Transcript Slide 1

History of Thought
G751
Regulation, ch. 11
Eric Rasmusen,
erasmuse@indian
a.edu
February 26, 2014
Adam Smith
1
Adam Smith, 1723-1790
Glasgow, Balliol-Oxford, Prof. at Glasgow
Friend of David Hume, philosopher.
The Theory of Moral Sentiments (1759)
An Inquiry into the Nature and Causes of the Wealth of Nations (1776)
Big ideas: Division of labor, Invisible Hand. Sympathy. Equality of the
profit rate across industries. Free trade as wealth-increasing. The
Classical School of Economics.
Laissez faire et laissez passer, le monde va de lui même!
2
Adam Smith, 1723-1790
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Making Pins I
A workman not educated to this business... could scarce, perhaps, with his utmost
industry, make one pin in a day, and certainly could not make twenty.
But in the way in which this business is now carried on, not only the whole work is a
peculiar trade, but it is divided into a number of branches, of which the greater part are
likewise peculiar trades.
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 the pins is another; it is
even a trade by itself to put them into the paper;
and the important business of making a pin is, in this manner, divided into about
eighteen distinct operations, which, in some manufactories, are all performed by
distinct hands, though in others the same man will sometimes perform two or three of
them.
Why are they all in the same firm?
4
Making Pins II
The spinner is almost always a distinct person from the, weaver; but
the ploughman, the harrower, the sower of the seed, and the reaper of
the corn, are often the same.
The occasions for those different sorts of labour returning with the
different seasons of the year, it is impossible that one man should be
constantly employed in any one of them.
This impossibility of making so complete and entire a separation of
all the different branches of labour employed in agriculture, is perhaps
the reason why the improvement of the productive powers of labour, in
this art, does not always keep pace with their improvement in
manufactures.
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True or False?
Economic Growth
THE GREATEST IMPROVEMENTS in the productive powers of
labour, and the greater part of the skill, dexterity, and
judgment, with which it is anywhere directed, or applied,
seem to have been the effects of the division of labour.
True or False?
6
Product Quality
But though the poor country, notwithstanding the inferiority of its
cultivation, can, in some measure, rival the rich in the cheapness and
goodness of its corn, it can pretend to no such competition in its
manufactures.
The hardware and the coarse woollens of England are beyond all
comparison superior to those of France, and much cheaper, too, in the
same degree of goodness.
Why?
7
Ricardo, David
(1772-1823)
A Jewish Unitarian convert.
He was a friend of Bentham, Malthus, and James Mill.
Before the battle of Waterloo, Ricardo posted an observer,
then
deliberately created the impression the French had won by selling
consols. A market panic ensued. He then bought consols. The Sunday
Times obituary in 1823, said he made more than a million pounds
sterling. He immediately retired from business, at age 41, and died 10
years later.
On the Principles of Political Economy and Taxation (1817).
Ideas: Comparative vs. Absolute advantage, rents, Ricardian
equivalence, labor theory of value.
8
Ricardo on Rent
Rent is that portion of the produce of the earth, which is paid to the landlord for the
use of the original and indestructible powers of the soil. It is often, however,
confounded with the interest and profit of capital, and, in popular language, the term
is applied to whatever is annually paid by a farmer to his landlord.
If, of two adjoining farms of the same extent, and of the same natural fertility, one
had all the conveniences of farming buildings, and, besides, were properly drained and
manured, and advantageously divided by hedges, fences and walls, while the other had
none of these advantages, more remuneration would naturally be paid for the use of
one, than for the use of the other; yet in both cases this remuneration would be called
rent. But it is evident, that a portion only of the money annually to be paid for the
improved farm, would be given for the original and indestructible powers of the soil;
the other portion would be paid for the use of the capital which had been employed
in ameliorating the quality of the land, and in erecting such buildings as were
necessary to secure and preserve the produce.
