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History of economic thought


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History of economic thought

  1. 1. The History ofEconomic Thought
  2. 2. LC Economics SyllabusEconomic System and Economic Thought• Brief historical outline of economic thought – Smith, Marx, Keynes etc.• Market, centrally planned and mixed economies.
  3. 3. Exam Questions OL Short Long• 2009 Q9 Match • 2010 Q 4 (b) Keynes - Mult• 2007 Q 9 Match • 2010 Q 5 (b) Smith - COT• 2006 Q 4 Match • 2008 Q 5 (c) Smith COT• 2004 Q 8 Cannons of Tax • 2005 Q 5 (c) Smith COT,• 2003 Q 7 Match DOL• 2001 Q 4 Match • 1999 Q8
  4. 4. Ordinary Level-Short Questions 2009 2007
  5. 5. 2004 2006
  6. 6. 2001 2003
  7. 7. Ordinary Level-Long Questions2005
  8. 8. 2008- Question 5
  9. 9. 2010- Question 4 (b)2010- Question 5
  10. 10. Exam Questions HL Short Long • 2010 Q 6 (b) Milton Friedman• 2005 Q 8 Keynes • 2009 Q 7(c) Ricardo• 2002 Q 4 Keynes • 2007 Q 4 (c)• 2001 Q 8 Monetarists Smith/Marshall/Keynes/Freidman• 2000 Q 9 Smith • 2003 Q 8 (c) Smith
  11. 11. 2010 -Question 6
  12. 12. 2009- Question 4
  13. 13. 2009- Question 7
  14. 14. 2007- Question 4
  15. 15. 2006- Question 4
  16. 16. 2006- Question 5
  17. 17. 2003- Question 8
  18. 18. 2002- Question 4
  19. 19. Short Questions2005
  20. 20. 2002 2004
  21. 21. 8. State THREE contributions made to economic thought by the Monetarist economists.2001 2000
  22. 22. Watch out for the following definitions contained in this presentation!!• Fiscal Policy • Iron Law of Wages• Monetary Policy • Law of Diminishing Marginal• Consumer Surplus Returns• Price Elasticity of Demand • Economic Rent (PED) • Law of Comparative• Cannons of Taxation Advantage• Quasi Rent • Say’s Law• Protectionism • The Multiplier• Laissez-faire • Liquidity Preference Theory
  23. 23. Early Economists• Plato (427-347 BC)• Aristotle (384-422 BC)• Thomas Aquinas (1225-1274) Not on the course but worth a look for interest sake!
  24. 24. Plato (427-347 BC)Division of labor Currency system Individual Public subordinate administration & to the state finance
  25. 25. Aristotle (384-322 BC) True/genuine wealth Unnatural wealth limited unlimitedE.g.. agriculture, mining e.g.. exchanging Money Value in useMeasure of wealth Value in exchange Store of value
  26. 26. Thomas Aquinas (1225-1274) Christian principals Common ground co-exist with economic life Concerned aboutMorality of wealth money lending & depended on its unjust price use charged for it
  27. 27. The Mercantilist (1500-1780)• Thomas Mun (1571-1641)• Believed that;1. Gold was the prime measure of a countries wealth.2.Exploitation of colonies.3.Protectionism.
  28. 28. 7. Trade from and toEngland could beincreased by developingthe country as a centre ofexchange.6. All English exporters shoulduse the English merchant fleetand keep as much of their costsas low as possible.5. Exporters should gain max benefit by obtaininghigh prices for essential goods and lower prices formore competitive goods.4. All domestic needs should be supplied by homeindustries.3. Unused agricultural land should becultivated.2. England must reduce the consumptionof all imported goods.1. England was to become wealthy byexporting more goods than she imported.
  29. 29. The Physiocrat (1750-1800)• Francois Quesnay (1694-1774)• Wrote “Economic Table”.• Believed that;1. Wealth had its origin in agriculture.2.Private ownership of property important.3.Non gov intervention (except for laws).4.Free trade.
  30. 30. A country generated In his famous book he set out the wealth from the surplus first attempt to explain the circular created by agriculture- flow of income. “Produit Net” He did this by comparing the flow of the economic resources in anHe also showed economy to the circulation ofhow the surplus of blood.agriculture spreadthroughout thecountry in his book. He divided society into 3 distinct classes: 1.The Working Class. 2.The Landowners. 3.The Sterile Class.
