Last Time: Late Pre-classical Economic Thought (1500 – 1750)

Last Time: Late Pre-classical Last Time: Late Pre-classical Economic Thought (1500 – 1750)Economic Thought (1500 – 1750)

1.1. Mercantilists, Mercantilists, 2.2. Precursors of classical economic Precursors of classical economic

thought,thought,3.3. Physiocrats.Physiocrats.

Q: What is the main contribution of Q: What is the main contribution of the Mercantilists and Physiocrats?the Mercantilists and Physiocrats?

A: The idea that the economy could A: The idea that the economy could be formally studied.be formally studied.

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History of Economic History of Economic ThoughtThought

Ch 4: Classical Economic Ch 4: Classical Economic Thought – Adam SmithThought – Adam Smith

04/20/2304/20/23 22Adam Smith (1723 - 1790)Adam Smith (1723 - 1790)

Classical EconomistsClassical Economists


Adam Smith (1723 – 1790) Thomas Malthus (1766 – 1834)

David Ricardo (1772 – 1823) John Stuart Mill (1806 – 1873)

Classical EconomistsClassical Economists

Main question: what is “the Nature Main question: what is “the Nature and Causes of the Wealth of and Causes of the Wealth of Nations”?Nations”?

Associated the wealth of nations with Associated the wealth of nations with its production, not with its gold.its production, not with its gold.

Studied how output and prices are Studied how output and prices are determined in a market economy.determined in a market economy.

04/20/2304/20/23 Adam Smith (1723 - 1790)Adam Smith (1723 - 1790) 44

Adam Smith (1723 – 1790)Adam Smith (1723 – 1790)


Adam Smith was a Scottish Adam Smith was a Scottish Philosopher and Economist.Philosopher and Economist.

Considered by many the Considered by many the father of father of economics.economics.

At age 14 he enrolled at Glasgow At age 14 he enrolled at Glasgow University to study moral philosophy, University to study moral philosophy, and later studied moral and political and later studied moral and political science in Oxford.science in Oxford.

Background – Influenced by – Contributions – Impact - Critique


1717thth century is “ century is “The Age of The Age of EnlightenmentEnlightenment”. ”.

Enlightenment thinkers believed that Enlightenment thinkers believed that reasoningreasoning might be applied to all might be applied to all areas of human activity, and carried areas of human activity, and carried into the governmental sphere, in into the governmental sphere, in their explorations of the their explorations of the individualindividual, , societysociety and the and the statestate..





Francis HutchesonFrancis Hutcheson (1694 –1746), his (1694 –1746), his teacher of Moral teacher of Moral Philosophy, inspired Philosophy, inspired Adam Smith to be Adam Smith to be passionate about passionate about liberty, reason, and liberty, reason, and free speech. free speech.



AristotleAristotle (384 – (384 – 322 BC), a student 322 BC), a student of Plato who of Plato who supported private supported private property. property.



Thomas Hobbes Thomas Hobbes (1588 –1679), (1588 –1679), English Philosopher, English Philosopher, famous for his book famous for his book “Leviathan”, in “Leviathan”, in which he studies the which he studies the need for need for governments in a governments in a society.society.



John LockeJohn Locke, (1632 –, (1632 –1704), English 1704), English Philosopher, considered Philosopher, considered private property as private property as natural right, advocated a natural right, advocated a government with checks government with checks and balances, and had and balances, and had influence on the influence on the Constitution of the United Constitution of the United States and its Declaration States and its Declaration of Independence.of Independence.



Bernard Mandeville Bernard Mandeville (1670 – 1733), (1670 – 1733), Argued that selfishness is a moral Argued that selfishness is a moral vice but social good could result from vice but social good could result from selfish acts if these actions were selfish acts if these actions were properly channeled by the properly channeled by the government.government.

Gave examples of Gave examples of division of labordivision of labor: : “But if one will wholly apply himself to the making “But if one will wholly apply himself to the making of Bows and Arrows, whilst another provides Food, of Bows and Arrows, whilst another provides Food, a third builds Huts, a fourth makes Garments… a third builds Huts, a fourth makes Garments… [the society will] receive much greater [the society will] receive much greater Improvements…”Improvements…”



MontesquieuMontesquieu (1689 – (1689 – 1755), famous for his 1755), famous for his articulation of the articulation of the theory of theory of separation separation of powersof powers (division of (division of government into the government into the Executive, the Executive, the Legislative, and the Legislative, and the Judicial branches).Judicial branches).



