History of Economic Thought
1) Why Study past economic thinkers?
a) This helps us to explain and teach the ideas of economics
b) The thoughts of brilliant people are always worth studying – even their mistakes are insightful.
c) We will understand our own thoughts better by observing the development of thought
2) Why did economics as a field of study show up in the middle Ages and not before?
a) The development of national political units in which there was shared national identity.
b) The idea of individuality began to develop.
i) Previously people were tied to certain social and occupational roles
ii) It is becoming possible to change social status from that of birth
c) Commerce is expanding
i) As populations grew people began to specialize
ii) Geography defined certain trade patterns
d) People became more accepting of material wealth and acquisition
i) Avarice was one of the 7 deadly sins
ii) The goal of human behavior was to fill niche and win salvation
iii) Now people began to pursue material enrichment
e) Systematic thought and invention became more prevalent
i) Scientists looked for natural patterns in reality
ii) Maps, printing press, windmill, bookkeeping and contracts were developed.
iii) People became confident in their ability to unravel the world’s mysteries
a) Mercantilism spanned various viewpoint for over 200 years
b) Tenants and thoughts include emphasis on building national power, building exports and accumulation of money (gold)
i) Economic policy focused on goal of national power
ii) National power depended on money held
iii) Mercantilists encouraged exports and discouraged imports to build nations supply of precious metal
iv) Favored large population of low-wage workers to build exports which brought in more gold
v) Gold collection stimulated economy by expanding supply of money and credit
c) Certain mercantilist concerns mirror issues of today
i) Want to have large trade surplus, subsidizing big businesses and keeping wages low
d) Josiah Child was 17th century mercantilist.
i) Was defense contractor
ii) Wrote book which was published anonymously “Circumstances on the Discourse of Trade”
iii) Argued that Britain must lower interest rates because Holland had done so.
iv) Didn’t have much of an economic foundation
e) Jean-Baptiste Colbert was French Minister of finance from 1661 to 1683.
i) Advocated ware as an instrument of economic policy
ii) Regulated the minute details of industry (cloth weave and thread count)
iii) Wanted to increase work, exports and child labor
iv) This extreme government control still lives in France today
f) Bernard Mandeville, a social satirist, wrote “The Fable of the Bees”
i) The satire preached the themes of hard work and the beneficial consequences of private self interested behavior.
ii) Linked avaricious behavior to increased trade.
g) David Hume questioned the mercantilist assumptions of his day.
i) He denied that money and gold were equivalent to wealth.
ii) He thought that hording gold would result in higher prices.
iii) He thought that imports and exports were beneficial
iv) He suggested that trade benefits both parties since they wouldn’t trade otherwise
4) Physiocracy, the first school of economics represents a reaction to mercantilism
a) The Physiocrats rose in reaction to Cobert
b) The “Tableau Economique” highlighted key thoughts
i) Held a “laissez-faire” attitude which contradicted the absolute gov control
ii) Divided society into three classes
c) Important social impact
i) French had physiocrat finance minister who reduced controls but was fired
ii) Started division of society into classes which is useful to analysis even today
iii) Adam Smith drew upon their work
5) Adam Smith
i) Smith harbored strong feelings about his education from his time at Oxford university. His initial university training was at Glasgow.
ii) He quit his job as a professor to become a private tutor, a job for which he received twice as professors wage
iii) Although an advocate of free trade, he served as a commissioner of customs in Scotland
b) Smith published The Wealth of Nations in 1776. In that he described the building blocks of national economic wealth
i) The starting point of wealth of nations is a division of labor which allows people specialize
(1) His example was the pin factory in which each worker performs a separate operation
(2) Productivity rises due to improvements and dexterity, use of time, and application of machinery
(3) The division of labor and leads to an interconnected economy
ii) The propensity to trade is the second building block
(1) So if perceived that in the real world, most people are motivated by self interest
(2) The notion of benevolence is admirable, but in most cases people expect to be paid for their goods or services
iii) Smith thought the “invisible hand” would guide people who act in their own self interest to provide benefits for each other and for society
iv) Smith attacked to the mercantilist ideas
(1) He emphasized that bullion is not equivalent to wealth
(2) He argued that trade benefits all parties involved. It is not a zero sum game
v) Despite his tremendous success, Smith fell short on certain points
(1) Economists questioned where value came from and how prices were determined
(a) Smith separated value in use from value in exchange
(b) He believed that labor was the source of value
(2) Smith search for the natural prices of goods and services
(3) He discussed the development of an economy including landlords, workers and capitalists.