  31. 31. Quesney’s Society
  32. 32. The Classical Economists1. Adam Smith (1723-1790)2. Thomas Robert Malthus (1766-1834)3. David Ricardo (1772-1823)4. Jean Baptiste Say (1767-1832)5. John Stuart Mill (1806-1873)
  33. 33. Adam Smith Pursuit of self Classical Economist Laissez-faire interest Scottish No justification for Benefited individual (1723 – 1790) government therefore society “……The Wealth of Nations” intervention except for defense/justice Division of LaborIncreases productivity Invisible hand of and a country’s competition wealth.E.g.. it takes 18 different Allows self regulationoperations to make a pin! to operate ensuring economic progress Labour theory of Free Trade value & wealth With no tariffs/tax,The value of an item is Cannons of Taxation markets operateequal to the amount of Fair tax system; effectively & trade tolabour that goes into equity be spread betweenproducing it economy nations certainty convenience
  34. 34. • Labour is the source of a country’s wealth.• Wealth should be increased by the division of labour( showed this by the observation of straight pins.)• Developed a labour theory of value; the value of an item is equal to the quantity of labour which it can demand in exchange for itself.• Free competition ensured that prices were set freely.• Encouraged free international trade.• Role of the government- defence, education & education.• Favoured taxation of rent to fund government and developed canons of tax: equity, economy, convenience & certainty.• Wrote: wealth of nations.
  35. 35. The wealth of Nations (benefits of free trade)• The pursuit of self interest- “what benefits the individual, best benefited the society.”• Division of Labour- increased productivity increased the wealth in a country. He illustrated his theory with the example with the manufacture of pins.• The labour of value theory- the value of an item was equal to the amount of labour that went into the producing the product. The value of anything is equal to the labour it can save you.• Invisible hand of competition- Smith advocated the operation of a self regulating market, thus ensuring economic progress was achieved.
  36. 36. • Paradox of value- Smith• State protection of property distinguished between “value in rights- encourages the use” and “value in exchange”. accumulation of property wealth. Some items had a vast utility but• Perfect competition- free entry are not exchanged, while others into markets; profits are sufficient possessed little utility but could to reward entrepreneurs, operate effectively and allow the inefficiencies penalised and price gains from trade to be spread would be based on the cost of between nations. production. Monopolies would • Smith advocated specialism of not persist. labour.• Laissez-faire- no justification for • He distinguished between government intervention except productive and non productive for defence/ justice. labour.• Cannons of Taxation-to fund the state’s defence/justice systems taxation was necessary and he developed the four principles of fair tax system:  Equity  Economy  Certainty  Convenience.
  37. 37. Thomas Robert Malthus Iron Law of Wages Classical EconomistWages will naturally tend English Theory oftowards the subsistence (1776-1834) Population & Foodlevel (just enough to get “The Principles of Population” •Population growsby/ the equivalent of Applied the Law of geometricallynormal profit). Diminishing Returns to (2,4,8,16,32).If they get any higher, Land •Food growsthe population will rise arithmeticallyand wages will be (1,2,3,4,5,6). •Best land taken upcompeted back down to •If population is not first, then next best,subsistence level. kept in check famine & then inferior…. •At each stage the disease would result.An increase in wage above ( The Green Revolution amount of food is less subsistence level helped to avert his than before. = increase in population predictions.) If wages  above the •SOL did not fall in = increase in supply of subsistence level population 19th C but his ideas labour will. were more relevant in =decrease in wage Therefore the supply of the population labour will  and Wage Rates explosion of the 20th C will . This would lead to a  in population and force wages up to subsistence level.
  38. 38. David Ricardo Law of Classical Economist Comparative Economic Rent English Costs/Advantage (1772-1823)•If population “The Principles of Political •Supported idea of freeincreases inferior land Economy & Tax” trade.used.•For use of land rent •A country shouldwas paid. specialise in the•Cost of producing on production of thosethe best land was goods in which it islower. relatively most•Food produced on efficient . •And trade for thegood land earned asurplus over that remainder of it’sproduced on inferior•This surplus led to anincreased rent Accepted the Subsistence Wage Theorypayable for the use of He agreed that angood land. increase in wage above subsistence level = increase in population =decrease in wage
  39. 39. Jean Baptiste Say (1767-1832) Wrote: “Treatise on Political Economy” t Say’s Law is om on Ec ch enFr Enterprise • Say said enterprise was the 4th Factor of Production . •The return being profit or loss.
  40. 40. • “Supply creates it’s own demand”. People make products they are most efficient at. Say’s Law•• They exchange their surplus for money.• They use this to buy goods that they want.• Therefore the supply of goods creates a demand for goods. According to Say, people work, not for its own sake, but only to satisfy their demand for goods & services. Workers cannot satisfy all their own needs directly from their own work. Through specialism they can exchange their surplus of output for the surplus output of others. Production is therefore an essential core of the demand for other goods. As a result there can never be overproduction. Aggregate Demand = Aggregate Supply – production on one side is reciprocated by demand on the other. Economic crisis & over production could not exist because production created demand. However they did occur and he explained this by the restrictions imposed Supply on free trade. creates its own If you make and manage to sell what you’re good at producing, you then have the demand. money to demand what others can produce.
