Classical Adam Smith 4

7/27/2019 Classical Adam Smith 4

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CLASSICAL ECONOMIC

THOUGHT


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MERCANTILISM

1500-1750

PHYSIOCRACY

1750-1780

MERCHANTINTERN. TRADEPROCTECT. POLICY

INTERRELATEDNESS

AGRICULTURE SECTORNATURAL LAWS

CLASSICAL

1776-1890s

CAPITALISTINTERRELATEDNESSL PRODUCTIVITY

NATURAL WORKINGECONOMIC FORCES


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Important Writersp:

Adam Smith (1723-1790) - Wealth of Nations,

1776.

Thomas Robert Malthus (1766-1834) an Essay on thePrinciple of Population, 1978.

David Ricardo (1772-1823) On the Principle of

Political economy and Taxation, 1817.1817

Nassau Senior An outline of the Science of PoliticalEconomy, 1836.

J ohn Stuart Mill (1806-1873) Principle of PoliticalEconomy, 1848.

Karl Marx Capital, Volume I, 1867.


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Smith, Ricardo and Millruledeconomic thought from 1776 until the finalpart of the nineteenth century (1890s).

Smith (1776-1820), Ricardo (1820-1850s) & Mill (1850s-1890s).

Malthus and Marx - thought in someways classical, are more significant ascritics than as advocates of classical

economics. Deviated significantlyfrom the orthodox classicaltradition in their analysis.


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Prior to 1776, no writer had been able to synthesize theimportant contributions of mercantilism & physiocracy intoa single coherent system - which later became theinterest of Adam Smith.

The view that markets automatically provideharmonious solutionsto the conflicts flowingfrom relative scarcity was first significantly advanced by

the physiocrats of France.

Assuming such harmony, the government should adopta general policy ofnoninterference in the economy apolicy oflaissez faire.

Scolastics considered it appropriate for the church toadjudicate the morality of the economic activity.


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Mercantilists advocated governmentintervention.

Classical, favored free, unregulatedmarkets and maximum individual freedom.

Economic freedom provided a means by whichthe economy could function most efficiently.

Individuals and businesses should be free to tradewithout government interference.

Political and economic freedom to be inseparablybound.


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ADAM SMITH (1723-1790)

An academic (SCOTTISH), a professor in Glasgow, insocial sciences and humanities.

Interrelatedness of the economy* - the importantconnections between economic and political freedom,between private property rights and just a state, andbetween individuals motivated partly by self-interestand partly by concern for the consequences of their

actions on others. Influenced by Francis Hutcheson (1694-1746) & David

Hume (1711- 1776). Smith shared Hutchesons strongdisapproval of the idea of Bernard Mandeville (c. 1670-1733).

Mandeville: individuals self-interest would generatemany undesirable social and economicconsequences, and therefore need for governmentintervention in the economy.


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Many of the attitudes toward knowledge andlearning during Smiths time differed sharplyfrom those of today.

No clear explanation between various areas ofinquiry existed (interdisciplinary approach).Philosophy, science, social scienceand ethics were all treated as a single

body of truth, not separate discipline.This is certainly not opposites.

The natural laws governing society.Theeconomy was not chaos but individual self-

interest interacting in competitivemarkets to produce harmony, aprofoundly significant insight.


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Father of Economics - none had been ableto integrate into a single vision of theforces determining the wealth of

nations, the appropriate policies tofoster economic growth anddevelopment - millions of economicdecision are effectively coordinated bymarket forces.

Smiths major book is An inquiry into the Natureand Causes of the Wealth of Nations (1776).

Interested in explaining the nature and cause of thewealth of nations.

Modern economists would describe Smith as a macrotheorist interested in the forces determining economicgrowth.


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Analysis of Markets and Policy Conclusions

A. Smith argument for laissez faire is based in partupon a theoretical model. But, his arguments aremore than just theoretical, they are contextualthat is, they are based on his observations of theexisting historical and institutional circumstances.

Smith advocated laissez faire not because hebelieved markets to be perfect but because, in thecontext of history and the institutional structure of theEngland of his time, markets usually producedbetter results than did governmentintervention.

He was a policy formulator par excellence.Had broad knowledge of history and how peoplebehave in practice contextual economicpolicy.


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Assumption:

For the most part, competitive market exists

(mercantilists), and within these markets the factorsof production move freely to advanced their economicadvantage.

A natural process @ work in the economy can

resolve conflicts more effectively than anyarrangements devised by human beings.

Human beings are rational, calculating &driven by self-interest (mercantilists). If left

alone, each individual will follow his/her self-interest, andin promoting self-interest promote the interest of society.

Government should not interfere & follow a policyoflaissez faire.


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Market harmony lies in the activities of the capitalist.

The capitalist increases revenuesby producing the

commodities that people desire.Competition among capitalists will result in

goods being produced at a cost of productionthat will return to the producer an amount justsufficient to pay the opportunity costs of variousfactors.

If profits above a normal rate of return, other firms will enterthese industries, force down prices to a cost of production atno excess profit.

Capitalists will bid for various factors ofproduction, offering higher prices for the more productivefactors and thereby channeling L & land into those areas ofthe economy in which their efficiency is greatest.


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By emphasizing the agricultureproductivity, they moved away from theolder concept that only commerce

produces and augments wealth.

Physiocrats emphasized productionrather than exchange as a source of

wealth

Capital accumulation through reducedconsumption by the wealthy


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The rate of profit falls over time


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WHY???


