Exam Preparation: Herewith all the questions (according to sections) of the last 6 exam papers.

Section A: This section counts 40 marks – have to explain 8 concepts counting 5 marks each.

The fear of goods One of the principles of the Mercantilist school is duty free importation of raw materials that could not be produced domestically, protection for manufactured goods and raw materials that could be produced domestically and export restrictions on raw materials. Emphasis on exports & a reluctance to import has been called the fear of goods.

The division of labour Petty did not develop this idea in details but he did recognize the economies associated with the specialization of labour and division of tasks. Adam Smith later further developed the idea. Smith said the division of labour increased the quantity of output produced for 3 reasons – 1. Each worker develops increase dexterity in performing on single task repeatedly. 2. Time is saved as workers need not go from one task to the other. 3. Machinery can be designed to increase productivity once tasks have been simplified & made routine.

Why, according to Marx, capitalists exploit labourers According to Marx all commodities sell at their value and thus to make a profit capitalists had to purchase a commodity that can create value greater than its own – labour. Exploitation only arise when workers can produce more in a day than they must consume in order to maintain themselves and their families. Employers (capitalists) pay the worker the full market value of their labour power but the daily pay equals only part of the value the labourers create. Thus there is a surplus. This surplus is then the profit for the capitalist while the labourers are exploited.

Inductive, historical method vs abstract, deductive method Inductive, historical method is the German Historical school. Economists of this school emphasized the importance of studying the economic historically as part of the integrated whole. Abstract, deductive method is the Marginalist school. Marginalists rejected the historical method in favor of abstract, deductive, analytical approach pioneered by Ricardo and other classicist.

Partial equilibrium analysis vs general equilibrium analysis Partial equilibrium analysis was used by Marshall. It only considers one aspect while leaving all other aspects constant. Example: If the price of oil increases, demand will decrease cetris paribus. General equilibrium analysis considers the interrelationship among many variables in the economy and was developed by Leon Walras. The GEA looks at every aspect this increase in the price will have – substitute demand will rise, other products prices will rise due to this increase thus reducing their demand, complementary goods demand will fall etc. The GEA looks at the bigger picture while PEA only looks at one piece of the picture.

The long-run Phillips curve Each short run Phillips curve shows the combinations of inflation and unemployment that are possible when the actual rate of inflation diverges from the expected rate. In the long run there is no trade off between inflation & unemployment. The long run Phillips curve is vertical, indicating that any one of several rates of inflation is compatible with the natural rate of unemployment.

“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” This statement was made by Adam Smith who was one of the major contributors of the Classical School. The consumer looks to find the lowest price for a good, given its quality. The worker tires to find the highest pay, given the nonwage aspects of the job. Each of these members of the market look out for themselves (self-interest) by first meeting their own needs but still give the client a far deal. Thus they are still being moral and everyone is better off in the end.

Functional distribution of income according to Ricardo Ricardo wanted to understand the force that determine the shares of the national income accruing as wages, profits & rents (interest was combined with profit). Wages – natural price is given the habits & customs of the people, enables workers to subsist and to perpetuate themselves without a change in their numbers. Market price depends on supply & demand. Ricardo felt that the rates f profits in different fields of enterprise within a country tend to equalize. Entrepreneurs want the highest profits and move money to obtain this. Due to increase demand for food poorer land will come into cultivation and will cause better land to be worked more intensively. Rent will therefore rise. Nominal wages will also rise to maintain the natural wage. Thus profit rates and profit share of national income will fall.

Wage fund doctrine Mill, like many before him, accepted the wage fund doctrine. Wages according to him depend mainly upon labour demand & supply. Wages cannot rise except by an increase of the aggregate funds employed in hiring labourers or by a decrease in the numbers of workers employed. Wages cannot fall except by a decline of the funds devoted to paying for labour or by an increase in the numbers of labourers to be paid. According to Mill, government cannot increase total wage payments by fixing a minimum wage about the equilibrium level. The higher wages that some workers would receive will be offset by the loss of employment others will face. This doctrine provided a basis for opposing unionism but Mill did not use it for this purpose. Workers cannot raise their income through collective action – if wages rise in one place it falls in another.

Institutions An institution is not merely an organization or establishment for the promotion of a particular objective, like a school/prisons/union. It is also an organized pattern of group behaviors, well established and accepted as a fundamental part of the culture. It includes customs, social habits, laws, modes of thinking and ways of living.

Institutions and their role in Institutionalist economics An institution is not merely an organization or establishment for the promotion of a particular objective, like a school/prisons/union. It is also an organized pattern of group behaviors, well established and accepted as a fundamental part of the culture. It includes customs, social habits, laws, modes of thinking and ways of living. Economic life, according to institutionalist, is regulated by economic institutions, not by economic laws. Institutionalists were especially interested in analyzing and reforming the institutions of credit, monopoly, absentee ownership, labour management relations, social security and the distribution of income. They advocate economic planning & the mitigation of the swings of the business cycle.