vi) Smith discusses many appropriately roles of government
(1) He’s not a complete believer in laissez-faire economics
(2) He believes that government should implement certain public works projects, public education, and certain trade regulations
(3) Smith understood that the division of labor could also ensure workers
(4) He describes the ignorance and landlords
(5) He distrusted businessmen since they often exploited others and created monopolies
(6) Smith also distrusted the government
6) Thomas Malthus (1766-1834)
a) Malthus studied at Cambridge and became a minister in the church of England and a professor of history and political economy
b) Malthus wrote and discussed mainly his principles on population
c) Malthus began with two postulates
i) First, that food is necessary
ii) Second, that the affection between the sexes would continue
iii) Malthus leave the population and the food supply would grow with different rates
(1) Population would grow geometrically
(2) The food supply would grow arithmetically
(3) Therefore population would out strip the food supply, and mass starvation would result
iv) Malthus predicted several different outcomes from this scenario
(1) The growth in population would lead to misery and famine
(2) Although voices such as prostitution and birth control would contain this population increase, Malthus did not recommend these auctions
(3) Instead, he suggested moral restraints to inhibit population growth
(4) He also believe that public education, especially for the poor, would help solve this problem
v) Malthus was a critic of the poor laws which were similar to today’s welfare programs
(1) He felt the poor laws encouraged people to have more children
(2) He encouraged abolition of the poor laws that he believed in workfare and in giving people land
vi) The Malthusian thesis has not stood up well over time
(1) Population has not outstripped food and famine has not wiped out the world’s population
(2) He overlooks changes in social custom and morality especially as relating to birth control
(3) Nor did he take into account the interaction of economic growth and birthrate
7) David Ricardo (1772-1823)
i) Was the son of Jewish immigrants from Holland
ii) His formal schooling ended at age fourteen
iii) He learned of the stockbroker trade from his father
iv) He was disowned by his family yet he made a fortune in the stock market
v) He became a best friend to Malthus
b) Ricardo’s economic career focused on inflation in the distribution of income
i) Ricardo believe that increasing the money supply during the bullion controversy caused inflation
ii) He discussed the distribution of income in his book, The Principles of Political Economy and Taxation
(1) He believed that landlords possessing good lanes would make increasing up amounts of money
(2) He wrote that wages would be set in accordance with the minimum that people need to live
(3) He thought profits would equalize overtime
iii) Malthus and Ricardo had differing worldviews
(1) The two economists disagreed on the nature and causes of gluts and recessions
(a) Ricardo adopted Say’s law which states that supply creates its own demand
(b) Malthus predicted that people would produce but not consume, which would lead to higher levels of saving
(2) They argued over the Corn Laws
(a) The corn laws protected British farmers by restricting imports of corn from France
(b) Malthus supported the corn laws since they would support and expand the British landlords
(c) Ricardo opposed the corn laws because the hurt the interests of workers and consumers
(3) They argued over value and price
8) John Stuart Mill (1806-1873)
a) James Mill raised a son John Stewart as a child prodigy who would carry the flag for a new type of economics
i) He read many great books
ii) Studied Greek and Latin at young age
b) Mill wrestled with Jeremy Bentham’s utilitarianism
i) Utilitarianism believes that the good news for patents of something should be measured in terms of its contribution to people’s happiness
ii) Utilitarian to emphasize the importance of the individual
iii) Thus they favor universal suffrage, a secret ballot, support for the poor, jobs for unemployed, and prison reform
iv) This philosophy did not take into account love and justice
v) These concepts, as well as well as his upbringing, lead Mill to a nervous breakdown
vi) During his recovery he fell in love with Harriet Taylor, a married woman
vii) They corresponded and spend time together for twenty years until her husband died at which time he married her
c) Mill wrote on economic and non economic topics
i) He wrote a number of political essays
ii) He wrote The Principles of Political Economy, one of the great texts in classical economics
d) The classical school hailed the following tenets
i) It advocated minimal government intervention
ii) It felt that self interested behavior was part of human nature
iii) Social harmony resulted when individuals pursue their own interests
iv) All economic resources and activities add value
