History
of
Economic
Thought
–
Adam
Smith
Influences
•
Enlightenment
–
Natural
order
–
People
have
strong
reasoning
ability
• Naturally discover laws governing society
•
Physiocrats
•
Physiocrats
–
Attacks
on
mercantilism
and
barriers
to
trade
–
View
of
wealth
as
production
rather
than
accumulation
–
Minimal
government
interference
–
Circular
process
of
production
and
distribution
•
Frances
Hutchison
–
People
themselves
could
discover
the
will
of
God
(ethics)
Books
•
The
Theory
of
Moral
Sentiments
discusses
moral
forces
that
restrain
selfishness
and
bind
people
together
•
Wealth of Nations
shows how individuals are
•
Wealth
of
Nations
shows
how
individuals
are
guided
by
economic
forces
Moral
Sentiments
•
Sympathy
comes
from
imagining
ourselves
in
other
people’s
positions
•
Unsocial
passions
(e.g.
hatred)
provoke
anger
of
bystanders
because
of
asymmetry
between
person
feeling
passions
and
the
object
•
Social
passions
(e.g.
generosity
or
compassion)
please
indifferent
spectators
•
People
parade
riches
and
conceal
their
sorrow
–
Much
of
wealth
‐
gathering
is
for
attention
Æ
corrupts
moral
sentiments
–
World
respects
rich
more
than
the
wise
• Seek to emulate wealthy
Moral
Sentiments
•
People
are
exposed
to
mutual
injuries
and
need
each
others’
assistance
–
When
offered
out
of
friendship,
society
flourishes
When offered out of utility less desirable
–
When
offered
out
of
utility,
less
desirable
•
System
of
justice
cannot
allow
people
to
injure
one
another
–
Justice
is
more
important
than
beneficence
–
Injustice
can
destroy
beneficence
Moral
Sentiments
•
Moral
faculties
restrain
exercise
of
selfishness
– torments
of
inner
shame
“When we are always so much more deeply affected by whatever concerns
ourselves than by whatever concerns other men; what is it which prompts
the generous upon all occasions and the mean upon many to sacrifice the generous upon all occasions, and the mean upon many, to sacrifice
their own interest to the greater interests of others? It is not the soft power
of humanity, it is not that feeble spark of benevolence which nature has
lighted up in the human heart that is capable of counteracting the
strongest impulse of self‐love. It is a stronger power, a more forcible
motive, which exerts itself upon such occasions. It is reason, principle,
Moral
Sentiments
•
Rich
save
and
reinvest
–
Inadvertently
sharing
profit
with
workers
for
selfish
reasons
–
Advance
interests
of
society
without
knowing
it
–“Business owners are led by an invisible hand to make nearly the samedi ib i f h i f lif hi h ld h b d h d h
distribution of the necessaries of life which would have been made had the earth been divided in equal portions among all its inhabitants; and thus, without intending it, advance the interests of society and afford the means to the multiplication of the species.”
•
Moral
Sentiments
:
sympathy
and
benevolence
restrain
selfishness
•
Wealth
of
Nations
:
competition
channels
self
‐
interest
towards
social
good
Division
of
Labor
•
Smith
was
the
first
to
use
this
term
•
Sources
–
Workers
develop
dexterity
in
a
single
task
–
Time saved for worker not to go from one task to
–
Time
saved
for
worker
not
to
go
from
one
task
to
another
–
Machinery
can
be
invented
to
increase
productivity
for
simple
tasks
•
Emphasis
is
on
manufacturing
and
productivity
–
Not
on
exchange
(mercantilist)
Division
of
labor
“One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business; to whiten it is another; it is even a trade by itself to put them into the paper. I have seen a small manufactory of this kind where ten men only were employed and where some of them consequently performed two or three distinct operations But them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them upwards of forty‐eight thousand pins in a day. But if they had all wrought separately and independently, they certainly could not each of them make twenty, perhaps not one pin a day.”
Harmony
of
Interests
“It is not from the benevolence of the butcher or the baker that we expect our
dinner, but from their regard to their own interest…Every individual
necessarily labors to render the annual revenue of the society as great as
he can. He generally neither intends to promote the public interest, nor
knows how much he is promoting it. By preferring the support of domestic
industryy to that off f foreigng industry,y, he intends onlyy his own security;y; 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 and end which was no
part of his intention…By pursuing his own interest, he frequently promotes
that of the society more effectually than when he really intends to promote
it.”
–Ultimately, everyone is self‐interested, but there is a natural order to the apparent chaos
Harmony
of
Interests
•
Competition
is
the
key
–
Ability
of
merchant
to
extract
profit
is
restrained
by
other
merchants
trying
to
do
the
same
•In case of a monopoly, should be new entrants
–
Employees
compete
with
each
other
for
the
best
jobs,
employers
compete
for
best
workers
•Keeps wages from rising or falling to exorbitant levels
–
Entrepreneurs
reinvest
capital
Æ
promotes
growth
–
In
contemporary
terms:
efficient
since
resources
are
directed
towards
highest
‐
value
use
Harmony
of
Interests
•
Monopoly
can
be
problematic
– worse
of
an
enemy,
to
Smith,
even
than
the
government
“
l
f h
d
ld
h
“People
of
the
same
trade
seldom
meet
together
but
that
the
conversation
ends
in
a
conspiracy
against
the
public,
or
in
some
diversion
to
Harmony
of
Interests
•
Government
intrusion
is
unnecessary
and
harmful
–“Every individual can, in his own local situation judge much better than
any statesman or lawgiver can do for him. The statesman, who should
attempt to direct private people in what manner they ought to employ
their capitals, would not only load himself with a most unnecessary
b h h h ld f l b d
attention, but assume an authority which could safely be trusted not
only to no single person, but to no council or senate, and which would
nowhere be so dangerous as in the hands of a man who had folly and
presumption enough to fancy himself to exercise it.”