9
Ricardo: Scarcity
On the common principles of supply and demand, no rent could be paid
for such land, for the reason stated why nothing is given for the use of
air and water, or for any other of the gifts of nature which exist in
boundless quantity. With a given quantity of materials, and with the
assistance of the pressure of the atmosphere, and the elasticity of
steam, engines may perform work, and abridge human labour to a very
great extent; but no charge is made for the use of these natural aids,
because they are inexhaustible, and at every man's disposal. In the
same manner the brewer, the distiller, the dyer, make incessant use of
the air and water for the production of their commodities; but as the
supply is boundless, they bear no price. If all land had the same
properties, if it were unlimited in quantity, and uniform in quality, no
charge could be made for its use, unless where it possessed peculiar
advantages of situation. 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, or less advantageously situated,
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is called into cultivation, that rent is ever paid for the use of it.
Ricardo: Rent Rising
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, or less advantageously situated, 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. When land of the third
quality is taken into cultivation, rent immediately commences on
the second, and it is regulated as before, by the difference in their
productive powers. At the same time, the rent of the first quality
will rise, for that must always be above the rent of the second, by
the difference between the produce which they yield with a given
11
quantity of capital and labour.
Jevons, 1835 –1882
A professor at Owens College, Manchester. Died of ocean drowning while swimming.
“A General Mathematical Theory of Political Economy” (1862)
The Theory of Political Economy (1871)
Neoclassical Revolution: with Marshall, Menger, Walras, Gossen.
Ideas: Marginal utility. marginalism. Jevon's paradox: increases
in energy efficiency can lead to more, not less, consumption.
12
Jevons I
J. S. Mill, indeed, has given an opinion inconsistent with this. “Political
economy,” he says,
“has nothing to do with the consumption of wealth, further than as
the consideration of it is inseparable from that of production, or from
that of distribution. We know not of any laws of the consumption of
wealth, as the subject of a distinct science; they can be no other than
the laws of human enjoyment.”
But it is surely obvious that Economics does rest upon the laws of
human enjoyment; and that, if those laws are developed by no other
science, they must be developed by economists.
13
Jevons II
Every manufacturer knows and feels how closely he must anticipate the
tastes and needs of his customers: his whole success depends upon it;
and, in like manner, the theory of Economics must begin with a correct
theory of consumption.
Sympathy is key. Greedy sellers must understand buyers in capitalism.
14
Jevons: Intrinsic Value
In the first place, utility, though a quality of things, is no inherent
quality.
It is better described as circumstance of things arising out of
their relation to man's requirements.
As Senior most accurately says, “Utility denotes no intrinsic
quality in the things which we call useful; it merely expresses
their relations to the pains and pleasures of mankind.” We can
never, therefore, say absolutely that some objects have utility
and others have not.
The ore lying in the mine, the diamond escaping the eye of the
searcher, the wheat lying unreaped, the fruit ungathered for want
of consumers, have no utility at all.
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Jevons: Marginalism
A pound of bread per day supplied to a person saves him from
starvation, and has the highest conceivable utility.
A second pound per day has also no slight utility: it keeps him in a
state of comparative plenty, though it be not altogether indispensable.
A third pound would begin to be superfluous.
It is clear, then, that utility is not proportional to commodity: the very
same articles vary in utility according as we already possess more or less
of the same article.
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Jevons: Food and Marginal Utility
We find these considerations fully illustrated by fig. 4, in which oa
represents x, and ab is the degree of utility at the point a. Now, if we
increase x by the small quantity aa', or Δx, the utility is increased by the
small rectangle abb'a', or Δu; and, since a rectangle is the product of its
sides, we find that the length of the line ab, the degree of utility, is
represented by the fraction Δu/Δx..
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Marginal Substitution:Variety
This great principle of the ultimate decrease of the final degree of utility
of any commodity is implied in the writings of many economists,
though seldom distinctly stated. It is the real law which lies at the basis
of Senior's so-called “Law of Variety.” Indeed, Senior incidentally states
the law itself. He says
“It is obvious that our desires do not aim so much at quantity as at
diversity. Not only are there limits to the pleasure which commodities
of any given class can afford,, but the pleasure diminishes in a rapidly
increasing ratio long before those limits are reached. Two articles of the
same kind will seldom afford twice the pleasure of one, and still less will
ten give five times the pleasure of two. ...”
18
Alfred Marshall (1842-1924)
Cambridge University, first Prof. of Economics.
Principles of Economics (1890)
Ideas: Using diagrams. Supply and demand
curves. Marginalism. Elasticities. Producer
and consumer surplus. Quasi-rents.