Soviet of technicians according to Veblen There is constant conflict between two sides – industries and business, big and small... Veblen was critical & friendly towards socialism but was not a socialist himself. Veblen though engineers – the technicians of society – might eventually lead the social revolution and operate industry for the common good. They are the ones to object ownership, finance, sabotage, credit and unearned income because these interfere with technological efficiency and progress. Engineers are the best representation of the community at large,

because capital and labour, bargaining over prices have become a loose knit vested interest that seeks its own benefit to the detriment of society. The outcome has been business like concessions and compromise between them. The two sides play a game of chance and skill, with the industrial system becoming a victim of interference on both sides. Material welfare of the community depends on the smooth working of the industrial system without interference. Engineers can achieve this as unlike owners and workers they are not motivated by self interest. Because they are more homogeneous and unified they are natural leaders and people with spirit of tangible performance and the most highly developed instinct of workmanship. Veblen believed technicians could solve the nation’s problems but the chances of this happening was remote.

Quasi-rent according to Marshall In the short run land and manufactured capital goods are similar because the supply of both is fixed. The return to old capital investments is something akin to rent: Marshall called it Quasi-rent. Quasi-rent is the earning on previous capital investments in the short run. In the long run quasi-rent disappears because a normal return to the fixed capital investment is essential if the investment isto be renewed and business perpetuated.

Why, according to Keynes, the economy is inherently unstable According to Keynes the economy is given to recurring booms & busts because the level of planned investment spending is erratic. Changes in investment plans cause national income and output to change by amounts greater than the initial changes in investments. Equilibrium levels of investment and saving – those that are applicable after the adjustment has occurred – are achieved through changes in national income as opposed to changes in the rate of interest. Investment spending is determined jointly by the rate of interest and the marginal efficiency of capital. Interest rate depends on people’s preference for liquidity and the quantity of money. Marginal efficiency of capital depends on the expected future profits and the supply price of capital. The expected rate of profit from new investment is unstable and therefore one of the most important causes of business fluctuation.

Malthus’s explanation for the failure of Say’s Law Malthus saw the economy as having perfectly synchronized production rounds of equal lengths. Thus all firms start producing at the same time, pay wages at the same time and start selling fished goods at the same time. It would then appear that the finance to buy up the output of the current production round consists of nothing more than the wages paid out during the current production round. Entrepreneurs are thus prevented from making any profit even when workers spend their wages in full (no leakages). Because these wages are a cost of production for the firm, the following must hold for the firm sector as a whole: aggregate demand for goods = cost of producing these goods. Firms can at best earn back what they previously paid in wages and demand is never sufficient for firms to make a profit. As a result of not making a profit, firms will not be inclined to invest and economic activity would stagnate. This was the problem Malthus saw. The only way for firms to make a profit is to find a demand for their goods which is not a cost of production for them.

The commonalities of socialism (ie what all forms of socialism have in common)

1. Rejection of classical view about harmony of interest between classes of society

2. Rejection of classical concept of laissez-faire

3. Rejection of classical idea of Say’s Law (markets are inherently unstable)

4. Perfectibility of people given the right social system; with the right system, people will become good

5. Need for some kind of collective action or state ownership

Consumer & producer surplus Consumer surplus = total utility of a good is the sum of the successive marginal utilities of each added unit. The price a person a person pays for a good never exceeds and seldom equals the price which he or she will be willing to pay for that good. Only at the margin will price generally match a person’s willingness to pay. Total satisfaction a person gets from purchasing successive units of goods exceeds the sacrifices required to pay for the goods. Producer surplus is everything between the equilibrium price and above the supply curve.

Collectivism (or dogmatic state socialism) This type of socialism regards private ownership of business firms as the root of the problem. For that reason, collectivism advocates the complete abolition of private property in the means of production. All business enterprises are to be nationalized. No private businesses will be allowed.

Friedman’s modern quantity theory of money According to Friedman the demand for money is relatively stable in the short run. The FEB (RBSA) system controls the supply of money. An increase in the supply of money will leave people holding cash balances in excess of amounts they want. In an attempt to get rid of the money they spend money on goods (transactions). However now the money on moves in the economy from the one to the other. Due to this the demand for goods, output & prices will increase. In an economy operating at its natural level of employment and output –only prices will rise over the long run. As the prices rise the demand to hold money will rise as more money is needed to buy the same goods. Eventually an equilibrium will be reached between the quantity of money supplied and demanded but this will be at a higher price level. Friedman assumed that the demand for money is highly stable – more stable than functions such as the consumption function that are offered as alternative key relations.

Tableau economique Quesnay, whom formed part of the Physiocratic school, constructed the Tableau economique for the king of France in 1758 and revised it later. It depicted the circular flow of goods and money in an ideals, freely competitive economy. This was the first systematic analysis of the flow of wealth on what later came to be called a macroeconomic basis. Quesnay assumed that land is owned by landlords but is cultivated by tenant farmers, who are therefore the only productive class. The products that the tenant farmers create has to satisfy not only their own needs but also the needs of the landowners. In addition the output of the farms provides for the needs of the sterile class (manufacturers & merchants). The tableau shows how the net product circulates among the three classes and how it is reproduced each year.

The distinction between natural prices and market prices Natural prices: In every society there is average or natural rate (wages, profit and rent). When a good is sold at the natural price there will be exactly enough revenue to pay these natural rates. This is the long run price below which the entrepreneur would no longer continue to sell the goods. Market prices: Actual price at which a good is sold. Depends on the short run supply & demand workings and it will fluctuate around the natural price.

Bullionism Bullion is another word for plain bars of precious metals. These bars have not been minted or coined. The idea that wealth is equal to precious metal money and that a nation’s wealth is therefore consists of the total amount of gold and silver within its borders is called Bullionism.