David Hume David Hume (1711 – (1711 – 1776), Scottish 1776), Scottish philosopher, historian philosopher, historian and economist, close and economist, close friend of Adam Smith, friend of Adam Smith, exchanged ideas, exchanged ideas, Adam Smith has been Adam Smith has been known to have added known to have added some of David Hume’s some of David Hume’s work in work in Wealth of Wealth of NationsNations. .



Richard Cantillon Richard Cantillon (c. 1680 – 1734), (c. 1680 – 1734), developed long run price equilibrium, developed long run price equilibrium, and a two sector general equilibrium, and a two sector general equilibrium, quoted by Adam Smith in the Wealth quoted by Adam Smith in the Wealth of Nations.of Nations.



MercantilistsMercantilists - The motivation to - The motivation to prove mercantilist theory wrong was prove mercantilist theory wrong was one of his major efforts in one of his major efforts in Wealth of Wealth of Nations. Nations.

ContributionsContributions

1.1. Division of LaborDivision of Labor

2.2. Invisible HandInvisible Hand

3.3. The Role of GovernmentThe Role of Government


Division of LaborDivision of Labor

““One man draws out the wire, One man draws out the wire, another straightens it, a third cuts it, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at a fourth points it, a fifth grinds it at the top for receiving the head; to the top for receiving the head; to make the head requires two or three make the head requires two or three distinct operations; to put it on is a distinct operations; to put it on is a peculiar business, to whiten the pins peculiar business, to whiten the pins is another; it is even a trade by itself is another; it is even a trade by itself to put them into paper.”to put them into paper.”




He observed a production unit of 10 He observed a production unit of 10 workers producing pins.workers producing pins.

If each of the 10 workers performed If each of the 10 workers performed all the tasks, the daily output would all the tasks, the daily output would be 200 pins.be 200 pins.

When the production is divided into When the production is divided into 10 different tasks, the same workers 10 different tasks, the same workers make 48,000 pins in one day (240 make 48,000 pins in one day (240 times more!).times more!).




He concluded that division of labor He concluded that division of labor can increase the output at the can increase the output at the global levelglobal level. Specialization and . Specialization and trade, is division of labor at the trade, is division of labor at the global level.global level.



Invisible HandInvisible Hand ““It is not from the benevolence of the It is not from the benevolence of the

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

The The Invisible HandInvisible Hand is the is the quest for quest for profit.profit.



Invisible Hand – Modern Invisible Hand – Modern IllustrationIllustration



Representative firm

Quantity Quantity

AC

MC

PLR

D

S

Market for Chinese Restaurants

profit

D1

S1

Consequences of Invisible HandConsequences of Invisible Hand1.1. Each firm will produce at Each firm will produce at

minimum average costsminimum average costs. If for . If for some reason the price is above Psome reason the price is above PLRLR, , then firms will enter the industry and then firms will enter the industry and reduce the price to minimum AC.reduce the price to minimum AC.

2.2. Firms have incentive to innovate Firms have incentive to innovate to improve quality and reduce to improve quality and reduce costscosts, and thereby have above , and thereby have above normal profit.normal profit.



Consequences of Invisible HandConsequences of Invisible Hand3.3. Firms respond to changes in Firms respond to changes in

consumers’ tastes without consumers’ tastes without government regulationgovernment regulation. If the demand . If the demand for some good drops, the price will for some good drops, the price will decline below Pdecline below PLRLR, profits will be below , profits will be below normal, and the number of producers will normal, and the number of producers will decline. Similarly, if the demand for some decline. Similarly, if the demand for some good rises, its price will rise above Pgood rises, its price will rise above PLRLR, , increasing the profits above normal, increasing the profits above normal, which leads to entry of new firms.which leads to entry of new firms.



Invisible HandInvisible Hand It is difficult to imagine any It is difficult to imagine any

government being able to collect government being able to collect information on all the consumers’ information on all the consumers’ preferences and all the firms’ preferences and all the firms’ technologies, and finding the optimal technologies, and finding the optimal output level in each firm. It turns out output level in each firm. It turns out that the that the Invisible HandInvisible Hand (or the (or the desire of firms to increase their desire of firms to increase their profit) makes everybody better off.profit) makes everybody better off.



The Role of GovernmentThe Role of Government

Adam Smith, although argued that Adam Smith, although argued that markets are efficient, pointed out markets are efficient, pointed out that sometimes there are market that sometimes there are market failures (public goods, monopolies).failures (public goods, monopolies).