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Changes in their desires are shown inrising & falling prices and consequently

rising & falling profits.

Without planning / government direction, itleads to the satisfaction of consumerdesires at the lowest possible social cost.

An optimum allocation of resources

occurs in competitive markets withoutgovernment intervention.


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Smiths most significant contributionp - analysis of theworkings of competitive markets.

He was able to specify with greater accuracy than previous writers(the mechanism) - price resulting from competitive would, in the

long run, equal the cost of production. He called short-run prices market prices & long-run prices

natural prices.

His primary concern was with the formation oflong-run naturalprices.

Competition involved a large number of sellers, a group ofresource owners who were knowledgeable about profit, wages, andrents & freedomof movement for resources among industries.

Given these conditions, the self-interest of resource owners wouldlead to long-run natural prices that would equalize therates of profits, wages and rents among varioussectors of the economy.

If the price of a final good is higher its long-run natural price,adjustmentwill take place via the movement ofresources until thenatural price prevails.


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Superiority of competitive markets, againstmonopoly & government intervention. Smith recognized thedesire of businessmen to monopolize trade by joiningforces. Monopolists would extract a higher price by

restricting output.

In general, any government interference is undesirable,because it infringes upon the natural rights and liberties ofindividuals.

From economic arguments (more extensive): mercantilistsregulations of domestic & foreign trade resulted in anallocation of resources that was less desirable than thatproduced by competitive market forces. The regulation

benefited not the nation but the merchant. Thiswas not purely theoretical argument, it came from Smithspersonal observation. They inevitably do more harmthan good.


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Government intervention was necessary :

for tariffs that protected infant industries.

Trade regulation was also necessary whennational defense might be weakened by a policy

of perfectly free international trade. The governmentwas to provide for the national defense, build and

maintain roads and schools, administerjustice and keep vital records

Advocating government provision ofgoods thathave greater social benefits but not supplied

by the private because supplying them would not besufficiently profitable. e.g. education, If the market isleft alone, less education will be supplied than issocially desirable.


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CAPITAL AND CAPITALISTS:

The wealth of the nation & econ dev depends uponCAPITALaccumulation.

Itdetermines the division of L & the proportion of the population engagedin productive labor. Productivity of L?????

Individual self-interest + cap acc leads to optimum allocation of Kamong various industries.

The source of capital in a private property economy issavings byindividuals.

Labor could not accumulate capital because the level of wagespermitted only the satisfaction of immediate consumption desires.

Landowners have incomes sufficient to accumulate capital but spendthem on unproductive laborto satisfy their immense desires for highliving.

It is the members of the rising industrial class, strivingfor profits, striving to accumulate capital to increase their wealth through

saving and investment, who are the benefactors of society.


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Without an unequal distribution

of income, economic growth is

not possible, for the whole of theyearly output it will be consumed


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An equal distribution of income in

favor of the capitalists is

therefore of tremendous socialimportance

The larger the share of the L forceproducing tangible goods, the

greater the wealth of the nation.


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The Nature and Causes of the Wealthof Nations

Wealth was an annual flow of goods &services, not an accumulated fund ofprecious metal (accumulation of bullion withthe wealth of nation mercantilists).

Fundamental of role ofexports is to pay for

imports.

The end purpose of economic activity isconsumption (production as an end mercantilists) &emphasizing laboras the

source of the wealth in a nation (physiocrats land).

Wealth of nations measured in per capitaterms (not on the total output/income).


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The greater the K acc - the larger the

proportion of the total L force involve inproductive L.

K - determines the ratio bet the numbersof L who are productively employed &those who are not so employed.


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Causes of the Wealth of Nations:

i. the productivity of labor

ii. the proportion of labor productively employed

The key determinant of wealth of the

nation is K acc.

assumed the economy will automaticallyachieve full employment of its resources.

examined only those forces that determine thecapacity of nation to produce goods andservices.


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Adam Smiths fundamentalcontribution to economic theory:

Not a detailed theoretical analysis buta broad overview of the way inwhich a market economyallocates scarce resourcesamong alternatives uses.

Major policy conclusion: The

government should follow a policy oflaissez faire.


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International Trade -

Value Theory (Price)

Distribution Theory Welfare and the General Level of Price


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International Trade

Free international trade.

Foreign trade is beneficial - a country trading the goodit produces at lowest costs for the good it produces at

higher costs (absolute advantage).

Markets develop dynamically over time.

L becomes more divided & specialized, productivity increasesdramatically increasing returns.

Over time any nation might achieve absolute cost advantage in

the production of certain goods through specialization and division of

L & that all nation could gain from intern. trade. Nations become more proficient by L specialization.

Total amount of goods in the world is greater after the trading(exchange) than before.


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All countries can benefit fromforeign trade & there are more

goods in the world after the

exchange.

Mercantilism: Tradeincreased the

wealth of one nation at the expense ofother nations


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Value Theory

What determines relative prices? What determines thegeneral level of prices?

Relative Prices are determined by costs ofproduction or SS

Short-run prices are determined by SS & DD.

Natural, long-run equilibrium, prices - dependupon costs of production (or sometimes depend onSS & DD).

Agricultural sector natural price depends SS &DD, lr SS curve upward-sloping, increasing costs.

Manufacturing sector lr SS curve perfectly elastic,constant costs, therefore P depends entirely on cost ofproduction.


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THE END

Classical Adam Smith 4

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