Lectures in the history of economic thought PURPOSE …nielspeterhahnemann.com/download/LecturesHistEcoThought.pdfeconomics as a science by A. Smith to the first comprehensive macroeconomic

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Lecture 1: Intro © Niels Peter Hahnemann 2011 1

•  LECTURE ONE •  1) Purpose and scope of the lectures •  2) Reading list •  3) Intro to the main ideas of the lectures •  4) Plan and overview •  5) A crash course in the philosophy of

science for economists

Lectures in the history of economic thought


•  PURPOSE AND SCOPE •  To familiarise students with the historical precursors of

contemporary economic theory •  To give students a deeper understanding of theory’s

capability to unravel political and social problems •  The lectures span the period from the foundation of

economics as a science by A. Smith to the first comprehensive macroeconomic theory by J. M. Keynes

•  Economic theory: cumulation of ideas, so why not study the latest textbook only?

•  Economic theory: a reflection of society and history, so why not study economic history only?

•  Because there exists no model for a true consistent theory with which to assess theory =>

•  Economics is about decisions that organise society in a certain manner ≡ no overall rational subject or guide

History of economic thought


•  In the footsteps of Enlightenment philosophy: using markets in a reasonable as opposed to traditional a priori given organisation of human interaction

•  Necessitates construction of a theory that goes from description and intuition to science and rationality

•  Goal 1: to explain modes of thought and reasoning by the great economists => to understand the enormous complexity of the subject matter of economics

•  Goal 2: to see the mistakes or roads not taken by economists in the history of economic thought => to acknowledge the need for carefulness and caveats

•  Curriculum: Mark Blaug (1997), Economic theory in retrospect; Adam Smith (1776), The wealth of nations; David Ricardo (1817), On the principles of political economy and taxation; Karl Marx (1867), Capital; John Maynard Keynes (1936), The general theory of employment, interest and money



•  INTRO TO MAIN IDEAS •  Economics: from technique to science •  From instrument in the organisation of

society, to knowledge about the economic organisation of society

•  From Quesnay + Smith, to Nash + Romer •  Economics as technique => a reasonable

arrangement of social relations •  From ”tradition, power, and feudalism”, to

”prices, profit, and capitalism”



•  Economics as science => a reasonable arrangement of theory

•  From description and intuition, to scientific interest i.e. an understanding of society’s economic organisation

•  Aim of scientific economics: knowledge based on reason and argumentation, decision-making according to truth concept

•  Terms of scientific economics: axioms, computability, proof of existence, determination of equilibrium



•  Economics = practical ethics: decisions that organise society according to purpose

•  Decision making: what is right, what is wrong => ethics, moral actions

•  1) Consequentialism, utilitarianism: only consequences count => economics

•  2) Deontology, categorical imperative: “duty is my command” => politics

•  Economics: calculating the effects of actions, the good comes with some bad

•  => ”Trade-off”: things seen in perspective


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•  Sketch of theory’s historical origins •  Classical economists founded economics

as a science in mid-to-end 18th century •  Contemporary historical events: American

independence, French revolution, Enlightenment philosophy, economic industrialisation

•  Idea about rational organisation of society inspired by the world view of emerging (natural) science

•  “Rational organisation” => calculation i.e. putting number (price) on decisions



•  Difficult: 1) Limited market price formation in domestic (national) economy

•  Short term market price determined only accidentally by supply and demand

•  Long term price determined by supply side production costs only

•  2) But international price formation more market orientated:

•  Demand mechanism effective in long run through “comparative advantage” =>

•  1)+2) = Very rudimentary equilibrium of trade determined far away from “home”



•  Facts: full currency convertibility on world markets only, not domestically

•  Domestic economy underdeveloped, few markets, many taxes and tolls =>

•  No demand function in classics, comes 100 years later with the marginalists

•  No aggregation, comes 150 years after with J. M. Keynes and national accounts

•  3) Aggregated price formation i.e. with prices and quantities = modern macro: international model turned national by quantity equation, money demand, etc.



•  PLAN OF THE LECTURES •  Lecture 1: Intro and ”crash course” •  Lecture 2: Mercantilists and physiocrats (Blaug: chapter 1) •  Lecture 3: Adam Smith and Wealth of Nations (Blaug: chapter 2, Smith:

volume 1, book 1, chapters 1-10 incl.) •  Lecture 4: Thomas Malthus, population growth, returns (Blaug: chapter 3) •  Lecture 5: David Ricardo and Principles (Blaug: chapter 4, Ricardo:

chapters I-VII incl. and XXX) •  Lecture 6: Say’s law, classical monetary theory, and John Stuart Mill (Blaug:

chapters 5+6) •  Lecture 7: Karl Marx and Das Kapital (Blaug: chapter 7, Marx: chapters in

English version 1+4+5+6+7+8+9) •  Lecture 8: The marginalists (Blaug: chapter 8+9) •  Lecture 9: Alfred Marshall (Blaug: chapter 15) •  Lecture 10: General equilibrium and welfare: Walras and Pareto (Blaug:

chapter 13) •  Lecture 11: Wicksell and the neoclassics (Blaug: chapter 15) •  Lecture 12: John Maynard Keynes and General Theory (Blaug: chapter 16,

Keynes: chapters 1-13 incl. and 23-24) •  Lecture 13: The aftermath. Foundations of modern economics



•  CRASH COURSE IN THE PHILOSOPHY OF SCIENCE FOR ECONOMISTS

•  Enlightenment and the scientific worldview •  R. Descartes (1637): science

necessitates truth concept: •  Doing the reasonable, arguing the right,

surmounting tradition-history-power •  Can science be objective? Are there

special interests related to science? •  Epistemology: theory about knowledge •  Cannot do history of economic thought

without philosophy of science Lecture 1: Intro © Niels Peter Hahnemann 2011 12

Philosophy of science for economists

•  Philosophy of science learns from science •  Not a science, can never be a science •  Phil. of sc. ≠ methodology where science

learns from philosophy •  Phil. of sc. ≠ purely normative theory that

guides choices researchers need to take •  Illuminates the reasoning and choices

made in any science •  Illuminates battle between different

theories and shifts of focus in research •  Reveals relation between science, history,

society and, thus, politics in theory

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•  Historically, 3 main schools or trends in the philosophy of science:

•  1) Inductivism, positivism •  2) Falsificationism, critical rationalism •  3) Methodological realism, pragmatism

2 world wars ”1968” “1789”

Inductivism

Falsificationism

Pragmatism

Where are we today?

“End of history”

Descartes, Hume Popper, Lakatos Foucault, Habermas

Timeline of methodological breakthroughs


•  Inductivism/positivism: build laws from observation

•  Classical and modern economics: A. Smith pin factory example, standard procedure of econometrics today: we cannot reject (with a certain degree of confidence) = double negation, verification

•  Rationalism/falsificationism: purely logical procedure => axiomatisation; “Bourbakism” as in neoclassical general equilibrium; heterodox economics

•  Realism/pragmatism: economics as part of society, history and politics; K. Marx



•  High point of philosophy of science in the 1970s, now more neglected (pragmatic)

•  3 schools only according to a very “broad brush”, in effect many overlaps and combinations between schools

•  A more subdued issue today, but still relevant

•  Most economists are (without knowing it) “spontaneous” inductivists + positivists

•  1) INDUCTIVISM and POSITIVISM •  1a) Inductivism: justification, verification



•  Connection between science and the organisation of society from beginning of renaissance and the enlightenment project

•  The scientific world view: Gallilei, Newton •  Logic of discovery: how to find knowledge •  General law on the basis of observations •  Justificationism: prove validity of statement •  Derived and non-derived statements: how

to justify the non-derived? •  Verification = confirmation by evidence •  Statements derived from experience =

unreflecting knowledge, a posteriori



•  Inference from all events of a certain kind, to universal statements

•  Data, or empirical evidence = statements of observation = singular statements

•  Adjust observation for subjective content •  Subjective = cannot be discussed •  Objective = can be discussed •  Generalisation based on assurances from:

1) many observations, 2) different obs. conditions, same result, 3) no single obs. contradicts general law

•  Are observations theory-independent?



•  Verification = modus ponens, i.e. THEOREM: if “A1 is B”, “A2 is B”, ..., “An is B” → then “all A are B” is true

•  Conclusion, “all swans are white”, could be false even though the premise, “so far all observed swans are white”, is true => no logical contradiction between affirming premise and denying conclusion

•  Thus, modus ponens not logically binding •  Verification ≈ jump from “particular” to “all”,

equivalent to bet based on assurances of non-arrival of a “black swan”


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•  Problem of induction: confirming induction with induction not logically tenable

•  Furthermore: probability that a universal theory is true goes to zero with increasing number of observations

•  D. Hume (1739): acknowledged problem of induction => scientific knowledge based on assurances, not logic ≡ inductivism

•  1b) Positivism (20th century): inductivism fortified with logical empiricism

•  Testable observations: experiments, no metaphysics



•  Science ≠ pseudo science •  Verification: theory is positive about what

is, not normative about what ought to be •  Synthetic statements only = empirical

generalisations i.e. modus ponens => still problem of induction

•  Terms or concepts that cannot be verified (e.g. “atoms” or “utility”) are not allowed

•  Operationalism: concepts = procedures for measurement, e.g. temperature = thermometer; pseudo science = no existing measurement procedures



•  Descriptivism: science should describe rather than explain

•  Reductionism: complexity reduced to more simple relations e.g. social relations to individual problems or even chemistry

•  Immunisations such as (non-testable) ceteris paribus clauses not allowed; but is that possible?

•  Covering law # 1: differentiation between explained (explicandum e.g. raindrops) and explaining (explicans i.e. the general law e.g. the depression to which explicandum is subjected)



•  Important: explicandum and explicans must be independent, but can they really?

•  The symmetry thesis: explanation and prediction have same logical structure

•  Explanation = explicandum known, explicans unknown; prediction = explicans known, explicandum unknown

•  M. Friedman (1953): moderate empiricism, positivism

•  Increasingly good predictions => positive not normative science, realism of model less important (“as if”), only prediction counts (instrumentalism)



•  2) FALSIFICATIONISM and CRITICAL RATIONALISM

•  2a) Falsificationism (1940-50s): fallibilism is the opposite of justificationism (once confirmed, always confirmed) i.e. all theories are hypothetical and subject to eventual correction

•  Logical impossibility of justifying a theory as true (Münchausen’s trilemma) => justificationism is self-contradictory

•  Rationalism: knowledge is given a priori i.e. by reason (the human intellect)



•  Verstand vs. Vernunft (Kant + Hegel) •  Reasoning based on logical deductions =>

deductivism: the opposite of inductivism •  Interest in logic of confirmation i.e. the

foundations of knowledge (as opposed to logic of discovery = how to get knowledge)

•  K. Popper: the asymmetry thesis = modus ponens not valid, modus tollens valid

•  Modus tollens i.e. THEOREM: if “An+1 is not B” → then “all A are B” is false


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•  Pure logic: observation of one black swan falsifies view that all swans are white

•  Empirical tests + error correction => truth contents of theory gradually increase

•  Science ≡ falsifiable => perpetual potential conflict with empirical data

•  “Dogmatic falsificationism” = “Popper(0)”: we must reject all theories that cannot withstand falsification

•  Ignores that falsification itself is fallible => impossible to show theory is absolutely false => risk of rejecting true, accepting false theory



•  “Naive falsificationism” = “Popper(1)”: we need methodological rules for falsification

•  Recognises that falsification does not imply that a theory is false with certainty =>

•  Non-falsifiable ad hoc assumption support (e.g. ceteris paribus) necessary for any theory, but we must have rules for this

•  Only reject theory, not data; testable ad hoc assumptions; ceteris paribus must not decrease theory’s falsifiability

•  Pass falsification tests => “corroboration”↑



•  Falsified theories i.e. false “explicans” must be rejected

•  But: necessary to maintain some false assumptions (theories) even though we know they are false

•  Because: we know something is wrong, but we do not know exactly where problem is (Duhem-Quine)

•  E.g. the principle of rationality is obviously false (people do not always act rationally)

•  If “rationality” is in explicans => no liberty, human behaviour fully determined



•  Conclusion: “rationality” must be removed from explicans = covering law # 2

•  Symmetry thesis only partly valid for social science and economics =>

•  “Popper(2)”: theories must be maintained or rejected in their totality only =

•  I. Lakatos: “sofisticated falsificationism”, new theory is better if more falsifiable => concept of “scientific progress”

•  Exclude possible events (observations) = make better predictions



•  2b) Research programmes (1960s-70s) ≈ “Popper(2)” in a dynamical context

•  Theories can only be assessed in their totality (weak version of Duhem-Quine)

•  Hard core: never subject to falsification, modus tollens prohibited here (e.g. utility and profit maximisation)

•  Protective belt: auxiliary hypotheses subject to falsification (e.g. decreasing returns, convexity)

•  Heuristics: common rules, approaches (e.g. exogenous/endogenous)



•  Progressive research programmes: increase in theory’s informative contents

•  Theoretical progressivity: capacity to incorporate novel facts i.e. adapt to new information that was not predictable with existing theory

•  Empirical progressivity: existing theory’s capacity to predict

•  Progressivity => new hypotheses incorporated in protective belt

•  Degenerating r.p. ≡ not progressive r.p.


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•  Lakatos: try to produce rational concept about progress in science and objectively distinguish between productive and non-productive research

•  But: that decision is never final => •  Impossible to rationally assess theories

(strong version of Duhem-Quine) •  Empiricism and falsificationism unrealistic:

social, historical, psychological, political factors also important =>



•  2c) T. Kuhn: Scientific paradigms (1950s-60s) i.e. commonly accepted fundamentals of “normal” science, not necessarily fully rational

•  Scientific revolutions rare •  Different paradigms are not on speaking

terms (basis not fully rational), tend to battle, only one becomes predominant

•  Research communication tends to stay within paradigm, conclusions of normal science known in advance



•  Agreement within paradigm on the matrix of the scientific discipline i.e. on:

•  Symbolic generalisations = what are the basic non-falsifiable theoretical laws

•  Basic models for explanation of empirical phenomena

•  Common values for what is good theory •  Shared metaphysics (do’s and don’ts in

research) •  Exemplars = implicit rules derived from

examples, e.g. apple falling from tree



•  Anomalies that cannot be solved within existing paradigm

•  Many anomalies => crisis for science => competing paradigms, incommensurability

•  No rational test exists for deciding which paradigm is best + cannot be done independently of a paradigm =>

•  Either: existing paradigm survives crisis, anomalies are reduced to puzzles

•  Or: scientific revolution (paradigm shift) that explains anomalies



•  New paradigm becomes predominant •  No rational basis for the paradigm shift,

can also decrease knowledge as in politically or religiously motivated shifts

•  Choice between theories not a purely logical internal matter

•  Shifts => loss of problem solving capacity, different paradigms solve diff. problems

•  Still: empirical success criteria for scientific progress, but more pragmatic, realistic



•  3) REALISM, PRAGMATISM (1980s) •  Expands on Kuhn (as in 2c above) •  Differentiate between good/bad science,

not between science/pseudo-science •  Different theories do not have the same

structure of explanation •  Covering law is a logical relation e.g. about

empirical regularities and covariation, does not reflect necessity

•  Causality = mechanism that relates cause and effect


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•  Explanation = causal relation in reality, can only accept locality not action at a distance e.g. “gravity“ or “invisible hand”

•  Locality = with space and time coordinates •  But: we cannot do physics without

assumptions about gravity (Einstein did not succeed in explaining gravity); we cannot do economics without assumption about invisible hand such as diminishing returns (we have problems in explaining and predicting market equilibrium) =>

•  Open system ontology: theory about being and reality (as opposed to epistemology)



•  Reality exists independently of observation (not a logical relation i.e. ≠ covering law) => knowledge is necessarily imperfect = pragmatism

•  Closure: theory must be as consistent and unequivocal as possible, necessary for understanding, but an economy is an open universe =>

•  Knowledge is always part of a discourse (as in rhetoric) => pluralism

•  Knowledge is about reality not about logic



•  SUMMARY •  1) Positivism •  Inductivism, logical empiricism, verification

or confirmation: modern philosophy of science

•  Problem of induction ≈ circular reasoning => need for empirical success

•  Justificationism, logic of scientific discovery knowledge is a posteriori (given through experience), modus ponens

•  Covering law #1, symmetry thesis



•  Moderate empiricism mrk.1: left hand side of hypothetico-deductive model

•  Carnap, Hempel, Friedman •  2) Critical rationalism •  Deductivism, falsificationism, fallibilism

(naive/dogmatic or sophisticated) •  Knowledge is a priori (given through logic

and reason), modus tollens •  Moderate empiricism mrk.2: right hand

side of hypothetico-deductive model



•  Covering law # 2, asymmetry thesis •  Logic of confirmation, “modernism” •  Popper, Lakatos •  3) Methodological realism •  Inductivism (again), discourse, rhetoric •  Pragmatism (soft hypothetico-deductive

model + “revolution”), pluralism •  Learning, knowledge as social activity •  Logic of discovery, post-modernism •  Kuhn, McCloskey (Foucault, Habermas)


Lecture 2: Mercantilists © Niels Peter Hahnemann 2011 42

LECTURE 2: Mercantilists and Physiocrats

•  Curriculum: Blaug, Chapter 1 •  1. Preconditions of classical economics: •  Old Greek expression: ”eco" = house,

family, the household and its management •  Before Adam Smith: theory develops not

only in England, but also on the Continent •  Middle Ages → Renaissance →

Enlightenment: gradual development of markets

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•  Incipient reflections on the economic organisation of society

•  Considerations regarding moral philosophy, the royal household, trade (the value of money)

•  An instrumentalist, practical approach •  Adam Smith distinguished between two

ancestors: the trading system (the mercantilists) and the agrarian system (the physiocrats)



•  2. Mercantilists, balance of trade, and ”specie-flow”

•  The ”trade balance” term dates back to Francis Bacon (1615), earlier in Italy

•  Balance of payments ≈ balance of trade, ”balance of the realm”

•  The only external mechanism to secure adaptation of price levels by means of flows in money and gold

•  An abstract device with no physical existence



•  ”Balance of payments” only makes sense combined with other economic data => does a surplus imply wealth, or decline?

