Economics 493/593 - History of Economic Thought

Syllabus for Fall 2008

[Syllabus in pdf format]

Course: Economics 493/593: The Evolution of Economic Ideas

Professor: Mark Thoma
Office/Hours: PLC 471 on T/Th 2:00-3:00 p.m.
Phone/Email: (541) 346-4673, mthoma@uoregon.edu
Web Page: http://darkwing.uoregon.edu/~mthoma/

Text: The Evolution of Economic Thought, 7th ed., by Brue and Grant.

Prerequisites: Economics 311 and 313, or the equivalent.

GTF/Office/Hours: Alex Twist: twist@uoregon.edu, PLC 507, T/Th: 10:00-11:00. 

Tests: There will be two midterms and a final. The midterms will be given on Tuesday, October 21st and Tuesday, November 18th. The final will be given on Tuesday, December 9th from 8:00 a.m. – 10:00 a.m.

Homework: Problem sets will be assigned periodically. These are graded, and exam questions will be based, in part, upon the problem sets.

Grading: Each midterm is worth 25%, the homework counts as 15%, and the final is worth 35%.  Grades will be assigned according to your relative standing in the class.

Tentative Course Outline:

Introduction	Ch. 1
The Mercantilist School	Ch. 2
The Physiocratic School	Ch. 3
The Classical School ‑ Forerunners	Ch. 4
The Classical School ‑ Adam Smith	Ch. 5
The Classical School ‑ Thomas Malthus	Ch. 6
The Classical School ‑ David Ricardo	Ch. 7
The Classical School ‑ Bentham, Say, Senior, and Mill	Ch. 8
The Rise of Socialist Thought	Ch. 9
Marxian Socialism	Ch. 10
The Marginalist School ‑ Forerunners	Ch. 12
The Marginalist School ‑ Jevons, Menger, et. al.	Ch. 13
The Marginalist School ‑ Edgeworth and Clark	Ch. 14
The Neoclassical School ‑ Alfred Marshall	Ch. 15
The Keynesian School ‑ John Maynard Keynes	Ch. 21
More Recent Developments

YouTube Class Video Playlist

Class Materials for Lecture 17

Brief Outline of Topics Covered in Lecture 17:

Marshall (ch. 13)
Modern Macroeconomic Thought

Video:

John Maynard Keynes (right) and Harry Dexter White at the Bretton Woods Conference

Additional Reading:

A colleague who was believed to be the last surviving U.S. economist involved in the Bretton-Woods negotiations, Ray Mikesell:

UO professor, Bretton Woods economist, dies at age 93, by Rebecca Nolan, The Register-Guard, 2006: A University of Oregon professor, believed to be the last surviving economist from the 1944 Bretton Woods conference that led to the creation of the World Bank and the International Monetary Fund, died Tuesday at his home in Eugene. Raymond Mikesell died of age-related causes. He was 93. ...

Toward the end of World War II, he became an adviser to Assistant Treasury Secretary Harry Dexter White, who led U.S. efforts to shape the world's economy after the war. Mikesell was present at the Bretton Woods conference, where White and the British economist John Maynard Keynes negotiated the design of the World Bank, the IMF and the General Agreement on Tariffs and Trade. The institutions funded the European recovery and laid the foundation for the postwar economic expansion.

Mikesell provided data for White to use against Keynes' attempts to preserve British interests. ... [Update: NY Times story]

Among all countries involved in the Bretton Woods negotiations the last surviving economist is, as far as I'm aware, Dr. Jacques J. Polak who was a member of the Netherlands delegation. He is 92, lives in Washington, D.C., and maintains an office at the IMF where he continues to write.

One of Ray's many books, Foreign Adventures of an Economist written in 2000, gives details of his experiences in all sorts of negotiations and advisory capacities.  One part of the book details his experiences at Bretton Woods and it's a history worth preserving. Ray's main lasting contribution at the conference was to determine the IMF and World Bank formula used to set quotas:

This exercise required many calculations with a 1940s-style calculator, using a number of variables and weights for each country. If I had had access to a modern computer, I could probably have come up with a better formula. ... My formula was ... used as a basis for determining the IMF and World Bank quotas at Bretton Woods for most member countries represented at the conference. Thereafter, it was used in a somewhat revised form for new members joining the Fund. In fact, the formula is still used, but with special adjustments for individual countries. I take no pride in having authored the formula and sometimes apologize for it as my claim to infamy! It has continued to be used in large part because the Fund wanted to apply the same conditions in determining quotas for new members as were applied to the original members.

The book has a lot of interesting detail and insider information on the negotiations, and I've included the pdf's for the chapters on Bretton-Woods below for anyone who is interested. Here's one small section:

A Note on Personalities
John Maynard Keynes

As a young academic who had studied and taught both The Treatise on Money and The General Theory I was awed by Keynes and grateful that I could sit in meetings with him. Although he fought hard for positions he regarded as important for Britain's welfare, his economic arguments were academic and dispassionate. Keynes could accept philosophically the economic advantages of multilateral trade while continuing to defend a discriminatory sterling area in terms of Britain's national interest.

There was a sharp contrast between the literary quality of Keynes's ICU proposal and the legalistic formulation of the July 1943 version of the White plan. Keynes displayed arrogance in the elegant language of an educated British lord. He disliked the style and format of the Fund's Articles of Agreement. He said they were written in Cherokee, and he blamed the language on the Treasury Department's lawyers. Keynes frequently complained that Americans were too dependent on attorneys, and once suggested that "when the Mayflower sailed from Plymouth, it must have been entirely filled with lawyers."

Keynes was capable of displaying temper and once threw one of White's drafts to the floor, but he usually expressed his anger through sarcasm. He always had an air of dignity and did not join the revelry at the Bretton Woods nightclub. I never saw him in sport clothes. Nevertheless, he was approachable. Junior members, such as myself, were able to talk privately with him, and I always found him willing to answer my questions. If we took too much time, however, Lady Keynes would tiptoe over to protect him from becoming too tired. Those of us who were privileged to shake his limp hand on the train from Savannah to Washington following a light heart attack were left with the memory of saying farewell to a truly noble man.