The credit system according to Veblen

According to Veblen credit plays an important role in modern business. Borrowing money can increase profits as long as the current rate of business earnings exceeds the rate of interest. Those who take advantage of the opportunities offered by credit will be in a position to undersell the other firms who do not take advantage of this. Thus credit becomes wide spread & typical. The use of credit gives a firm a differential advantage against other firms but the credit expansion has no aggregate effect on earnings or on total industrial output. Aggregate net profits in fact reduce because firms have to pay back the loan + interest.

Endogenous money according to the Post Keynesians Post Keynesians regard the stock of money as being essentially endogenous to the economy, changing in response to changes in the level of wages. The need of trade dictates the supply of money. Keynes himself pointed out that money “comes into existence along with debt”. Inflation arises from the fight over the shares of the distribution of income. Wage increases cause production costs to rise, creating a greater demand on the part of firms for working capital to finance their more expensive goods in progress and inventories. Hence, business borrowing rises and the money stock increase.

Why a fall in the nominal wage rate need not raise the level of employment according to Keynes A single firm can increase sales & employment through wage cuts because the demand for its products will remain unchanged. A whole economy, can however not easily increase sales buy cutting nominal wages (assuming it is isolated from international trade) because wages are a source of demand for goods as well as a cost of production. If wages begin to fall, people may come to expect them to fall further – which may cause firms to postpone investment spending, making the depression worse. If these falling wages result in falling prices, this again worsens matters as the real burden of debts increases, transferring wealth from the entrepreneurs to the rentier. Profit margins also become smaller thus reducing incentive for new investments. Because wage cuts hurts wage earners who have a high propensity to consumer (spend) and helps employers who have a low propensity to consumer (spend) the overall propensity to consume is diminished and this again makes matters worse. Less spending and less investment means that the growth of firms is standing still – thus no new jobs created.

The distinctions between rational expectations & adaptive expectations Rational expectations: Market participants reflect on their past errors, use and process all available information, and succeed in eliminating regularities in errors in predicting future price level changes. Because people understand that expansionary fiscal & monetary policies produce inflation they immediately adjust their inflation expectations upward when government undertakes these policies. Adaptive expectations: People determine their expectations about the future inflation on the basis of past and present inflation and change their expectations only as new events unfold.

The Physiocrats on land and taxation of landowners Physiocrats thought that industry, trade and other professions were sterile and only agriculture was productive. Land is therefore equal to rent. Physiocrats thought that because only agriculture produced a surplus, which the landowner received in the form of rent, only the landowner should be taxed. All taxes imposed on others would be passed on to the landowners anyway. A direct tax on landowners was preferable to indirect taxes, which increase as they were passed along to others.

Smith on self-interest Smith’s self-interest refers to the desire to meet one’s own needs – earn your own money, pay your own food. This type of self-interest is entirely moral and can even go a step further where one is concerned with the interests of others. Self-interest as the dire to meet one’s own needs is thus not inherently immoral, selfish or greedy. It only becomes theses when done at the exclusion of a concern for the interests of others, when it is pushed so far that it squeezes out any generosity or any desire to see others get a fair deal to.

Malthus on the Poor Laws

Malthus believed poverty and misery are natural punishments for the failure by the “lower classes” to restrain their reproduction. He felt that their must be no government relief for the poor. He believed that by giving them aid would cause more children to survive thus ultimately worsening the problem of hunger. Some of his ideas were adopted into the Poor Laws. This law abolished all relief for able-bodied people outside workhouses. A man applying for the relief had to pawn all his possessions and then enter a workhouse before assistance was granted; his family either entered a workhouse or was sent to work in the cotton mills. Either way, the family was broken up and treated harshly to discourage it from becoming a public charge. These workhouses were invested with a social stigma and entering them can at a high physiological cost. The law aimed at making public assistance so unbearable that most people would rather starve quietly than submit to its indignities.

Ricardo on technological unemployment (that is, unemployment due to machines replacing workers) Ricardo believed that the introduction of machinery would help all 3 major classes of income receivers. Their money incomes would remain the same, while their real incomes would rise – because goods could be produced cheaper with machines. Even workers would gain because the same labour would be demanded as before mechanizations and therefore their nominal wage would not fall. He believed that even if the number of workers in one industry became excessive, capital would shift to another industry and thus workers would be needed there. The only temporary problem would be maladjustment that occurs when capital and labour move from one employment to the other. He later revised his arguments and said that the capital now invested in machinery was deducted from the capital available to pay wages. The long run effect was definitely more favorable than the short run effect. Even if the money profit of the capitalist remains the same after an increase in investment in machinery, more could be saved due to the reduction of costs of production. Thus the capitalist can invest more, ultimately reemploying the redundant workers. Thus technological unemployment is more likely to be a short term problem but a problem nevertheless for workers.

Marx’s theory of history For Marx, history is a process through which the static relations of production (the thesis) come into eventual conflict with the dynamic forces of prodcution (the antithesis) . The static forces are rules, social relations among people and property relations which are all reinforced by the superstructure. The dynamic forces include the technology, types of capital, skill level of labour and these all are constantly changing. The result of this conflict revolutionized the system so that new relations of prodcution permit the higher development of the forces of production. The mechanism for overthrowing old societies is the class struggle and Marx saw society evolving through 6 stages. The first stage had no classes or exploitations and so the society gradualy moved to a stage where classes and exploitation were very common.