•  Practical considerations rather than theory •  Antonio Serra, Breve trattato delle cause…

(1613): the first to relate flows of gold and silver with the trade balance

•  The balance takes care of itself, (change in) monetary matters are a consequence



•  Thomas Mun, England's Treasure by Foreign Trade (1664): surplus of exports = advantage of trade to a nation

•  John Locke, Some Considerations of the Consequences (1692): money exists only by common consent, M↓=>IMP↓=>EXP↑, but no idea about automatic adjustment

•  Exports = gain, imports = loss; gain of a nation = loss of another nation

•  Zero sum game, economics externally given, ”just price”, moral system



•  Main points of mercantilist programme: •  Gold etc. (“treasure”) is key to wealth •  Money = specie = capital = wealth •  Foreign trade must be regulated to secure

largest possible inflow of gold etc. •  Protection of home industries supported by

imports of low-priced commodities •  Duty on manufactured goods from abroad •  Subsidies on exports •  Population growth promoted + low wages



•  Realised that inflows of bullion lead to home price increases, and that a surplus of trade will be offset in the long term

•  => Policies to maintain persistent trade surplus are self-defeating

•  I. e. idea about existence of economic self regulation, the economy is considered as a coherent unity

•  Automatic mechanisms at play by means of relative price levels in different countries


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•  Josiah Child (1668): trade has its own ways, profit motive a regulatory principle

•  Isaac Gervaise, The System or Theory of Trade of the World (1720): credit increase => C↑ => EXP↓ => IMP↑ => outflow of specie => binding credit constraint, i.e. an automatic mechanism

•  David Hume, Of the Balance of Trade and Of Money (1752): clarified the mechanism by emphasising price adjustments

•  No idea about international division of labour



•  3. In defence of mercantilism •  Smith and other classical economists were

strongly against the mercantilist view, Keynes in defence

•  Economics subsumed to political purposes •  Economics put in a national context:

protectionism => equilibrium (Keynes) •  No idea about effective demand:

unemployment seen to be caused by adverse weather conditions in agriculture

•  England needed gold in order to trade



•  4. Quantity theory, inflation, interest rate •  Monetary analysis: theory about the

economic process as expenditure streams •  The economy as an aggregated whole •  If we must aggregate then we need a

measure i.e. money •  Metallism: purchasing power of money

originates with the purchasing power of the metal independently of its monetary role

•  Cartalism: denial of metallism (fiat money)



•  Mercantilists demanded permanent inflow of specie: self-contradiction

•  MV = PT: dilemma is ”solved” by assuming that M affects primarily T rather than P, i.e. ”money stimulates trade”

•  The quantity equation linked quantity of money with quantity of goods => absolute magnitude of quantity of money not important for wealth of nations

•  Hume: proportionality between M and P => money defined as unit of measurement and medium of exchange



•  John Law, Money and Trade Considered... (1705): money increases employment

•  R. Cantillon, Essai sur la nature… (1755): entrepreneurs invest money, land owners consume money (Cantillon effect) => M↑ => P↑; power depends on the abundance of money => sell dear, buy cheap

•  Ignores that decrease in price level abroad turns trade balance in their favour

•  No idea about adjustment mechanism or equilibrium



•  Mercantilists: higher inflation from larger quantity of money is OK => focus on foreign trade, monetary analysis, glimpse of the overall (macro) perspective

•  Smith + Ricardo: focus on savings and thrift, real analysis, no macro perspective

•  Interest rate = price of borrowing money: M↑=>r↓ because more money makes it easier to borrow, i.e. a sign of wealth

•  Cantillon effect: rudimentary idea about real interest rate


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•  Nicholas Barbon, Discourse of Trade (1690): interest rate = return on “wrought or artifical stock” i.e. profits = rent i.e. ”rent of unwrought or natural stock” => money is but a veil, a value made by law

•  Capital = principal of a loan = advance deposit: necessary condition for production

•  Anne-Robert Jacques Turgot, Reflexions sur la formation… (1766): capital comes from saving and is ”immediately” turned into investment



•  5. Physiocrates: the agrarian system •  William Petty, A Treatise of Taxes and

Contributions (1662): “Political Arithmetick”: concept about government and national income, labour = father of wealth, land = mother of wealth

•  Theory about the real economy, wealth = quantity of goods, theory about productive labour = agriculture, free trade

•  French agriculture squeezed by higher taxes, physiocrates wanted to streamline



•  Francois Quesnay, Tableau economique des physiocrates (1758): income flows in an agrarian economy between sectors = social classes

•  Stationary balance (equilibrium) from period to period, no explanation, only description

•  Only land i.e. farmers produce value, capital = advance deposit, landlords receive rent, sterile class = manufacturing

•  Everything bought is sold, everything sold is bought (≈ Say’s law)



•  Output = yearly harvest i.e. not value but ”stuff”; consumed in the following period, i.e. period = year: basic form of economics

•  Quesnay’s economic principle: how to get largest possible ”jouissance” with less possible trouble of labour? A utilitarian maximisation problem

•  Free competition; pursue of own interests; consumption, no saving

•  Mutual dependency of social classes: prosperity for landlords => prosperity for all



•  The nation is an institution, the economy a ”machine” that is maintained by materials

•  Only rent produces a net yield (and can therefore be taxed), while all other returns are offset by a cost entry in the accounts

•  Production by ”stuff” calculated in amounts => use of arithmetic to balance revenue with expenditure

•  Natural distribution of resources maintained in everybody’s interest, laws of nature are assumed to be known



•  Famous tableau page 58 in Quesnay:


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•  Famous tableau page 58 in Quesnay:

•  At start of period t landowners possess net national income from period t-1 (2 bn.). Everybody else stands ready to sell and produce

•  Landowners use some to buy agricultural produce (1 bn.) and some to buy manufactures (1 bn.), the latter produced by the “sterile class”

•  Farmers thereby receive a return from period t-1 (1 bn.), which they increase (redouble) in period t through their productive activities

•  Some of the surplus goes to the landlords, who use it in period t+1, some of the surplus is consumed by farmers, and the last part goes to the sterile as payment for the manufactures that the farmers use



•  The “steriles” do not add value, only reproduce it. They spend some of the proceeds received from landlords on consumption of their own produce, and the rest on purchases from farmers, who then increase (redouble) these proceeds through their productive activities

•  The same happens with the proceeds the sterile class receive from farmers. They receive a total of 2 bn. from farmers and landlords and spend 1. The rest, i.e. 1 bn., is saved for the next period

•  Farmers steadily redouble the proceeds they receive from sales, and spend the proceeds on payments of rent to landlords and on purchases from the “steriles”. Farmers receive 3 bn. in toto of which 1 bn. is interest on their annual advance. The interest is spent on repair, maintenance, reserves, and depreciation. Farmers may spend 2 bn. on themselves and they then redouble this amount, i.e. net national income = 2 bn. payable as rent to landlords for spending in the next period



•  When the period terminates, the same amount is in the hands of the landlords as when the period started

•  This is the first explicit conceptualisation of the nature of economic balance, a milestone in the history of economic thought!!

•  But: why the particular terms of trade? •  Important because terms of trade explains

population’s distribution on 3 social classes •  Tableau describes a natural state, in which

the wealth of the kingdom is at its highest => all unnecessary expenditure of sterile class harmful luxury



•  6. Scholastics, philosophers of natural law •  Middle ages: natural law and philosophy •  Scholastic economic ideas e.g. Thomas

Aquinas (13th century): utility is source of value; just price; money capital is sterile => economics is a legal-moral system determined by satisfaction of human needs

•  Ferdinando Galiani, Della moneta (1751): ”value’s paradox” is caused by utility’s role in the pricing of a commodity, value depends on utility and scarcity



•  Beccaria, Elementi di economia pubblica (1769): theory of utilitarian, hedonistic egotism as driving principle of economic behaviour

•  Mercantilists: focus on own interests and profit motive, not a legal-moral system

•  Smith wanted to turn economics into an autonomous science => rejected explanations of value by utility i.e. by demand in relation to supply

•  Demand reappears in explanations only 100-150 years later with the marginalists


Lecture 3: Smith © Niels Peter Hahnemann 2011 66

Adam Smith and the Wealth of Nations

•  Curriculum: Blaug, Chapter 2 + Wealth of Nations, Book One Chapter I-X (please also read the first 2½ pages of Chapter XI)

•  1. Smith as economist •  His interest was in the long term forces that

govern an economy (“economic development”)

•  Wealth = income produced over time, flow •  Wealth’s basis: division of labour •  Wealth’s main source: agriculture


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•  First treatise on economics based on abstract economic principles

•  The price system is a mechanism that governs the actions of people (agents)

•  Self-propelled, automatic, and human mechanics, neither selfish or benevolent

•  How can human decision-making be self-governing? Against metaphysics

•  Wrote Theory of Moral Sentiments (1759) on the moral basis of economics



•  Morals/ethics based on reason •  Competition is a process, division of labour

is a powerful engine for capital accumulation

•  Which social institutions best propagate human self-sustaining mechanics?

•  Not naive ”laissez-faire”: appropriate institutional and legal framework must be in place (political economy)

•  Intuitive outline of an economy’s organisation, its first comprehensive account



•  2. Contents of the ”Wealth of Nations” •  1st edition published 1776 •  Introduction: Against mercantilism: •  "The annual labour of every nation is the fund which originally

supplies it with all the necessaries and conveniences of life, which it annually consumes, and which consists always either in the immediate produce of that labour, or in what is purchased with that produce from other nations" (WN I-III, page 104).

•  Wealth of nations = production, which in particular depends on labour’s skills:

•  "first, by the skill, dexterity, and judgement with which its labour is generally applied; and, secondly, by the proportion between the number of those who are employed in useful labour, and that of those who are not so employed" (WN I-III, page 104).



•  Civilisation versus the savage state: •  "Among civilised and thriving nations, on the contrary, though a great

number of people do not labour at all, many of whom consume the produce of ten times, frequently of a hundred times more labour than the greater part of those who work; yet the produce of the whole labour of the society is so great that all are often abundantly supplied, and a workman (…) may enjoy a greater share of the necessaries and conveniences of life than it is possible for any savage to acquire" (WH I-III, side 105).

•  => Affordability of ”idlers” (the aristocracy), ordinary workmen also more wealthy

•  Why? Skill and dexterity of labour •  Chapter 1: Importance of division of labour



•  Division of labour ≈ Smith’s only explanation for economic progress:

•  (1) inside the factory: command, non-market, (2) outside and between factories: markets

•  Smith primarily interested in (1) because he believes it explains value/price

•  Economics: labour division network tied together by a price system

•  Famous example: manufacturing of pins with considerable gain in productivity



•  The pin factory example •  “One man draws out the wire, another straights it, a third cuts it, a

fourth points it, a fifth grinds it at the top for receiving the head; •  to make the head requires three distinct operations; to put it on is a

peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper;

•  and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which in some manufactories are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.

•  I have seen a small manufactory of this kind where ten men only were employed. (…) Those ten persons could make among them upwards of forty-eight thousand pins in a day.

•  Each person, therefore, making a tenth part of forty-eight thousand pins might be considered as making four thousand eight hundred pins in a day.

•  But if they had all wrought separately and independently (…) they could certainly not each of them have made twenty” (WN I-III, page 110).


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•  Chapter 2: More on the division of labour •  Division is spontaneous and natural: •  "This division of labour, from which so many advantages are derived,

is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual consequence of a certain propensity in human nature" (WN I-III, page 117).

•  The propensity in humans ”to truck and barter” is:

•  ”the necessary consequences of the faculties of reason and speech” (WN I-III, page 118).

•  I.e. knowledge => expression => exchange: the basis of trade



•  Trade is a rational exchange: •  ”this is mine, that yours; I am willing to give this for that (…) Give me

that which I want, and you shall have this which you want” (WN I-III, page 118)

•  Not the thing-in-itself, but one-thing-for- another, what does it take to get some:

•  ”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” (WN I-III, page 119)

•  Economic ”spacetime” emerges from division of labour => production ≠ consumption

•  Exploitation of different natural talents



•  Chapter 3: The extent of the market limits the division of labour

•  ”As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encourage- ment to dedicate himself entirely to one employment” (WN I-III, page 121).

•  The market takes place in a space defined and bounded by the power of exchanging; this is not necessarily = marketplace; a necessary prerequisite is active use of ”reason and speech”



•  Chapter 4: On money’s origin and use •  Division of labour => barter/exchange: •  ”When the division of labour has been once thoroughly established, it

is but a very small part of man’s wants which the produce of his own labour can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his consumption, for such parts of the produce of other men’s labour as he has occasion for” (WN I-III, page 126).

•  Barter/exchange => money needed due to need for a commodity that:

•  ”few people would be likely to refuse in exchange for the produce of their industry” (WN I-III, page 127).

•  Under what conditions does the exchange of money for goods take place, at what rate?



•  ”It is in this manner that money has become in all civilised nations the universal instrument of commerce, by the intervention of which goods of all kinds are bought and sold, or exchange for one another. What are the rules which men naturally observe in exchanging them either for money or for another, I shall now proceed to examine. These rules determine what may be called the relative or exchangeable value of goods” (WN I-III, page 131).

•  It is by putting forward this problem, that Smith’s account becomes de facto a major oeuvre in the history of classical economic theory!!

•  => Distinction between use value and exchange value, market price and natural price



•  Chapter 5: The price of commodities. Important chapter!!

•  What is the characteristic common to all commodities? They are produced by labour:

•  "The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities" (WH I-III, page 133).

•  ”Labour” term used in 3 different ways: as measure of value; as quantity with which a commodity will exchange = the quantity that it takes to produce it; as disutility that determines the real price of the commodity


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•  "The real price of everything (…) is the toil and trouble of acquiring it" (WN I-III, page 133).

•  "Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour that all the wealth was originally purchased; and its value (…) is precisely equal to the quantity of labour which it can enable them to purchase or command" (WN I-III, page 133).

•  Labour ≈ provenance of the economy, its material basis ≠ labour value theory! Wealth is power = purchasing power:

•  "Wealth, as Mr Hobbes says, is power. But the person who either acquires or succeeds to a great fortune, does not necessarily acquire or succeeds to any political power, either civil or military (…). The power which that possession immediately and directly conveys to him, is the power of purchasing" (WN I-III, page 134).



•  Labour = ”toil and trouble” = ”time spent” + ”degree of hardship” (WN I-III, page 134)

•  Labour is no exact measure, movements of the market achieve only a ”rough equality” (WN I-III, page 134)

•  Quantity of money eventually estimates good’s exchange value (WN I-III, side 135)

•  "At all times and places that is dear which it is difficult to come at, or which it costs much labour to acquire; and that cheap which is to be had easily, or with very little labour. Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard (…). It is their real price; money is their nominal price only" (WN I-III, page 136).

•  No concept about supply and demand



•  Market price: short term •  Equilibrium price: long term = costs of

production •  “Market” and “equilibrium” are not linked

together due to the labour value theory •  "But though equal quantities of labour are always of equal value to

the labourer, yet to the person who employs him they appear sometimes to be of greater and sometimes of smaller value. He purchases them sometimes with a greater and sometimes with a smaller quantity of goods (…). In reality, however, it is the goods which are cheap in the one case, and dear in the other" (WN I-III, page 136).

•  Labour: value’s measure and determinator



•  Real price = labour value: •  "Its (i.e. labour’s) real price may be said to consist in the quantity of

the necessaries and conveniences of life which are given for it; its nominal price in the quantity of money" (WN I-III, page 136).

•  Tautology: real price = value: •  "The same real price is always of the same value; but on account of

the variations in the value of gold and silver, the same nominal price is sometimes of very different values" (WN I-III, page 134).

•  I.e. mercantilists and quantity theory say: market price = supply + demand; but Smith says: real price = labour value:

•  "Labour, therefore, it appears evidently, is the only universal, as well as the only accurate measure of value" (WN I-III, page 139-140).



•  Chapter 6: Components of goods’ prices •  Compares the primitive society, in which

products are not brought to the market: •  "that early and rude state of society“, hvor "the whole produce of

labour belongs to the labourer" (WN I-III, page 150-51),

•  - to the advanced society, in which: •  "something must be given for the profits of the undertaker of the work

who hazards his stock in this adventure. The value which the workmen adds to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced" (WN I-III, page 151).

•  => Price composed by wages and profits



•  Products not brought to the market = the production function

•  If total production belongs to the worker: value of the commodity = terms of trade = relative contents of labour:

•  "If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer" (WN I-III, page 150).

•  First use of algebra in economic theory? •  Value = long term price determined by the

value of labour, not market price determined by supply and demand


15


•  Advance of capital => profit is payable: •  “Profits should bear a regular proportion to his capital. In the price of

commodities, therefore, the profits of stock constitute a component part altogether different from the wages of labour, and regulated by quite different principles. In this state of things, the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him" (WN I-III, page 152).

•  If land is advanced (i.e. private property) => also rent is payable

•  Real value of a commodity determined outside of the market, i.e. outside of the economy, by its cost of production, i.e. by value of labour:



•  "The real value of all the different component parts of price, it must be observed, is measured by the quantity of labour which they can, each of them, purchase or command. Labour measures the value not only of that part of price which resolves itself into labour, but of that which resolves itself into rent, and of that which resolves itself into profit" (WN I-III, page 153).

•  I.e. measure of (labour) = measure of (labour + rent + profits): the contradiction and inconsistency in Smith's theory, and the cause of countless theoretical disputes

•  "Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from some one or other of these" (WN I-III, page 155).



•  The annual labour product buys more (because it also contains profits + rent) than the labour product (??!!):

•  "As in a civilized country there are but few commodities of which the exchangeable value arises from labour only, rent and profit contributing largely to that of the far greater part of them, so the annual produce of its labour will always be sufficient to purchase or command a much greater quantity of labour than what was employed in raising, preparing, and bringing that produce to market" (WN I-III, page 157).

•  It does not add up •  Max growth (determined by population) =>

full employment => zero profits and rent => production function has only labour input



•  Chapter 7: Natural and market price •  Natural price given by costs of production: •  "When the price of any commodity is neither more nor less that what

is sufficient to pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price. The commodity is then sold precisely for what it is worth, or for what it really costs" (WN I-III, page 158).