e) Mill laid out the foundations of supply and demand
i) He articulated how supply and demand would equalize as prices rose or fell
ii) He thought about what happened when the supply did not change or when the supply change repeatedly
iii) He studied the short and long-term effects of economic decisions
f) He practically raised the problems of economies of scale and market break down
i) He understood that this production increased fixed costs decreased
ii) He explored monopolies and there effects on markets
g) He clarified that really ideas regarding international trade
i) He supported free trade and build a model based on comparative advantage
h) He was open to government intervention under certain circumstances
i) He thought that the government should perform certain tasks and accomplish certain goals
ii) He did criticize the government as many points
i) He developed the idea of Homo Economicus or economic man
i) The economic manages a simple theory to understand how people act economically
ii) People’s goals include building up wealth, enjoying a luxury, desiring leisure, wanting children
iii) This idea rests on the assumption that people base their actions on these goals
j) Mill influenced both utilitarianism and utopianism
i) He brought in the subject of economics
ii) He separated production and distribution
iii) He considered an ideal of reformed capitalism as a defense against socialism
iv) He was a radical moderate
9) Karl Marx and Socialism
a) The origins of socialism
i) We’ve examined the intellectual trajectory of the classical economists
(1) This trajectory began with Adam Smith and went through John Stuart Mill
(2) These economists believe that natural propensities drove people toward certain natural harmony
ii) The industrial revolution disrupted these assumptions
(1) The building of factories for new manufacturing change social structures of city and country
(2) Karl Marx criticized capitalism and that new and often dreadful working conditions that it produced
iii) The utopian socialists responded by giving up on capitalism
(1) They objected to capitalism on moral grounds
(2) They set up a detailed plans to run people’s lives, but these plans lacked realism
iv) Scientific socialists such as Marx responded that capitalism was doomed for scientific reasons
b) The biography of Karl Marx (1818 to 1883)
i) Marks had a relatively uneventful but literally productive life
(1) He was born in Prussia
(2) He studied in Germany and was exiled first to Paris and then to Brussels
(3) He wrote the Manifesto of the Communist Party in 1848
(4) He was exiled to London and 1849 and lived there the rest of his life
(5) He published Das Capital in 1867
ii) A prototypical scholar, Marx sent mixed messages
(1) He both to read and disagreed with everything
(2) He had many negative qualities, including difficulties in dealing with other people
(3) He was sick and impoverished for most of his life
iii) Was Marx responsible for Soviet totalitarianism?
(1) Some have tried to hold Marx responsible for Stalin
(2) Although he may have been wrong an unpleasant, he cannot be held responsible for the many uses to which his ideas have been put
iv) Marks tried to formulate a capitalist laws of motion
(1) The relation of the bourgeoisie to the proletariat involved over time
(2) Marx felt that society was divided into two conflicting groups
(3) He had enormous respect for the productive power of the bourgeoisie, but he decried its room is impact on workers’ lives
v) The labor theory of value assumed a linkage between surplus value and capital accumulation
(1) Marx argued that workers needed to produce more than they were paid
(2) The bourgeoisie’s needs to have ever rising profits will lead to exploit the workers selected appropriate surplus of value for itself
(3) Marx thought that the workers should retain all the value they created
vi) This thinking had certain implications
(1) Marx’s ideas imply that the rate of profit would fall
(2) He believed that big companies would concentrate both capital and wealth and undercut smaller producers
(3) He predicted that economic instability and class conflict would ensue
vii) Marx predicted the ultimate establishment of the socialist utopia
(1) He thought that the number of capitalists would dwindle as the proletariat grew in power
(2) He did not clearly lay out all this would happen
viii) Marx’s views do not seem import to us who enjoy the benefits of 20-20 hindsight
(1) The proletariat has not become isolated and immiserated
(a) Poverty and income equality remain
(b) Yet the crushing poverty of which Marx wrote is not evident today
(c) Technology has created more jobs than it has eliminated
(2) The labor is area value is also open to criticism, in fact it is been largely destroyed
(3) Profit rates is not collapsed
(4) Scale has increased, but not continually
(5) Economic instability does not seem to grow continuously
(6) Marx did not think the political system would adapt, as it is done in numerous cases over time
(7) Marks failed to accept a dynamic markets had a gut level
