economy assignment

Overview of History of Economic Thought:

ADAM SMITH

Outline:

· The birth of “Economics”

· Adam Smith’s view of the system of “perfect liberty”

· The birth of “Economics”

When “tradition” and “command” rule (like during the entire pre-capitalist era), there is no need for a discipline called “economics” to understand the functioning of the economic life. In this context, the way in which production and distribution work are intrinsically intermixed with the cultural, technological and/or political features of those societies.

Capitalism differs substantially from previous economic systems, as production and distribution occur through markets.

· Economic activities are left to men and women freely responding to the opportunities and signals given by the market, not to the established routines of tradition or the dictates of someone’s command.

· Each person can do what it is in his/her individual monetary advantage. Individual gain becomes the motive of economic activities. It is not obvious how all the needs of a society can get fulfilled if each person is only after his/her individual gain => there is need for “Economics.”

· Adam Smith’s view of the system of “perfect liberty”

Adam Smith (1723-1790) lived during the development of what is called “commercial capitalism” (pre-industrial capitalism). In this era, England experienced a very rapid productivity growth that put England into the position of the greatest economic and political power of its time + by the mid-18th century, in many cities a significant amount of production took place in what have been called “manufactories”

· In this context, Smith wanted to understand how the system of perfect liberty came into being and how it worked.

1759: The Theory of the Moral Sentiment. Questions: How does it happen that a man, whose economic behavior is driven by self-interest, can form moral judgment and conform to the prevailing rules? What saves us from disorder and anarchy?

It is “sympathy”: human ability to understand actions and emotions of many kinds. It is the effect that is produced when we imagine that another person’s circumstances are our own circumstances + the desire to be respected and be honorable beings.

In a complex commercial society, economic exchanges are motivated by self-interest. There is “something” that ensures that the interest of the whole society (i.e. social harmony) is realized through the pursuing of private interests

· Smith wants to understand how this system works.

1776: The Wealth of Nations. Question: How can a society get rich and powerful?

· Wealth = the goods that people consume in a society => Smith proposes a new definition of wealth with respect to the traditional notion of ‘treasures.’

For Smith, it is labor that produces wealth (= seeds of the ‘labor theory of value” elaborated by David Ricardo and Karl Marx) => the role of “division of labor.” The larger the market, the more finely detailed is the degree to which labor can be specialized and divided, largely with the use of machinery.

· There is a limit to the extension of markets and there is a limit to the possible division of labor. In the very long run, the growth momentum of society would come to a halt. Smith mentioned 200 years to be the longest period over which a society could grow.

· The price of commodities. Smith distinguishes between “market prices” and “natural prices:”

· The market price was the actual commodity price that existed at any particular point in time in a particular market;

· The natural price was a kind of equilibrium price around which day-to-day changes in the market price fluctuated, and it was the forces of supply and demand in a competitive environment that tended to make the market price gravitate around the natural price.

· The market is a “self-regulating system” through the power of competition. Competition is the regulator of self-interest. This explains the functioning of the “invisible hand.”

· In a capitalist society, for Adam Smith, there are three clear social classes (laborers, entrepreneurs, and landlords), which are due to different conditions of property ownership. Of the three classes, for Smith only labor was the true creator of wealth (=> labor theory of value).

The distribution of income between wages and profits was determined in the class struggle between laborers and capitalists over what the wage rate would be. Smith had no doubt that the capitalists were the dominant class in the conflict. According to Smith, however, in a competitive environment this conflict would be solved in a manner conducive to social welfare.

Both the interests of the landlords and the interest of the workers, according to Smith, are directly related to the general interest of the society (whatever obstacles one, it necessarily does the same to the other). The story is different for those who live by profit: they do not have the same connection with the general interest of the society as the other two classes (they always aim to reduce competition).

Even though the interests of the landlords may coincide with those of the nation, rent comes to him without any participation on his part. And laborers lack education and time.

· For different reasons, landlords, laborers and capitalists cannot become ‘advisors’ to their country.

· There is need for a separate government.

· The roles of the government. In a society of perfect liberty, the government should perform three tasks:

1) DEFENSE

2) JUSTICE

3) ‘PUBLIC GOODS’ (i.g. infrastructures, education,..)

+ The government should prevent the formation of market power.

· Smith’s intellectual influence can be seen in two rival traditions in the 19th and 20th century economic thinking:

A. One tradition emphasizes the labor theory of value and class conflict => see Karl Marx and the radical tradition of critical economics;

B. The second tradition is based on Smith’s idea of the ‘invisible hand’ => see the model of supply and demand in traditional economics (Ch.3 of the textbook).

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