•  Market price given by supply + demand: •  "The market price of every particular commodity is regulated by the

proportion between the quantity which is actually brought to market, and the demand of those who are willing to pay the natural price of the commodity" (WN I-III, page 158).

•  => Effective demand (= willingness to pay natural price) plays no role in the economy



•  Supply ≠ effective demand => fluctuations in market price, but no explanation for ”≠”

•  Competition = a process or mode of behaviour, not a state

•  "The natural price, therefore, is, as it were, the central price to which the prices of all commodities are continually gravitating. (…) The whole quantity of industry annually employed in order to bring any commodity to market naturally suits itself in this manner to effectual demand. It naturally aims at bringing always that precise quantity thither which may be sufficient to supply, and no more than supply, that demand" (WN I-III, page 160-61).

•  Natural price varies with price-components •  "The natural price itself varies with the natural rate of each of its

component parts, of wages, profits, and rent" (WN I-III, page 166).



•  Chapter 8: The return to labour •  Subsistence wage determined by number

of persons in household: •  ”A man must always live by his work, and his wages must at least be

sufficient to maintain him. They must even upon most occasions be more; otherwise it would be impossible for him to bring up a family” (WN I-III, page 170).

•  National wealth↑ => capital↑ => wage advance (fund)↑ => wage↑:

•  "It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour" (WN I-III, page 172).

•  => Real wage level higher in America than in England (WN I-III, page 172)?!


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•  Why? In a wealthy country wealth does not grow, but the population grows => no ”scarcity of hands”, but rather ”scarcity of employment”

•  "Though the wealth of a country should be very great, yet if it has been long stationary, we must not expect to find the wages of labour very high in it. The funds destined for the payment of wages, the revenue and stock of its inhabitants, may be of the greatest extent; but if they have continued for several centuries of the same, or very nearly of the same extent, the number of labourers employed every year could easily supply, and even more than supply, the number wanted the following year. There could seldom be any scarcity of hands, nor could the masters be obliged to bid against one another in order to get them. The hands, on the contrary, would, in this case, naturally multiply beyond their employment. There would be a constant scarcity of employment…” (WN I-III, page 173-74).

•  Too many ”hands” drive wages down



•  Only the worst of poverty puts limit to the growth of the population, the more wealthy part of the population will still grow:

•  ”But in civilised society it is only among the inferior ranks of people that the scantiness of subsistence can set limits to the further multiplication of the human species” (WN I-III, page 182).

•  Chapter 9: On profits. Increase in ”stock” => reduction in profits due to increase in competition

•  Profits will be lowest in the most wealthy country => tendency of rate of profit to fall

•  Else: a primarily descriptive chapter



•  Chapter 10: Wage and profit (descriptive) •  Differences in wages according to labour’s

agreeableness or disagreeableness, difficulty, etc. (WN I-III, page 202-222)

•  Differences in profits: corporations try to limit free competition (WN I-III, page 227) => unequal exchange between city and country (WN I-III, page 228-230)

•  A highly regulated European economy •  Point: market mechanism equalises

returns and wages – if allowed to operate



•  Chapter 11: On rent (very long and descriptive, only page 247-249 of general interest)

•  Rent for use of land is the highest price that the tenant can afford

•  While wages and profits cause high commodity prices, high rent is a consequence of high commodity prices;

•  Increase in economic welfare causes higher rent (but lower profits)

•  Digression on the value of silver and the general development of prices



•  Book Two: On the accumulation of capital, gross and net product, productive and unproductive labour, S ≡ I => money is only a means of exchange

•  Book Three: On the development of agriculture in Europe

•  Book Four: Mercantilism, Physiocrates, “political economy” (÷), “laissez faire” (+), free trade (+), the “invisible hand”

•  Book Five: On public finances



•  “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society. (…) He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention”, that is the common good: Adam Smith (1776), The Wealth of Nations, Books IV-V, pp. 30 and 32.

•  Only place in Wealth of Nations where Smith used famous expression. Smith also used it in his earlier work: Theory of Moral Sentiments


17

Lecture 4: Malthus © Niels Peter Hahnemann 2011 97

•  LECTURE 4: Malthus, population, returns •  Curriculum: Blaug Chapter 3 •  ”Savage state”: consumption ≡ production •  ”Civilised state”: division of labour, needs

satisfied via the market •  => consumption ≠ production savings: •  Consumption + savings = production =

consumption + investments •  => Number and growth of population no

longer governed by production?



•  Overpopulation = underproduction: •  Analytical problem for economic theory •  Practical problem for society •  Important issue for discussion over the 40

years between Smith and Ricardo •  Link between S&R is: Thomas Robert

Malthus (1798), Essay on Population •  Strong relation between growth of

population and food supply •  Capacity to grow of human population

given by man’s reproductive instincts



•  Positive limits to population growth: food production, morals, ”vice”

•  Negative limits to population growth: ”vice”, poverty

•  Man’s biological capacity for reproduction (geometrical growth) > man’s physical capacity to increase the production of food (arithmetical growth)

•  Dynamical argument that affects the poor only, who therefore must respect ”vice”



•  ”I think I may fairly make two postulata. First, that food is necessary to the existence of man. Second, that the passion between the sexes is necessary, and will remain nearly in its present state. These two laws, ever since we have had any knowledge of mankind, appear to have been fixed laws of our nature. (...) Assuming then my postulata as granted, I say that the power of population is indefinitely greater than the power in the earth to produce the subsistence for man” (EPP, page 12-13).

•  ”This natural inequality of the two powers of population and of the production on the earth, and that great law of our nature which must constantly keep their effects equal, form the great difficulty that to me appears insurmountable in the way to the perfectibility of society” (EPP page 14).

•  We will suppose the means of subsistence in any country just equal to the easy support of its inhabitants. The constant effort towards population, which is found to act even in the most vicious societies, increases the number of people before the means of subsistence are increased. The food therefore which before supported seven millions must now be divided among seven million and a half or eight millions. The poor consequently must live worse” (EPP page 19).



•  If no economic inequality, no need to respect ”vice”:

•  ”We have seen the fatal effects that would result to a society if every man had a valid claim to an equal share of the produce of the earth. The members of a family which was grown too large for the original division of land appropriated to it could not then demand a part of the surplus produce of others, as a debt of justice. It has appeared that, from the inevitable laws of nature, some human beings must suffer from want. These are the unhappy persons who, in the great lottery of life, have drawn a blank” (EPP, page 85).

•  Fear of starvation makes food constraint effective: empty non-falsifiable statement

•  Builds on postulate about declining returns regardless of technical progress, from:

•  Turgot (1765), Reflexions sur la formation et la distribution des richesses



•  Turgot: Increase in a factor of production + other factors remain constant => decline in rate of growth of total production

•  Malthus: ”Where there are few people, and a great quantity of fertile land, the power the earth to afford a yearly increase of food may be compared to a great reservoir of water, supplied by a moderate stream. The faster population increases, the more help will be got to draw off the water, and consequently an increasing quantity will be taken every year. But the sooner, undoubtedly, will the reservoir be exhausted, and the streams only remain. When acre has been added to acre, till all the fertile land is occupied, the yearly increase of food will depend upon the amelioration of all the land already in possession; and even this moderate stream will be gradually diminishing. But population, could it be supplied with food, would go on with unexhausted vigour” (EPP page 48, footnote).

•  Subsistence wage is function of ”habit & custom” => overpopulation is possible = food production too low, supply of land too low => return to production declines with increase in population


18


•  Price of corn a political issue (corn laws) •  Thomas Robert Malthus (1815), Inquiry

into the Nature and Progress of Rent: high price on corn due to rent, not customs

•  David Ricardo (1815), An Essay on the Influence of a Low Price of Corn: rent is payment to landowner that equilibrates (equalises) rates of profit on land of different fertility, rent is determined by price (as in Smith)



•  The emerging classical model: capital + labour cultivate land, output = corn (one good same price)

•  Ongoing inputs of increasing, homogenous amounts of capital and labour in a fixed proportion, i.e. a two-factor model on land

•  Two factors determine price: K,L •  Third factor: J, determined by price •  Price determines production’s return = rent •  Costs differ (good or bad land) •  Diminishing returns = rent declines



•  Rent is "unearned income" from the good land

•  The land-resource is inexhaustible and non-reproducible: always in fixed supply and necessary as input (á la oil?)

•  Rent = taxation object, e.g. Henry George (1879), Progress and Poverty

•  Over-population ≈ under-consumption ≈ over-production => possibility of ”gluts” (too many goods): this is a dynamical argument in Malthus


Lecture 5 Ricardo © Niels Peter Hahnemann 2011 106

•  LECTURE 5: David Ricardo, On the Principles of Political Economy and Taxation (1st edition 1817, 3rd 1821)

•  Curriculum: Blaug, Chapter 4, Principles, Chapter I-VII and XXX

•  LECTURE PART ONE: CHAPTERS 1+4+30

•  Probably one of the most difficult of the major works in the history of economics

•  Leading idea: Growth ceases due to lack of natural resources (marginal land)



•  Chapter I divided in 7 sections. 1st Section: value of commodity depends on quantity of labour required for its production

•  Based on Smith, but also critique of Smith •  "Possessing utility, commodities derive their exchangeable value

from two sources; from their scarcity, and from the quantity of labour required to obtain them" (Principles, page 12).

•  Ricardo: ”utility” = Smith: ”use value” •  Smith’s correct definition of value: •  "If the quantity of labour realised in commodities regulate their

exchangeable value, every increase of the quantity of labour must augment the value of that commodity on which it is exercised, as every diminution must lower it" (P., page 13).



•  Smith’s incorrect definition of value: wage fund determines relative price i.e. he

•  "speaks of things being more or less valuable in proportion as they will exchange for more or less of this standard measure" (P, p. 14).

•  Ricardo: value = embodied quantity of labour => terms of trade

•  Smith: value = terms of trade i.e. regards •  “the standard measure of value as not the quantity of labour

bestowed on the production of any object, but the quantity which it can command in the market" (P., page 14).

•  Smith: labour determines exchange value •  Ricardo: returns to labour and product of

labour not the same thing:


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•  "If the reward of the labourer were always in proportion to what he produced, the quantity of labour bestowed on a commodity, and the quantity of labour which that commodity would purchase, would be equal, and either might accurately measure the variations of other things; but they are not equal" (P., page 14).

•  Smith: the produce of labour = the reward of the labourer (because value = exchange value) is sufficient to purchase a much greater quantity of labour

•  Ricardo: they are not the same •  "It is the comparative quantity of commodities which labour will

produce, that determines their present or past relative values, and not the comparative quantities of commodities, which are given to the labourer in exchange for his labour" (P., page 17).



•  2nd Section: different types of labour have different returns => different

•  ”estimation of which different qualities of labour are held", (...which...), "when once formed, is liable to little variation". It is a matter of a "proper scale of value" (P., page 20-21).

•  Does not change much over time •  Variation = temporary fluctuation •  => Rejects that fluctuations have any

impact on the commodities’ relative value •  3rd Section: labour bestowed (embodied) in

capital must also be included



•  Share of capital small part of total value (P., page 23)

•  Total labour = commodity’s production + supply to market (P., page 25)

•  Value of capital = value of past labour embodied/put down/bestowed in capital

•  Labour savings reduce relative value of commodities

•  ”Quantity of labour bestowed" ≠ "reward of labour" =>



•  "The proportion which might be paid for wages is of the outmost importance in the question of profits; for it must at once be seen, that profits would be high or low exactly in proportion as wages were low or high” (NOTE: because total labour value is unchanged); “but it could not in the least affect the relative value of fish and game as wages would be high or low at the same time in both occupation" (P., page 27)

•  Equal wages in "fish" and "game". One wage: subsistence

•  Ricardo thinks that the distribution between wages and profits can change

•  Idea: distribution ≠ production ("proportion which might be paid"), i.e. value of labour is distributed between wages and profits



•  "If with the same quantity of labour a less quantity of fish or a greater quantity of game were obtained, the value of fish would rise in comparison with that of game" (P., side 27). "No alteration in the wages of labour could produce any alteration in the relative value of these commodities; for suppose them” (NOTE: wages) “to rise, no greater quantity of labour would be required in any of these occupations, but it would be paid for at a higher price" (P., page 28).

•  Reduced quantity of labour in the production of either "fish" or "game" by saving labour and investing capital => decreased labour value

•  Change in wage does not change value of labour, only the distribution between wages and profits



•  Sections 4 + 5: capital, labour, value •  Complexities in the labour value theory: •  "This difference in the degree of durability of fixed capital, and this

variety in the proportions in which the two sorts of capital may be combined, introduce another cause, besides the greater or less quantity of labour necessary to produce commodities, for the variations in their relative value – this cause is the rise or fall in the value of labour" (P., page 30).

•  Another cause ≠ quantity of labour? •  Difference in combination and durability of

capital => difference in labour saving => change in labour’s value even if quantity of labour is constant:


20


•  "But although commodities produced under similar circumstances would not vary with respect to each other from any cause but an addition or diminution of the quantity of labour necessary to produce one or other of them, yet compared with others not produced with the same proportionate quantity of fixed capital they would vary from the other cause also which I have mentioned before, namely a rise in the value of labour, although neither more nor less labour were employed in the production of them" (P., page 32-33).

•  Fixed capital = machinery, buildings; circulating capital = wages

•  Labour value becomes dependent upon time to the market

•  => More than one explanations for relative value?

•  Value of labour ↑ ≡ profits ↓



•  Change in relative value depends on share of fixed capital, but:

•  ”There can be no rise in the value of labour without a fall of profits” (P., page 35)

•  Total product will be of constant value for constant contribution of capital and labour

•  Labour’s return ≠ labour’s exchange value •  => Effect of wage↑ depends on fixed

capital: •  ”The degree of alteration in the relative value of goods on account of

a rise or fall in the relative value of labour, would depend on the proportion which the fixed capital bore to the whole capital employed” (P., page 35).



•  But this effect is small, says Ricardo => labour value theory only an approximation

•  Difference between ”approximation” and ”actual” is due to time:

•  ”The superior price of one commodity is owing to the greater length of time which must elapse before it can be brought to market (…) The difference in value arises in both cases from the profits being accumulated as capital, and is only a just compensation for the time that the profits are withheld” (P., page 37).

•  The more fixed capital, the larger the fall in exchange value (P., page 38)

•  Equivalent effect from difference in fixed capital’s ”durability”



•  Ricardo wanted to: •  1) determine the average of relative value,

2) determine the distribution of value •  Necessitated finding unit of measurement

for economy’s total returns, but value ends up being co-determined by distribution

•  He ”solved" the problem by measuring only goods with the same capital-labour ratio

•  Change in wage-profit relation will not change the average and, consequently, will not change total product value



•  Wage increase => more machinery => equalisation of profit rates. Illustrated with numbers (P., page 40-41):

•  If a manufacturer of machines increases his price (remember that wages are identical for all manufacturers), he will end up using "an unusual quantity of capital” in the production to get labour savings, and the price of his machines will fall ”till their price afforded only the common rate of profits”



•  Wages↑ does not increase price of machines but increases amount of capital and decreases amount of labour:

•  "With every difficulty of providing for the maintenance of men” (NOTE: because the population grows all the time), “labour necessarily rises” (NOTE: because more food is necessary), “and with every rise in the price of labour, new temptations are offered to the use of machinery" (P., footnote page 41).

•  => Change in commodities’ relative value as a consequence of wage increase => equalisation of profit rates ≡ ”Ricardo effect”

•  Increasingly over time, machines (“these mute agents”) substitute capital for labour


21


•  Section 6: on the invariable standard of value (only in 3rd edition)

•  Approximate labour value => does an invariable measure exist?

•  "Of such a measure it is impossible to be possessed, because there is no such commodity which is not itself exposed to the same variations as the things, the value of which is to be ascertained" (P., page 43-44).

•  Gold not a perfect measure either •  Ricardo then assumes that gold is

produced with proportion of labour, fixed capital, etc. ≈ average of the economy:



•  "May not gold be considered as a commodity produced with such proportions of the two kinds of capital as approach nearest to the average quantity employed in the production of most commodities?" (P., page 45).

•  => Gold’s labour value will always only vary with quantity of labour => useable as measure

•  Extra implicit assumption: corn is produced under same conditions as gold => corn/gold-standard => critique of Smith:

•  "Smith (…) maintained that a rise in the price of labour would be uniformly followed by a rise in the price of all commodities. I hope that I have succeeded in showing (…) that only those commodities would rise which had less fixed capital employed upon them than the medium in which price was estimated" (P., page 46).



•  Section 7: money is introduced •  Money is neutral: Ricardo runs through the

argument •  Fall in value of money => increase in

money wage + commodity prices => relative value unchanged:

•  "Money, being a variable commodity, the rise of money-wages will be frequently occasioned by a fall in the value of money. A rise of wages from this cause will, indeed, be invariably accompanied by a rise in the price of commodities; but in such cases it will be found that labour and all commodities have not varied in regard to each other, and that the variation has been confined to money" (page 48).

•  Money’s value only changes through trade:



•  "Money, from its being a commodity obtained from a foreign country (…) is subject to incessant variations" (P., page 48).

•  No effect on profits because constant quantity of labour goes to workers (P., page 48-49)

•  "Wages are to be estimated by their real value, viz. by the quantity of labour and capital employed in producing them, and not by their nominal value" (P., page 50).

•  "The variation in the value of money, however great, makes no difference in the rate of profits" (P., page 50) --

•  -- because capital input is constant •  Chapter 4 linked up with Chapter 1



•  Chapter IV: on the accidental temporary deviation of market from natural price

•  "There is no commodity which continues for any length of time to be supplied precisely in that degree of abundance, which the wants and wishes of mankind require" (P., page 88).

•  Demand fluctuates => capital diverts => rates of profit adjust:

•  "It is then the desire, which every capitalist has, of diverting his funds from a less to a more profitable employment that prevents the market price of commodities from continuing for any length of time either much above or much below their natural price. It is this competition, which so adjusts the exchangeable value of commodities that after paying the wages (…) and all other expenses to (…) the capital employed (…) the remaining value or overplus will in each trade be in proportion to the value of the capital employed" (P., page 91).



