Relativism: all theories become correct and valuable relative to the context in which the authors
worked and lived.
Chapter 2: What about economics before Adam Smith?
Scholastics (13th century)
Mostly priest and teachers at medieval universities. Studied the market economy in an ethical
way. Their task was to provide guidance regarding the determination of the just price (the natural
price). It was possible for one of the parties to a transaction to exploit the other through a stringer
bargaining position or better information. They acquired empirical knowledge of how transactions
actually occurred and how the markets functioned. Economic life obeys certain laws that can be
studies by scientific methods.
Mercantilism
Aim was to promote their country’s interest, wealth and power relative to other nations. The
production of all goods ought primarily to take place, when at all possible, in the country itself.
Source of wealth are species (gold and silver).
Richard Cantillon (168? – 1734, merchantalist)
Developed a theory about the determination of relative prices and tries to explain the distribution
of income for which he developed a theoretical framework for analysis of the economic circulation
in the economy. He was the first to formulate a general equilibrium model (input-output model).
Francois Quesnay (1694 – 1774) & the Physiocrats
Construct a tabular showing the flows of commodities and incomes in the economy. He estimated
the coefficients in the model on basis of empirical knowledge of the French economy. Agriculture
was the main foundation of economic wealth and free competition (laissez faire) was good. He
thought there were three classes; the productive class, the landowners and the sterile class
(farmers, do not produce a surplus). It is a criticism of luxury consumption, because it’s spent
mainly on production of the class sterile. The larger expenses to the class sterile, the more the
economy enters a state of decline (against Versailles). The Physiocrats were the first to sustain
theorizing on the structure of the economy and the source of wealth was agriculture and not
trade. This was because trade nor money is able to produce a surplus. Surplus production is tied to
a natural source: agriculture. Accounting system and the balance were important.
Chapter 3: Adam Smith
Historical context: the importance of the Union of Scotland and England (exchange political
independence for access to England’s (world) market). The industrial revolution started and there
was a jealousy of trade, were trade happened in face-to-face relations or at a distance. He
believed in self-interest and prudence, taming the passions, from martial to commercial virtues.
Critical on mercantilists and physiocrats. Efficiency was not in his vocabulary.
Contradiction: his first book explored view of man as a basically moral and altruistic being, his
second book explored self-interest as the force between human action.
He was against the mercantilist view of economic policy and was in favour of free trade and
markets. Mercantilist trade policies prevent the market system from functioning efficiently.
He made a difference between exchange value and use value, but only studies exchange value.
He developed the labour theory of value: relative prices of commodities are determined by the
relative amounts of labour needed to produce them. He describes annual labour as a ‘fund’
, because the magnitude of the population determines what can be produced. The value of produce
is distributed among three components of cost: labour, capital and land. In any society, wages,
profits and rent all tend towards their respective normal levels, and these normal levels are what
determines the natural price. He didn’t have a general equilibrium on price determination, but had
a causal explanation of price. The unit cost of production depend on:
- Technological relationships.
- Organization of labour (depends on technological possibilities).
- Size of the market (demand).
Why manufacture instead of agriculture? Agriculture is seasonal work and it is impossible to
employ different workmen for these different activities. There can be skills, but these differences
are not caused by an increase of the division of labour. Trade is the consequence of a
characteristic of human nature (the gift of speech), from which then follows the division of labour.
Self-interest is in fact what we expect in the market place and that we also expect to work out for
our own interest (our diner).
Natural price: the normal level of the three components of cost (free competition needed).
Market price: the actual price that prevails in the market at a given moment of time. Determined
by the relationship between the quantity bought and the demand of those who are willing to pay
the normal price (effectual demand).
What are the long run determinants of prices of the factors of production?
- Level of wages: determines by employment contracts (employers have more power). The
treatment of labour and wages as homogeneous is a simplification of reality. Wages in
different professions reflect noneconomic (dis)advantages: theory of compensating wage
differentials.
- Reward for capital: depends on the risk.
- Level of rent: high profits and wages are causes of high commodity prices, whereas high
rents are effects of high prices.
Invisible hand: works in two ways that are both beneficial for society. One achieves a right balance
between domestic and foreign investment and the composition of domestic investment is such
that it yields the greatest possible return on the nation’s capital. Producers think primarily of their
own interest and not of their customers, but it is their self-interest that provides us with the goods
and services we demand (market liberalists). Smith was aware that there would be inequalities,
and this might motivate intervention.
Population growth is of great importance for economic development because it implies more
workers (increase productivity capacity) and larger markets (more possibilities for the division of
labour, skill, dexterity and judgement). So there’s a link between population, market size and
specialisation in the growth of the economy. Individual saving leads to an increase of capital and
together with population growth this leads also to the link.
Mandeville: private vices, public benefits.
Chapter 4: The classical school: Malthus and Ricardo
William Godwin
Utopian vision of the future and claimed that in the human society of the future war and crime
would cease to exist and there would be no need for law enforcement. Each person would strive
to promote the common good. Passion between sexes would decline with increasing wealth.
There would be no artificial institutions as marriage and private property in the future. He had a
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