Harry White

Personalities played an important role in the Bretton Woods debates and in the final outcome. I saw White in numerous meetings and on dozens of other occasions when we talked alone in his Treasury Department office. His Monetary Research staff was largely composed of former academicians, and many of us returned to universities after the war. The staff was intensely loyal to White, and he respected us as scholars and strongly supported us even when he thought we had made mistakes. I do not recall White's embarrassing any staff member by dressing him down, but he showed another side when he was involved in negotiations outside the Treasury Department. He was often brusque, even crude, in his meetings with Keynes and the British delegation.

When annoyed, he sometimes cynically addressed Keynes as "Your Royal Highness" or "Your Lordship." Lord Robbins, who participated in many of the pre-Bretton Woods meetings but was not close to White, described White well in his book Autobiography of an Economist:

It is true that White was not a very beautiful character. He was brash, truculent, and, I suspect, somewhat unscrupulous where his own interests were concerned. In his younger days he had been the victim of academic unemployment, possibly due to the discreditable anti-Semitism which at that time tended to affect the policies of the great university with which he had been associated; and I am fairly clear that he was determined that henceforth Harry White should not be worsted in the struggle for survival-- or eminence. But that he was in any way associated with the groups in the United States who actively wished harm or wished to exploit our [Britain's] position of weakness will not stand up to examination for a moment. (Robbins, 1971).

White often expressed to his staff his hostility toward the State Department, with which he frequently struggled for power within the U.S. government. Like Morgenthau, he wanted the Treasury Department to be the center of postwar economic policy and planning. This helps to explain the comprehensive nature of the original White plan. International financial institutions were not a high priority in the State Department; without White's zeal, there probably would not have been a Fund or a Bank. The Bretton Woods institutions might not have come into being if they had not been well advanced before the end of the war, since by then there was a plethora of immediate economic problems that these institutions were not equipped to handle.

White sought to conduct his own foreign policy independently of the State Department. He dealt directly with foreign officials in Washington, and members of the Monetary Research staff in American embassies in Allied countries, including myself, secretly reported directly to White without going through their embassies. White sometimes used the press to promote his policies that were in opposition to those of the State Department. On one occasion, while I was alone with him in his office, he dictated over the phone a long, top-secret State Department statement to a reporter. I do not know the reasons for White's antipathy toward the State Department, but it was not directed at individuals since he had close relations with some of them. I believe it was a reaction to the State Department's traditional insistence that it have commanding responsibility over foreign policy.

White believed that the U.S. government should have sought closer cooperation with the Russians. Through certain members of his staff, he provided information to and discussed policy with Soviet embassy officials. These relations were later discovered by the FBI and led to White's dismissal from the government, but they were not known to most of us in Monetary Research.

Many people have asked me if White was a Communist. I am convinced that he was not. White believed in free markets and capitalism and devoted his energies to planning for a postwar world with free and nondiscriminatory trade and payments. He was, however, quite willing to deal with Communist officials to achieve his objectives. The Soviet Union shared his political objectives regarding postwar Germany, and he believed that Soviet officials would support the Fund and the Bank proposals. He did not share the pervasive fear that the Communist ideology would spread to the rest of the world, or that the Soviet Union might dominate the world by military conquest. He believed that a Communist state could operate under a system of nondiscriminatory trade rules, abiding by the trade and exchange obligations of his plan.

White's associates who were later accused of being spies for the Soviet Union -- Sol Adler, Frank Coe, and Harold Glasser -- never indicated to me that they were not completely loyal to the United States or that they did not believe in a democratic capitalist society. I knew them so well personally that it is difficult for me to believe they could have concealed communist ideology from me. Although they may have had some association with the American Communist movement in their youth, as did many of my college acquaintances in the 1930s, I believe that the accusations directed against them arose from White's propensity to carry on direct relations with the Soviet government outside regular diplomatic channels. If these same activities had been carried on with the British or Canadians, they would have been acceptable. White and his closest associates simply ran their own foreign ministry.

A few weeks before White's death, he and I were speakers at a conference of the American Academy of Political and Social Science in Philadelphia. After the evening meeting on April 19, 1947, I spent a couple of hours with him in the lobby of the Benjamin Franklin Hotel. He was in a reflective mood, and we reminisced about the events leading to the creation of the Bretton Woods institutions. White had already been compelled to give up his position as the U.S. executive director of the Fund. He had been working as a consultant to the Chilean government and had recently returned from Santiago. He was scheduled to testify before the House Committee on Un-American Activities, but he spoke very confidently of being able to disprove the charges against him and appeared to look forward to the opportunity. White was charged with providing confidential information to the Soviet Union, but I have never believed he gave any information that was harmful to U.S. national interests. White did speak of his heart condition and, when we parted, he apologized for taking the elevator rather than walking the two flights to where both of our rooms were located. Some say he committed suicide to avoid testifying before the House committee. I do not believe it.

Class Materials for Lecture 16

Brief Outline of Topics Covered in Lecture 16:

Edgeworth and Clark (ch. 14)
Marshall (ch. 13)

Video:

John Bates Clark


Francis Ysidro Edgeworth


Alfred Marshall

Review Questions - Material after Midterm 2

Review for first midterm is here.
Review for second midterm is here.

Review questions for material since the second midterm:

1. What are the reasons, according to Marx, for the falling rate of profit over time, capital accumulation, and crises? What are the consequences of the falling rate of profit, capital accumulation, and crises?

2. What was Jevons' main contribution to the theory of exchange?

3. Explain Jevons' determination of the length of the working day.

4. What is the water-diamond paradox? How does Jevons solve it?

5. Discuss and illustrate (using a table) Menger's ideas on total and m arginal utility.

6. Compare and contrast Menger's and Jevon's views on total and marginal utility.

7. What are Menger's views on factor price determination? How can they be used to refute the labor theory of value?

8. Explain Clark's marginal productivity theory and how it was used to counter Marx's claim that labor is exploited under capitalism.

9. What was Edgeworth's main contribution to utility theory? Explain.

10. Explain the contributions made by Edgeworth to production theory.

11. Explain why Marshall felt that economics is the most precise of all the social sciences.

12. Explain Marshall's views on consumer and producer surplus.

13. According to Marshall, what determines prices, supply or demand? Does the time period matter?

14. What factors, according to Marshall, cause firms to become more efficient as they grow? What determines whether they are increasing or decreasing cost industries? Why don't decreasing cost industries eventually become monopolized?