•  Competition adjusts exchange value, not 100 pct. determined by labour value, so that rates of profit are equilibrated

•  Ricardo’s model is only about natural price: •  "We are treating of the laws which regulate natural prices, natural

wages and natural profits, effects totally independent of these accidental causes" (P., page 92).

•  Same message in Chapter XXX on supply and demand:

•  "It is the cost of production, which must ultimately regulate the price of commodities and not, as has been often said, the proportion between the supply and demand" (P., page 382).


22


•  Controversy about role of demand, "which has been the source of much error in that science”, i.e. in economics

•  Demand for monopolised goods: •  "they fall in proportion as the sellers augment their quantity, and rise

in proportion to the eagerness of the buyers to purchase them; their price has no connexion with their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production" (P., page 385).

•  The position of the classical economists cannot be expressed any better!!



•  Economics: organisation of society according to certain objectives

•  “Society” => concerns, limits, constraints •  Classical economics: land limited resource, labour

+ capital unlimited, decreasing returns on average due to limited resources

•  No utility, only supply i.e. production costs •  Neoclassical economics: unlimited or reproducible

resources, limitation is from taste (preference of something over something else), decreasing returns at the margin with given resources

•  Demand & supply => maximisation constraints •  Ecological economics: limited resources (again)



•  LECTURE PART TWO: David Ricardo, On the Principles..., Chapters 2+3+5+6

•  On the returns to production factors, and on foreign trade

•  Chapter on value: laws of total production •  Expanded in 3rd edition with “on machinery” •  Primary interest: distribution (Ch. 2-3, 5-6) •  Corn laws depress rate of profit •  Modelling of basic economic relationships



•  ”The produce of earth – all that is derived from its surface by the united application of labour, machinery, and capital, is divided among three classes of the community”, (i.e. landowners, capitalists and workers). “To determine the laws which regulate this distribution is the principal problem in Political Economy” (P., page 5).

•  Chapter II: on rent •  Basic theorem: rate of profit inversely

proportional to wages, i.e. it is a question about distribution

•  From total product = price is deducted rent depending upon the land’s fertility

•  Rent redistributes purchasing power



•  ”Rent is that portion of the produce of the earth, which is paid to the landlord for the use of the original and indestructible powers of the soil” (P., page 67).

•  Land is limited = it has value: •  ”On the first settling of a country (…) there will be no rent; for no one

would pay for the use of land, when there was an abundant quantity not yet appropriated and, therefore, at the disposal of whosoever might choose to cultivate it. On the common principles of supply and demand, no rent could be paid for such land for the reason stated why nothing is given for the use of air and water or for any other of the gifts of nature, which exist in boundless quantity. (…) they are inexhaustible and at every man’s disposal. (…) but as the supply is boundless, they bear no price. If all land had the same properties, if it were unlimited in quantity and uniform in quality, no charge could be made for its use unless where it possessed peculiar advantages of situation. It is only, then, because land is not unlimited in quantity and uniform in quality, and because of the progress of population, land of inferior quality or less advantageously situated is called into cultivation, that rent is ever paid for the use of it” (P., page 69-70).



One good, one price, one cost, limited land


value (in corn)

production (material)

price

Ricardo: land of increasingly inferior fertility i.e. limited in quantity, not uniform in quality

value

prod.

Physiocrats: land unlimited for the family holding

surplus, excess over needs

23


•  Output determined by population size and technical conditions in agriculture

•  Decreasing returns only in agriculture and results in rent:

•  ”If, then, good land existed in a quantity much more abundant that the production of food for an increasing population required, or if capital could be indefinitely employed without a diminished return on the old land, there could be no rise of rent; for rent invariably proceeds from the employment of an additional quantity of labour with a proportionally less return” (P., page 72).

•  Production↑ => exchange value of corn↑: •  ”When land of inferior quality is taken into cultivation, the

exchangeable value of raw produce will rise, because more labour is required to produce it” (P. page 72)



Population drives output


corn output

c + l input

Growth of population

AP = average prod.

MP = marginal prod.

wage

profit

rent


•  One price on market for corn => •  “But that corn, which is produced by the greatest quantity of labour is

the regulator of the price of corn; and rent does not and cannot enter in the least degree as a component part of its price” (P., page 77).

•  Rent is a symptom of wealth: •  ”The rise of rent is always the effect of the increasing wealth of the

country and of the difficulty of providing food for its augmented population. It is a symptom, but it is never a cause of wealth (P., page 77).

•  Accumulation of capital↑ = population↑ => share of rent↑ because more marginal land increases distance to the good land

•  Technical progress => rent’s share↓:



•  ”With every portion of additional capital, which it becomes necessary to employ on the land with a less productive return, rent would rise. It follows from the same principles that any circumstances in the society which should make it unnecessary to employ the same amount of capital on the land, and which should therefore make the portion last employed more productive, would lower rent” (page 78).

•  Why? Same quantity of corn is produced with less land => poorest marginal land withdrawn from production => distance to good land decreases => rent↓

•  Quantity of labour↓ => relative corn value↓ => profit↑ => capital accumulation↑ etc.

•  I.e. fall in rent is only temporary



•  But technical improvements need not lead to lower rent: numerical example in Principles page 82. Conclusion:

•  ”that whatever diminishes the inequality in the produce obtained from successive portions of capital employed on the same or new land tends to lower rent; and that whatever increases that inequality necessarily produces an opposite effect, and tends to raise it” (P., page 83).

•  Chapter III on rent from mining: same mechanism =>

•  Possibility of fluctuations in value of bullion



•  Chapter V and VI: core of Ricardo’s model, on wage and profit

•  Natural wage given by subsistence: •  ”The natural price of labour, therefore, depends on the price of the

food, necessaries, and conveniences required for the support of the labourer and his family” (P., page 93).

•  Price of food↑ => wage↑: •  ”With the progress of society the natural price of labour has always a

tendency to rise, because one of the principal commodities by which its natural price is regulated has a tendency to become dearer from the greater difficulty of producing it” (P., page 93).

•  Other goods fall in price:


24


•  ”for though, on the one hand, they are enhanced in real value from the rise in natural price of the raw material of which they are made” (agricultural produce), “this is more than counterbalanced by the improvements in machinery” (machines substitute for more labour, than they embody), “by the better division and distribution of labour, and by the increasing skill, both in science and art, of the producers” (P., page 94).

•  Capital = advance = wage fund+machinery •  “Capital is that part of the wealth of a country, which is employed in

production and consists of food, clothing, tools, raw materials, machinery etc. necessary to give effect to labour” (P., page 95).

•  1) Wage fund↑ => capital↑ both in volume and value => natural wage↑

•  2) Machinery↑ => capital↑ but only in volume => natural wage constant or↓



•  Market price of labour will increase in both cases and subsequently adjust downwards to natural wage

•  Δ wage fund = Δ natural wage: outside of the model

•  Development of society => price of manufactures declines + price of agricultural produce increases => disproportion in their relative value => increase in wealth:

•  ”In rich countries, a labourer by the sacrifice of a very small quantity only of his food is able to provide liberally for all his other wants” (P., page 97).



•  If Δ capital > Δ population => wage↑ •  Page 99: rich countries = countries where

all arable land is under cultivation •  Wealth ≈ maximal cultivation of all

accessible and marginal land •  Poverty ≈ abundant i.e. redundant quantity

of the means of production, only fertile land is exploited/cultivated

•  Overpopulation ≈ poverty = the result of not fully exploiting earth’s productive means. The solution:



•  ”the labouring classes should have a taste for comforts and enjoyments, and that they should be stimulated by all legal means in their exertions to procure them. There cannot be a better security against a superabundant population” (P., page 100),

•  Increase subsistence wage (comforts and enjoyments, i.e. outside of the model), not decrease population

•  But: increase in capital accumulation => land of worse quality cultivated => decline in growth of capital, while the population continues to grow regardless =>



•  ”In the natural advance of society, the wages of labour will have a tendency to fall as far as they are regulated by supply and demand; for the supply of labourers will continue to increase at the same rate, whilst the demand for them will increase at a slower rate. (…) Wages would fall if they were regulated only by the supply and demand of labourers; but we must not forget, that wages are also regulated by the prices of their commodities on which they are expended. As population increases, these necessaries will be constantly rising in price, because more labour will be necessary to produce them” (P., page 101).

•  Wage will not increase sufficiently to buy same quantity of necessities as before because land of worse quality is cultivated

•  ”Notwithstanding, then, that the labourer would be really worse paid, yet this increase in his wages would necessarily diminish the profits of the manufacturer; for his goods would sell at no higher price, and yet the expense of producing them would be increased” (P., page 102).



•  I.e. wage↑ profit↓ BINGO!! •  Argument expanded in chapter 6 on profit •  Illustrated with figures (see Blaug page

113-118) •  ”Profits depend on high or low wages, wages on the price of

necessaries, and the price of necessaries chiefly on the price of food because all other requisites may be increased almost without limit” ( P., page 119).

•  Natural price ≠ supply + demand, depends on quantity of labour, affected by lack of fertile land

•  Market price = supply + demand, fluctuates around natural price


25


•  ”If there be not plenty of fertile land, if to produce this additional quantity more than the usual quantity of capital and labour be required, corn will not fall to its former level. Its natural price will be raised” (P., page 120).

•  Price of corn ↑ => wage↑ profit↓ •  ”The farmer, instead of obtaining permanently larger profits, will find

himself obliged to be satisfied with the diminished rate, which is the inevitable consequence of the rise of wages produced by the rise of necessaries. The natural tendency of profits then is to fall; for, in the progress of society and wealth, the additional quantity of food required is obtained by the sacrifice of more and more labour” (P., page 120).

•  Profit rate’s tendency to fall countered by machinery and labour improvements

•  Profit = 0 => capital accumulation ceases + rent = MAX



•  Theory of production (Smith): value determined by quantity of labour embodied (bestowed) in commodity

•  Theory of distribution (Ricardo): value of commodity different from the value, which the commodity can purchase

•  Distribution => argument against protectionism and in favour of free trade: duty on corn↑ => profit↓, profit is not affected in Smith’s theory

•  Ricardo tried to explain why profits decline, but he maintained theory of production costs = labour theory of value



•  LECTURE PART THREE: David Ricardo, On the Principles..., Chapter 7

•  Chapter VII on foreign trade •  Money creation from trade surplus =>

discussion of why •  Ricardo’s political interests: free trade •  Ricardo’s basic claim: foreign trade does

not increase the value of commodities, but it increases the quantity of commodities available => wealth↑



•  ”As the value of all foreign goods is measured by the quantity of the produce of land and labour, which is given in exchange for them, we should have no greater value if by the discovery of new markets we obtained double the quantity of foreign goods in exchange for a given quantity of our’s” (P., page 128).

•  An example: export goods for 1000£, import goods for this amount and sell them for 1200£ => profit rate 20%

•  Sell them for more than 1200£ => profit↑ => capital flows in => price↓ => profit↓

•  Foreign trade does not change total value or the general profit rate



•  Advantage of trade: it frees capital for employment elsewhere:

•  “In the purchase of foreign commodities, either the same, a larger, or a less portion of the produce of the land and labour of England will be employed. (…) If, in consequence of the price of foreign commodities being cheaper, a less portion of the annual produce of the land and labour of England is employed in the purchase of foreign commodities, more will remain for the purchase of other things” (P., page 129).

•  Condition: imported goods must be “cheaper” => quantity of available goods↑ => wealth↑

•  Extension of market = increase in quantity (volume) of goods:



•  ”Such extension may be equally efficacious in increasing the mass of commodities and may thereby enable us to augment the funds destined for the maintenance of labour (…) It is quite as important to the happiness of mankind, that our enjoyments should be increased by the better distribution of labour, by each country producing those commodities for which by its situation, its climate, and its other natural or artificial advantages, it is adapted, and by their exchanging them for the commodities of other countries, as that they should be augmented by a rise in the rate of profits” (P., page 132).

•  Comparative advantage => increased wealth, not higher profit except if price of necessaries falls ≈ effect of machinery:

•  ”If, therefore, by the extension of foreign trade or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise” (P., page 132).


26


•  Labour quantity determines relative price between goods, not between countries:

•  ”The same rule, which regulates the relative value of commodities in one country, does not regulate the relative value of the commodities exchanged between two or more countries” (P., page 133).

•  Due to limited mobility of capital •  Capital flows to production in home

country where it is relatively most advantageous relative to the quantity of goods, which this production can buy abroad

•  => Famous example with Portugal versus England, cloth and wine (P., page 135)



•  Why? To realise saving that gives larger quantity of goods for same value and thus increases wealth, not to have higher profits ≡ demand principle!!

•  Rate of profit is the same within countries and differs between them (P., page 134)

•  Terms of trade between countries determined by goods’ purchasing parity

•  ”Such an exchange could not take place between the individuals of the same country. (…) The difference in this respect between a single country and many is easily accounted for by considering the difficulty with which capital moves from one country to another” (P., page 135).

•  Gold flows in stead of capital movements



•  Survey: Ricardo’s oeuvre in Principles •  Production part: chapters 1+4+30

(required reading) plus chapter 31 on machinery (only available as of 3rd edition)

•  Distribution part: chapters 2+3+5+6 (required reading) plus: chapter 21(relation between capital accumulation and profit rate), chapter 24 (rent theory, and critique of Smith), chapter 32 (rent, and critique ff Malthus)

•  Taxation and trade parts based on distribution part:



•  Taxation and public finance: chapters 8-18 incl., chapters 22+23 (on ”bounties” i.e. subsidies), chapters 26+29

•  Trade theory + monetary issues: chapters 7, 19, 25, 27 and 28

•  Welfare theory ≈ conclusion to Ricardo’s oeuvre: chapter 20

•  Wealth ≠ riches: •  "A man is rich or poor according to the abundance of necessaries

and luxuries, which he can command" (P., Chapter XX, page 275).



•  "Value, then, essentially differs from riches, for value depends not on abundance, but on the difficulty or facility of production. The labour of a million of men in manufactures will always produce the same value but will not always produce the same riches. By the invention of machinery, by improvements in skill, by a better division of labour, or by the discovery of new markets where more advantageous exchanges may be made, a million of men may produce double or treble the amount of riches (…); but they will not on that account add any thing to value; for every thing rises or falls in value (…) in proportion to the quantity of labour employed on its production" (P., Chapter XX, page 273).

•  Increase wealth through either savings or through "making the same quantity (of capital) more productive" by machinery or foreign trade



•  Wealth depends on the quantity of goods for either necessaries or enjoyments

•  Ricardo prefers the situation where people are most productive because people does then not need to limit enjoyments (P. Chapter XX, page 279)

•  The larger the wealth/welfare, the less human effort needed per unit of production, the larger the riches (see Blaug page 110)


27

Lecture 6 Say + Mill © Niels Peter Hahnemann 2011 157

•  LECTURE 6: Say and Mill •  Curriculum: Blaug Chapter 5+6 •  1: Jean Baptiste Say, Traité d'economie

politique, ou simple exposition de la maniere dont se formet, se distribuent, et se composent les richesses (1803, English translation same year)

•  Pupil of Adam Smith •  Ricardo: value determined solely from the

supply side. Say: blurred picture of supply and demand, loose argumentation



•  Purchasing power (“to afford a market”) = production capacity

•  Production => supply of goods + income to purchase/demand goods

•  Intuition: total demand in an economy can not be different from total supply

•  Supply creates its own demand •  Chapitre XV in Traité d'economie politique

titled: Des débouchés, i.e. on markets



•  "It is worth while to remark, that a product is no sooner created, than it, from that instant, 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 diminish 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 creation of one product immediately opens a vent for other products" (Say, Traité ch. 15, page 140-41).

•  Products are paid for with products (as in foreign trade):

•  ”L’argent ne remplit qu’un office passager” (i.e. means of exchange) “dans ce double echange; et, les echanges terminés, il se trouve toujours qu’on a payé des produits avec des produits” (Say, Traité ch. 15 page 140).



•  => Over- or underproduction impossible: •  "a glut can take place only when there are too many means of

production applied to one kind of product and not enough to another", (Say, Traité, ch. 15, page 141).

•  Laissez-faire argumentation •  Whole economy, not single industry, i.e. a

macroeconomic point: •  ”C’est pour cela qu’une bonne recolte n’est pas seulement favorable

aux cultivateurs, et qu’elle l’est en meme temps aux marchands de tous les autres produits » (Say, Traité, ch. 15, page 141).

•  In an exchange economy: excess supply of goods ≡ excess demand for money, i.e. disequilibrium is logically impossible



•  Appendix on Say’s law •  Chapitre XV in Traité: Des débouchés •  What does Say say himself? •  « La vente ne va pas » = over-production or

excess supply of goods (« glut ») = deficient excess demand for goods = - ∑ ED(n-1)

•  « L’argent est rare » = excess demand for money = deficient supply of money = ED(n)

•  where ED is excess demand, n-1 is goods, n is money



•  First statement: •  “Lors donc qu’on dit: La vente ne va pas parce que l’argent est rare,

on prend le moyen pour la cause; on commet une erreur qui provient de ce que presque tous les produits se resolvent en argent avant de s’echanger contre d’autre marchandises, et de ce qu’une marchandise qui se montre si souvent parait au vulgaire etre la marchandise par excellence, le terme de tous les transactions dont elle n’est que l’intermediare. On ne devrait pas dire: La vente ne va pas parce que l’argent est rare, mais parce que les autre produits le sont. Il y a toujour assez d’argent pour servir à la circulation et à l’echange reciproque des autres valeurs, lorsque ces valeurs existent reellement” (Traité Chap. 15, page 138-139).

•  I.e. Say asks: over-production of goods = deficient supply of money? WRONG! Over-production of some goods = deficient supply of other goods? CORRECT!


