescription was to have a positive
trade balance, which for example could be achieved by maximizing production. The
government should intervene so as to minimize imports, through for example taxes or import
quotas, and maximize exports, through for example subsidies.
Physiocrats held a theory of value, where the only place that surplus value was generated in
an economy was from agriculture. This is the only sector which convincingly showed that a
net product could be generated, as all the other sectors would produce enough to just cover
the costs. Their policy prescription was laissez faire as free competition leads to the best price
and societal benefits. In comparison, Mercantilists had a value theory based on adding value,
whereas physiocrats’ value theory stated that land was the only place where value was
created. In this case we could argue that both views are sort of similar. Mercantilists favored
activist government policies, while the physiocrats were advocates of laissez faire policies.
2. Explain the idea of laissez-faire and why physiocrats supported this idea
The idea of laissez faire is that the government should not intervene in the economy as this
leads to the greatest general good. Physiocrats supported this idea as they thought that there
was a natural law which would direct the economy to the best possible outcome as the
economy is self-regulating. Under this natural law individuals would follow their self-interest
and by doing so they will maximize welfare in society.
3. Describe the major contributions and shortcomings of the physiocratic doctrine
They founded economics as a social science by studying society as a whole and the laws that
governed the circulation of wealth and goods. They also introduced the law of diminishing
returns. They analyzed the tax shifting and incidence, a topic that we sill study today. They
were the first to question the proper role of the government in society and economy, and
came up with the idea of laissez-faire. Their shortcomings were that industrial sector became
one of the most important sectors in an economy.
4. What were the main elements and intuitions of the classical approach to political
economy?
The classical approach to political economy consisted of a couple of main elements. First,
they believed that the total annual product was the source of wealth for a nation, which is a
macroeconomic view. Secondly, people were driven by the power of self-interest. This will
lead to the harmony of market forces. An invisible hand will guide us towards collective
wealth. The invisible hand is an effect of a market, when everybody is driven by the power of
self-interest, we will obtain a social wealth. Third, classicals focused on the supply and not
on the demand (diamond-water paradox). Fourthly, they were known for their long-term
perspective . They emphasized the natural prices of goods rather than their market prices
and put more emphasis on value theory instead of price theory.
1
,5. 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?
The division of labor means that workers in a production process specialize in some part of
the process. By specializing in some part of the production process, workers become more
productive in doing their task and as a result the production process improves. This leads to
more exchange, not only due to having more parts in the production process, but also due to
the improvement in the production process which raises the output. The division of labor is
the principle on which all of Smith’s work is based. The shortcoming is that doing the same job
every day, it becomes very boring. But the remedy is schooling, we need to be intellectually
stimulated. We also distance ourselves from our jobs, because we don’t see the whole process
anymore, only the part that we are working on.
1. Time is saved by not moving from job to job.
2. More dexterity.
3. Specific machinery could be invented.
6. What, according to Smith, determines exchange value in a primitive and in an
advanced economy?
According to Smith value can be determined with the labor theory of value. In this theory
value is defined as the amount of labor that is put into the production of a good. In a primitive
economy, only labor determines the exchange of value of products, since capital has only
limited effect here. But in an advanced economy, more capital investments and land resources
are used in production, therefore in advanced economies the exchange value of products is
not solely determined by labor, but also by capital investments and land resources.
7. Explain the meaning of Smith's 'invisible hand' doctrine. Discuss the analytical and
normative significance of the ‘invisible hand’.
The invisible hand has everything to do with competition. The pursuit of self-interest
restrained by the competition produces the social good: maximum output and economic
growth. Employers compete for the best workers, workers compete for the highest wages and
consumers compete for the lowest prices and the right to consume; resources get allocated
to their highest valued uses; economic efficiency prevails.
The analytical significance is that when people follow their own self-interest, there will be an
unintended consequence, namely social harmony. There will be a spontaneous order in
society and thus no government intervention is needed.
The normative significance of the invisible hand is that self-interest can be socially optimal,
there is a spontaneity of order and there is no need for government regulation.
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,8. What are the factors of economic development, according to Smith?
Smith contended that the division of labor spurs capital accumulation and that both work
together to increase labor productivity. The rise in labor productivity increases national
output, which widens the market and justifies further division of labor and capital
accumulation. As result of the capital accumulation, the wages fund increases and wages rise.
Higher wages motivate further productivity growth. The rise in national output increases the
goods available for consumption, which, for Smith, increases the wealth of a nation.