15. What economic conditions set the stage for the emergence of Keynesian economics? Prior to Keynesian economics, what was the prevailing view regarding government intervention to cure recessions? What was the basis for this view? What is the Keynesian view on government intervention? Broadly, how has that view changed over time?

Class Materials for Lecture 15

Brief Outline of Topics Covered in Lecture 15:

The Marginalist School (ch. 13)

Video:

Jevons

Homework #7

Economics 493
Fall 2008
Homework 7
Due Thursday, December 4

1. According to Marx, why does profit fall over time?

2. Use the numerical example developed in class to examine what happens to the rate of exploitation and profit if the length of the working day is extended to 15 hours.

3. What is Clark's response to Marx's theory of exploitation?

[Solution to Homework 7]

Class Materials for Lecture 14

Brief Outline of Topics Covered in Lecture 14:

Marxian Socialism (ch. 10) [cont.]
The Marginalist School (ch. 13)

Video:

Lecture 14 - YouTube
Lecture 14 - Google Video

Menger

Midterm 2 Solution

Midterm 2 and solution.

Review Questions for Midterm 2

Review Questions for Midterm 2
Economics 493/593
Fall 2008

1. According to Adam Smith, what is the difference between the market price and the natural price? Why is this distinction important?

2. Explain why Smith's value theory involved circular reasoning.

3. Why did Adam Smith believe wages would differ across occupations? What is the wages fund doctrine?

4. What did Smith think would happen to the rate of profit over time? What reasons did he give for his conclusion?

5. Explain Malthus' population theory. What policy implications did Malthus draw from this analysis?

6. Explain Malthus's theory of gluts. What policy conclusions did he draw from the analysis?

7. Explain Ricardo's theory of rent and the law of diminishing returns. What policy conclusions did he draw from this analysis?

8. Explain Ricardo's theory of comparative advantage.

9. Explain Ricardo's theory of distribution. Also explain why Ricardo believed that rent and profit are inversely related, and that that profit and wages are inversely related

10. How does hedonism differ from utilitarianism?

11. How did Bentham's utilitarianism lead him to egalitarian reform proposals? Why didn't he advocate complete equality of income?

12. According to J.B. Say, what was the fourth factor of production? How did the addition of this fourth factor of production this remove potential sources of class conflict from classical theory?

13. What is Say's law? What are the implications of Say's law?

14. Discuss Nassau William Senior's beliefs concerning positive and normative economics.

15. Discuss Nassau William Senior's views on the poor laws. What policies did he help to enact as a member of the Poor Law Inquiry Commission?

16. How did Nassau William Senior's views on rent differ from Ricardo's? How does this reduce class distinctions based upon the receipt of rent?

17. How do Mill's views on utility differ from Bentham's?

18. According to Mill, what are the three types of goods? Which is the most common?

19. What are Mill's views on government intervention?

20. Define and explain the following modes of production: Capitalism, State Capitalism, State Socialism, Utopian Socialism, Anarchism, Marxian Socialism (including the six stages of production), and Syndicalism.

21. What were Marx's views on the writings of Smith, Ricardo, Mill, Bentham, Say, and Senior? Why was he critical of much of what they wrote?

22. Explain Marx's theory of exploitation.

[Many of these are also homework problems]

Class Materials for Lecture 13

Brief Outline of Topics Covered in Lecture 13:

Marxian Socialism (ch. 10) [cont.]

Video:

Lecture 13 - YouTube
Lecture 13 - Google Video

Younger Karl Marx

"Fibonacci, Fermat, and Finance"

I went to a seminar yesterday in the Physics Department to see the manager of a hedge fund, John Seo, talk about "Fibonacci, Fermat, and Finance: How a Biophysicist Built a Multi-Billion Dollar Catastrophe Bond Fund after Re-Reading the Foundations of Modern Finance" (NY Times magazine story). One thing I learned at the seminar and from asking questions at dinner afterward was about the origins of present value analysis. It goes back to the mathematician Leonardo Fibonacci and chapter 12 of his book "Liber Abaci" written in 1202. Here's a working paper on the topic:

Fibonacci and the Financial Revolution William N. Goetzmann NBER Working Paper No. 10352: ...Traveling Merchant Problems The second type of financial problem is a set of “traveling merchant” examples, akin to accounting calculations for profits obtained in a series of trips to trading cities.

The first example is:

A certain man proceeded to Lucca on business to make a profit doubled his money, and he spent there 12 denari. He then left and went through Florence; he there doubled his money, and spent 12 denari. Then he returned to Pisa, doubled his money and it is proposed that he had nothing left. It is sought how much he had at the beginning.

[Update: the problem isn't clear about this, but 12 denari are spent at each of the three stops, including Pisa] Leonardo proposes an ingenious solution method. Since capital doubles at each stop, the discount factor for the third cash flow (in Pisa) is ½ ½ ½ . He multiplies the periodic cash flow of 12 denari times a discount factor that is the sum of the individual discount factors for each trip i.e. (1/2) + (1/4) + (1/8). The solution is 10½ denari. The discount factor effectively reduces the individual cash flows back to the point before the man reached Lucca.

Notice that this approach can be generalized to allow for different cash flows at different stages of the trip, a longer sequence of trips, different rates of return at each stop, or a terminal cash flow. In the twenty examples that follow the Lucca-Florence- Pisa problem, Leonardo presents and solves increasingly complex versions with various unknown elements. For example, one version of the problem specifies the beginning value and requires that the number of trips to be found – e.g. “A certain man had 13 bezants, and with it made trips, I know not how many, and in each trip he made double and he spent 14 bezants. It is sought how many were his trips.” This and other problems demonstrate the versatility of his discounting method. They also provide a framework for the explicit introduction of the dimension of time, and the foundation for what we now consider finance.