  41. 41. John Stuart Mill (1806-1873) Wrote: “Principals of Political Economy…”
  42. 42. John Stuart Mill (1806-1873) Wrote: “Principals of Political Economy…”• He advocated the following;1. Demand & supply were important in assessing the value of a product.2.Law of diminishing marginal returns.3.Predicted the emergence of dominant firms.4.Establishment of trade unions to counteract the power of dominant firms.Mill became disillusioned by the capitalist system & began to lean towards a mild form of socialism.
  43. 43. Correctly predicted the emergence of large The excess of earnings companies and oligopolies should be due to economies of scale. redistributed in order to increase welfare of Saw a role for trade society in general. unions in moderating the power of large companies. He was guided by the principle that the individual hasHe believed that the right to doDemand & Supply whatever he wisheswere equally as as long as it causesimportant in no harm to others.determining Value. Recognised the importance of the LDMRWages are determined by the capital available to pay wages divided by the working population.Wages can be increased by:1.Cutting the population. or2.Increasing the capital fund.
  44. 44. “Nothing can be done for Ireland without transforming the rural population from cottier tenants into ….land proprietors (owners)”. JS Mill, “Principles of Political Economy” (1848)
  45. 45. The SocialistsKarl Marx (1818-1883)
  46. 46. Karl Marx (1818-1883)
  47. 47. Capitalism Predicted Karl Marx Socialism Growth of oligopolies Socialist Communism Forecasted German Emergence of trade (1818-1883) cycles “The Communist Manifesto” Social revolution Where proletariat Labour theory would take publicPeople required to work ownership of the FOP more hours than necessary to generate the income needed to Saw a class division: pay their wages. Two tiered society =unequal distribution of wealth Profit Capitalists (owners) Labour produced a Profits invested in Proletariat (workers) surplus value which was technology profit for employers Reduced need for labor He overlooked the = unemployment power of the trade unions to improve the Marx inspired many communist regimes, such rights of the workers. as the Soviet Union that collapsed in 1991.
  48. 48. Labour Theory of Value• The value of a good was the cost needed to produce the good.• Labour paid just enough to raise a family but workers were required to work a number of hours in excess of this.• For this he was producing profit/value for his employer.• This excess value was called the “Surplus Value” and represented the exploitation of the workers by the capitalist.
  49. 49. • Marx predicted a worker revolution to collectively seize the means of production.• He believed that since workers generated all the income they deserved all the profits.• The exploited working class would grow in numbers, organise themselves, revolt and over throw capitalists.• The workers would then redistribute wealth.• A Communist society could be created to replace Capitalism- it would be a classless society with no need to struggle.• He downplayed the role of land, labour, capital and especially enterprise in generating income and profit.
  50. 50. Criticism of Karl Marx• Despite what Marx believed, the growth of unions ensured protection of working class and improved the.• Middle & professional classes emerged.• Technology did not lead to mass unemployment.• The Labour theory of value has been discarded: Labour is useless without land or capital.• He falsely predicted that the advances of technology would lead to mass unemployment. However• Predictions on emergence of oligopolies & trade cycles came true.
  51. 51. The Neo-classical Economists Alfred Marshall (1842-1924)•Came up with the concept of elasticity.•Introduced the concept of short & long runs.•Introduced the concept of DiminishingMarginal Utility.•Scissors analogy.•Quasi-rent•Saw a role for government in the economy.
  52. 52. Competition Quasi Rent Theory of ValueThe value of an item is determined; Regulated economic Economic rent earned•SR by utility and demand activity as well as by FOP in SR when D>S•LR by cost of production some government intervention. Consumer Surplus Growth of monopolies could be prevented by; The difference between•Gov regulation what a consumer actually Alfred Marshall pays for a good and the•Consumer information Neo-classical maximum which he/she•More accountability English would have been willing to (1842-1924) pay rather than goingMarginal Revenue “The Principles of without it.Productivity Economics & Money,The return to each FOP is Credit & Commerce”.determined by its MPP- i.e. the Price-elasticity ofproductivity of the last unit of demandFOP used to produce output. Quantified buyers’ sensitivity to priceDistribution of income/wealth changesThe return to each FOP is determined by their marginal utility
  53. 53. Marshall’s scissors analogy.• Demand & supply are interdependent just like the blades of a scissors.• One cannot cut without the help of the other.