(a) He did not understand how a free economy creates new jobs
(b) He did not understand that employ years have a vested interest in treating workers well
(c) He thought that markets would break down
ix) Marxist economics summarized
(1) Economists must separate social and economic analysis
(a) Recognize the importance of the separation
(b) He saw himself as advocating the interests of the working man
(c) He was a scientific rather than a sympathetic
(2) Although Marx purported to be a scientific finger, his theories rested on weak scientific foundations
(a) He held the labor theory of value
(b) His scientific economic analysis was not borne out by events
(3) Nevertheless, Marx was a brilliant thinker
(a) He touched the hearts and emotions that many of his readers
(b) Many of his ideas remain with us today
(c) He set the intellectual agenda for the social sciences for nearly a century
10) Alfred Marshall and Marginalist Thought
a) The Marginalists revolutionized economics
i) Marginalism applied the concepts of physics to economics
ii) Marginalists focused on the events that occurred on the margin
iii) A whole group of thinkers came to the same idea of thought about the same time
iv) The Marginalists theorized about how people valued and demanded goods and services
v) The believed economic actors balanced utility and price
vi) Williams Stanley Jevons challenged the labor theory of value
vii) John Bates Clark challenged Marx’s labor theory of value
viii) In a Marginalist thinking, all workers did not contribute equally to productivity
b) Alfred Marshall ( 1842 to 1924) combined various aspects of marginalist thinking
i) First we examine Marshall’s early life and educational pursuits
(1) His father was a taskmaster
(2) He began by studying at six moved on to mathematics, then onto physics, and finally ended up in economics
ii) Marshall shrank from publishing his ideas
(1) He developed ideas but it took in longer to perfect and published them
(2) He was quirky regarding his intellectual pursuits
(3) He was progressive in its treatment of women even though he opposed admitting them to Cambridge
iii) In his later career, Marshall built the modern economics profession
iv) Marshall focused on human behavior rather than on wealth of nations, relationships between classes, or analytical problems
(1) He regarded economics as a social science
(2) He believed that worksheet people’s lives
(3) He wrote about the impact of poverty upon economics and upon people’s lives
v) Marshall brought mathematical clarity to economic terms
vi) His analysis was based on systematized theory of supply and demand
(1) Marginal thinking led to the formation of the demand curve
(2) Marginal costs of production led to the formulation of the supply curve
(3) Marshall’s writings ended the dispute over value
(4) Marshall developed economic diagrams still in use today
vii) Marshall completed the vocabulary of modern economics
(1) He developed the idea of measuring price elasticity
(2) He broke costs into fixed and marginal costs
(3) He wrote about substitution among different objects of consumption and labor
(4) He spoke about the long run and shorter on how the passage of time affecting economic analysis
(5) He discussed economies of scale and external economies
viii) Marshall was neoclassical with a concern for social justice
(1) He did not think a Marxist scientific thoughts worked in practice
(2) He did not agree that the state would wither away
ix) Marshall felt it was important to deal with human beings as they actually behave rather than as we would prefer them to behave
x) Marshall launched an economic counter attack in support of social justice
(1) He regarded both apathy of exaggeration as the evils
(2) He made an honest effort to devise sensible ways to improve society
11) Ludwig Von Misses, Henry Hazlitt and F.A. Hayek
a) The Socialist Calculation Debate
i) By the beginning of the twentieth century socialism faced an intellectual crisis. Marginalism, in theory, had demolished socialism. Empirically, Marx’s predictions did not come true.
ii) Socialists seized the opportunity to rethink their ground. They look to John Stuart Mill for inspiration. They discussed the viability of managing the economy scientifically. They blended neoclassical economics with social planning
iii) In 1908, Enrico Barone proposed the possibility of putting these ideas into practice. He replaced the invisible hand with the ministry of planning. He proposed the establishment of a planned society in which markets would operate. This is known as the idea of market socialism.
b) The Austrians, Ludwig von Mises ( 1881 – 1973) and Friedrich Hayek ( 1899 – 1992) offered a critique of this new socialism.
i) Mises, Hayek and others founded the school of Austrian economics.
ii) Hayek was the leading Austrian economist of the twentieth century
iii) The Austrian’s responded to the concept of market socialism
(1) They saw the market as the best mechanism for calculating, coordinating and making choices.