In case you don't see this, though he didn't explicitly use this formula, he realized that the "present value" of the cash flow is:

PV = [R₁/(1+i)¹] + [R₂/(1+i)²] + [R₃/(1+i)³]

where R_j is the cash spent at each point j on the trip, and i is the profit rate. In this case,  R_j = 12 for all j, and i=100%, or 1.0. Thus:

PV = [12/(1+1)¹] + [12/(1+1)²] + [12/(1+1)³]

      = [12/2] + [12/4] + [12/8]

      = 12[(1/2) + (1/4) + (1/8)] (as above)

      = 10.5

But does Fibonacci realize this applies not just to traveling merchants, but also to discounting financial cash flows over time? Yes. All you have to do is convert the problem back to the traveling merchant example. Going back to the NBER paper:

Immediately following the trip problems, Fibonacci poses and solves a series of banking problems. Each of these follows the pattern established by the trips example – the capital increases by some percentage at each stage, and some amount is deducted. For example:

A man placed 100 pounds at a certain [banking] house for 4 denari per pound per month interest and he took back each year a payment of 30 pounds. One must compute in each year the 30 pounds reduction of capital and the profit on the said 30 pounds. It is sought how many years, months, days and hours he will hold money in the house....

Fibonacci explains that the solution is found by using the same techniques developed in the trips section. Intervals of time replace the sequence of towns visited and thus a time-series of returns and cash draw-downs can be evaluated. Once the method of trips has been mastered, then it is straightforward to construct a multiperiod discount factor and apply it to the periodic payment of 30 pounds – although in this problem the trick is to determine the number of time periods used to construct the factor. Now we might use logarithms to address the problem of the nth root for an unknown n, but Fibonacci lived long before the invention of logarithms. Instead, he solves it by brute force over the space of three pages, working forward from one period to two periods etc. until he finds the answer of 6 years, 8 days and [5 and 1/2] hours. The level of sophistication represented by this problem alone is unmatched in the history of financial analysis. Although the mathematics of interest rates had a 3,000 year history before Fibonacci, his remarkable exposition and development of multi-period discounting is a quantum leap above his predecessors.

And, one final example:

Present Value Analysis The most sophisticated of Fibonacci’s interest rate problems is “On a Soldier Receiving Three Hundred Bezants for his Fief.” In it, a soldier is granted an annuity by the king of 300 bezants per year, paid in quarterly installments of 75 bezants. The king alters the payment schedule to an annual year-end payment of 300. The soldier is able to earn 2 bezants on one hundred per month (over each quarter) on his investment. How much is his effective compensation after the terms of the annuity have changed? ...

As before, Fibonacci explains how to construct a multi-period discount factor from the product of the reciprocals of the periodic growth rate of an investment, using the model developed from mercantile trips in which a percentage profit is realized at each city. In this problem, he explicitly quantifies the difference in the value of two contracts due to the timing of the cash flows alone. As such, this particular example marks the discovery of one of the most important tools in the mathematics of Finance – an analysis explicitly ranking different cash flow streams based upon their present value.

Class Materials for Lecture 12

Brief Outline of Topics Covered in Lecture 12:

The Rise of Socialist Thought (ch. 9)
Marxian Socialism (ch. 10)

Video:

Lecture 12 - YouTube
Lecture 12 - Google Video

Karl Marx
(1818-1883)

Homework #6

Economics 493
Fall 2008
Homework 6
Due Thursday, November 13

1. How do Mill's views on utility differ from Bentham's?

2. According to Mill, what are the three types of goods? Which type is the most common?

3. According to Marx, in the transition from slavery to feudalism to capitalism, how does each new system fool workers into working harder even though, in the end, they are no better off (i.e. still at subsistence)?

[Solution to Homework 6]

Class Materials for Lecture 11

Brief Outline of Topics Covered in Lecture 11:

Senior, and Mill (ch. 8)
The Rise of Socialist Thought (ch. 9)
Marxian Socialism (ch. 10)

Video:

Lecture 11 - YouTube
Lecture 11 - Google Video

John Stuart Mill
(1806-1873)

Homework #5

Economics 493
Fall 2008
Homework 5
Due Tuesday, November 11

1. Explain Ricardo's theory of rent and the law of diminishing returns. What policy conclusions did he draw from this analysis?

2. What is utilitarianism? How did Bentham's utilitarianism lead him to egalitarian reform proposals? Why didn't he advocate complete equality of income?

3. According to J.B. Say, what was the fourth factor of production? How did the addition of this fourth factor of production this remove potential sources of class conflict from classical theory? .

4. Discuss Nassau William Senior's views on the poor laws. What policies did he help to enact as a member of the Poor Law Inquiry Commission?

Solution to Homework 5 (Google, YouTube):

Note: I am told that, even with all that talking, I didn't cover the policy implications of Ricardo's theory of rent. Here is the response I gave by email:

The result of his analysis was the conclusion that corn laws raised rent. Since rent and profit are inversely related in Ricardo's model, this meant profit was lower, so capital accumulation was lower as well.  On this basis, he opposed the corn laws.

Class Materials for Lecture 10

Brief Outline of Topics Covered in Lecture 10:

Bentham, Say, Senior, and Mill (ch. 8)

Video:

Lecture 10 - YouTube Video
Lecture 10 - Google Video

Jeremy Bentham Auto-Icon

Jeremy Bentham: As requested in his will, his body was preserved and stored in a wooden cabinet, termed his "Auto-icon". Originally kept by his disciple Dr. Southwood Smith, it was acquired by University College London in 1850. The Auto-Icon is kept on public display at the end of the South Cloisters in the main building of the College. For the 100th and 150th anniversaries of the college, the Auto-Icon was brought to the meeting of the College Council, where he was listed as "present but not voting". Tradition holds that if the council's vote on any motion is tied, the auto-icon always breaks the tie by voting in favor of the motion.

The Auto-Icon has always had a wax head, as Bentham's head was badly damaged in the preservation process. The real head was displayed in the same case for many years, but became the target of repeated student pranks including being stolen on more than one occasion. It is now locked away securely

Homework #4 Solution

Economics 493
Fall 2008
Homework 4 Solution

1. According to Adam Smith, what is the difference between the market price and the natural price? Why is this distinction important?

From page 73 in the text:

Like Cantillon, Smith distinguished between the intrinsic or natural price of a good and its short-run market price. According to Smith, there are ordinary, or average, rates of wages, rent, and profit in every society or neighborhood. He called these the natural rates of each. When a commodity is sold for its natural price, there will be exactly enough revenue to pay these natural rates of wages, rent, and profit. The natural price is the long-run price below which the entrepreneurs no longer would continue to sell their goods. In a desperate situation they would sell goods more cheaply, but this would not continue. They could always go out of business or enter another line of production.

