RH351 Rhetoric of Economic Thought Transparencies Set 3 Classical Economics

1. RH351 Rhetoric of Economic Thought Transparencies Set 3 Classical Economics

2. Toward the birth of modern economics 1500 1600 1700 1800 1900 Francis Bacon 1561 - 1626 Galileo 1564 - 1642 Descartes 1596 - 1650 Locke Thomas Hobbes 1588 - 1679 John Locke 1632 - 1704 François Quesnay 1694 - 1774 Hobbes Frances Hutcheson 1694 - 1746 Adam Smith 1723 - 1790 David Ricardo 1772 - 1823 Italian Renaissance Marx Karl Marx 1818 - 1883 Protestant Reformation Smith Mercantilism Industrial Revolution In England

3. Adam Smith and classical economics The Theory of Moral Sentiments (1759) Part I, Section 1, Chapter 1: How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derivesnothing from it, except the pleasure of seeing it. Part IV, Chapter 1: The rich only select from the heap what is most precious and agreeable. They consume little more than the poor; and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life which would have been made had the earth been divided into equal portions among all its inhabitants; and thus, without intending it, without knowing it, advance the interest of the society… Part VI, Chapter 2: … he is certainly not a good citizen who does not wish to promote, by every means in his power, the welfare of the whole society of his fellow-citizens.

4. Adam Smith and classical economics An Inquiry Into The Nature and Causes of The Wealth of Nations (1776) From the “Introduction and Plan of Work”: The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniencies of life which it annually consumes and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations. According therefore, as this produce, or what is purchased with it, bears a greater or smaller proportion to the number of those who are to consume it, the nation will be better or worse supplied with all the necessaries and conveniencies for which it has occasion. But this proportion must in every nation be regulated by two different circumstances; first by the skill, dexterity, and judgment with which its labour is generally applied; and secondly, by the proportion between the number of those who are emplolyed in useful labour, and that of those who are not so employed.

5. Adam Smith and classical economics An Inquiry Into The Nature and Causes of The Wealth of Nations (1776) It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. Book IV, Chapter 2: Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view … He generally, indeed, neither intends to promote the public interest, nor know how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

6. Adam Smith and classical economics An Inquiry Into The Nature and Causes of The Wealth of Nations (1776) Book I, Chapter 6: The real value of all the different component parts of price, it must be observed, is measured by the quantity of labour which they can, each of them, purchase or command. Labour measures the value not only of that part of price which resolves itself into labour, but of that which resolves itself into rent, and of that which resolves itself into profit. In every society the price of every commodity finally resolves itself into some one or other, or all of those three parts …

7. Adam Smith and classical economics An Inquiry Into The Nature and Causes of The Wealth of Nations (1776) Book IV, Chapter 2: What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. The general industry of the country … is certainly not employed to the greatest advantage, when it is thus directed towards an object which it can buy cheaper than it can make … The industry of the country, therefore, is thus turned away from a more, to a less advantageous employment, and the exchangeable value of its annual produce, instead of being increased, according to the intention of the lawgiver, must necessarily be diminished by every such regulation. By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expence for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?

8. Adam Smith and classical economics An Inquiry Into The Nature and Causes of The Wealth of Nations (1776) Book I, Chapter 7: The actual price at which any commodity is commonly sold is called its market price. It may either be above, or below, or exactly the same with its natural price … The natural price, therefore, is as it were, the central price, to which the price of all commodities are continually gravitating. The price of monopoly is upon every occasion the highest which can be got. The natural price, or the price of free competition, on the contrary, is the lowest which can be taken… Book I, Chapter 9: When the stocks of many rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profit …

9. Thomas Malthus and the Malthusian problem An Essay on the Principle of Population (1798, 1803) Book I: It may be safely pronounced … that population when unchecked goes on doubling itself every twenty-five years, or increases in a geometrical ratio … It may be fairly pronounced … that, considering the present average state of the earth, the means of subsistence, under circumstances the most favourable to human industry, could not possibly be made to increase faster than in an arithmetical ratio. The necessary effects of these two different rates of increase, when brought together, will be very striking.