(2) The Austrians saw markets and competition as a method for discovering information
(3) In the Austrian view, prices were an information signal in the market.
(4) They thought the competition led to desirable decentralized social planning.
(5) They worried about the problem of who would watch the planners
(6) They also proposed that the business cycle was created based upon expansions and contractions of the money supply.
iv) The socialists responded with a set of tough questions
(1) The market socialist proposed and involved version of pure socialism in which the free markets would determine both buying and selling prices. Yet they thought the means of production would be socially controlled.
v) Oscar Lange ( 1904 – 1965) epitomize this new market socialism. He described how to reach the market price faster, distributed income more fairly, took social costs into account, avoided monopoly capitalism, and led to greater economic stability.
vi) We must take various factors into account and trying to decide which side prevailed in this debate
(1) Each side thought it had prevailed over the other
(2) The feelings about winners and losers were based on timing
(3) At the time of the debate it was commonly felt that the socialists had won
(4) Current thought however that the Austrians have scored a victory.
(5) However one must define what socialism really is. To the economists from the nineteen thirties Our present economic system would be considered socialism.
12) Joseph Schumpeter and Entrepreneurialism
a) Schumpeter believes that entrepreneurs were central to the business cycle
b) He believed that creative destruction of entrepreneurs drove an economic growth. Innovation was central to capitalism and new production functions serve to shake up the system. He believes that new businesses and new firms were central to the economy.
c) Schumpeter thought the entrepreneurs should think up new things and devise new ways of doing things. He believed people acted as entrepreneurs only occasionally, not continually. He believed that entrepreneurs were buried inside institutions. In his view entrepreneurs were driven because of their desire to build a dynasty and establish themselves as lords or kings in some way.
d) Schumpeter wrote a book on the business cycle
i) On the upside, innovation led to new investment opportunities, which had a ripple effect.
ii) Yet this welcoming the investment climate lead people to overbuild and borrow thinking that the good times would continue indefinitely. The result was a decline in the business cycle.
iii) He saw the shifts the cycles of innovation. And thought that the availability of profits signals where money should be invested.
iv) He characterized these waves into three types
(1) Large entrepreneurial innovations cause Kondratieff waves that lasted for decades
(2) Smaller innovations caused Jugular waves that lasted approximately ten years
(3) Kitchin waves were shorter still
(4) These waves do not appear with the regularity that Schumpeter had predicted
v) Schumpeter offered the following explanation for the great depression.
(1) The depression occurred when all three cycles headed down and turn at the same time.
(2) Thus the depression was part of a necessary correction process
e) Schumpeter mused on capitalism and socialism
i) He argued that with pure productive power, capitalism would continue
ii) He believe that over time, large firms would make entrepreneurs obsolete
iii) He thought that the political weakness of entrepreneurs would undermine efforts of capitalism
iv) He believed that intellectual complainers would become disgruntled and more powerful, and that they would undermine the moral stability of capitalism
v) He claimed that socialism could work and that it was possible to plan the economy. He was not for socialism that he believed that central planning was inevitable.
vi) Marx and Schumpeter believe that capitalism was doomed and that socialism would prevail
(1) Marx thought the poor would lead the revolution against capitalism
(2) Schumpeter thought that the intellectuals would leave the assault of capitalism
(3) Schumpeter recognized Marx’s intellect but also saw his limitations
vii) Schumpeter have a truly free mind that transcended ideology. He was a deep thinker who is bold enough to predict the future that did not appeal to him. He thought that socialism would collapse for political rather than economic reasons. He anticipated the large government structure that we have today
13) John Maynard Keynes (1883-1946) and Keynesian Economics
a) Keynes lived as if he had more than 24 hours per day.
b) World war one was followed by a sense of economic stagnation and stability
c) He perceived that the economy, the world, and especially the capitalists institutions were breaking down
d) He believed that if the long run economic progress within two or
i) He believes that the economy would grow with 2% annually
ii) He concluded that, barring wars, the economic problem would be solved within 100 years
iii) Although he believed that the short run outlook was terrible, he was confident that things would improve the long run
e) Keynes Attempted to explain the reasons for the great depression
i) He distinguished between the decision to save and the decision to invest. In Practice he thought people generally saved the same, regardless of the interest rates. Yet he also thought that business investment fluctuated greatly depending on the interest rate. Therefore savings and investment would be out of sync.