The actual price at which any commodity is sold is called its market price. It may be above, below, or exactly the same as its natural price. The market price depends on the aberrations of short-run supply and demand, and it will tend to fluctuate around the natural price. If it is above the natural price, more goods will come to market, depressing the price. If it is below the natural price, some productive factors will be withdrawn, the quantity supplied will fall, and the market price will rise toward the natural price. Restated, short-run supply and demand are not fundamental determinants of prices (exchange values), but instead simply cause fluctuations in market prices around the natural prices or values of commodities.

The reason it's important is shown by the description above, he was able to show how a capitalist economy would direct resources toward their most productive uses. There is no need for any sort of central director to ensure that resources are directed to the proper places and this led to his call to minimize government involvement in the economy.

2. Explain why Smith's value theory involved circular reasoning.

Smith starts with an adding up theory of value. Thus, the value of a good is the sum of wages, profit, and rent (that is, price = wages + profit + rent). However, when he defines each component on the right-hand side of the equation, he says they are each functions of the price. For example, both rents and profits will be higher when prices are higher according to Smith, and the same is true for labor. Thus, we have that price = wages(P) + profit(P) + rent(P) which defines price in terms of itself and is hence circular.

3. Explain Malthus's theory of gluts. What policy conclusions did he draw from the analysis?

This is explained on pages 91-94:

In Book II of Principle of Political Economy, Malthus developed his theory of the potential insufficiency of effective demand. He assumed that workers receive a subsistence wage. Employers hire these workers because they produce a value greater than that which they receive as wages; that is, the employer makes a profit. Because workers cannot buy back the total output, others must. The profit cannot be returned to workers in the form of higher wages because the disappearance of profits causes production and employment to cease. So who will purchase the extra output? Capitalists will buy some of it in the form of capital goods. Spending on capital goods stimulates production and employment, as does spending on consumption goods. But, said Malthus, the consumption by workers employed in productive labor can never alone furnish a sufficient motive to the continued accumulation and employment of capita. Investment is undertaken in the final analysis only to provide consumption, and if the final products cannot be sold, no investment will be forthcoming. To be sure, capitalists have the power to consume profits, but it is not their habit to do so. The central object of their lives is to amass a fortune, and they are too busy in the counting-house to consume it all:

There must therefore be a considerable class of persons who have both the will and power to consume more material wealth than they produce, or the mercantile classes could not continue profitably to produce so much more than they consume. In this class the landlords no doubt stand preeminent; but if they were not assisted by the great mass of individuals engaged in personal services, whom they maintain, their own consumption would of itself be insufficient to keep up and increase the value of the produce, and enable the increase of its quantity more than to counterbalance the fall of its price. Nor could the capitalist in that case continue with effect the same habits of savings.[10]

The Need for Unproductive Consumption

Spending by landlords is essential to avoid a glut of goods on the market that in turn would produce economic stagnation.[11] Rent, said Malthus, is a surplus based on the difference between the price of agricultural produce and the costs of production (wages, interest, and profits). Its expenditure therefore adds to effective demand without adding to the cost of production. The other forms of income - wages, interest, and profit - increase purchasing power but also raise production costs, and costs must be kept down if a nation is to maintain its competitive position in world markets.

Policy Implications

This theory of market gluts and the need for unproductive consumption had several policy implications. The most important one, according to Malthus, was that the corn laws must be retained. These tariffs on imported grain enrich the landlords and consequently promote unproductive consumption. The latter is necessary to avoid economic stagnation. Although Malthus favored unproductive consumption by landlords, including the hiring of large numbers of menial servants, he opposed excessive unproductive consumption financed by the government. Government officials, soldiers, sailors, and those who live from interest on the national debt necessitate higher taxes, which might impede the increase of wealth. Society should consider private property sacred, and it should not allow the redistribution of wealth through excessive taxation. Nor is a growing government debt desirable, because the inflation it promotes will hurt those on fixed incomes. In his Principles of Political Economy, Malthus implied that war offered another stimulus that could eliminate gluts... For times of acute economic distress, Malthus recommended government spending on public works...

4. Why did Ricardo focus on distribution rather than production?

In Smith's time, the analytical goal was to understand production, and Smith focused on issues such as division of labor and the keys to capital accumulation. He wanted to understnd what made a nation wealthy, and understanding production was a means of explaining the determinants of the wealth of nations. By Ricardo's time, there had been substantail growth in the ability to produce goods and services, enough so that it appeared people might escape the Malthusian trap. Hence, the key question become one of understanding how and why goods were distributed in particular patterns, and how the distribution would change over time.

Class Materials for Lecture 9

Brief Outline of Topics Covered in Lecture 9:

David Ricardo (ch. 7) [cont.]

Video:

Lecture 9 [Google video] - Fall 2008
Lecture 9 [YouTube] - Fall 2008

Lecture 9


Jean-Baptiste Say (1767-1832)
on Say's Law and the Impossibility of Gluts

"It is worth while to remark, that a product is no sooner created, than it, from that instance, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should vanish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent for other products ..."

"But it may be asked, if this be so, how does it happen, that there is at times so great a glut of commodities in the market and so much difficulty in finding a vent for them? Why cannot one of these 11 superabundant commodities be exchanged for another? I answer that the glut of a particular commodity arises from its having outrun the total demand for it in one or two ways; either because it has been produced in excessive abundance, or because the production of other commodities has fallen short."

David Ricardo (1772-1823)
on the Impossibility of Gluts

"No man produces, but with a view to consume or sell, and he never sells, but with an intention to purchase some other commodity, which may be immediately useful to him, or which may contribute to future production. By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person. 

Productions are always bought by productions, or by services; money is only the medium by which the exchange is effected. Too much of a particular commodity may be produced, of which there may be such a glut in the market, as not to repay the capital expended on it; but this cannot be the case with respect to all commodities."

John Maynard Keynes (1883-1946)
on Malthus and the Possibility of Glut

"The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo?s doctrine that it was impossible for elective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas. 

But although the doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation;? a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away."