10. David Ricardo and the Ricardian system The Principles of Political Economy and Taxation (1817) The produce of the earth – all that is derived from its surface by the united application of labour, machinery, and capital, is divided among three classes of the community, namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the labourers by whose industry it is cultivated. But in different stages of society, the proportion of the whole produce of the earth will be allotted to each of these classes, under the names of rent, profit, and wages, will be essentially different; depending mainly on the actual fertility of the soil, on the accumulation of capital, and population, and on the skill, ingenuity, and instruments employed in agriculture. To determine the laws which regulate this distribution is the principle problem in Political Economy … David Ricardo 1772 - 1823

11. John Stuart Mill – culmination of classical thinking The Principles of Political Economy (1848) In every department of human affairs, Practice long precedes Science. The systematic enquiry into the modes of action of the powers of nature, is the tardy product of a long course of efforts to use those powers for practical ends. The conception, accordingly, of Political Economy as a branch of science is extremely modern; but the subject with which its enquiries are conversant has in all ages necessarily constituted one of the chief practical interests of mankind, and, in some, a most unduly engrossing one. That subject is Wealth. Writers on Political Economy profess to teach, or to investigate, the nature of Wealth, and the laws of its production and distribution: including, directly or remotely, the operation of all the causes by which the condition of mankind, or of any society of human beings, in respect to this universal object of human desire, is made prosperous or the reverse. John Stuart Mill 1806 - 1873

12. Ricardo and Mill on rent It is only, then, because land is not unlimited in quantity and uniform in quality, and because, in the progress of population, land of an inferior quality … is called into cultivation, that rent is ever paid for the use of it. When, in the progress of society, land of the second degree of fertility is taken into cultivation, rent immediately commences on that of the first quality, and the amount of that rent will depend on the difference in the quality of these two portions of land. David Ricardo 1772 - 1823 Ricardo, The Principles of Political Economy and Taxation (1817) The rent of land consists of the excess of its return above the return to the worst land in cultivation. John Stuart Mill 1806 - 1873 Mill, Principles of Political Economy (1848)

13. Ricardo’s “functional” distribution – a simulation Basic parameters of simulation Assumption about output price: Exogenous – may be set to any level

14. Classical Economics: Profits and the Stationary State Ys Y3 Y2 Output curve Rents Y1 Classical stationary state Output (Y) Profits Subsistence Wage bill N1 N2 N3 Ns Population and labor force (N) Source: Based on William J. Baumol, Economic Dynamics, 2nd ed., (New York: Macmillan, 1959).

15. Say’s Law (the “general glut” controversy) [Jean Baptiste Say, 1767 – 1832, A Treatise on Political Economy (1803)] From Say’s Treatise (1803): It is worth while to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value.   When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands.  Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable.  But the only way of getting rid of money is in the purchase of some product or other.  Thus the mere circumstance of creation of one product immediately opens a vent for other products." From John Stuart Mill, Principles of Political Economy (1848): A general over-supply, or excess of all commodities above the demand, so far as demand consists in means of payment, is thus shown to be an impossibility … there is no over-production; production is not excessive, but merely ill assorted. From John Maynard Keynes, The General Theory (1936): From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; -- meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product … As a corollary of the same doctrine, it has been supposed that any individual act of abstaining from consumption necessarily leads to, and amounts to the same things as, causing the labour and commodities thus released from supplying consumption to be invested in the production of capital wealth … Evidently this amounts to the same thing as full employment … Thus Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment.

16. Mill asks some interesting questions: Towards what ultimate point is society tending by its industrial progress? When the progress ceases, in what condition are we to expect that it will leave mankind? John Stuart Mill, Principles of Political Economy (1848), Book IV, Chapter VI: “Of the Stationary State” John Stuart Mill , 1806 – 1873 Smith on the value of education: The more they are instructed, the less liable they are to the delusions of enthusiasm and superstition, which, among ignorant nations, frequently occasion the most dreadful disorders. An instructed and intelligent people besides, are always more decent and orderly than an ignorant and stupid one. Adam Smith, The Wealth of Nations (1776), Book V, Chapter I Adam Smith , 1723 – 1790