9. Summarize Malthus' theory of population and relate it to his position on the poor laws
Malthus population theory is based on two mechanisms. The first being that the population
will grow geometrically and the second that the food supply is only able to grow arithmetically.
This means that the growth of the food supply cannot keep up with the population growth
and that it ultimately leads to poverty and misery. We should have preventive checks to
population: reduce the birth rate by letting people who could not afford children, postpone
marriage or not marry at all. But also positive checks to population: increase the death rate
famine, misery, plague and war are all unfortunate evils required to limit the population. This
relates to his view on the poor laws: poverty and misery are natural punishment for the failure
of lower classes to restrain their reproduction, so there must be no government relief for the
poor. These people should die off, if you cannot sustain yourself, you shouldn’t have been
born in the first place.
10. Compare and contrast the implication for wages of the theory of population presented
by Thomas Malthus with the wage theory provided by Adam Smith
The theory of population implies that workers should receive a subsistence wage; a wage that
is lower than the value that they produce for their employer, so that the employer can still
make a profit. They should receive a minimum wage, for the lowest standard of living. If people
receive more, they will have enough to sustain kids and multiply, reaching the unsustainable
rate earlier. The wage rate will go back to the original level; too much workers die, not enough
workers multiply.
Whereas, Adam Smith handled efficiency wages; pay people more to make them happy; work
harder; healthier; more output; capital accumulation; so wages will go up again (positive
feedback loop).
11. State and explain J.-B. Say's 'Law of markets'
Supply creates demand, however it’s a misconception to assume that if I make a shoe
someone wants to buy it. Aggregate supply must be equal to aggregate demand. Long-run
model. Supply creates a potential demand: by creating shoes, I pay laborers, and others, so
now they have a demand for a product. They receive income and income is the basis of
demand. So if there is excess supply in one industry, it must be the case that there is excess
demand in another industry, but if you look at the economy as a whole, it must be in balance.
As capitalists accumulate more capital and invest more of their capital into production, there
would automatically be more aggregate demand created.
3
,12. What, according to Malthus, are market gluts? How and why do they come about?
How can they be avoided? What is the significance of corn laws to all of this?
Market gluts: excess supply, shortage demand; solved by the landowning class; if they were
consuming more, there would be an equilibrium again. Capitalists save money instead of
consuming because they are greedy bastards. Part of the product don’t create demand, just
investments, so that more products can be created in the following period. But they don’t
consume, so at some point they won’t reinvest because they know the extra products that are
generated with this extra investment will not have enough demand to sell these products,
because they were not consuming in the first place. The corn laws were regulations that
placed tariffs on imports of grain into England. The people in favor of the corn laws said that
rent is price-determining for the price of grain. The significance of corn laws: maintained; rent
of landowners will increase, which they can use to solve these market gluts.
- Unproductive consumption.
13. State and explain Ricardo's theory of rent.
Land is not infinite; there are 2 elements: different pieces of land have different productivities,
and the more you use a piece of land, the less it will produce (decreasing marginal returns).
Intensive margin; basically we will use land more intensively as labor and capital becomes
cheaper, so we only pay rent if the production sale will yield profit. The lower the price of
capital and labor, the more pieces of labor we will use (extensive margin), even though they
are less productive, because they now yield enough money to create more money than it costs
to produce
14. Summarize Ricardo's distribution theory and its policy implications.
Ricardo’s distribution theory shows that workers receive a natural price for their work in the
long run, but in the short run there is a market price which does depend on supply and demand
and fluctuates around this natural price. This would lead to a minimum acceptable wage for
workers in the long run, which he would call the iron law of wages. The theory of distribution
has three parts: Wages, Profit and Rent.
Wages: minimum wage is the subsistence wage. The wage rate is determined by wage fund
and the number of workers. If wage rate is high enough, we are able to sustain more people,
so more land will be used and it will get to the subsistence wage again.
Profit: Prices – wages. So, look at marginal piece of land and the price, and then look at the
wages. This equalizes across industries. It is a residual.
Rent: Land is not infinite; there are 2 elements: different pieces of land have different
productivities, and the more you use a piece of land, the less it will produce (decreasing
marginal returns). Intensive margin; basically, we will use land more intensively as labor and
capital becomes cheaper, so we only pay rent if the production sale will yield profit. The lower
the price of capital and labor, the more pieces of labor we will use (extensive margin), even
though they are less productive, because they now yield enough money to create more money
than it costs to produce.
Policy implications: against corn laws because the corn laws raise the price artificially, and this
would slow the steady state.