Class Materials for Lecture 8

Brief Outline of Topics Covered in Lecture 8:

Thomas Robert Malthus (ch. 6) [cont.]
David Ricardo (ch. 7)

Video:

Lecture 8 [Google video] - Fall 2008

Lecture 8


Ricardo

Homework #4

Economics 493/593
Fall 2008
Homework #4
Due 10/30/2008

1. According to Adam Smith, what is the difference between the market price and the natural price? Why is this distinction important?

2. Explain why Smith's value theory involved circular reasoning.

3. Explain Malthus's theory of gluts. What policy conclusions did he draw from the analysis?

4. Why did Ricardo focus on distribution rather than production?

Class Materials for Lecture 7

Brief Outline of Topics Covered in Lecture 7:

The Classical School - Adam Smith (ch. 5) [continued]
Thomas Robert Malthus (ch. 6)

Video:

Lecture 7 [Google video] - Fall 2008

Lecture 7


Malthus

The Peterloo Massacre, 1819: The French Revolution postponed in England many reforms which had been rendered necessary by rapid industrial progress. Radicalism was associated in the public mind with a French origin, and that killed it politically. After Waterloo the tide turned and agitators gained a hearing. The landed interests wished to maintain the late war prices, and the artisan population desired cheap bread. Hence discontent, oratory, and riots which resulted in the loss of life. The most celebrated disturbance of these years is the "Peterloo Massacre" of 1819. On August 16th a mass meeting was arranged by the Manchester radicals to hear Henry Hunt, a speaker who advocated annual parliaments, universal suffrage, and the ballot. A crowd gathered in St. Peter's Fields, and trouble arose between it and the Lancashire militia who were present on the plea of preserving order. The troops charged and killed several persons, to the intense indignation of radical sympathizers in every part of the island.

The adjournment of the preceding meeting, the considerable interval of preparation which had been allowed; a vague feeling perhaps, that such assemblages would not much longer be permitted,---all conspired to render the concourse great beyond all former example. A little before noon on the 16th of August, the first body of reformers began to arrive on the scene of action, which was a piece of ground called St. Peter's Field, adjoining a church of that name in the town of Manchester. These persons bore two banners, surmounted with caps of liberty, and bearing the inscriptions: "No Corn Laws," "Annual Parliaments," "Universal Suffrage," "Vote By Ballot." Some of these flags, after being paraded round the field, were planted in the cart on which the speakers stood; but others remained in different parts of the crowd. Numerous large bodies of reformers continued to arrive from the towns in the neighborhood of Manchester till about one o'clock, all preceded by flags, and many of them in regular marching order, five deep. Two clubs of female reformers advanced, one of them numbering more than 150 members, and bearing a white silk banner. One body of reformers timed their steps to the sound of a bugle with much of a disciplined air; another had assumed to itself the motto of the illustrious Wallace, "God armeth the Patriot." A band of special constables assumed a position on the field without resistance. The congregated multitude now amounted to a number roundly computed at 80,000, and the arrival of the hero of the day was impatiently expected.

David Ricardo: The Iron Law of Wages, 1817

David Ricardo (1772-1823), an English banker was also an important early economist. His most well-known argument was that wages "naturally" tended towards a minimum level corresponding to the subsistence needs of the workers. The attraction of this idea for factory owners is evident. It also influenced Marx in his early pessimistic views about the possibility of workers benefiting from capitalism. Ricardo's views on the "labor theory of value" were also important in Marx's economic thought.

From David Ricardo. On Wages

Money, from its being a commodity obtained from a foreign country, from its being the general medium of exchange between all civilized countries, and from its being also distributed among those countries in proportions which are ever changing with every improvement in commerce and machinery, and with every increasing difficulty of obtaining food and necessaries for an increasing population, is subject to incessant variations. In stating the principles which regulate exchangeable value and price, we should carefully distinguish between those variations which belong to the commodity itself, and those which are occasioned by a variation in the medium in which value is estimated, or price expressed.

A rise in wages, from an alteration in the value of money, produces a general effect on price, and for that reason it produces no real effect whatever on profits. On the contrary, a rise of wages, from the circumstance of the labourer being more liberally rewarded, or from a difficulty of procuring the necessaries on which wages are expended, does not, except in some instances, produce the effect of raising price, but has a great effect in lowering profits. In the one case, no greater proportion of the annual labour of the country is devoted to the support of the labourers; in the other case, a larger portion is so devoted.

Labour, like all other things which are purchased and sold, and which may be increased or diminished in quantity, has its natural and its market price. The natural price of labour is that price which is necessary to enable the labourers, one with another, to subsist and to perpetuate their race, without either increase or diminution.

Midterm 1 Solution

Midterm 1 and Solution.

Solution to Homework #3

Economics 493/593
Fall 2008
Solution to Homework #3

1. What is the significance of the specie flow mechanism? Briefly, what is the essential difference between the views of Richard Cantillon and David Hume on how the specie flow mechanism operates?

The specie flow mechanism was significant because it undermined that idea that a country could run a positive balance of payments permanently - the source of wealth according to the mercantilists. Instead, the idea was based upon the natural law notion of an equilibrium that would prevail over the efforts of governments to manipulate the system to their advantage.

The essential difference between Cantillon and Hume centers on two factors, the extent to which they relied upon natural law and a notion of equilibrium, and in their analysis of  exports. Cantillon said, in essence, that an inflow of gold would raise domestic prices, and that would cause imports to rise. The rise in imports would then reverse the inflow of gold and cause the nation to become more impoverished. However, in this story he does not rely upon the idea of a long-run equilibrium, and exports are not emphasized.

Hume adds both. In his model, an inflow of gold can only be temporary. As gold (specie more generally) flows in, prices rise and this causes imports to rise, as Cantillon said, but he added that exports would also fall contributing to the decline in the inflow of gold. In the long-run, there is an equilibrium (all nations at zero balance), and natural law would force economies to this equilibrium point over time.

2. According to Adam Smith, what are the four stages of economic and social development? What are the characteristics of each stage?

The four states are:

Hunting: this is the lowest, rudest stage. The economies are too small to allow privilege, power, and class, and have (essentially) equal division of goods.