He argued that government He argued that government intervention is justified in cases of intervention is justified in cases of market failure.market failure.




1.1. ““The first duty of the sovereign, that The first duty of the sovereign, that of protecting the society from the of protecting the society from the violence and invasion of other violence and invasion of other independent societies”independent societies”

2.2. ““The second duty of the sovereign, The second duty of the sovereign, that of protecting, as far as possible, that of protecting, as far as possible, every member of the society from every member of the society from the injustice or oppression of every the injustice or oppression of every other member of it”other member of it”




3.3. ““The third and last duty of the sovereign or The third and last duty of the sovereign or commonwealth is that of erecting and commonwealth is that of erecting and maintaining those public institutions and those maintaining those public institutions and those public works, which, though they may be in the public works, which, though they may be in the highest degree advantageous to a great society, highest degree advantageous to a great society, are, however, of such a nature that the profit are, however, of such a nature that the profit could never repay the expence to any individual could never repay the expence to any individual or small number of individuals, and which it or small number of individuals, and which it therefore cannot be expected that any individual therefore cannot be expected that any individual or small number of individuals should erect or or small number of individuals should erect or maintain.”maintain.”



The Role of GovernmentThe Role of Government ““After the public institutions and public works After the public institutions and public works

necessary for the defence of the society, and for necessary for the defence of the society, and for the administration of justice, both of which have the administration of justice, both of which have already been mentioned, the other works and already been mentioned, the other works and institutions of this kind are chiefly those for institutions of this kind are chiefly those for facilitating the commerce of the society, and facilitating the commerce of the society, and those for promoting the instruction of the those for promoting the instruction of the people. The institutions for instruction are of two people. The institutions for instruction are of two kinds: those for the education of youth, and kinds: those for the education of youth, and those for the those for the instruction of people of all instruction of people of all agesages.”.”



Adam Smith’s Contributions: Adam Smith’s Contributions: – He helped make Political He helped make Political

Economy into an “autonomous Economy into an “autonomous systematic discipline”systematic discipline”

– The invisible hand, division of The invisible hand, division of labor, labor,

Adam Smith has influenced Adam Smith has influenced many Economistsmany Economists– David RicardoDavid Ricardo

• David Ricardo became interested David Ricardo became interested in Economics after reading in Economics after reading Wealth Wealth of Nationsof Nations. .

• All the other economists that All the other economists that followed.followed.



Adam Smith’s efforts arguing against Adam Smith’s efforts arguing against Mercantilism paved way for Britain to Mercantilism paved way for Britain to engage in free trade. engage in free trade. – Britain dropped some Mercantilist Britain dropped some Mercantilist

thought years after thought years after Wealth of Nations. Wealth of Nations. Adam Smith’s theories appear today Adam Smith’s theories appear today

in our microeconomic and in our microeconomic and macroeconomic text books macroeconomic text books – Some recognizable theories are: The Some recognizable theories are: The

Invisible Hand, Division of Labor, and Invisible Hand, Division of Labor, and the concept of Lassiez-faire. the concept of Lassiez-faire.



Adam Smith did not believe in the Adam Smith did not believe in the usefulness of statistics in usefulness of statistics in economics, an approach proposed economics, an approach proposed by William Petty (1623 – 1687).by William Petty (1623 – 1687).

His almost 1000 pages book, the His almost 1000 pages book, the wealth of nations, could have been wealth of nations, could have been much shorter and clearer had he much shorter and clearer had he used graphs and math. used graphs and math.



Questions and DiscussionQuestions and Discussion1.1. Give an example of Give an example of division of labordivision of labor from your from your

everyday life.everyday life.

2.2. Give an example of the workings of the Give an example of the workings of the Invisible HandInvisible Hand from your everyday life.from your everyday life.

3.3. These days we often hear a call for government These days we often hear a call for government intervention in the intervention in the market for energymarket for energy, , environment and global warmingenvironment and global warming, , health health carecare. How would Adam Smith propose to . How would Adam Smith propose to address these issues?address these issues?

4.4. In In Wealth of NationsWealth of Nations Smith emphasized how Smith emphasized how self self interestinterest, while in his previous work , while in his previous work Moral Moral SentimentsSentiments he emphasizes he emphasizes sympathy for sympathy for othersothers. How would you reconcile this apparent . How would you reconcile this apparent contradiction? contradiction?


Last Time: Late Pre-classical Economic Thought (1500 – 1750)

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