The Chicago school on the role of government This school believed in a limited governemt. Government is inherently inefficient as an agent for achieving objectives that can be satifsied through private exchange. Government officials have their own objectives that they seek to optimize and therefore inevitable divert a portion of the resouerces at their disposal to purpose other than those that benefit taxpapers. Rather than being in the public interest, government regulation normally benefit those who seek the regulation or those who learn to marshal it to their private advantage.

Smith on the role of government Adam Smith believed in an invisible hand that channels self-interested behaviour in such a way that the social good emerges. The pursuit of self-interest, restrained by competition, thus tends to produce Smith’s social good – max output & economic growth. This harmony of interests implies that intrusion by Government into the economy is unneeded & undesirable. According to Smith governments are wasteful, corrupt, and inefficient and the grantors of monopoly privileges to the detriment of the society as a whole. He also argued that governments should not interfere in international trade. He did however see 3 major roles of government – 1 to protect society from foreign attack, 2 – to establish the administration of justice and 3 – to erect & maintain public works and institutions that private entrepreneurs cannot undertake profitable.

Mill on production Mills analyzed 3 productive factors – land, labour & capital. Productive labour includes only those kinds of exertions that produce utilities embodied in material objects. Labour that yields a material product only indirectly is also held to be productive thus including educators & government officials. Unproductive labour is that which does not terminate in the creation of material wealth. Capital is the result of saving and is the accumulated stock of the produce of labour, and its aggregate amounts limits the extent of industry. Everything that is not spent is saved and everything saved is invested. Thus the rich by use of their savings (investments) can give employment to the poor. If the rich spend less o luxury goods and more on investments then the wage fund & demand for labour would rise. If the population increase, the increase in demand by wage earners would offset the decrease in demand for luxury goods by capitalists. If the population does not increase in proportion to the growth of capital, wages would rise and luxury consumption by workers would supplant luxury consumption by their employers. This is the optimistic world of full employment. Population is limited by the fear of want rather than by want itself (people do not reproduce above a point where they can support their wants/needs). Increase of capital depends on two things – the surplus product after the necessities are supplied to all engaged in production and the disposition to save. The greater the products that can be made from capital the stronger the motive for its accumulations. Land is limited and Mill applied the short run law of diminishing returns and the long run concept of returns to scale to land.

The New Keynesians on unemployment The decline in aggregate demand produce declines in real output and corresponding increases in unemployment because the price level and nominal wages are inflexible downward. Factors such as menu costs, formal and implicit contracts, efficiency wages & inside-outside relationship create this downward inflexibility of prices & wages. Persistent, lasting low output & high unemployment, not an automatic rightward shit of the aggregate supply curve may result unless government undertakes as expansionary fiscal and monetary policy to increase aggregate demand.

Say on Say’s Law Say’s chief claim to fame rests on his theory that general overproduction is impossible. This is known as Say’s Law. It is worthwhile 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.

Veblen on the instinct of workmanship – PG 406 Veblen believed that work is not generally irksome, or else the survival of the human race would be jeopardized. Humanity’s greatest triumph over other species in the struggle for survival has been a superior ability to control the forces of environment. People want to work and they want to do it well. They deprecate waste. Allied with the equally important instinct for parenthood, the instinct for workmanship impels the current generation to improve life for posterity. Basically we try to avoid greed and indolence, we educate and train our children, we improve technology, and we conserve our resources – all because of our instinct for workmanship and our wish to provide for our descendants. Formerly the market was narrow and business was managed with a view to earning a livelihood. The growth of markets and investments has created new opportunities for shrewd manipulation. As the captains of industry enlarge their domain, their interests diverge more and more from those of the rest of the community. Instead of being interested in the production of goods, they are interested primarily in maximizing profits. When making money takes precedence over making goods, the instinct for workmanship is thwarted because production comes to be rated in terms of salability. The absentee owners, who are in control, hamper the increased output of goods that would otherwise occur. Their manipulations prevent prices from falling. They force workers and capital into the more competitive sectors of the economy, thus worsening the situation there. They profit from disturbances in the system that may hinder output. If the economy is unstable the opportunities for

profit increase. The shrewd operator can make money as a bull during the upswing of the business cycle and as a bear during the downswing. Big firms are more interested in the vendibility of goods than in their serviceability for the needs of society. Those interested in problems of price rather than in production include business entrepreneurs and their assistants – salespeople, accountants etc.

Lucas’s aggregate supply analysis Lucas distinguished between short & long run aggregate supply. Producers expecting higher profits, increase employment and output moving along the supply curve. The short run aggregate supply curve is upsloping, the unanticipated price level increase and the real output expands. But all prices are increasing due to the general increase in aggregate demand. All firms collectively experience rising costs, causing the short run aggregate supply curve eventually to shift leftward. In the long run the aggregate supply curve is simply a vertical line with the same output but higher price. As nominal cost fall, the short run aggregate supply curve shits rightward. The economy is self correcting and so the recession automatically ends as the curves move and shift.