Pasturage: This is the next highest stage, and it supports larger social groupings (because it is more productive). Production is centered upon domesticated animals and herding, and for that reason it is generally a nomadic culture. This represents the first accumulation of wealth (e.g. cattle), and this leads to power and class distinctions, and the need for a government to protect property and other rights.

Agriculture: An example is medieval, feudal Europe. In this stage, people are predominantly settled in one area, and agriculture is the most important activity. Thus, classes are distinguished by ownership of the land. Adam Smith thought two features were important, (i) people were limited in how they could use their wealth (there was very little manufacturing and trade), and (ii) there was very little freedom or rights for the majority of the people.

Commerce: This is the highest stage. There is an increase in freedom and rights, and this was very important to Smith. In this system, people are allowed to pursue their self-interest, and thus they had more freedom, and with the behavior properly moderated by moral sentiments and competition, the pursuit of self-interest also promoted the greater good through the harmony of interests doctrine. The development of European cities was a major force in the development of capitalism as this spurred trade and freed people from the stifling nature of feudal technology. Classes were distinguished by ownership, and he defined three classes, landlords (who own land), capitalists (who own the means of production), and laborers (who own nothing but the ability to provide labor). Capitalists were the most important of the three classes.

3. What is the role of the state according to Adam Smith? What makes for good taxes?

Adam Smith believed in a minimal role for the state, a laissez-faire approach, but he recognized that government would still be necessary. In particular, government is needed to (1) protect society form attack by foreigners, (2) administer justice within the country, and (3) to erect and maintain public works and institutions the private sector cannot undertake profitably (e.g. education, bridges, roads, canals, harbor, post office, coins, churches, etc.)

Good taxes are taxes that (1) are proportional to the revenue enjoyed under protection of the state (he was arguing against the current regressive structure), (2) are predictable and uniform (time, amount, and means of payment), (3) are levied at the time most convenient to the taxpayer, and (4) are collected at minimum cost to the government.

Review Questions for Midterm 1

Review Questions for Midterm 1
Economics 493/593
Fall 2008

1. Why does the book choose to begin the study of the evolution of economic thought around the year 1500?

2. What factors were important in the transition from feudalism to capitalism? Discuss each factor.

3. Discuss the main features and policies associated with mercantilism.

4. Why did the mercantilists focus on exchange as the source of wealth? What was the role of the government under mercantilism?

5. What was Thomas Mun's major contribution to mercantilist ideas?

6. Discuss the ideas and contributions of Jean Babtiste Colbert.

7. Discuss the ideas and contributions of Sir William Petty.

8. Who were the Physiocrats? What policies did they advocate, and what problems did their policies address?

9. Discuss the ideas and contributions of Francois Quesnay. Explain Quesnay's Tableau Economique. Why is the table important in the history of economic thought?

10. Discuss the ideas and contributions of Anne Robert Turgot. Why was Turgot dismissed from his duties as finance minister in 1776?

11. Discuss the ideas and contributions of Richard Cantillon

12. Discuss the ideas and contributions of David Hume.

13. Discuss the ideas and contributions of Sir Dudley North.

14. What is the price-specie flow mechanism and why is it important? How do the ideas of Cantillon and Hume differ on this topic?

15. What is the essence of the classical school?

16. What is the main message of Adam Smith's book The Theory of Moral Sentiments?

17. According to Adam Smith, what are the four stages of economic and social development? What are the characteristics of each stage? How did the progression through the stages illustrate the invisible hand at work?

18. What is the role of the state according to Adam Smith? What makes for good taxes?

19. What reasons did Adam Smith give for increases in productivity brought about by the division of labor? What is the most fundamental division of labor? How does productive labor differ from unproductive labor, and why did he make this distinction? Ultimately, what is responsible for the wealth of nations?

20. Why does Adam Smith believe in free international trade? Are tariffs ever acceptable?

Class Materials for Lecture 6

Brief Outline of Topics Covered in Lecture 5:

The Classical School - Adam Smith (ch. 5) [continued]

Video:

Lecture 6 [Google video] - Fall 2008

 
Lecture 6

Additional reading:

The Theory of Moral Sentiments (1759): In 1759, Smith published his first work, The Theory of Moral Sentiments. He continued to revise the work throughout his life, making extensive revisions to the final (6th) edition shortly before his death in 1790.^[b] Although The Wealth of Nations is widely regarded as Smith's most influential work, it has been reported that Smith himself "always considered his Theory of Moral Sentiments a much superior work to his Wealth of Nations".^[58] P. J. O'Rourke, author of the commentary On The Wealth of Nations (2007), has agreed, calling Theory of Moral Sentiments "the better book".^[59] It was in this work that Smith first referred to the "invisible hand" to describe the apparent benefits to society of people behaving in their own interests.

In The Theory of Moral Sentiments, Smith critically examined the moral thinking of the time and suggested that conscience arises from social relationships.^[60] His aim in the work is to explain the source of mankind's ability to form moral judgements, in spite of man's natural inclinations toward self-interest. Smith proposes a theory of sympathy in which the act of observing others makes people aware of themselves and the morality of their own behavior. Haakonssen writes that in Smith's theory, "Society is ... the mirror in which one catches sight of oneself, morally speaking."^[61]

In part because Theory of Moral Sentiments emphasizes sympathy for others while Wealth of Nations famously emphasizes the role of self interest, some scholars have perceived a conflict between these works. As one economic historian observed: "Many writers, including the present author at an early stage of his study of Smith, have found these two works in some measure basically inconsistent."^[62] But in recent years most scholars of Adam Smith's work have argued that no contradiction exists. In Theory of Moral Sentiments, Smith develops a theory of psychology in which individuals find it in their self-interest to develop sympathy as they seek approval of the "impartial spectator". The self-interest he speaks of is not a narrow selfishness but something that involves sympathy.

Haakonssen adds that Theory of Moral Sentiments and Wealth of Nations "only contradict each other if Smithian sympathy is misinterpreted as benevolence and self-interest wrongly is narrowed to selfishness and then taken to be the reductive basis for all human motivation".^[63] Rather than viewing the Wealth of Nations and Theory of Moral Sentiments as presenting incompatible views of human nature, most Smith scholars regard the works as emphasizing different aspects of human nature that vary depending on the situation. The Wealth of Nations draws on situations where man's morality is likely to play a smaller role—such as the laborer involved in pin-making—whereas the Theory of Moral Sentiments focuses on situations where man's morality is likely to play a dominant role among more personal exchanges.