28


•  Why? Money is a means of circulation only •  Second statement: •  “Quand l’argent vient a manquer à la masses des affaires, on y

supplee aisement, et la necessité d’y suppler est l’indication d’une circonstance bien favorable: elle est une preuve qu’il y a une grande quantité de valeurs produites, aves lesquelles on désire se procurer une grande quantité d’autres valeurs. La marchandise intermediare, qui facilite tous les echanges (la monnaie), se remplace aisement dans ce cas-là par des moyens connus des negociants, et bientot la monnaie afflue, par la raison que la monnaie est une marchandise, et que toute espece de marchandise se rend aux lieux ou l’on en a besoin. C’est un bon signe quand l’argent manque aux transactions, de meme que c’est un bon signe quand les magasins manquent aux marchandises” (Traité Chap. 15, page 139).



•  Deficient supply of money = excess demand for money = excess demand for goods => difference between the two = 0:

•  ∑ ED(n-1) - ED(n) = 0 (where n = money) as equilibrium, not identity

•  => Goods are bought and paid for with goods, Say’s principle:

•  ”De toute maniere, l’achat d’un produit ne peut etre fait qu’avec la valeur d’un autre” (Traité Chap. 15, page 140).

•  I.e. the value of excess demand for money = 0: this is Say’s law



•  Say draws 4 conclusions from his principle that goods are bought with goods:

•  1) “Plus les producteurs sont nombreux et les productions multipliees, et plus les debouches sont faciles, variés et vastes” (Traité Chap. 15, page 140).

•  I.e. the more producers (= supply), the more markets for their products (= demand)

•  2) “Que chacun est interessé à la prosperité de tous” (Traité Chap. 15, page 142).

•  This is a macroeconomic concern about interdependence



•  3) “Que l’importation des produits étrangers est favorable à la vente des produits indigène: car nous ne pouvons acheter les marchandises étrangere qu’avec des produits de norte industrie” (Traité Chap. 15, page 144).

•  I.e. it is necessary to export in order to import

•  4) “La consommation pure et simple, celle qui n’a d’autre objet que de provoquer de noveaux produits, ne contribue point à la richesse du pays. (...) Pour que la consommation soit favorable, il faut qu’elle remplisse son objet essentiel, qui est de satisfaire à des besoins” (Traité Chap. 15, page 144).

•  Exchanging/buying of goods with goods does not have a purpose by itself: the purpose is to satisfy desires/needs



•  Conclusion of appendix: value of excess demand for money = 0, but it is a pure postulate, i.e. disequilibrium is claimed to be practically, not logically, impossible

•  P(∑ ED(n-1)) – M(ED(n)) = 0 PT = MV •  Assumption: money has no function as

store of value, only as means of exchange •  Quantity equation as equilibrium =>

dichotomy between real and monetary: T↑ V↑ and M↑ P↑



•  Money is but a veil = account money, not a real monetary macro economy

•  Say + the classicals: interest rate = price of capital, not “time preference”

•  Does: ∑ ED(n-1) - ED(n) ≠ 0 correspond to deficient supply of money? No, not permanently for whole economy, says Say:

•  ”Les entrepreneurs des diverses branches d’industrie ont coutume de dire que la difficulté n’est pas de produire, mais de vendre; qu’on produirait toujours assez de marchandises, si l’on pouvait facilement en trouver le debit. Lorsque le placement de leur produits est lent, penible, peu avantageux, ils disent que l’argent est rare” (Say, Traite, ch. 15 page 137).


29


•  => Denies that deficient money supply can be a cause for crisis, but admits that it is possible as temporary phenomenon

•  Deficient supply of money ≈ slump, i.e. crisis = secular stagnation? Denied

•  => The economic system operates as a macro system: Say’s historic contribution

•  Savings = resource saving = accumulation ≡ investments => no idea about role of interest rate

•  Henry Thornton (1802), Nature of the Paper Credit of Great Britain



•  Forced saving = money supply increase, can it create capital ≈ lowering of rate of interest? No, says the classicals

•  Problem: absolute price level and value of money are undetermined

•  Malthus, Principles of Political Economy (1820), a theory of general and permanent over-production (”gluts”):

•  Over-production ≈ over-accumulation ≈ over-saving ≈ surplus of hands + secular stagnation

•  Under-consumption theory = the macro-economy does not work: S = I?



•  2: John Stuart Mill (1848), The Principles of Political Economy, With Some of Their Applications to Social Philosophy

•  Summary of classical economic theory, update on Adam Smith

•  Main point: separation between laws of production and laws of distribution

•  Production laws: based on physical reality that cannot be changed

•  Distribution laws: based on human decision-making that is subject to change



•  Classical economic theory as of Mill: •  Productive and unproductive labour (Blaug

page 174-175): physical-material basis for value added

•  Capital + wage fund (Blaug page 175-181): •  Capital = purchasing power over labour

and over other firms’ products = sum of all intermediate products = inventory of consumption goods (i.e. wages) + buildings + machinery = time interval between production and final consumption



•  Mill: capitalists are workers’ creditors •  Marx: workers are capitalists’ creditors •  Wage fund no labour market •  Machinery and technical unemployment

(Blaug page 181-82): relation between fixed and circulating (= wage fund) capital is a technical problem, not a relative price problem

•  Economies of scale (Blaug page 182-83): one of first economists to talk about this

•  Socialism (Blaug page 183-184): ditto



•  Distribution and interest rate (Blaug page 184-188): theory of profits = theory of interest: reward for abstinence

•  Value and demand (Blaug page 188-191): relation between volume of commodity and desire to buy ≈ demand curve

•  Augustin Cournot, Recherches sur les principes mathématiques de la théorie des richesses (1838): D = f(p), but not “willingness to buy”


30


•  Money supply, inflation and banking (Blaug page 191-196). Mill tried to strike a balance between:

•  Currency School: issue of notes/bills must be controlled, gold convertibility maintained

•  Banking School: not necessary to control note issue as long as gold convertibility is maintained

•  Law of Reflux: price increases are not a consequence of but a cause for money supply increases = real bills doctrine, i.e. a Banking School argument



•  International trade, value and prices (Blaug page 196-204): elaborated on Ricardo’s theory (offer curves)

•  Tendency of the rate of profit to fall (Blaug page 204-206): an empirical question, says Mill

•  Discussion of several social issues that increasingly were considered to be economic problems (Blaug page 206-211)


Lecture 7 Marx © Niels Peter Hahnemann 2011 177

•  LECTURE 7: Karl Marx, Capital. A Critique of Political Economy (1st edition 1867)

•  Survey of Marx’s economic writings •  Ökonomisch philosopisches Manuskript (written 1844,

published 1932 by MEI) •  Grundrisse der Kritik der politischen Ökonomie (written

1857-58, published 1939 by MEI) •  Zur Kritik der politischen Ökonomie (written 1858,

published 1859 by Marx) •  Theorien über die Mehrwert (written 1861-63, published by

Kautsky in 1905-10) •  Das Kapital. Erster Band (published 1867 by Marx) •  Das Kapital. Zweiter Band (published 1885 by Engels) •  Das Kapital. Dritter Band (published 1894 by Engels)



•  Summary so far: why a return to investment, reward for waiting, for not working, when value is labour?

•  Theory of decisions over time (intertemporal allocation) ≈ theory of interest ≈ theory of capital

•  Ricardo: no idea, but rent (from land) •  Theory of exploitation (Marx) •  Theory of productivity: abstinence, intertemporal

allocation of some decisions (Mill, Marshall) •  Macroeconomic theory: aggregation => constraint

=> precaution, i.e. monetary economy (Keynes) •  Game theory: intertemporal allocation of all

decisions (Nash)



•  Curriculum: Capital, Volume I, chapters 1+4+5+6+7+8+9 (chapters 1+4+5+6+7 in German and Danish version) = basic ideas of Marx’ model

•  Chapter 1: Commodities. Important stuff!! •  1. The dual character of a commodity.

Smith commenced with division of labour, Marx commenced with the commodity:

•  ”The wealth of those societies in which the capitalist mode of production prevails, presents itself as an immense accumulation of commodities, its unit being a single commodity. Our investigation must therefore begin with the analysis of a commodity” (Capital, Vol. 1, page xx).

•  Use value = satisfaction of human needs



•  Exchange value = the quantitative relation at which use values exchange:

•  ”A commodity is, in the first place, an object outside us, a thing that by its properties satisfies human wants of some sort or another. (…) The utility of a thing makes it a use value. (…) The use values of commodities furnish the material for a special study, that of the commercial knowledge of commodities. Use values become a reality only by use or consumption: they also constitute the substance of all wealth, whatever may be the social form of that wealth. In the form of society we are about to consider, they are, in addition, the material depositories of exchange value. Exchange value, at first sight, presents itself as a quantitative relation, as the proportion in which values in use of one sort are exchanged for those of another sort, a relation constantly changing with time and place.” (C., page 49-50).

•  Exchange value = the abstraction from use value that puts different use values at equality


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•  ”The exchange values of commodities must be capable of being expressed in terms of something common to them all, of which thing they represent a greater or less quantity. This common “something” cannot be either a geometrical, a chemical, or any other natural property of commodities. Such properties claim our attention only in so far as they affect the utility of those commodities, make them use values. But the exchange of commodities is evidently an act characterised by a total abstraction from use value.” (C. page 51-52).

•  Socially necessary labour •  Each individual commodity only counts as

average sample, not of the best or worst labour, but of the labour with average skills and intensity:



•  ”Some people might think that if the value of a commodity is determined by the quantity of labour spent on it, the more idle and unskilful the labourer, the more valuable would his commodity be, because more time would be required in its production. The labour, however, that forms the substance of value, is homogeneous human labour, expenditure of one uniform labour power. The total labour power of society, which is embodied in the sum total of the values of all commodities produced by that society, counts here as one homogeneous mass of human labour power, composed though it be of innumerable individual units. Each of these units is the same as any other, so far as it has the character of the average labour power of society, and takes effect as such; that is, so far as it requires for producing a commodity, no more time than is needed on an average, no more than is socially necessary. The labour time socially necessary is that required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time. (...) We see then that that which determines the magnitude of the value of any article is the amount of labour socially necessary, or the labour time socially necessary for its production. Each individual commodity, in this connexion, is to be considered as an average sample” (C., page 53-54).



•  Capitalists want max labour intensity •  Marx: max ≈ average labour intensity at

constant costs, i.e. marg(cost) = avg(cost) (Blaug page 255-56)

•  => Horizontal supply curve, demand has no effect on price (as all classical economists)

•  The commodity form = a social relation: •  ”A thing can be useful, and the product of human labour, without

being a commodity. Whoever directly satisfies his wants with the produce of his own labour, creates, indeed, use values, but not commodities. In order to produce the latter, he must not only produce use values, but use values for others, social use values” (page 55).



•  2. The dual character of labour. Concrete and abstract labour

•  Production of commodities presumes division of labour, but division of labour does not presume commodity production

•  Productive labour = commodity production •  Labour = consumption of human labour

power => value •  Skilled, complex labour counts as a

multiple of non-skilled, simple labour



•  ”Productive activity, if we leave out of sight its special form, viz., the useful character of the labour, is nothing but the expenditure of human labour power. (…) Of course, this labour power, which remains the same under all its modifications, must have attained a certain pitch of development before it can be expended in a multiplicity of modes. But the value of a commodity represents human labour in the abstract, the expenditure of human labour in general. (…) A commodity may be the product of the most skilled labour, but its value, by equating it to the product of simple unskilled labour, represents a definite quantity of the latter labour alone. The different proportions in which different sorts of labour are reduced to unskilled labour as their standard, are established by a social process that goes on behind the backs of the producers, and, consequently, appear to be fixed by custom” (C., page 58-59).

•  Value determined by labour quantity = time •  Productivity ↑ = larger quantity of

commodities for the same value



•  ”Productive power has reference, of course, only to labour of some useful concrete form, the efficacy of any special productive activity during a given time being dependent on its productiveness. Useful labour becomes, therefore, a more or less abundant source of products, in proportion to the rise or fall of its productiveness. On the other hand, no change in this productiveness affects the labour represented by value. Since productive power is an attribute of the concrete useful forms of labour, of course it can no longer have any bearing on that labour, so soon as we make abstraction from those concrete useful forms. However then productive power may vary, the same labour, exercised during equal periods of time, always yields equal amounts of value. But it will yield, during equal periods of time, different quantities of values in use; more, if the productive power rise, fewer, if it fall. The same change in productive power, which increases the fruitfulness of labour, and, in consequence, the quantity of use values produced by that labour, will diminish the total value of this increased quantity of use values, provided such change shorten the total labour time necessary for their production; and vice versâ” (C., page 60-61).

•  Gives meaning only if value = exogenously given average of labour time


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•  3. Value form: exchange value, 4 types •  A) Elementary value form: one commodity

expressed in terms of another (barter): •  ”The second peculiarity of the equivalent form is, that concrete

labour becomes the form under which its opposite, abstract human labour, manifests itself. But because this concrete labour, tailoring in our case, ranks as, and is directly identified with, undifferentiated human labour, it also ranks as identical with any other sort of labour, and therefore with that embodied in the linen. Consequently, although, like all other commodity-producing labour, it is the labour of private individuals, yet, at the same time, it ranks as labour directly social in its character. This is the reason why it results in a product directly exchangeable with other commodities. We have then a third peculiarity of the equivalent form, namely, that the labour of private individuals takes the form of its opposite, labour directly social in its form” (C., page 73).

•  Private labour becomes social labour



•  ”There was, however, an important fact which prevented Aristotle from seeing that, to attribute value to commodities, is merely a mode of expressing all labour as equal human labour, and consequently as labour of equal quality. Greek society was founded upon slavery, and had, therefore, for its natural basis, the inequality of men and of their labour powers. The secret of the expression of value, namely, that all kinds of labour are equal and equivalent, because, and so far as they are human labour in general, cannot be deciphered, until the notion of human equality has already acquired the fixity of a popular prejudice. This, however, is possible only in a society in which the great mass of the produce of labour takes the form of commodities, in which, consequently, the dominant relation between man and man, is that of owners of commodities” (C., page 74).

•  Human equality ≈ produce of labour takes form of commodity, i.e. a social relation

•  B) Expanded value form: one commodity expressed in terms of all other commod.



•  C) General value form: all commodities expressed in terms of the same commodity

•  ”The two earlier forms either express the value of each commodity in terms of a single commodity of a different kind, or in a series of many such commodities. In both cases, it is, so to say, the special business of each single commodity to find an expression for its value, and this it does without the help of the others. These others, with respect to the former, play the passive parts of equivalents. The general form of value, C, results from the joint action of the whole world of commodities, and from that alone. A commodity can acquire a general expression of its value only by all other commodities, simultaneously with it, expressing their values in the same equivalent; and every new commodity must follow suit. It thus becomes evident that since the existence of commodities as values is purely social, this social existence can be expressed by the totality of their social relations alone, and consequently that the form of their value must be a socially recognised form” (C., page 80-81).



•  D) Money form: gold universal equivalent •  Value form A)-D): cumbersome deduction

but important to Marx’ way of thinking •  Marx wants to demonstrate the social

consequences of an economy •  4. The fetishism of commodities. Important! •  Relations between people i.e. social

relations are treated as relations between things i.e. commodities



•  Class relations originate in dual character of labour, supply and demand is trivial

•  ”A commodity is therefore a mysterious thing, simply because in it the social character of men’s labour appears to them as an objective character stamped upon the product of that labour; because the relation of the producers to the sum total of their own labour is presented to them as a social relation, existing not between themselves, but between the products of their labour” (C., page 86).

•  ”Man’s reflections on the forms of social life, and consequently, also, his scientific analysis of those forms, take a course directly opposite to that of their actual historical development. He begins, post festum, with the results of the process of development ready to hand before him. The characters that stamp products as commodities, and whose establishment is a necessary preliminary to the circulation of commodities, have already acquired the stability of natural, self-understood forms of social life, before man seeks to decipher, not their historical character, for in his eyes they are immutable, but their meaning” (C., page 89-90).



•  I.e. science must expose/uncover •  Commodity fetishism => commodity form =

forms of thought •  ”The categories of bourgeois economy consist of such like

forms” (i.e. the commodity form). ”They are forms of thought expressing with social validity the conditions and relations of a definite, historically determined mode of production, viz., the production of commodities. The whole mystery of commodities, all the magic and necromancy that surrounds the products of labour as long as they take the form of commodities, vanishes therefore, so soon as we come to other forms of production” (C., page 90).

•  The “Robinsonianisms” of bourgeois economics (page 90-92): independent human beings, self interest (A. Smith)


33


•  Middle ages: dependent man •  ”… the European middle ages… Here, instead of the independent

man, we find everyone dependent, serfs and lords, vassals and suzerains, laymen and clergy. Personal dependence here characterises the social relations of production just as much as it does the other spheres of life organised on the basis of that production. But for the very reason that personal dependence forms the ground-work of society, there is no necessity for labour and its products to assume a fantastic form different from their reality. They take the shape, in the transactions of society, of services in kind and payments in kind. Here the particular and natural form of labour, and not, as in a society based on production of commodities, its general abstract form is the immediate social form of labour” (C., page 91).

•  Associated labour: no markets •  ”the patriarchal industries of a peasant family, that produces corn,

cattle, yarn, linen, and clothing for home use. These different articles are, as regards the family, so many products of its labour, but as between themselves, they are not commodities” (C., page 92).



•  Socialism = intelligible social relations •  ”Let us now picture to ourselves, by way of change, a community of

free individuals, carrying on their work with the means of production in common, in which the labour power of all the different individuals is consciously applied as the combined labour power of the community. All the characteristics of Robinson’s labour are here repeated, but with this difference, that they are social, instead of individual. Everything produced by him was exclusively the result of his own personal labour, and therefore simply an object of use for himself. The total product of our community is a social product. One portion serves as fresh means of production and remains social. But another portion is consumed by the members as means of subsistence. A distribution of this portion amongst them is consequently necessary. The mode of this distribution will vary with the productive organisation of the community, and the degree of historical development attained by the producers. We will assume, but merely for the sake of a parallel with the production of commodities, that the share of each individual producer in the means of subsistence is determined by his labour time. Labour time would, in that case, play a double part” (cont’ed).