  54. 54. Keynesian Economists • John Maynard Keynes (1883- 1946) • Studied at Eton and Cambridge. • Wrote: Treatise on Money (1930), The General Theory of Employment, Interest & Money (1936)
  55. 55. John Maynard Keynes (1883 – 1946)He wrote The General Theory of Employment Interest and Money. He represented theUK government at the Versailles peace conference in 1919 and at Bretton Woods in1944. He strongly criticized the laissez- faire balanced budget policies of the UKgovernment in the 1920’s and 1930’s. He maintained that full employment was not anatural state and that economies could settle in equilibrium at less than fullemployment i.e. an economy could slide into a slump and stay there.His unorthodox views created a storm among the establishment but he stuck to his viewthat the government would have to intervene in the economy, increase its ownspending and raise aggregate demand to the full employment level. Keynes was not infavour of overthrowing capitalism but instead put forward ideas to support it. Keynesalso had his Liquidity Preference Theory of Interest Rates and The Multiplier. Keynes wasinto controlling the economy through fiscal policy and demand management.
  56. 56. Favored government John Maynard Keynes intervention Keynesian Liquidity•It is the job of the British preference theorygovernment to run the (1883-1946)economy “The General Theory of Employment, Interest & Money”•Gov should stimulatedemand in a recession 3 reasons (motives)by spending money for holding money(fiscal policy).•Gov can use fiscalpolicy (any action taken bythe government which alters •Transaction motivecurrent revenue & exp) to •Precautionarycreate full employment •SpeculativeIf Inv<Saving=Leakage Investment decisions Leads to a decrease in Depends on national income & expectations not rate employment of interest The multiplier Shows the relationship between an initial injection into the circular flow of income and the eventual total increase in national income.
  57. 57. KEYNESIAN ECONOMICS.Keynesian economics was born during the Great Depression of the 1930sand has been, for the most part, followed in most capitalist countries eversince. English economist John Maynard Keynes (1883-1946) argued thatself-adjusting market forces would take a long time to restore fullemployment. He held that the government should intervene to increaseaggregate demand through the use of fiscal policy, which involvesgovernment spending and taxation. By increasing government spending, forinstance, jobs will be created which will increase income levels, which willincrease the aggregate demand for goods and services and thus create newjobs.Modern Keynesians (also, known as neo-Keynesians) recommend monetarypolicy, in addition to fiscal policy, to manage the level of aggregate demand.An increase in the money supply, for example, leads to a decrease in theinterest rate which increases private investment and consumption, boostingthe aggregate demand in the economy.An increase in aggregate demand under the Keynesian system, however, notonly generates higher employment but also leads to higher inflation. Thiscauses a policy dilemma—how to strike a balance between employment andinflation. According to laws that were enacted following the GreatDepression, policy makers are expected to use monetary and fiscal policies toachieve high employment consistent with price stability.
  58. 58. Supported Laissez-faire and Believed in the free market. privatisation & deregulation.Nobel Prizewinner 1976 The Monetarists Milton Friedman (1912-2009) Wrote: •A Monetary History of the United States 1867- 1960 •Inflation- Causes and Consequences. •Free to Choose.
  59. 59. Monetary policyShould be the main Milton Friedman Laissez faireinstrument used by the Monetarist •Minimum stategovernment to manage (1912 -2009) interventionthe economy. “A Monetary History of the US” •De-regulation of(Actions taken by the marketsgov/ECB which influences •Privatisationthe money supply, interestrates and availability of Friedman supported Laissez-credit). faire & the free market. He believed that government spending in a recession would Control of money only lead to inflation supply Control inflation by Reduction in inflation Supply side policies Leads to increases competitiveness, strict control of Improve market cheaper exports & job creation in money supply. efficiency, boost the long run. Restrict loans & high supply, reduce the Companies keep wage increases to a interest rates. power of trade unions. minimum to avoid cost-push inflation. Low inflation creates stable wages & prices, encourages investment, Monetarist: increases national competiveness and i.e. advocates use of interest rate and as a result generates economic restricted money flow to control inflation. growth and jobs.
  60. 60. The Shock DoctrineAdvisor to Nixon, Pinochet, Thatcher, Regan & GW Bush Jnr
  61. 61. Other Modern Economists• Supply-siders• J. K. Galbraith (1908-2006)
  62. 62. Supply-sider theorists Late 20th Century1. Economy developed by stimulating the supply of goods.2. Reduce taxes, encourage work, investment & government revenue.3. Deregulation & privatisation encourages competition, increase word production & reduce prices.• Controversial because it advocates reduction of higher rates of tax which benefits the wealthy.• However supply siders claim that reducing tax rates will lead to increased tax revenue.• This is because increasing tax rates is a disincentive to work & invest.
  63. 63. J. K. Galbraith MaverickKeynesian/liberalist (1908-2006) • Wrote the book “The Affluent Society”. • Recommended that governments should increase tax to reduce conspicuous consumption. • Warned of economic power of multinational oligopolies.