Harmony
of
Interests
“Though the profusion of government must have retarded the progress of
England towards wealth and improvement, it has not been able to stop it.
In the midst of all the exactions of government, capital has been silently
and gradually accumulated by private frugality and good conduct of
individuals, by their universal and uninterrupted effort to better their own
condition. It is this effortff which has maintained the progressp g off Englandg
towards opulence and improvement. England has never been blessed with
a very parsimonious government. It is the highest impertinence, therefore,
in kings and ministers to pretend to watch over the economy of private
people. Let them look well after their own expense. If their own
extravagance does not ruin the state, then surely that of their subjects
never will.”
Harmony
of
Interests
•
Extended
Laissez
‐
faire
to
international
trade
– “The wealth of a neighboring nation is certainly advantageous to trade. As a rich
man is likely to be a better customer to the industrious people in his neighborhood,
so is likewise a rich nation.”
•
Clear
statement
about
comparative
advantage
“T i th l f th h k t t th d f d ti i d t – “To give the monopoly of the home market to the produce of domestic industry
must be either a useless or harmful regulation. If the produce of domestic industry
can be bought here as cheap as that of foreign industry, the regulation is useless. If
it cannot, it must be harmful. It is the maxim of every prudent master of a family
never to attempt to make at home what will cost him more to make than to buy.
The tailor does not make his own shoes, but buys them from the shoemaker. The
shoemaker does not make his own clothes….What is prudence in the conduct of a
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 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.”
Harmony
of
Interests
•
Foreign
trade
contributes
to
division
of
labor
by
extending
home
market
•
Condemned
subsidies
for
exports
“ imposes two different taxes on the people: first the tax which they – …imposes two different taxes on the people: first, the tax which they
are obliged to contribute in order to pay the bounty, and secondly the
tax which arises from the advanced price of the commodity in the
home market, paid by the whole body of the people…The second tax is
by much the heaviest of the two.”
Harmony
of
Interests
•
Limits
to
Laissez
‐
Faire
Theory
–
To
protect
society
from
foreign
attack
–
Enforce
performance
of
contracts
–
Control
over
issue
of
paper
money
–
Fixed
interest
rate
–
Laws
ensuring
property
rights
of
tenants
–
Tariffs
•In the case of national defense
•To equalize a tax burden imposed on domestic industry
–
Public
works
–
Public
education
•To reverse psychological effects of division of labor
Harmony
of
Interests
•
Financing
government
projects
–
Taxes
should
be
proportional
to
revenue
–
Taxes
should
be
predictable
and
uniform
Taxes should be collected at a time and in a way
–
Taxes
should
be
collected
at
a
time
and
in
a
way
that
is
convenient
to
the
contributor
–
Taxes
should
be
collected
at
minimum
cost
to
the
Value
•
Diamond
‐
water
paradox
–“The word VALUE has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods that the possession of that object conveys. The one may be called ‘value in use’ and the other ‘value in exchange’.”
Did
ll
l
l
•
Did
not
really
resolve
use
‐
values
–
Modern
theory:
marginal
vs.
total
utility
Value
•
Exchange
values:
basically
determined
by
production
costs
–
Without
capital
or
land,
relative
values
determined
by
necessary
labor
inputs
• Labor theory of value
–
With
capital
and
land,
exchange
values
must
be
high
enough
to
cover
wages,
rent
and
profits
• Profits depend on value of capital advanced by employer
–
Demand
does
not
affect
exchange
value
• Reasonable assumption in a competitive, constant‐cost industry
Market
Price
•
Short
‐
run
market
price
can
fluctuate
around
value
–
Natural
price:
price
below
which
producers
would
not
sell
in
the
long
‐
run
•Depends on ages rents and profit rates •Depends on wages, rents and profit rates
•Might sell below this in the short‐run, but not forever
–
Market
price:
actual
selling
price
•Depends on abberations of short‐run supply and demand,
but tends back to natural price
•Fluctuations are not fundamental determinants of prices
–
Distinguished
between
real
and
money
price
Wages
•
Wages
fund:
wages
are
paid
out
of
a
stock
of
circulating
capital
– “It seldom happens that the person who tills the ground has wherewithal to
maintain himself till he reaps the harvest. His maintenance is generally advanced to
him from the stock of the farmer who employs him, and who would have no
interest to employ him unless he was to share in the produce of his labor, or unless
his stock was to be replaced to him with a profit.”
•
Size
of
wages
fund
depends
on
revenue
from
previous
sales
–
Fixed
in
the
short
run,
can
change
in
the
long
run
•
Average
annual
wage
=
(wages
fund)
/
(laborers)
Wages
•
Minimum
wage
is
at
subsistence
level,
but
can
rise
higher
when
demand
for
labor
is
high
–
Rate
of
economic
growth
determines
demand
for
labor and wage by influencing the size of the
labor
and
wage
by
influencing
the
size
of
the
wages
fund
–
If
wealth
were
stationary,
labor
supply
would
multiply
and
so
the
wage
would
fall
•
Capital
accumulation
and
economic
growth
needed!
Wages
•
Smith
supported
growth
in
wages
–
Efficiency
wages
theory
–
Generally
resulted
from
economic
growth
–
Equity
Equity
Wages
•
Bargaining
matters
–
“Workmen
are
disposed
to
combine
in
order
to
raise
the
wage,
masters
in
order
to
lower
wages.”
•
Equalizing
differences
for
different
occupations
–
Agreeableness
of
the
occupation
–
Cost
of
acquiring
skills
and
knowledge
•Income must pay a rate of return on educational investment