Economies of scale. Representative firm.
Short run vs. long run.
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Marshall’s System
(1) Use mathematics as shorthand language, rather than as an engine of
inquiry.
(2) Keep to them till you have done.
(3) Translate into English.
(4) Then illustrate by examples that are important in real life.
(5) Burn the mathematics.
(6) If you can’t succeed in 4, burn 3. This I do often."[4
20
Marshall I
Thus we assume that the forces of demand and supply have free play;
that there is no close combination among dealers on either side, but
each acts for himself, and there is much free competition; that is, buyers
generally compete freely with buyers, and sellers compete freely with
sellers.
But though everyone acts for himself, his knowledge of what others
are doing is supposed to be generally sufficient to prevent him from
taking a lower or paying a higher price than others are doing.
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Marshall II
In such a market there is a demand price for each amount of the
commodity, that is, a price at which each particular amount of the
commodity can find purchasers in a day or week or year. The
circumstances which govern this price for any given amount of the
commodity vary in character from one problem to another; but in every
case the more of a thing is offered for sale in a market the lower is the
price at which it will find purchasers; or in other words, the demand
price for each bushel or yard diminishes with every increase in the
amount offered.
The unit of time may be chosen according to the circumstances of
each particular problem: it may be a day, a month, a year, or even a
generation: but in every case it must be short relatively to the period of
the market under discussion.
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Marshall III
Let us call to mind the "representative firm," whose economies of
production, internal and external, are dependent on the aggregate
volume of production of the commodity that it makes*14; and,
postponing all further study of the nature of this dependence, let us
assume that the normal supply price of any amount of that commodity
may be taken to be its normal expenses of production
(includinggross earnings of management*15) by that firm. That is, let us
assume that this is the price the expectation of which will just suffice to
maintain the existing aggregate amount of production; some firms
meanwhile rising and increasing their output, and others falling and
diminishing theirs; but the aggregate production remaining unchanged.
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Marshall IV
This is the real drift of that much quoted, and much-misunderstood
doctrine of Adam Smith and other economists that the normal, or
"natural," value of a commodity is that which economic forces tend to
bring about in the long run. It is the average value which economic forces
would bring about if the general conditions of life were stationary for a
run of time long enough to enable them all to work out their full effect
24
Arthur Pigou (1877 –1959)
Cambridge Professor—successor of Marshall
The Economics of Welfare(1920), at least 4 editions.
Ideas: Externalities, price discrimination (1st, 2nd,3rd),
the Pigou Effect, Pigovian taxes on externalities.
25
Joseph Schumpeter (1883-1950)
Professor at Czernowitz, Graz, Bonn, Harvard.
Finance Minister of Austria in 1919.
Bank president 1920-24.
Co-founder of the Econometric Society.
Theorie der wirtschaftlichen Entwicklung (transl. 1934, The Theory of Economic
Development: An inquiry into profits, capital, credit, interest and the business cycle)
1911.
Capitalism, Socialism and Democracy, 1942.
Ideas: Innovation and entrepreneurs matter. Creative destruction. The
interaction of politics and economics. The Schumpeterian Hypothesis
(big firms innovate more).
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Schumpeter on
The Entrepreneur I
“When he swims with the stream in the circular flow which is
familiar to him, he swims against the stream if he wishes to
change the channel. What was formerly a help becomes a
hindrance. What was a familiar datum becomes an
unknown. Where the boundaries of routine stop, many
people can go no further, and the rest can only do so in a
highly variable manner.”
“...every man would have to be a giant of wisdom and will, if he
had in every case to create anew all the rules by which he
guides his everyday conduct.”
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Schumpeter on
The Entrepreneur II
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“In the breast of one who wishes to do something new, the
forces of habit rise up and bear witness against the
embryonic project.”
“It is no part of his function to “find” or “create” new
possibilities. They are always present, abundantly
accumulated by all sorts of people. Often they are also
generally known and being discussed by scientific or literary
writers.”
“For its success, keenness and vigor are not more essential than
a certain narrowness which seizes the immediate chance and
nothing else.”
5 Types of Innovation
1. new goods (product innovation)
2. new methods of production (process innovation)
3. new markets
4. new sources of inputs
5. new organization
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