•  (cont.) ”Its apportionment in accordance with a definite social plan maintains the proper proportion between the different kinds of work to be done and the various wants of the community. On the other hand, it also serves as a measure of the portion of the common labour borne by each individual, and of his share in the part of the total product destined for individual consumption. The social relations of the individual producers, with regard both to their labour and to its products, are in this case perfectly simple and intelligible, and that with regard not only to production but also to distribution” (page 92).

•  Political economy: imposed by nature •  ”Political Economy has indeed analysed, however incompletely,

value and its magnitude, and has discovered what lies beneath these forms. But it has never once asked the question why labour is represented by the value of its product and labour time by the magnitude of that value. These formulæ, which bear it stamped upon them in unmistakable letters that they belong to a state of society, in which the process of production has the mastery over man, instead of being controlled by him, such formulæ appear to the bourgeois intellect to be as much a self-evident necessity imposed by Nature as productive labour itself” (C., page 94-95).



•  Chapter 4: Capital’s general formula •  Simple circulation: C → M → C •  Capitalist circulation: M → C → M' with M’

> M, i.e. supply side driven •  ”The final result of every separate circuit, in which a purchase and

consequent sale are completed, forms of itself the starting-point of a new circuit. The simple circulation of commodities - selling in order to buy - is a means of carrying out a purpose unconnected with circulation, namely, the appropriation of use-values, the satisfaction of wants. The circulation of money as capital is, on the contrary, an end in itself, for the expansion of value takes place only within this constantly renewed movement. The circulation of capital has therefore no limits. As the conscious representative of this movement, the possessor of money becomes a capitalist. His person, or rather his poc- ket, is the point from which the money starts and to which it returns. The expansion of value, which is the objective basis or main-spring of the circulation M-C-M, becomes his subjective aim” (p. 166-67).



•  Chapter 5: Contradictions in general form •  ”As capitalist, I buy commodities from A and sell them again to B, but

as a simple owner of commodities, I sell them to B and then purchase fresh ones from A. A and B see no difference between the two sets of transactions. They are merely buyers or sellers” (p. 170).

•  Circulation is not a source of new value •  ”A, therefore, may get, for the same exchange-value, more corn, and

B more wine, than each would respectively get without any exchange by producing his own corn and wine. With reference, therefore, to use-value, there is good ground for saying that “exchange is a transaction by which both sides gain.”” (...) ”There is in an exchange nothing (if we except the replacing of one use-value by another) but a metamorphosis, a mere change in the form of the commodity. The same exchange-value, i.e., the same quantity of incorporated social labour, remains throughout in the hands of the owner of the commodity, first in the shape of his own commodity, then in the form of the money for which he exchanged it, and lastly, in the shape of the commodity he buys with that money. This change of form does not imply a change in the magnitude of the value” (page 172).



•  Chapter 6: Buying and selling of labour •  Labour is source of surplus value •  ”In order to be able to extract value from the consumption of a

commodity, our friend, Moneybags, must be so lucky as to find, within the sphere of circulation, in the market, a commodity, whose use-value possesses the peculiar property of being a source of value, whose actual consumption, therefore, is itself an embodiment of labour, and, consequently, a creation of value. The possessor of money does find on the market such a special commodity in capacity for labour or labour-power. By labour-power or capacity for labour is to be understood the aggregate of those mental and physical capabilities existing in a human being, which he exercises whenever he produces a use-value of any description” (page 181).

•  The “labour power” concept differentiates Marx from the other classical economists, but is it really important?


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•  Value of labour power determined by social average of labour time

•  ”The value of labour-power resolves itself into the value of a definite quantity of the means of subsistence. It therefore varies with the value of these means or with the quantity of labour requisite for their production” (C., page 186).

•  This is as with the other classical economists, but the surplus value concept is particular to Marx:

•  ”The consumption of labour-power is at one and the same time the production of commodities and of surplus-value” (C., page 189).

•  Chapter 7: Labour process and production of absolute surplus value



•  Description of labour process as in Smith (”not for the benevolence of the butcher…”) + surplus value concept:

•  ”Use-values are only produced by capitalists, because, and in so far as, they are the material substratum, the depositories of exchange-value.” (...) ”His aim is to produce not only a use-value, but a commodity also; not only use-value, but value; not only value, but at the same time surplus-value” (C., page 201).

•  Value determined by labour, as in Smith: •  ”The value of each commodity is determined by the quantity of

labour expended on and materialised in it, by the working-time necessary, under given social conditions, for its production” (p. 201). ”The value of the product is exactly equal to the value of the capital advanced” (p. 205).



•  Surplus value: more labour than necessary •  ”But the past labour that is embodied in the labour-power, and the

living labour that it can call into action; the daily cost of maintaining it, and its daily expenditure in work, are two totally different things. The former determines the exchange-value of the labour-power, the latter is its use-value. The fact that half a day’s labour is necessary to keep the labourer alive during 24 hours, does not in any way prevent him from working a whole day. Therefore, the value of labour-power, and the value which that labour-power creates in the labour-process, are two entirely different magnitudes; and this difference of the two values was what the capitalist had in view, when he was purchasing the labour-power” (C., page 208).

•  ”If we now compare the two processes of producing value and of creating surplus-value, we see that the latter is nothing but the continuation of the former beyond a definite point. If on the one hand the process be not carried beyond the point, where the value paid by the capitalist for the labour-power is replaced by an exact equivalent, it is simply a process of producing value; if, on the other hand, it be continued beyond that point, it becomes a process of creating surplus-value” (C., page 209).



•  Surplus value = product of a free service?!! •  Absolute surplus val.↑: longer working day •  Relative surplus val.↑: shorter necessary

working day •  Chapter 8: Constant and variable capital.

Labour creates new, machines transfer old value

•  ”By the very act of adding new value, he” (the labourer) ”preserves their former values. Since, however, the addition of new value to the subject of his labour, and the preservation of its former value, are two entirely distinct results, produced simultaneously by the labourer, during one operation, it is plain that this two-fold nature of the result can be explained only by the two-fold nature of his labour; at one and the same time, it must in one character create value, and in another character preserve or transfer value” (C., page 214).



•  Constant capital is transferred, not changed: = Smith + Ricardo

•  ”That part of capital then, which is represented by the means of production, by the raw material, auxiliary material and the instruments of labour does not, in the process of production, undergo any quantitative alteration of value. I therefore call it the constant part of capital, or, more shortly, constant capital” (C., page 223).

•  Variable capital = free value increase: ≠ Smith + Ricardo

•  ”On the other hand, that part of capital, represented by labour-power, does, in the process of production, undergo an alteration of value. It both reproduces the equivalent of its own value, and also produces an excess, a surplus-value, which may itself vary, may be more or less according to circumstances. This part of capital is continually being transformed from a constant into a variable magnitude. I therefore call it the variable part of capital, or, shortly, variable capital” (C., page 224).



•  Chapter 9: The rate of surplus value •  ”Resource”: exploitation ≈ resource does

not get a return, is not reproduced •  Ricardo: exploitation of land => rent •  Marx: exploitation of labour => surplus

value •  1. Degree of exploitation of labour power •  C = c + v, C’ = c + v + m, v + m = v + ∆v •  ”This relative increase in the value of the variable capital, or the

relative magnitude of the surplus-value, I call, “The rate of surplus-value”” (C., page 230).


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•  Surplus labour is in all societies, difference is in the way it is extracted

•  ”That portion of the working-day, then, during which this reproduction” (of the value of the labourer’s necessities) ”takes place, I call “necessary” labour time, and the labour expended during that time I call “necessary” labour. Necessary, as regards the labourer, because independent of the particular social form of his labour; necessary, as regards capital, and the world of capitalists, because on the continued existence of the labourer depends their existence also. During the second period of the labour-process, that in which his labour is no longer necessary labour, the workman, it is true, labours, expends labour-power; but his labour, being no longer necessary labour, he creates no value for himself. He creates surplus-value which, for the capitalist, has all the charms of a creation out of nothing. This portion of the working-day, I name surplus labour-time, and to the labour expended during that time, I give the name of surplus-labour” (C., page 231).

•  Rate of surplus value m/v > rate of profit m/(v+c)



•  2. Components of the value of the product •  Value of product proportional to value of

production’s components c + v + m •  3. Senior’s last hour •  Share of surplus value proportional to

share of living labour, not ”last hour” •  4. Surplus product •  ”Since the production of surplus-value is the chief end and aim of

capitalist production, it is clear, that the greatness of a man’s or a nation’s wealth should be measured, not by the absolute quantity produced, but by the relative magnitude of the surplus-produce” (C., page 243).



•  Summary of required reading in “Capital” •  Variable capital v = wages for productive

labourers (flow) •  Constant capital c = fixed capital + raw

materials (flow) •  Rate of surplus value σ = m/v where m is

surplus value •  Organic composition of capital q = c/(c+v) ≈ capital pr. labourer C/v and thus "organic", where C is capital stock (see Blaug page 216)

•  Rate of profit r = m/(c+v)



•  No labour market, as in all classical economists, but differentiates between labour and labour power

•  Value of labour = necessary labour time for the production of wage goods

•  Labour: the only commodity the use value of which is to produce value

•  Labour adds new value to a commodity. Machines transfer the value, they embody

•  Surplus value = unpaid labour => value of labour power’s product > value of labour power



•  The remaining parts of ”Capital” •  Common surplus value rate necessary in

all sectors but if different quantity of capital •  => Organic composition q differs => •  Profit rate differs but will be equilibrated

due to capital movements between sectors •  Profit rate r = σ (1 – q), where σ is surplus

value rate, q organic composition •  If common surplus value rate + same profit

rate common organic composition in the whole economy: assumption in Volume 1-2



•  Volume 3: Organic composition differs between sectors => value ≠ price?

•  Infamous problem regarding transformation from value to price

•  Marx tried to solve contradiction •  Assumption, either: •  1) Capital’s organic composition is the

same in all the economy’s industries, or: •  2) There exists one industry in which

capital’s organic composition actually works as median for the whole economy


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•  => Value equal to price only in the average industry

•  => Value is redistributed between industries according to an average – with no role for demand

•  Similar to Ricardo’s ”solution” i.e. Marx does not make any progress compared to the other classical economists

•  von Bortkiewicz (1907): organic composition in gold production = average organic composition of economy



•  Classicals ÷ Marx: population growth is an economic process (á la Malthus)

•  Marx: exploitation => fundamental disequilibrium due to industrial reserve army = chronic excess supply of labour ≈ subsistence wage > equilibrium wage

•  Surplus value not economic necessity, not reward for effort => profit and interest express exploitation, not time preference

•  => No considerations re demand or re allocation of resources over time (problem with all classicals)



•  Marx + Ricardo + Smith in common: •  1) labour value determines relative price •  2) money is neutral, non-monetary econ. •  3) constant returns in manufacturing •  4) diminishing returns in agriculture •  5) perfect competition •  6) rational agents •  7) wage fund •  Marx alone: industrial reserve army, no

fixed production coefficients = organic composition q will differ between sectors



•  How can q change? Increase in competition => increase in fixed capital => increase in organic composition:

•  c↑ => [c/(c+v)]↑ and (c+v)↑ => [m/(c+v)]↓ •  Or: given r = σ (1 – q), if q↑ then r↓ •  c↑ => relative surplus value↑ via v↓ •  Technical progress is labour saving,

unemployment is technical => increasing impoverishment of population

•  Increase in rate of surplus value σ can not compensate for increase in q => r↓



•  I.e. tendency of rate of profit to decline due to capital’s increasing organic composition: BASIC THEOREM OF MARX!

•  r↓: like all other classical economists •  Ricardo: stationary state •  Marx: collapse •  Reproduction and circulation of capital

(Volume 2): attempt to demonstrate how the economy can follow a balanced path based on 2 sectors producing wage goods and capital good respectively (inspired by physiocrats)



•  Summary: part of classical economic theory but at the same time a major work in opposition to ruling doctrine

•  Reflections on the economic system e.g. “exploitation” => will always be topical:

•  Basis and superstructure of society? •  Economy determines in the final instance? •  Relationship between forces of production

and relations of production? •  Commodity fetishism and reification?


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Lecture 8 Marginalists © Niels Peter Hahnemann 2011 217

•  LECTURE 8: The marginalists •  Curriculum: Blaug chapter 8. Milestones: •  Supply- and demand curves and monopoly theory: Antoine

Augustin Cournot (1838), Recherches sur les Principes Mathématiques de la Theorie des Richesses

•  Curve with declining marginal utility: Arsene Jules Etienne Dupuit (1844) in Annales des ponts et chaussés

•  Theory of marginal productivity and substitution: Johan von Thünen (1850), Der isolierte Staat Vol. II Part 1

•  Marginal utility in a theoretical economic context: William Stanley Jevons (1871), The Theory of Political Economy

•  General equilibrium incl. theory of an exchange economy: Leon Walras (1874), Element d'economie politique pure, ou theorie de la richesse sociale



•  Several simultaneous but independent contributions to the same idea

•  Marginalist revolution => neoclassical economics, major representative survey:

•  Alfred Marshall (1890), Principles of Economics. An Introductory Text

•  New methods => new theoretical insights •  Main mathematical instrument = differential

calculus. Main principles: •  Sociological individualism: ”Robinson

Crusoe” economics, economic man



•  Methodological individualism: ”pure” economics, does not attempt to make new overall theory of society

•  Political individualism: no connection between economic theory and political views

•  Basis in classical economists’ problem: analyse the effect on output of changes in labour input => wealth depends on:

•  1) capital accumulation: classicals •  2) effective resource allocation:

neoclassicals



•  Taking economic resources as given and then analysing the equilibrium solution

•  Supply and demand ≈ relation between given objectives and given, limited means

•  The new: ”theory of value” = theory of relative prices and exchange values

•  The breakthrough: theory of marginal utility •  Carl Menger (1871), Grundsätze der

Volkswirtschaftslehre: human wants are categorised and ordered according to rank

•  Need for ”Teilquantität” falls toward zero



•  Herman Heinrich Gossen (1854), Die Entwicklung der Gesetze des menschlichen Verkehrs und der daraus fließenden Regeln für menschliches Handeln

•  1st law: rate of increase of a commodity’s total utility to a person is monotonously decreasing i.e. there is a point of saturation

•  2nd law: utility maximisation = marginal utility equal on all commodities, i.e. it is a relativity principle

•  => Marginal utility ≈ (concept of) scarcity



•  Same baby, different names: •  “desire for an extra unit” (Fischer), •  “Grenznutzen” (Wiser), •  “final degree of utility” (Jevons), •  “rareté” (Walras), •  “ophelimité élémentaire” (Pareto), •  “specific utility” (Clark). •  Menger: principle of marginal utility also

valid (indirectly) for production •  => Concept of use value resurrected


38


•  Jevons’ exchange equation: •  Consumer 1 surrenders quantity x of commodity a and receives

quantity y of commodity b. Consumer 2 surrenders quantity y of commodity b and receives quantity x of commodity a. Consumers’ final degree of utility, i.e. marginal utility, is φ(1,2) and ψ(1,2), respectively, i.e.:

•  φ(1) (a – x) / ψ(1) (y) = y/x = φ(2) (x) / ψ (2) (b – y)

•  Jevons defined individual marginal utility mathematically wrong, thought that it could be added to a collective decision problem

•  Decreasing marginal utility as a subjective psychological principle



•  Francis Isidoro Edgeworth (1881), Mathematical Psychics. An essay on the Application of Mathematics to the Moral Sciences

•  Principle of marginal utility á la Ricardo + Jevons = indifference curves between quantity of commodities received and quantity of commodities surrendered

•  Problem: marginal utility presumes that individuals unwittingly impute (calculate) marginal quantities, but how?



•  Costs = negative marginal utility of commodities that could have been produced with the resources but were employed for something else =

•  Opportunity cost: D.I. Green (1894) in Quarterly Journal of Economics

•  Diminishing returns as consequence of increasing opportunity costs: resource for production of good A↑, good B↓ => marg. utility of A↓, B↑ => utility returns to prod. of A↓ + costs of production of A↑

•  Purely economic, no longer physical, law



•  Revolution completed by Walras’ theory of general equilibrium: not dynamics or macro, but better understanding of:

•  1) Wage theory: equilibrium employment given by the level of commodity production where the marginal utility of product is equal to the marginal disutility of labour, which is necessary to produce one extra unit (Jevons, Chap. 5)

•  I.e. an equilibrium wage exists, all other wages gives unemployment => no idea about ”involuntary unemployment”



Jevons: the existence of an equilibrium wage History of economic thought


•  2) Capital theory: resource allocation over time

•  Jevons: existence of capital makes it possible to ”expend labour in advance” => time is a limit (has to be financed)

•  Productivity of capital = f(time) •  Eugen von Böhm-Bawerk (1884), Kapital

und Kapitalzins: capital = intermediary products = detour (”Produktionsumwege”) necessary to have consumption goods

•  All economic theory is about planning ≈ strategic decisions over time


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•  Revival for theories on “abstinence” and waiting

•  3) Theory of the interest rate: how to insure against the unexpected?

•  Neoclassical theory: rate of interest = profit, source of entrepreneurs’ profit is that things do not turn our as planned

•  Money has a purely passive role as means of exchange ≈ quantity equation & classical economists



•  Frank Knight (1921), Risk, Uncertainty, and Profit: differentiated between insurable risk and non-insurable uncertainty => we cannot insure fully against unexpected

•  Cambridge-economists (1920s and 1930s): differentiated between normal and windfall profits that result from the operations of the monetary system

•  Theory of economic consequences of uncertainty => foundations of macroeconomic approach to rate of interest


Lecture 9 Marshall © Niels Peter Hahnemann 2011 231

•  LECTURE 9. Marshall (Blaug chapter 9+10) •  Alfred Marshall, Principles of Economics. An

Introductory Text, 1st edition 1890, 8th and final edition 1920

•  State-of-the-art neoclassic economic theory as of turn of the 19th century

•  Theory of marginal utility => possibility of analysing equilibrium => scientific approach to economic theory

•  Relation between wants and efforts, i.e. about effective resource allocation:



•  ”Economics is, on the one side, a science of wealth; and on the other that part of the social science of man’s action in society, which deals with his efforts to satisfy his wants in so far as the efforts and wants are capable of being measured in terms of wealth or its general representation, i.e. money. We shall be occupied during the greater part of this volume with these wants and efforts; and with the causes by which the prices that measure the wants are brought into equilibrium with those that measure the efforts” (P., book 2, chapter 1, page 41).