ii) He criticizes stock market investors in the disease of speculation. He thought that the stock market investing was merely a game, based on anticipation rather than on logical sense. He proposed a tax on speculation to slow it down just like one would do to gambling.
iii) Keynes found that a lack of effective demand caused economic problems. He believed that when savings increased and investment was discouraged, buying power, and in turn production, would decrease, causing a vicious circle to develop. He found that as an economy became richer, people save their money, which also slowed down the economy.
iv) He felt the businesses had two choices when demand fell. They could respond to the lack of demand by cutting wages or laying off workers. He argued it was easier for workers to accept a rise in inflation than a personal cut in pay.
v) He defended the government’s ability to pump up demand. He wanted the government rejects money into the economy. He Encouraged the government to do something other than watch the economy sink into a depression.
vi) Keynes altered economic thinking
(1) He referred to his predecessors and used their work. He was not wholly original and his ideas.
(2) He violated the negative aspects of saving. He showed the effects of too much savings on government deficit.
(3) He thought that the government needed to encourage investment and spending
vii) He brought macroeconomic analysis to fore. Macroeconomic analysis did not exist prior to the nineteen thirties. Keynes focused on the economy as a whole an aggregate demand in the economy
viii) Keynes conceived the idea that government had of responsibility and the power to manage the economy. Because of this we hold the president accountable for the economy. His analysis focused on solving current economic problems he understood both the policies and theories of economics
14) Milton Friedman and the Chicago School of Economics
a) Friedman began his career as a statistician. He developed the method of sequential sampling for statistics. He won the Nobel prize in economics in 1976 and was a key player in the Chicago school of economics.
b) Friedman worked on the permanent income hypothesis and studied farsighted expectations. He explained the difference between annual income and permanent income.
i) He found that current consumption also depended on expectations of future income
ii) Friedman believe that people would spend extra income on an investment, such as the car or a major appliance
c) Prevent study income and consumption patterns over time and over cross section of the population. He found that as income rose overtime 90% of income went to consumption. In cross section analysis, Freidman and found that poor family spent a larger percentage of their incomes and rich people did. He concluded that people look to have in life to determine spending patterns, and therefore consumption patterns depended on expectations of income.
d) The study had harsh implications for Keynesian thought, theories of expectations, and the methodology of economics. Friedman’s work brought Keynesian assumptions into question by showing that the economy was working more smoothly and Keynes had expected. Friedman combined theoretical underpinnings with his theoretical background.
e) Friedman changed how the economic profession regarded money matters
i) Despite the importance of balancing the money supply, economist did not think much about money. That’s all money as a tool to help goods and services circular pattern economy
ii) Freedom and set out to read the complete monetary history. He did this at a time and others thought it was useless. This was modern social science research at its finest. From his history of money, Friedman developed the quantity theory of money.
f) From his historical research freedom and found the money affected the economy in four ways
i) He’s argued that incompetent monetary policy caused the great depression. The depression was a great contract should have the money supply and the Federal Reserve was unwilling to counteract it.
ii) He believed that money was useful for social convention. He found that monetary policy to present money from causing economic problems. He argued that the Federal Reserve should expand the money supply at a steady rate over time.
iii) Friedman’s ideas have implications for the unemployment inflation tradeoff
(1) He argued that the level of unemployment was determined by many different factors. He believed that the economy would move to a natural level of unemployment.
(2) Understanding this, he argued that the country needed to decide if it wanted high inflation or low inflation when this happened.
(3) He said there would be a given amount of unemployment, unless the government got out of the way.
iv) Friedman brought market oriented thinking and economic freedom into public discourse
(1) He believed that the system of fixed exchange rates would not work. And twenty years later it collapsed.
(2) In 1952 he argued for an all volunteer army, which was later adopted.
(3) He argued for school vouchers in 1962
(4) He proposed both replacing welfare with cash payments and instituting a negative income tax
(5) He supports the flat rate income tax
(6) He proposed that government should cease printing money and let private enterprise handle it.
(7) He opposes Social Security because he thinks people take it for granted