Solution to Homework #2

Economics 493/593
Fall 2008
Solution to Homework #2

1. What was Thomas Mun's most notable contribution to mercantilist thought? Explain.

Mun's most important contribution was to show that a nation should aim for an overall positive balance of trade, not a positive balance with each and every country if it want to maximize the inflow of gold.

Mun was a director of The East India Company, which relied upon imports, so he needed to provide a defense of the company's activities since imports resulted in gold flowing  out of the country. He argued that a country could import raw materials from one country (and hence run a negative trade balance), process the goods, and then sell them to another country for more than they paid for the raw materials. Thus, by allowing a negative balance with the resource producing country, more gold flowed in than if only positive balances were allowed.

2. Why do Physiocrats believe agriculture is the only productive class?

The guilds lasted longer in France than they did in other countries, and they were very unproductive. Thus, to the extent that there was any manufacturing (mostly crafts), it didn't add much value. When the Physiocrats looked at this, they did not see production as a source of value and wealth.

What they did see was occasional huge harvests from the farm sector, and even in normal years you got more out of it than you put into it. Thus, they believed that nature - through agriculture - was the only source of value in the economy (which corresponded with their general adherence to natural law precepts).

3. Why is the Tableau Economique important in the history of economic thought?

The Tableau (a) is the first analysis of the circular flow of goods and services through an economy, (b) represents the origins of macroeconomics, (c) provides the means to answer questions about the distribution of income, (d) foreshadows national income accounting, and (e) illustrates the notion of an equilibrium or stationary state.

4. Why was Turgot dismissed from his duties as finance minister in 1776?

Turgot managed to make just about everyone angry, except perhaps the powerless peasants:

Nobility: disliked plans to place all taxation on agriculture. Turgot tried to placate them with a tax incidence argument (i.e. that they pay it all anyway since that's the only source of surplus), but it didn't do much to ease their dissatisfaction.

Clergy: distrusted him because he didn't go to church regularly and he urged religious liberty. Also, they didn't like that he viewed them as unproductive.

Financiers: disliked that he took out loans from foreigners at lower interest rates - that cost them money.

Royal Family: weren't happy with his opposition to extravagance.

Tax farmers: didn't like that he wanted to replace them with government tax collectors.

Rich Capitalists: Turgot wanted to break up their monopolies, that didn't make them very happy.

The result: Ousted in 1776 and all of his reforms were canceled immediately.

Solution to Homework #1

Economics 493/593
Fall 2008
Homework #1

1. List and briefly explain the major tenets of the mercantilist school.

They are:

They believed gold and silver are the most desirable forms of wealth. They also believed that the wealth of a nation depended upon the quantity of gold and silver in its possession. To achieve this, countries should maintain a positive balance of trade (with every country in the early years, but in later years they thought that an overall positive balance of payments was the goal, not a positive balance with every country you trade with).

They promoted nationalism. Since everyone cannot have a positive trade balance - they saw trade as a zero-sum game - a country needs to be powerful in order to compete effectively. This led to a desire for a strong military, a strong navy in particular.

They promoted protectionism in all its guises to maximize exports and minimize imports.

They supported colonization. This was a source of cheap raw materials, and a captive market to sell the finished goods. This essentially creates monopoly power since they did not let other countries trade with their colonies.

They believed in free trade within a country, but monopolies on external trade so as to be as powerful as possible in trade negotiations.

They favored a strong central government to enforce regulation of business (regulation was widespread and used to try to maintain the quality of goods so they would be in high demand on international markets)

They believed a strong central government would also help with another goal, that of maintaining a large, hard-working, poorly paid labor force (e.g., they had maximum wage laws) . The point of focus was the nation, not the individual, and this helped to keep goods cheap, made them competitive, and hence helped with the accumulation of gold and silver. They did not tolerate idleness, and forced children into the workforce as soon as they were able.

2. Choose a country that is currently attempting to use economic policy to affect their trade balance and interpret those policies from a mercantilist perspective. In what way do the policies fit the mercantilist framework? In what way are they different?

I suspect many people will choose China, so I will too. In a lot of ways, China pursues a mercantilist philosophy. There is an emphasis on a positive trade balance, they use a strong central government and policies such as export subsidies and currency pegs to try to manipulate the trade balance, nationalism is promoted, and while there isn't direct colonization, they have certainly worked to promote strong ties with resource producing countries in Africa and elsewhere. I'd argue they also place more emphasis on the welfare of the individual household than the mercantilists did, though I'm not sure everyone would agree.

But I would argue there is an important difference, and that is in the goal of the balance of payments policy. For mercantilists, the accumulation of gold and silver was an end in and of itself, that was the point. But it is not the point in China, a positive trade balance is a means to an end (one of which is building reserves to protect against currency speculation and other problems). They are pursuing what they believe is an effective development strategy, but they understand what Adam Smith understood, that the wealth of a nation is in its technology and productive capacity, not in the quantity of gold and silver in it possession. Thus, China is using its development policy to try to acquire the technology it needs to be more than a simple assembly-line country (as many of its industries now are), and in that respect is very different from what a typical mercantilist would have advocated. For example, many of the deals they sign with companies have element of technology transfer, and this is a deliberate strategy.

Class Materials for Lecture 5

Brief Outline of Topics Covered in Lecture 5:

The Classical School - Forerunners (ch. 4)
The Classical School - Adam Smith (ch. 5)

Homeworks 1 and 2 due at end of class.

Video:

Lecture 5 [Google video] - Fall 2008

Lecture 5

Additional reading:

Adam Smith

Two famous quotes from the Wealth of Nations:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual value of society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; 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 an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

And:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.

Homework #3

Homework #3
Due 10/16 (Thursday) at the end of class

1. What is the significance of the specie flow mechanism? Briefly, what is the essential difference between the views of Richard Cantillon and David Hume on how the specie flow mechanism operates?

2. According to Adam Smith, what are the four stages of economic and social development? What are the characteristics of each stage?

3. What is the role of the state according to Adam Smith? What makes for good taxes?