•  Measurement, aggregation, interpersonal comparisons of utility: not considered as a problem in the beginning

•  Analysis of marginal utility by means of mathematics: an invitation to trouble

•  Equilibrium: what are the conditions?



•  Demand curves: Marshall was the first after Walras

•  Book 3 in Principles on demand introduced by somewhat of an understatement:

•  "Until recently the subject of demand or consumption has been somewhat neglected. (…) But recently several causes have combined to give the subject a greater prominence in economic discussions. The first of these is the growing belief that harm was done by Ricardo's habit of laying disproportionate stress on the side of cost of production when analysing the causes that determine exchange value. (…) Secondly, the growth of exact habits of thought in economics is making people more careful to state distinctly the premises on which they reason. This increased care is partly due to the application by some writers of mathematical language and mathematical habits of thought" (P., book 3, chapter 1, page 70).



•  4 steps in Marshall’s theory on demand = platform for neoclassic theory

•  (1) ”The marginal utility of a thing to anyone diminishes with every increase in the amount of it he already has” (P., book 3, chapter 3, page 79).

•  I.e. (du/dx)∆x = MU(x) diminishes with increasing x, the second derivative is negative

•  Marshall refers to among other Jevons and Gossen

•  Translates Gossen’s 1st law into prices:


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•  (2) “The larger the amount of a thing that a person has the less, other things being equal (i.e. the purchasing power of money, and the amount of money at his command being equal), will be the price which he will pay for a little more of it: or in other words his marginal demand price for it diminishes” (P., book 3, chapter 3, page 80).

•  p = price that a person is willing to pay for quantity x of a commodity that gives utility u:

•  I.e. (dp/dx)∆x = marginal demand price decreases with increasing x, second derivative < 0

•  Ceteris paribus assumption is new with respect to the classical economists => static analysis



•  (3) “At one and the same time, a person’s material resources being unchanged, the marginal utility of money to him is a fixed quantity, so that the prices he is just willing to pay for two commodities are to one and another in the same ratio as the utility of those two commodities" (P., book 3, chapter 3, page 80):

•  p(x) / p(y) = MU(x) / MU(y) MU(x) / p(x) = MU(y) / p(y)

•  I.e. weighed by money = weighed by price marginal utilities must be equal. Must hold for all commodities x,y,z and money e:

•  MU(x) / p(x) = MU(y) / p(y) = MU(z) / p(z) = MU(e) , where MU(e) is constant



•  MU(e) constant => MU(x)↓ if x↑ according to step (1) => p(x)↓

•  The demand curve seems to be declining •  But: by identity/definition, not equilibrium •  Gossen’s 2nd law => utility maximisation =>

equilibrium: •  (4) "The richer a man becomes the less is the marginal utility of

money to him; every increase in his resources increases the price which he is willing to pay for any given benefit” (P., book 3, chapter 3, page 81):

•  MU(e)↓ => [MU(x) / p(x)]↓ => p(x)↑ at given MU(x)



•  I.e. the second derivative of the utility of money is negative

•  Substitution between money and commodities => equilibrium: if marginal utility of money↓ => person’s willingness to pay for commodities↑

•  Marshall’s conclusion: d2p /de dx > 0 •  I.e. e↑ => willingness to pay p↑ •  Point: utility maximisation and negative

marginal utility of money necessary in order to make the demand curve declining



•  Marginal utility of money: Daniel Bernoulli (1738), Specimen theoriae novae de mensura sortis

•  Desirability of a sum ≈ natural logarithm to this sum => elasticity of money’s marginal utility = [x / 1/x]*[-1 /x2] = -1, i.e. is a negative constant

•  Marshall: ”Bernouilli” => 2 assumptions: •  Marginal utility of income = constant < 0 •  ”Fair gambling is an economic blunder”:

MU(gain) < MU(loss) (P. page 693)



•  ≈ Assumes that Δmacro-conditions = 0 •  I.e. neoclassicals take small but decisive

steps away from classicals •  Assumptions in Marshall’s marginal utility

argument: commodities are not substitutes or complementary, i.e. marginal utilities are independent and additive

•  Marginal utility weighed by price so that utility maximisation ≈ equalisation => declining demand curve


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•  Marshall draws curve DD’ for person’s demand for a commodity: chart 1, P., book 3, chapter 3, page 81, footnote 2

•  Assumptions: knowledge of person’s willingness to buy at given prices,

•  Next he draws curve DD’ for total demand for the commodity: chart 2, P., book 3, chapter 3, page 83, footnote 1

•  Summation of individual demands in a certain place e.g. city. Assumption: persons’ average consumption over a period is equal to the known consumer’s



Chart 1. Person’s demand for a commodity



Chart 2. Total demand for a commodity



•  Assumption: exogenous money flow, i.e. decrease in price of commodity must not affect marginal utility of money flow

•  No income effect ≈ MU(e) = constant •  Utility functions for each commodity are

mutually independent and thus additive •  Marshall: goes for commodities that are

”small” in total budget ≈ cardinal ranking order (statement on second derivative)

•  Ordinal utility measure: can only determine whether marginal utility is positive or negative (statement on first derivative)



•  Consumption curve indicates willingness to pay for each person; difference to actual price paid = consumer surplus

•  Price as subjective magnitude measures desires rather than satisfactions

•  Difference between desires and satisfactions = ”welfare”

•  Monopolist nicks some of this gain •  Marshall’s measure of welfare not correct

because he disregards income effects •  That’s problem when measuring efficiency



•  3 assumptions behind Marshall's theory of demand:

•  No income effects = marginal utility of money flow is constant

•  Many consumers, and they are price takers

•  Marginal utility of money flow is equal for all persons i.e. irrespective of social class

•  Take-off point for Keynesian macro theory


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•  Supply curves: P., book 5, chapter 3, where Marshall considers the conditions for equilibrium of supply and demand

•  Supply price = price at which commodity can be sold, i.e. willingness to sell =>

•  SS’-curve in chart 18, footnote 2 (page 286 in P.) = point indicating price and quantity

•  SS’-curve in chart 19, footnote 1 (page 288 in P.) but slope = ?

•  => Theory of supply: differentiates between short and long run (re production capacity)



Chart 18. Supply of a commodity



Chart 19. Equilibrium of supply and demand



•  Only in the short run is it certain that increased supply => increased price regardless of industry

•  => Uncertain whether equilibrium exists => •  Need to disregard internal economies, i.e.

the supply curve must be increasing => assumption of “short run”

•  External economies disregarded => assumption of independent firms, i.e. prod. function must not have variables that are effects of other firm’s activities (non-market interdependencies disregarded)



•  Actual supply curve, which he calls ”particular expenses curve”: appendix H, book 5, chapter 12 (P., page 668)

•  Particular expenses of producing a given quantity for a representative firm

•  Chart 39 in P. page 668 shows equilibrium of supply and demand: quantities adapt and then a price is determined; price = dependent variable

•  Producer surplus = excess earnings with respect to marginal producer ≈ Ricardo’s rent



Chart 39. Equilib. with particular expenses curve History of economic thought

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•  Quasi-rent = short term profits from productive resource in temporary fixed supply

•  PE-curve is only a picture of the short run, not a normal or true supply curve

•  This was as far as Marshall got •  Summary of problems that serve as

stepping stone for the subsequent development of macroeconomic theory:



•  1) Internal and external economies on the supply side (economic interdependency) cannot be disregarded, causes non-market relations such as involuntary unemployment

•  (2) Marginal utility of income, i.e. money, is not constant

•  (3) Developments in macro conditions takes place under, or causes, uncertainty

•  (4) Aggregation of consumer surpluses and interpersonal comparisons impossible => an argument for taxes?


Lecture 10 Wal+Par © Niels Peter Hahnemann 2011 255

•  LECTURE 10. Walras and Pareto. Curriculum: Blaug, Chapter 13

•  Leon Walras (1874), Elements d'economie politique pure. 4th and final edition 1900

•  Reference to Gossen, Jevons, and Cournot; same result as Gossen's 2nd law

•  Marshall: equilibrium and stability of one market (= one industry, one commodity)

•  Walras: equilibrium and stability of several or all markets (= general equilibrium)



•  "L'economie politique pure est essentiellement la theorie de la determination des prix sous un regime hypotetique de libre concurrence absolue. L'ensemble de tous les choses, materielles ou immaterielles, qui sont susceptibles d'avoir un prix parce qu'elles sont rare, c'est-a-dire a la fois utiles et limitees en quantite, forme la richesses sociale. C'est pourquoi l'economie politique pure est aussi la theorie de la richesse sociale" (Elements, Preface de la 4eme edition, page xi).

•  Derivation of demand curves from utility functions by means of mathematics

•  Marginal utility = ”intensite du dernier besoin satisfait”, or ”rarete”

•  Conclusion: free competition maximises utility



•  "La mathematique seule peut nous apprendre la condition du maximum d'utilité. Elle le fait en attribuant á chacque échangeur, pour chacque objet de consommation ou service consommable, une equation ou courbe exprimant l'intensite du dernier besoin satisfait, ou la rareté, en fonction decroissante de la quantité consommée, et en nous faissant voir que l'echangeur obtiendra la plus grande somme possible de satisfaction de ses besoins si, á de certains prix criés, il demande et offre des marchandises en quantités telles que les raretes de ces marchandises apres l'echange soient proportionelle a leurs prix" (Elements, Preface de la 4eme edition, page xiv-xv).

•  Prices are cried out randomly as in a market (”criée aux hasard”) => equilibrium prices

•  No trading (exchange of quantities) allowed until equilibrium prices exist = ”tatonnement”



•  Demand curve for each single person, d = f(p) derived from his/hers utility function for each single commodity

•  Section II in Elements: exchange of two commodities, person 1 has commodity A, person 2 has commodity B

•  Chart 1, 6th lesson, Elements, page 56: curve shows "dispositions à l'enchère", i.e. a person’s willingness to buy

•  Horizontal axis: price = terms of trade of two commodities measured as relative quantity; vertical axis: quantity of com’dity


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Walras Chart 1. Three person’s willingness to buy


p = oats/wheat

d = quantity of oats A demanded by holder of wheat B

discrete steps

p’ = different possible prices of oats A in terms of wheat B


•  Chart 2, 6th lesson, Elements, page 58: Sum of individual quantities with price given => demand curve for commodity A in terms of commodity B as function of price of A expressed in B

•  Extensive utility = utility of commodity A, is independent of utility of commodity B

•  Intensive utility = slope of demand curve = marginal utility: depends on marginal utility of both A and B

•  Quantity of medium of exchange (commodity B) is given = budget restriction



Walras Chart 2. Demand curve for commodity A


demand effective de A en B = offre effective de B contre A (equal for whole market)

one commodity (continuity according to law of large numbers)


•  Chart 3, 8th lesson, Elements, page 74: demand curve expressed in medium of exchange at given point in time with fixed marginal utility

•  But: marginal utility declines for each extra unit of the commodity =>

•  Utility maximisation: relation between marginal utility of two com’dities = relation between their prices, i.e. Gossen’s 2nd law

•  Chart 4, 9th lesson, Elements, page 93: willingness to buy for a person who has two commodities A and B



Walras Chart 3. Demand expressed in medium of exch.


r = marginal utility of B, declines with increasing q

quantity of commodity A = 0, q = quantity of commodity B,

if B ↑ => q ↓ => willingness to pay for A ↑


Walras Chart 4. Person’s willingness to buy 2 goods


q ↑ => willingness to pay for B ↑

q’ ↑ => willingness to pay for A ↑

the two charts can also be draw for person 2, person 3, etc.

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•  Two charts with common horizontal axis = price axis, each with vertical quantity axis

•  Marginal utility = price will be equal in max of utility => prices and quantities can be expressed in terms of each other

•  2 demand curves expressed in 1 offer curve => equation system with 2 equations and 2 unknowns: quantity + (relative) price (9th lesson, Elements, page 96)

•  Price = relative quantity translated to marginal utility



•  Free competition = only one price on the market that maximises utility (10th less., E. p. 99)

•  Section III of Elements: multilateral exchange on same principle as bilateral

•  Following sections: theory of production •  Assumption of gross substitution for all

commodity pairs: price increase for one commodity will create excess demand for at least one other commodity because it affects marginal utility from both = Gossen 2nd law: how is equilibrium produced?



•  Marshall: through assumption of constant marginal utility from money flow, i.e. no income effect and cardinal utility

•  Walras: through tatonnement, i.e. no market transactions allowed as long as prices are adjusting, i.e. ordinal utility

•  Tatonnement: abstract model, or exchange of the real world? Primarily imagined as theory about consumer behaviour

•  Money: "encaisse desirée" ≈ usual quantity theory, primarily "numeraire”



•  Equilibrium: proof of existence and stability explanation not of much use

•  Walras was resurrected by Hicks in 1939: showed that gross substitutability between all pair of goods ≈ no income effects

•  I.e. Walras' “solution” (tatonnement) ≈ Marshall's (no income effects)

•  Existence of general equilibrium firstly proved by Kenneth Arrow, Gerard Debreu (1954), Existence of Equilibrium for a Competitive Economy



•  Conditions for general equilibrium á la Arrow-Debreu (Blaug page 553):

•  Constant or decreasing returns to scale •  No joint products or external effects in

either consumption or production •  Gross substitution between all

commodities •  Forward markets exist for all markets, i.e.

no uncertainty •  => Marshall, Walras are of the same family



•  General equilibrium: analysis of economic imperfections, what are the obstacles to equilibrium and optimality?

•  A model for the road to perfect competition, i.e. the perfect economy

•  Vilfredo Pareto (1906), Manuale di economia politica

•  Before Pareto: welfare = consumer surplus measured as sum of cardinally surveyed individual utility functions, e.g. Marshall


46


•  Pareto: rejected cardinal utility measuring and additive utility functions

•  Conclusions regarding welfare without the use of interpersonal comparisons, i.e. without ”consumer surplus”

•  Utility is an intra-personal ranking, not an inter-personal, can therefore not be added

•  => An exchange only improves welfare if all agents gets larger utility, or if at least one agent gets improved utility while all other are constant (Pareto optimality)



•  Indifference curves for wine/bread, utility measurement not necessary

•  Commodity exchange is an expression of the limitations to taste

•  Free competition = agents move along indifference curves until all are satisfied

•  If only one is not satisfied => all other can not move, stuck in points a,α (Chart 7+12)

•  Free competition = choice of price (relative quantity) is bilateral, an agent cannot force through a price, only say: at this price, what quantity? = OPTIMUM



Pareto Chart 5. Indifference curves for wine and bread

m’ preferred to m


Source: Pareto (1906) page 123.


Pareto Chart 6. Changes in utility



x = change in holding of a (bread), y = changes in holding of b (wine)

surrender bread, receive wine = agent moves from b to c


Pareto Chart 7. Changes in marginal utility (”ofelimitá”)



t, t’, t’’ = indifference curves, movement from m to c => increasing ofelimitá, movement from c to n => decreasing ofelimitá


Pareto Chart 9. Limitations to the exchange



exchange of commodity A for commodity B

limitations to the exchange come from the exchange

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Pareto Chart 10. Optimum



agents move along indifference curves through exchanges until all are satisfied; if only one is not satisfied, the rest cannot move


Pareto Chart 12. Equilibrium of preferences, or taste History of economic thought


the agent moves along mn by exchanging A for B; α is not equilibrium, it has an indifference curve with higher ofelimitá that intersects mn; c’’ is equilibrium


•  “We can say that members of a community (“componenti di una colletività”) enjoy, in a certain position, maximal utility (“ofelimità”) when it is impossible to move away just a little bit from that position good for, or harmful to, all the members of the community; every small change from that position would necessarily have the effect of being good for one part of the community and harmful for the others” (Manuale, p. 253, see Chart 50 on p. 254).


PARETO OPTIMALITY:

”It is impossible to move away from c good for, or harmful to, all the individuals; of necessity, if the move is good to some it is harmful to others.”



•  Optimum = no mutually advantageous trades can be implemented, the allocation cannot be changed without changing ”ofelimità”

•  An indication of willingness to pay does not localise one unique and socially desirable optimum => multiple equilibria exist

•  Agents, markets find best equilibrium by themselves => liberalism, free markets, but also desires = satisfaction for each single person, i.e. “emancipation”



•  => No need to aggregate individual utility functions in order to define welfare optimum

•  Economic policy advice ≈ markets, agents cannot fix right solution by themselves

•  But Pareto says: Watch out, be careful! We can only say very little about equality and distributive concerns as distinct from economic efficiency concerns

•  Pareto optimum ≈ the individual is the agent, see Blaug page 577

•  Blaug page 578-595: general reading only


Lecture 11 Wicksell © Niels Peter Hahnemann 2011 282

•  LECTURE 11: Wicksell and neoclassical monetary theory (Blaug, Chapter 15)

•  Johann Gustav Knut Wicksell (1898), Interest and Prices and (1901-06), Lectures on Political Economy

•  Transition between classic/neoclassic economic theory and Keynesian macro economics

•  Starting point: quantity equation MV = PT •  V = velocity of money (transactions per

coin), T = total transactions (output)


48


•  Step 1: Say's law i.e. ∑ ED(n-1) - ED(n) = 0

•  Factor in quantity of money M and prices P on each side of equation under assumption that they are proportional:

•  (1) M * ED(n) = P * ∑ ED(n-1) or MV = PT •  I.e. V can be regarded as determined by

the excess demand for money •  ≈ Ricardo: labour theory of value holds true

if average composition of capital and labour in whole economy = composition in gold production



•  Step 2: Marshall and Gossen’s 2nd law: •  (2) MU(x) / p(x) = MU(y) / p(y) = MU(z) /

p(z) = MU(n) where x,y,z = n-1, n = money •  Put marginal utility MU = excess demand

for commodities ED •  Sum total over all commodities: ∑

MU(n-1) / p(n-1) = ∑ ED(n-1) / p(n-1) •  Substitute into relation (1) above, again

with money and prices being proportional: •  (3) M * MU(n) = P * ∑ [MU(n-1) / p(n-1)]



•  The result is a “micro version” of Say's law and of the quantity equation => V determined by marginal utility of money

•  Step 3: Walras and the quantity equation (Elements, lesson 30, page 311):

•  p'(u') * Q(u) = H(a) where p' = prices of commodities u', Q = transactions (i.e. T), H = total quantity of money (i.e. M) with implicit assumption that V ≡ 1

•  Point of steps 1-3: understanding of V decisive for understanding of total output



•  Understanding of V is made more difficult if rate of interest is determined by other variables than profits (e.g. liquidity preference), see Blaug page 614 on transmission from money to prices:

•  1) direct classical mechanism (as above) •  2) indirect mechanism via the rate of

interest, e.g. Thornton, resurrected by Wicksell, see Blaug page 618 =>

•  Theory of the natural rate of interest = no connection between interest and profits other than via prices



•  Wicksell’s paper in Economic Journal Vol. 17, No. 66, June 1907:

•  "The thesis which I humbly submit to criticism is this. If, other things remaining the same, the leading banks of the world were to lower their rate of interest, say 1 per cent below its ordinary level, and keep it so for some years, then the prices of all commodities would rise and rise and rise without any limit whatever; on the contrary, if the leading banks were to raise their rate of interest, say 1 per cent above its normal level, and keep it so for some years, then all prices would fall and fall and fall without any limit except zero" (E.J., Vol. XVII, page 213).

