short paper
gesleyssn
smith.pptEvolution of Development Thought
Adam Smith (1723 - 1790)
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Classical Economics
Main question: What is “the Nature and Causes of the Wealth of Nations”?
Smith associated the wealth of nations with their production, not with their gold.
Studied how output and prices are determined in a free market economy.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
Smith’s Contributions
Division of Labor
Invisible Hand
The Role of Government
He concluded that division of labor can increase the output at the global level. Specialization and trade promote the division of labor at the global level.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
Division of Labor
Example: a production unit of 10 workers producing pins.
If each of the 10 workers performed all the tasks, the daily output would be 200 pins.
When the production is divided into 10 different tasks, the same workers make 48,000 pins in one day (240 times more!).
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Invisible Hand
Firms respond to changes in consumers’ tastes without government regulation. If the demand for some good drops, the price will fall, profits will be below normal, and the number of producers will decline. If the demand for some good rises, its price will rise, increasing the profits above normal, which leads to new entries.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
Invisible Hand
It is difficult to imagine any government being able to collect information on all the consumers’ preferences and all the firms’ technologies, and finding the optimal output level in each firm. It turns out that the Invisible Hand (or the desire of firms to increase their profit) makes everybody better off.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
The Role of Government
Although arguing that markets are efficient, Adam Smith pointed out that sometimes there are market failures (public goods, monopolies, externalities).
He argued that the government intervention was justified in cases of market failure. The government also set the rules of the game: property rights, contract enforcement, etc.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
On Inequality
All uses of resources yield an equal rate of return (adjusted for the relative riskiness). Otherwise reallocation would occur. Equality of returns explains why wage rates differ. Wage rates would be higher for trades that were more difficult to learn, because people would not be willing to learn them if they were not compensated by a higher wage.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
On Inequality
This Smith’s idea gave rise to the modern notion of human capital. Similarly, wage rates would also be higher for those who engaged in dirty or unsafe occupations, such as coal mining and butchering. In short, differences in work were compensated by differences in pay. Modern economists call Smith’s insight the theory of compensating wage differentials.
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Adam Smith (1723 - 1790)
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Adam Smith (1723 - 1790)