Why, according to Ricardo, price determines rent rather than the other way around Ricardo could ignore the influence of rent on price, because he (Ricardo) assumed a single use of agricultural land, say grain production. There being no alternative uses, the opportunity cost of grain production is zero. As an opportunity cost of land use, rent is therefore zero; so it cannot influence price. Ricardo assumes “marginal cost pricing” of agricultural products (price = marginal cost), while rent is not part of the marginal cost of the land cultivator. Rather it is a fixed cost, which remains the same for the land cultivator, irrespective of how much he produces on his parcel of land. Because rent is reckoned as part of average cost (total cost divided by quantity produced), rent then impacts price.

“People dive for pearls because they have value” vs “Pearls have value because people dive for them. Smith stated that pearls have value because people need to dive to get them, that is, that the cost of production determines a good’s exchange value or relative price. Labour was the only resource in a primitive society and thus the time it took to dive the pearl was the element that gave it the value.

Keynes on the instability of capitalism The role of capital in production & employment Ricardo on the labour theory of value Marshall on interpersonal utility comparisons people dive for them” Land as a production factor Competition vs cooperation, and the pros and cons of both “Rent is price determined but not price determining” Marginal utility and its role in marginalist economy The role of cooperation-associations & competition-disassociation sin a collectivist

economy and a liberal-capitalist economy

Section B: Answer two of the three questions, each of which carries 30 marks. Section counts 60 marks

Explain the classical labour theory of value. Indicate how Smith’s, Ricardo’s and Marx’s versions of the theory differ. Assess the merits of the theory by indicating the unrealistic assumptions involved.

Adam Smith broke the Labour theory of value into two parts – primitive society and advanced economy. In a primitive society labour was the only resource and the relative value of the good would be determined by the amount of labour necessary to produce it. If it took two hours to kill a deer and only one hour to kill a pig – one deer would be equal to two pigs. The value of a commodity to a person who wishes to exchange it for another commodity is equal to the quantity of labour which it enables him to purchase. Labour is thus the real measure of the exchange value of all the commodities. In a primitive society labour is the source and the measure of exchange value. Smith realized that in an advance economy the growth of capital would invalidate a simple labour cost theory of value. The reason for this is, let’s assume there are two commodities made from labour of equal skill. Suppose we add up all the time required to make each commodity, including the labour needed to produce the raw materials and the labour needed to produce the capital goods used in production. Let’s assume each commodity takes two hours to produce but commodity A – potatoes can grow anywhere where there is land. Commodity B - cotton requires a large capital injects to start. Most people will choose the potato route seeing that there is little capital investment (or none) and that they can get the same return for labour. In a society where capital investment and land resources become important goods will normally be exchanged for other goods, money, or for labour at a figure high enough to cover wages, rent and profits. The real value of commodities can no longer be measured by the labour contained in them. The quantity of labour that a commodity can buy exceeds the quantity of labour embodied in its production by the total profits and rents. According to Smith, demand does not influence the value of commodities, the cost of production – wages, rent and profits – are the only determinants of value in the long run. Smith assumed that production will expand or shrink at constant cost per unit of output. Competition will drive prices down to costs, including a normal profit. Any increase in demand will not increase value because the costs of producing each unit of commodity remain unchanged. If we assume either increasing or decreasing costs, Smith’s principle becomes untenable.

Ricardo believed that for a commodity to have exchange value it must have use value. Possessing utility or use value, commodities derive their value from two sources – their scarcity and the quantity of labour used to obtain them. Thus non-reproducible good’s value will only be determined by their scarcity. But most commodities fall in the reproducible goods class and Ricardo assumed that they are produced without restraint under conditions of competition. Ricardo’s labour theory only applied to these goods. Ricardo, unlike Smith, only applied his theory to an advanced economy and stated that Smith’s distinction between the two is artificial. According to Ricardo the exchange value of a commodity depends on the labour time needed to produce it. This labour time not only includes the work done by making the commodity but also the work embodied in the raw materials and capital goods used in the process of production. Ricardo felt that is could be used to determine that causes of changes. Example if 1 deer = 2 pigs but in two years it changed to 1 deer = 3 pigs. However the problem with this theory is, it does not seemingly account for such factors as differences in capital-labour ratios among industries, different combinations of skilled and unskilled workers, variation in wages, profit rates and rent among producers. Ricardo recognized each and addressed them. Difference in capital-labour ratios: Ricardo simply stated that a commodity will sell at more than its labour-time value if more than average capital is invested in this production and vice versa. Difference in labour quality: Ricardo recognized that all labour is not equal and broke it down into groups – A and B. If worker A is twice as productive as worker B then 1A = 2B. Thus exchanging 1A for 2B workers will leave the total labour time unaffected. Wages, profits and rents: Exchange value does not depend on wages, it depends on the quantity of labour. Thus skilled workers will receive higher wages. As wages increase the profits will decrease by the same amount. Therefore a change in wages will only affect the ratio of

profits to wages and not the exchange value of the good. Rent does not figure into the exchange value of a commodity. Rent does not affect the price of goods – but prices of goods are one of the elements that determine rent.