4
,15. What are the major sources of Marxism? Explain how each contributed to Marx‘s
understanding of capitalism.
Marxism had been under the influence of 3 major sources.
1. German classical philosophy (Hegel). Marx started as a follower of Hegel, who was a
famous philosopher. He took the dialectical thinking that was developed by Hegel. The
dialectical way of thinking stated that historical knowledge and progress occurred
through a process of conflict of opposing ideas. A thesis gets confronted with a
antithesis, and together they would merge and create a new idea or synthesis. This
synthesis then becomes the new thesis. This progress repeats itself, and drives history
forward. Marx used this method in his own theory of Marxism, which is called historical
materialism. He also stated that we should analyse things in the total picture and with all
its assets.
2. British classical political economy (Smith & Ricardo). Marx strongly believed in the
classical economic thought, and in particular the labour theory of value. This means that
labour is the source of value and thus wealth. By exploiting workers, capitalists could
obtain profits. Marx also believed in the dynamics of capitalism. The reproduction of
capital is a circular process in which commodities which embody surplus value are
produced and sold. In addition, labour power and the means of production are bought to
renew the process. Marx explains this by utilizing two models of a capitalist economy,
one in a stationary state general equilibrium and another of a growing economy, to make
manifest the role that money plays in the growth process.
more machines per worker, less opportunities for exploitation
3. French socialism (Fourier & Saint-Simon). He took the critique of capitalism from French
socialism. French socialism emphasised the struggle of interests which stood for the
social conflict in society. They also emphasised the need for government-regulation and
were against laissez-faire. Economic equilibrium was impossible to achieve, and people
needed to cooperate. Furthermore, Marx stated that goods needed to be publicly
owned, and not privately.
16. Explain Marx's theory of history. What are the major factors of historical development,
for Marx?
Marx’s theory of history was that history was moving forward in a straight line, progressively
by the interaction of the thesis, antithesis and synthesis. Initially you have a thesis, let’s say
feudalism, which is the accepted idea, but this idea is soon contradicted by an antithesis, for
example that feudalism as an economic system is not the most efficient system. The accepted
idea could be seen as the relations of production, which are the rules of the games and the
antithesis, the technology used by the society in producing material goods could evolve and
contradict the relations of production. Out of this conflict of ideas comes a synthesis, which is
a higher form of truth, which becomes a new thesis. Following Marx’s line of history after
feudalism would come capitalism. The process behind the thesis, antithesis and synthesis is
an endless process in which all things become gradually more perfect. Eventually the
economic system would end in communism, which Marx believed to be the highest truth.
5
, 17. How and why does capital accumulation lead to the decreasing rate of profit, according
to Marx? Compare his views on the dynamics of profit rate with those of Smith and
Ricardo.
The reason for the decreasing rate of profit is the drive towards increasingly efficiency
through their mechanization. this means that output rises, while future rate of profit will
decrease. This is because rate of profit is directly linked with rate of surplus value, and
inversely with output. Since labourers are the source of all value, the process of getting rid of
workers will decrease the future rate of surplus value and thus the rate of return. Both Smith
and Ricardo thought that rate of profit would fall, just as Marx. Smith: The rate of profit will
fall because of competition among entrepreneurs, increasing competition.
Ricardo: rate of profit will fall because of the increasingly difficulty of growing food for an
expanding population. Also were profits inversely linked with wages, thus if wages rose
(which they did) rate of profit would decrease.
18. What are the strengths and the weaknesses of Marx‘s doctrine?
Marx’s legacy had many contributions to history and economics as a science. Marx
contributed to a new understanding of economic science, he had a critical analysis of
historical institutions and their relationships with social inquiry. Secondly he noticed had an
interdisciplinary view on inequality and other different social struggles. Third, Marx had an
emphasis on conflict and instability rather than harmony and equilibrium. Furthermore, he
had a huge influence on social and human sciences. His contributions to economics were
limited, but he did provide valuable theories, such as his theory on value.
There were a couple of criticisms on Marx:
1. His defects in the labour theory of value. Many economists state that workers are not
the source of all exchange value, and that capital and land are also productive.
2. Problems with theory of exploitation. The wages paid to workers tend to cultural
substance because of a presence of a large reserve army of the unemployed. The worker
is thus forced to deliver good enough work for the capitalist. But, there is no such thing
as an army of the unemployed since people tend to move in and out of employment.
3. History suggest that there will not be a division between 2 classes, but that there will
rather be a great middle class being developed within advanced nations.
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