Chapter 6: J.S. Mill and the Decline of Classical Economics

Chapter 6: J.S. Mill and the Decline of Classical Economics Questions for Review, Discussion and Research 1, 2, 3, 5, 10, 11

Overview of John Stuart Mill • Tremendous intellectual powers • A social philosopher intent on improving the role of the individual in society • Addressed broader issues of political economy • his contribution was to simultaneously make: • A mature statement of classical school • Initiate a new era of economic thinking

Believed his task was to write a lucid exposition of the Ricardian doctrine and incorporate it into the contemporary ideas of the mid – 1800's

Contemporary Critique of Ricardo • Disparity between doctrine and the empirical evidence of the mature stages of the industrial revolution. • Critique of • labour theory of value • treatment of consumer theory • role of capital profits in the determination of output prices

Humanist and socialist writers rejected the assumption of social harmony. They attacked the classical vision of a market-oriented society in capitalists were the key actors and benefactors.

Nassau Senior • Foundations of economics as a science rested on “self-evident” principles • People are rational, use economic calculus in discussion-making and seek to acquire wealth with a minimum of sacrifice • Malthusian population doctrine • Discredited by mid 1830’s

Nassau Senior Cont’d • Doctrine of diminishing returns in agriculture and other renewable resource sectors failed to foresee an acceleration of technological improvements • Principle of historically increasing returns in the industrial sector pp. 164

Senior’s Theory of “Normal” Profits • Improved logical consistency of value theory by including capital costs. • Developed an abstinence theory of interest • Senior’s value theory • Placed more emphasis on utility on the demand side of output markets • Disutility viewed as a real cost of production

Approach of J.S. Mill to Economics • “Pure” economics was a hypothetical science using the a priori method • One makes valid assumptions and the deduces conclusions • Social scientists can not use the inductive method as experimentation is not available

Made clear distinction between • Laws of production that cannot be changed by human will or institutional arrangements • Laws of distribution that result from social institutions and custom

Approach of J.S. Mill to Economics Cont’d • Overhead pp. 167-68 Read pp.168-73 on your own • Believed his task was to write a lucid exposition of the Ricardian doctrine and incorporate it into the contemporary ideas of mid 1800’s

Influence of Richard Jones • Forerunner of British historical school • Questioned proposition that Ricardian theory was for all times and places • Advocated empirical approach in accounting for changes in structure of institutions • Emphasized the role of custom (ie. tradition)

Criticism of Ricardo • Disparity between doctrine and the empirical evidence from evolving nature of the industrial revolution in G.B. • Critique of • Labour theory of value • Treatment of consumer demand • Role of capitalist profits in the determination of output prices

Humanist and socialist writers rejected assumptions of social harmony. They attacked the classical vision of a market-oriented society on which capitalist

Mill’s Methodology • Correct the logic of an economic model to make certain that the conclusions followed from given assumptions • Influence of Comte – The founder of sociology – leads Mill to regard “pure” economics as just one discipline within social sciences

Role of Economic Theory in Mill’s Writings Overhead pp. 175 • Used Smithian techniques of contextual analysis where economic phenomena is only part of all social activity

Mill’s Value of Theory • The purpose of value theory is to explain relative prices in input and output markets • Gave up Ricardian search for absolute value based on invariant measure of value

Mill’s Value of Theory Cont’d • Similar to Senior’s cost of production theory of value where monetary costs represent • Real costs of disutility • Abstinence theory of interest in savings – investment process • Rent is a social cost of production when land has alternate uses

Mill’s Value of Theory Cont’d • Long-run theory of prices can be represented with a Marshallian, partial equilibrium format and summarized as follows • Price of output almost always depends on the cost of production rather than consumer utility (Figure 6-1)

Prices in manufacturing and service sectors (Panel B) • Constant costs

Mill’s Value of Theory Cont’d • Use value determines exchange value in market transactions of (Panel A) • Wine • Rare books, coins, stamps, art, etc. • Site value of urban land • Intermediate case (Panel C) of agriculture and renewable resources where diminishing returns results in increasing costs and rising LRS Overhead pp. 178

Original Contributions • Theory of non-competing groups in labour market • Prices for joint outputs • Sheep: Mutton and wool • Cattle: Beef and hides • Rent is Price determining when land has alternate use • Economies of scale Overhead pp. 178

International Trade Theory • Ricardo demonstrated potential gains in aggregate terms but did not show • How prices are determined in exchange • Distribution of benefits • Mill did both by assuming that the terms of trade depend on the consumer demand

International Trade Theory Cont’d • Set stage for mathematical and geometrical presentations by Marshal and Edgeworth • Mill’s other contribution include • Consideration of transportation costs • Influence of tariffs • Theory only challenged by Ohlin and Keynes in the 1930’s

Defense of Say’s Law • Two types of economies would never have an insufficiency of aggregate demand • Barter • Monetary system where • Money is a commodity • Money’s only function is a medium of exchange • No credit

Temporary disequilibrium and oversupply when money functions as a store of value and credit markets operate Overhead pp. 181

Mill’s Monetary Theory • Modification of Ricardo’s strict gold standard and quantity theory • Fell between • Currency school • Sought to prevent inflation through strict adherence to gold standard

Necessary during periods of speculative financial booms • Predecessors were Bullionists II. Banking school • Predecessor was Real Bills Doctrine that sought flexible money supply • Correct during “normal” times

Recantation of Wage Fund Doctrine • The wage ratio is not conclusively predetermined but has a range of possible levels

Chapter 6: J.S. Mill and the Decline of Classical Economics