Marx said a commodity is something produced for profit and capable of satisfying human wants. This commodity may satisfy these wants directly or indirectly and the use values constitute the substance of all wealth. Marx did not try to measure use values quantitatively not did he consider diminishing utility with increasing quantities of a commodity. Marx would say that a large wheat crop represents a greater utility and therefore greater wealth than a small crop. This would be true, even if the demand is inelastic, the more abundant crop might have lesser value in exchange but there would be more to exchange. Marx said the socially necessary labour time embodied in the commodity, considering normal conditions of production and the average skill and intensity of labour at the time determined the value of the commodity. This socially necessary labour time includes the direct labour in producing the commodity, labour embodied in the machinery and raw materials that are used up during the process of production and the value transferred to the commodity during this process. A product’s value is measured in units of simple average labour. Skilled workers count as multiple unskilled workers. The market place equalizes the labour time of different skills to one common denominator of unskilled labour. The market also determines the prices that are based on the underlying labour costs. Temporary fluctuations of supply and demand will cause prices to deviate from true values, sometimes rising above value and sometimes falling below it. This continual oscillation of prices allows them to compensate each other and reduce themselves to average prices that reflect the values of commodities. To Marx, labour time determines the absolute value of goods and Ricardo believed that the relative values of different commodities are proportional to the labour time embodied in each. Marx believed his theory stripped away the illusion that owners of land and capital contribute to a commodity’s value. His theory thus opened the door to exploitation of labour.

Write an essay on the economics of John Maynard Keynes. To what extent have the post-Keynesians and New Keynesians carried forward the most important elements of Keynes’s message?

John Maynard Keynes was the founder of the Keynesian school. This school is one of the most significant schools of economic though and it arose out of the neoclassic school. His system was based on subjective psychological approach and it was permeated with marginalist concepts. Major tenets of this school:

1. Macroeconomic emphasis: Keynes and his followers concerned themselves with the determinants of the total or aggregate amounts of consumptions, saving, income, output and employment.

2. Demand orientation: Keynesian economist stressed the importance of effective demand as the immediate determinant of national income, output and employment. Aggregate expenditure = sum of consumption, investment, government and net export spending. Effective demand established the economy’s actual output, which in some cases is less than the level of output that would exist if there were full employment.

3. Instability of the economy: Economy is given to recurring booms and busts because the level of planned investment spending is erratic.

4. Wage and price ridged: Wages tend to be inflexible downward because of such institutional factors as union contracts, minimum wage laws and implicitly contracts. Reduced aggregate demand for goods -> lower sales -> firms produce less commodities -> lay off workers ->THEN prices will go down. Deflation occurs only under conditions of severe depression.

5. Active fiscal and monetary policy: Keynesian economists advocated that the government should intervene actively through appropriate fiscal and monetary policies to promote full employment, price stability and economic growth.

Lasting contributions: concepts such as the consumption function, marginal propensity to consume, saving function, marginal propensity to save, marginal efficiency of capital, transaction, precautionary and speculative demands for money, multipliers, IS-LM analysts – are all now standard in economic textbooks.

The post-Keynesians are a small, diverse group of economists. Major tenets of this school with regard to Keynes:

1. Piero Sraffa produced a novel conclusion – the level of domestic output is entirely independent of how it is distributed between wages and profits. Any distribution of wages and profits is consistent with a particular level of output. Robinson and others expanded on this theory. Robison believed these policies are firmly rooted in the proper interpretation of Keynes’s The General Theory.

2. Endogenous money – post-Keynesians regard the stock of money as being essentially endogenous to the economy, changing in response to changes in the level of wages. The needs of trade dictate the supply of money. Keynes pointed out that money “comes into existence along with debts”.

3. Pronounced cyclical instability – The economy is inherently unstable. This links with Keynes Instability of the economy. Post Keynesians stated that investment must grow sufficiently to keep national income and output growing at a steady rate. But because of periods of alternating environment of business optimism and pessimism (booms and busts) it often does not.

4. Need for an incomes policy – post-Keynesians believed that inflation cannot be controlled through conventional instruments of fiscal and monetary policy. An incomes policy limits the average annual wage increase to the nation’s annual rate of productivity growth. A successful incomes policy holds down inflation, minimizes the redistribution of income from inflation, and avoids the loss of output associated with anti-inflationary fiscal and monetary policies.

The New Keynesians, most modern Keynesians who reject the neo-Ricardian value theory and call for incomes policies of the Post-keynesians.The NK have refocused their attention on the traditional Keynesian question of why recession occur. Their answer is that declines in aggregate demand produce declines in real output and corresponding increases in unemployment, because the price level and nominal wages are inflexible downward. They also believed that active fiscal and monetary policy may be needed to affect the rightward shift of the aggregate demand curve.

Write an essay on the institutional school of economics, whereby you refer to the contributions by Veblen & Galbraith. To what extent does institutional economics offer a credible alternative to mainstream, mathematically-oriented economics?

At the time the institutional school was started the two major methods of achieving social change were recognized – reorganize society along socialist lines and undertake social reform. The major tenets of this school:1. Holistic, broad perspective. The economy must be examined as a whole. 2. Focus on institutions. The school emphasized the role of institutions in economic life. Institutions is also an

organized patter of group behavious, well-established and accepted as a fundamental part of the culture. 3. Darwinian, evolutionary approach. The evolutionary approach should be used in economic analysis, because

society and its institutions are constantly changing. 4. Rejection of the idea of normal equilibrium. Rather than the idea of equilibrium, Institutionalists emphasized

the principle of circular causation, or cumulative changes that may be either salutary or harmful in seeking economic and social goals.

5. Clashes of interest. Instead of the harmony of interests that most of their contemporaries and predecessors deduced from their theories, the institutionalist recognized serious differences of interest.

6. Liberal, democratic reform. The institutionalist espoused reforms in order to bring about the more equitable distribution of wealth and income.

7. Rejection of pleasure-pain psychology. The Institutionalists challenged the development of rigid orthodoxy in economic thinking. The Institutionalists stress on looking at the economy as a whole as part of an evolutionary process and in an institutional setting added elements of realism to economic analysis. They promoted a reform movement that effectively removed many of the rough edges of capitalism.

Veblen was critical of social movement favoured a radical reconstruction of society. Veblen’s first book was the Theory of the Leisure Class. This class is characterized by conspicuous consumption, propensity to avoid useful work and conservatism. Veblen attacked the Neoclassical economics and stated that consumers are not sovereign (‘dollar/rand votes’ very uneven and skewed towards conspicuous consumption), hedonistic motive is too narrow, rational calculation (profit/utility maximisation) is unrealistic and distribution theory: a justification for present power relations. Veblen on the instinct for workmanship - Workers do not regard work as inherently irksome and unpleasant( no negative utility as under neoclassical economics), People want to work and do it well (motivated by the pleasure of achievement, and of providing a better life for children.Veblen on credit and business cycles - Bank credit allows firms to buy capital goods without first having to save, bank credit does not add to total real income, which is not true. Veblen overlooks: that bank lending expands the money stock and thus boost money income, that increases in the money stock stimulate investment and employment. Yet Veblen is right: the easier access to credit creates an advantage for big business over small business; big gets even bigger. Credit money system tends to create cyclical instability. Veblens Solution: Soviet of Technicians - Hope lies in technicians and engineers, as the true carriers of the instinct for workmanship.

Galbraith’s major writings constitute both an attack on neoclassical economic though and an analysis of modern capitalism. He felt cconventional (neoclassical) economic wisdom is obsolete; circumstances have changed and only survives because of lack of alternatives. Large firms create a Dependence Effect with advertising. They create artificial wants for goods through advertising and the welfare no longer increases with the rise in output. The neoclassical theory of consumer demand, with its emphasis on consumer sovereignty, implies that the market dictates the optimal compostion of output and allocation of resources. There is also an overprovision of private goods, underprovision of public goods (roads, parks, schools, hospitals).Galbraith’s Theory of the firm - Corporate big business (“planning sector”) not controlled by shareholders but by technostructure (elite managers, engineers, scientists, etc). Technostructure pursues more complex purposes than mere profit maximisation - protective purpose: survival and affirmative purpose: growth.

Write an essay on Marx’s law of motion of capitalism. To what extent has the historical record borne out Marx’s predictions?

Marx used 6 important interrelated concepts to construct his theory of capitalism: the labour theory of value, the theory of exploitation, capital accumulation and the falling rate of profit, capital accumulation and crises, centralization of capital and concentration of wealth and class conflict. Labour Theory of value: Marx said a commodity is something produced for profit and capable of satisfying human wants. This commodity may satisfy these wants directly or indirectly and the use values constitute the substance of all wealth. Marx did not try to measure use values quantitatively nor did he consider diminishing utility with increasing quantities of a commodity. Marx would say that a large wheat crop represents a greater utility and therefore greater wealth than a small crop. This would be true, even if the demand is inelastic, the more abundant crop might have lesser value in exchange but there would be more to exchange. Marx said the socially necessary labour time embodied in the commodity, considering normal conditions of production and the average skill and intensity of labour at the time determined the value of the commodity. This socially necessary labour time includes the direct labour in producing the commodity, labour embodied in the machinery and raw materials that are used up during the process of production and the value transferred to the commodity during this process. A product’s value is measured in units of simple average labour. Skilled workers count as multiple unskilled workers. The market place equalizes the labour time of different skills to one common denominator of unskilled labour. The market also determines the prices that are based on the underlying labour costs. Temporary fluctuations of supply and demand will cause prices to deviate from true values, sometimes rising above value and sometimes falling below it. This continual oscillation of prices allows them to compensate each other and reduce themselves to average prices that reflect the values of commodities. To Marx, labour time

determines the absolute value of goods and Ricardo believed that the relative values of different commodities are proportional to the labour time embodied in each. Marx believed his theory stripped away the illusion that owners of land and capital contribute to a commodity’s value. His theory thus opened the door to exploitation of labour. Theory of Exploitation: Profit can be made by purchasing the one commodity that can create a value greater than its own. This commodity is labour power. Labour power refers to a person’s ability to work and produce commodities. Labour time is the actual process and duration of work. Labour power is itself a commodity that is bought and sold in the market, this is what capitalists need to make a profit. The exploitation of workers is the extraction of surplus value by capitalists. This arises only when workers can produce more in one day than they must consume in order to maintain themselves and their families. Now capitalists pay the worker a full day’s wage but the daily pay only equals a part of the value the worker created. The rest or surplus is the profit. The selling prices of commodities produces in constant cost, capital intensive industries will sell above their values, whereas labour intensive commodities will sell at prices below their true values. Thus according to Marx the labour theory of value still holds but only for the capitalist system as a whole. Capital accumulation and the falling rate of profit: According to Marx the rate of profit received by capitalists will tend to fall over the long run. The reason is the drive toward increasing efficiency through mechanization and labour saving inventions. Capital accumulation and crises: The falling rate of profit is just one of the insoluble problems of capitalism according to Marx. Marx attacked Say’s law, stating that at best it applied only to simple commodity production. Self- employed artisans, seeking to acquire use values, produce commodities in order to exchange them for others they wish to consume. C-->M-->C. Money is simply the medium of exchange. Under large scale capitalist productions the process becomes MCM, where people buy in order to sell. Money is changed into commodities such as labour power, raw materials and machinery. The products are then sold for money. The above does not make sense except if the second M is larger than the first thus making it MCM’, and it is larger by the amount of surplus value squeezed out of the productive workers. This is the process of expanding investments. Centralization of Capital and concentration of wealth: the dynamics of capital accumulation and the tendency for recurring business crises centralize the ownership of capital and concentrate wealth in fewer hands. Class Conflict: The concentration of wealth in the hands of a few capitalist and the absolute and relative impoverishment of the workers together set the stage for class conflict.

Write an essay on Say’s Law (Supply creates its own demand) in which you pay attention to:

o Why, according to Say, the law holds

General overproduction is impossible according to Say. If a nation’s power of purchasing is exactly measured by its annual produce – the more you increase the annual produce the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation. Supply creates its own demand.

o Why, according to Malthus, the law does not hold. Refer to Malthus’s advocacy of the Corn Law in this context

Malthus saw the economy as having perfectly synchronized production rounds of equal lengths. Thus all firms start producing at the same time, pay wages at the same time and start selling fished goods at the same time. It would then appear that the finance to buy up the output of the current production round consists of nothing more than the wages paid out during the current production round. Entrepreneurs are thus prevented from making any profit even when workers spend their wages in full (no leakages). Because these wages are a cost of production for the firm, the following must hold for the firm sector as a whole: aggregate demand for goods = cost of producing these goods. Firms can at best earn back what they previously paid in wages and demand is never sufficient for firms to make a profit. As a result

of not making a profit, firms will not be inclined to invest and economic activity would stagnate. This was the problem Malthus saw. The only way for firms to make a profit is to find a demand for their goods which is not a cost of production for them. The corn laws placed tariffs on imported grain and effectively placed a minimum price on grain imported.

o Why, according to Marx, the law does not hold. Refer to Marx’s schematic M->C->M’ in this context

Marx attacked Say’s law, stating that at best it applied only to simple commodity production. Self- employed artisans, seeking to acquire use values, produce commodities in order to exchange them for others they wish to consume. C-->M-->C. Money is simply the medium of exchange. Under large scale capitalist productions the process becomes MCM, where people buy in order to sell. Money is changed into commodities such as labour power, raw materials and machinery. The products are then sold for money. The above does not make sense except if the second M is larger than the first thus making it MCM’, and it is larger by the amount of surplus value squeezed out of the productive workers. This is the process of expanding investments.

o Why, according to Keynes, the law does not hold. Refer to Keynes’s different treatment of consumption & investment spending in this context

One of the Keynesian school’s major tenets is demand orientation. Effective demand determines the economy’s actual output and thus Say’s law does not hold. Keynes state that there is a positive functional relationship between consumption and national income and that the ratio of the change in consumption to the change in income (marginal propensity to consume) is positive and less than one. This implies that savings also rises with income and is thus a positive function of income. Keynes defines economic investment as the purchase of capital goods. Unintended investment occurs when sales decline and inventories of unsold goods rise. Businesses undertake investment on the expectation that the new capital will add to profits. Keynes disagreed with the classic and neoclassic economist who thought that the rate of interest produces an automatic balance between the amount of saving businesses desire for new investment and the quantity of savings supplied.

o How, according to the Chicago School, Say’s Law can be made to hold in a modern economy

Market system, left free of government interference, produces maximum economic freedom. Yields maximum individual and collective well-being (Chicago view benefits society)

o Assess the chances of Say’s Law holding in modern economy.

Write an essay on the Chicago School of thought and pay attention to:

o Rejection of Keynesianism & the role of government

o Friedman’s monetary rule & his restatement of the quantity theory of money

o Friedman’s long-run Phillips curve & adaptive expectations

o Lucas’s long-run supply curve & rational expectations

o Some criticism & the relevance of its ideas for modern day South Africa

Write an essay on the German historical school & the Institutionalist school

Write an essay on the Chicago school of economics with particular reference to Friedman & Lucas

The Chicago school fits within the broader classical-neoclassical tradition and is a variant of neoclassicism which is referred to as the “new classicism”. The major tenets of this school:1. Optimizing behavior: members of this school stress the neoclassical principle that people attempt to

maximize their well-being, they engage in optimizing behavior at the time of their decisions. People make rational choices, although such choices do not always produce the results expected. Benefits and costs are uncertain.

2. Observed prices and wages in general tend to be good approximations of their long run competitive ones: prices and wages reflect opportunity costs to society at the margin. Monopoly prices persist in the long run only in instances where government blocks competitive entry. Even in those instances competitors will eventually generate a substitute product that will undermine the monopoly.

3. Mathematical orientation: This school relies heavily on mathematical theorizing.4. Rejection of Keynesianism: this school rejected everything the Keynesian school stood for5. Limited government: this school believed that government is inefficient and should be limited.