•  ”Normal level” = natural rate of interest => classical theory ≈ general opinion ≠ neoclassical theory:



•  "According to the general opinion among economists the interest on money is regulated in the long run by the profit on capital, which in its turn is determined by the productivity and relative abundance of real capital, or in the terms of modern political economy, by its marginal productivity" (E.J., Vol. XVII, page 214).

•  Wicksell: interest rate ≠ profits because of banking sector:

•  "In our days demand and supply of money have become about the same thing, the demand to a large extent creating its own supply. (…) But then, what becomes of the connecting link between interest and profit? In my opinion there is no such link, except precisely the effect on prices, which would be caused by their difference" (E.J., Vol. XVII, page 215).

•  Introducing an interest rate in a macro argument via change in bank’s reserves:


49


•  "In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low, and expected to remain low. The rate of interest on money follows, no doubt, the same course, but not at once, not of itself; it is, as it were, dragged after the rate of profit by the movement of prices and the consequent changes in the state of bank reserve, caused by the difference between the two rates. In the meantime this difference acts on prices" (E.J., Vol. XVII, p. 217).

•  If interest rate is low in relation to profits => trade↑ => P↑ => citizens cash holdings↑ => bank reserves↓ => r↑

•  "The point about which the rate of interest would then oscillate, and to which it would constantly gravitate, would be precisely what I have called its normal level, that one prescribed by the simultaneous state of the marginal productivity of real capital, the alterations of which we, of course, cannot control but only have to comply with" (E.J., Vol. XVII, page 219).



•  => There comes an adaptation process in money demand, see Blaug page 619-20 on "the cumulative process”

•  => Discussion on conditions of equilibrium between savings and investment

•  Classical quantity model: assumption of proportionality between money quantity and price level guarantees that change in V is equivalent to change in transaction level T

•  Ricardo: money goes into a wages fund + fixed capital deposit i.e. split V in C + I =>



•  (4) MV = PT ≈ M * (C + I) = P * Y , or in real terms:

•  (5) C + I = Y Y – C ≡ S = I •  Condition for equilibrium: rate of interest is

argument for either M or V, not both •  Neoclassicals: idea about time that passes

=> compare planned with realised •  => Possibility of disequilibrium between

savings and investment because natural rate of interest ≠ market rate of interest =>



•  Either that total output of the economy has increased/declined from one period to the next as in Blaug's relation 4 page 622: Y(t) – Y(t-1) = I(t) – S(t), note the error of sign in the book

•  Or that planned total output of the period was larger/smaller than actually realised e.g. because of unintended build up of inventory as in Blaug's relation after relation 5 page 622: Y(p) – Y(r) ≡ ( [S(p) – I(p)] – [I(r) – I(p)] )



•  Wicksell maintained assumption about proportionality between money and prices i.e. neutrality of money in the long run

•  Keynes rejected idea about natural interest rate and equilibrium between savings and investment; argued instead that S ≡ I

•  => Assumption about proportionality between money and prices dropped by Keynes => all quantity theory dropped

•  Today: natural interest theory resurrected (Woodford, central banks) but money and prices not proportional => DIFFICULT?!


Lecture 12 Keynes © Niels Peter Hahnemann 2011 294

•  LECTURE 12. Keynes and The General Theory

•  John Maynard Keynes (1936), The General Theory of Employment, Interest, and Money. Curriculum: chapter 1-13, and Blaug chapter 16

•  Difficult text, milestone in economics’ history, quickly very influential, rupture with previous views – also with Keynes’ own

•  Many new ideas about economic theory, of which only a subset has been translated into models


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•  The return of monetary theory as part of theory about output as a whole

•  "It is found that money enters into the economic scheme in an essential and peculiar manner, technical monetary detail falls into the background. A monetary economy, we shall find, is essentially one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction. But out method of analysing the economic behaviour of the present under the influence of changing ideas about the future is one which depends on the interaction of supply and demand, and is in this way linked up with our fundamental theory of value. We are thus led to a more general theory, which includes the classical theory with which we are familiar, as a special case" (GT, Preface, page xxiii).

•  The classics (= from Smith to Marshall) are seen as a special case. 3 differences:



•  (1) Keynes: S ≡ I, identity by necessity for economic system as a whole. Classics: S = I, equilibrium condition determined by previous period’s incomes:

•  "It is shown that, generally speaking, the actual level of output and employment depends, not on the capacity to produce or on the pre-existing level of incomes, but on the current decisions to invest and on present expectations of current and prospective consumption" (GT, Preface to the French Edition, page xxxiii),

•  i.e. Y = I + f(C), C = Cexp,now + Cexp,future •  (2) The role of the rate of interest:

equilibrium between money demand and money supply, not a price of capital:



•  "In recent times it has been held by many economists that the rate of current saving determined the supply of free capital, that the rate of current investment governed the demand for it, and that the rate of interest was, so to speak, the equilibrating price-factor determined by the point of intersection of the supply of savings and the demand curve of investment. (…) I find (…) that it is the function of the rate of interest to preserve equilibrium, not between the demand and the supply of new capital goods, but between the demand and the supply of money" (GT, Preface to the French Edition, p. xxxiii-xxxiv).

•  (3) Prices are determined by supply and demand, not by money supply:

•  ”The following analysis registers my final escape from the confusions of the quantity theory, which once entangled me. I regard the price level as a whole as being determined in precisely the same way as individual prices; that is to say, under the influence of supply and demand. (…) Money, and the quantity of money are not direct influences at this stage of the proceedings” (GT, Preface to the French Edition, page xxxiv-xxxv).



•  Chapter 1: General theory, short preamble •  Chapter 2: Postulates of classical theory •  Employment measures output as a whole •  Classics: a model where the size of total

output is taken as given => 2 postulates, which Keynes addresses:

•  1) wage ≈ marginal product of labour = employment’s demand curve? OK

•  2) marginal disutility of labour = employment’s supply curve? NO!



•  ”For, admittedly, more labour would, as a rule, be forthcoming at the existing money-wage if it were demanded” (GT, Chapter 2, page 7).

•  I.e. the reality could be different, total demand can be insufficient => involuntary unemployment because:

•  Labour supply in nominal not real terms •  A given real wage can be insufficient to

bring forward a given quantity of labour •  Point: agent’s labour decisions are also

influenced from other markets in the economic system than the labour market



•  ”For, although a reduction in the existing money-wage would lead to a withdrawal of labour, it does not follow that a fall in the value of the existing money-wage in terms of wage-goods would do so, if it were due to a rise in the price of the latter. In other words, it may be the case that, within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage” (GT, Chapter 2, page 8).

•  There are other arguments than the real wage in the labour supply function:

•  ”The classical school have tacitly assumed that this” (i.e. wage bargaining) “would involve no significant change in their theory. But this is not so. For if the supply of labour is not a function of real wages as its sole variable, their argument breaks down entirely and leaves the question of what the actual employment will be quite indeterminate” (GT, Chapter 2, page 8).


51


•  Examples from the real world (1930s depression in the USA):

•  ”Wide variations are experienced in the volume of employment without any apparent change either in the minimum real demands of labour or in its productivity” (GT, Chapter 2, page 9).

•  Classics’ economics lacks macroeconomic variables:

•  ”the wage-goods equivalent of the existing money wage is not an accurate indication of the marginal disutility of labour, and the second postulate” (of classical economics) “does not hold good” (GT, Chapter 2, page 10).

•  Classics’ argument ≈ workers can determine their real wage by themselves; does not hold good in reality, says Keynes:



•  ”There may be no method available to labour as a whole whereby it can bring the wage-good equivalent of the general level of money-wages into conformity with the marginal disutility of the current volume of employment. There may exist no expedient by which labour as a whole can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs. This will be our contention” (GT, Chapter 2, page 11).

•  Classics’ 1st problem: wage fund theory •  Classics’ 2nd problem: quantity theory: •  ”The conviction (…) that money makes no real difference except

frictionally and that the theory of production and employment can be worked out (like Mill’s) as being based on ’real’ exchanges with money introduced perfunctorily in a later chapter, is the modern version of the classical tradition. Contemporary thought is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another” (GT, Chapter 2, page 19-20).



•  Classics: income that is not consumed will automatically be invested

•  ”Those who think in this way are deceived, nevertheless, by an optical illusion, which makes two essentially different activities appear to be the same. They are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former” (GT, Chapter 2, p. 21).

•  Chapter 3: principle of effective demand •  Involuntary unemployment impossible

because of Say’s law => necessary to reinvent aggregate demand



•  Definitions (GT, Chapter 3, page 23-26): •  Value of total output = factor cost F + user

cost U + profit P, where: •  Factor cost = expenses to production

factors (≈ production factors’ income) •  User cost = expenses to other

entrepreneurs + opportunity cost by using equipment instead of leaving it idle

•  Profit = entrepreneurs’ income •  Total income = aggregate income = F + P



•  Aggregate income = proceeds resulting from a given amount of employment

•  Aggregate supply price of output by employing a certain number of workers = expected proceeds resulting from a given amount of employment

•  User cost included in total gross amount that entrepreneurs are paying, but amount in the aggregate is net of user cost

•  Aggregate supply price = Z •  Employment = N = f(expected proceeds of

employment)



•  Aggregate supply function: Z = Φ(N) •  Aggregate income, i.e. proceeds that the

entrepreneurs expect from given quantity of employment, determines aggregate demand, i.e. D = f(N)

•  For given value of N: D > or < Z? •  If D is larger than Z => the entrepreneurs

increase employment up to value of N where Z = D

•  Intersection between Z and D = effective demand


52


Whole economy: Mr Keynes and the classics


p p ≈ income

Z = Φ(N)

D = f(N)

N(t) N(t)

Z = D

effective demand

Keynes Classics

t = given, or future, time t = historical time

Ne


•  Intersection invisible, or trivial, in classic economics because of Say’s law:

•  ”For ’Supply creates its own Demand’ must mean that f(N) and Φ(N) are equal for all values of N, i.e. for all levels of output and employment; and that when there is an increase in Z (=Φ(N)) corresponding to an increase in N, D (= f(N)) necessarily increases by the same amount as Z. The classical theory assumes, in other words, that the aggregate demand price (or proceeds) always accommodates itself to the aggregate supply price; so that, whatever the value of N may be, the proceeds D assume a value equal to the aggregate supply price Z which corresponds to N. That is to say, effective demand, instead of having a unique equilibrium value, is an infinite range of values all equally admissible; and the amount of employment is indeterminate except in so far as the marginal disutility of labour sets an upper limit” (GT, Chapter 3, page 25-26).

•  => Classics: infinite number of equally possible equilibrium values for effective demand



•  => Level of employment indeterminate •  Keynes: unique equilibrium value for

effective demand ≤ D ≈ full employment •  ”The outline of our theory can be expressed as follows. When

employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less than is required to induce them to offer the given amount of employment” (GT, Chapter 3, p. 27).



•  Psychology of the community ≈ uncertainty in an economic context

•  Equilibrium employment ≤ full employment •  Depends on current investments i.e. on

inducement to invest, which depends on the rate of interest

•  Full employment only exists if inducement to invest and propensity to consume happens to have the right relation:

•  ”It can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed” (GT, Chapter 3, page 28).



•  Summary of theory in 8 points (GT Chapter 3, page 28-30), please note item 8:

•  Widening gap between Z (aggregate supply) and consumption, must be closed by investments

•  => Propensity to consume must increase •  ”Poverty in the midst of plenty” caused by

insufficient effective demand •  Under-production/under-consumption =>

positive language on Malthus •  Chapter 4: no national accounts => need

to measure everything in wage units



•  Chapter 5: expectations as determinants of output and employment, must be divided á la Marshall:

•  Short term expectations given productive capacity

•  Long term expectations: production’s return if entrepreneur increases capacity

•  Expectations are in current period: •  ”Past expectations, which have not yet worked themselves out, are

embodied in the to-day’s capital equipment with reference to which the entrepreneur has to make to-day’s decisions, and only influence his decisions in so far as they are so embodied. It follows, therefore, that, in spite of the above, to-day’s employment can be correctly described as being governed by to-day’s expectations taken in conjunction with to-day’s capital equipment” (GT, Chapter 5, page 50).


53


•  Chapter 6. Definition of income, saving and investment: difficult stuff!!

•  Entrepreneur’s factor cost = rest of economy’s income = income from employment or total income = aggregate income = F + P

•  Total value produced over a period = entrepreneur’s finished output sold to consumers and other entrepreneurs A plus inventory accumulation and working capital G less purchase of finished output from other entrepreneurs A1, i.e.:



•  Total income = A + G – A1 •  Part of total income derived from activities

inherited from previous periods, attributable to capital equipment at period’s beginning

•  Change in capital equipment’s value during current period consisting of:

•  1) user cost = cost due to entrepreneur’s voluntary decisions in seeking to maximise profit as opposed to leaving equipment idle

•  2) supplementary cost = involuntary cost: depreciation or windfalls



•  User cost = excess of reduction in equipment’s value due to the decision to use it over reduction in equipment’s value that would have occurred by not using it

•  Prime cost of output A = user cost U + factor cost F

•  Potential value of equipment entrepreneur might have conserved: G’ – B’, G’ = value at beginning, B’ = cost of maintenance

•  The excess of potential value over own contribution to actual equipment value after use G – A1 must be equal to U, i.e.:



•  (G’ – B’) – (G – A1) = U •  ”User cost has, I think, an importance for the classical theory of value

which has been overlooked” (GT, Chapter 6, Appendix, p. 66).

•  User cost an expression of: 1) degree of integration of an industry, 2) expected cost of giving up future income in return for current use of capital equipment (if something is used today it cannot be used tomorrow), 3) long term risk such as rate of discount, i.e. interest rate

•  ≈ Macroeconomic opportunity cost, or “social” depreciation, a link between the present and the future:



•  "User cost constitutes one of the links between the present and the future. For in deciding his scale of production an entrepreneur has to exercise a choice between using up his equipment now and preserving it to be used later on. It is the expected sacrifice of future benefits involved in present use which determines the amount of the user cost, and it is the marginal amount of this sacrifice which, together with the marginal factor cost and the expectation of the marginal proceeds, determines his scale of production" (GT, Chapter 6, Appendix on User Cost, page 69-70).

•  Important for choice of production scale and for supply curve’s inclination: ↑ or ↓?

•  Marshall disregarded the problem through his short run assumption

•  Keynes’ solution: an unsuccessful attempt at grasping economic interdependencies?



•  User cost at micro level for the individual entrepreneur, but in aggregate: proceeds = income must be less of user cost. Thus (GT, Chapter 6, page 54):

•  Aggregate income = A – U •  Agg. consumption C = ∑(A – A1) ≈ A – A1 •  Aggregate investments I = ∑(A1 – U) •  A fully integrated one-good economy =

entrepreneurs produce all inputs & machines by themselves:

•  A1 = 0 => C = A and I = - U


54


•  “The effective demand is simply the aggregate income (or proceeds) which the entrepreneurs expect to receive, inclusive of the incomes which they will hand on to the other factors of production, from the amount of current employment which they decide to give. The aggregate demand function relates various hypothetical quantities of employment to the proceeds which their outputs are expected to yield, and the effective demand is the point on the aggregate demand function which becomes effective (…) taken in conjunction with the conditions of supply" (GT, Chapter 6, page 55).

•  Marginal proceeds (income) = marginal factor cost exclusive of user cost as with (neo) classical economics. Saving?

•  "Saving means the excess of income over expenditure on consumption" (GT, Chapter 6, page 61)

•  i.e.: S ≡ (A – U) – (A – A1) = A1 – U = I !!



•  "Saving, in fact, is a mere residual. The decisions to consume and the decisions to invest between them determine incomes. Assuming that the decisions to invest becomes effective, they must in doing so either curtail consumption or expand income. Thus the act of investment in itself cannot help causing the residual or margin, which we call saving, to increase by a corresponding amount" (page 64)

•  Chapter 7: Further observations regarding saving and investment

•  Must by necessity be equal, not a balance •  Two sides to every transaction: •  "There cannot be a buyer without a seller or a seller without a buyer.

Though an individual whose transactions are small in relation to the market can safely neglect the fact that demand is not a one-sided transaction, it makes nonsense to neglect it when we come to aggregate demand. This is the vital difference between the theory of the economic behaviour of the aggregate and the theory of the behaviour of the individual unit, in which we assume that changes in the individual's own demand do not affect his income" (GT page 85)



•  Double entry bookkeeping + macro economics = scientific revolution!!

•  Chapter 8: On the propensity to consume •  χ: C = χ(Y) , where Y is income •  Propensity to consume, “reasonably stable

function”, determined by (GT, page 91-95): •  change in real wage •  change in difference between income and net income (this is about

depreciation: the more allowed for depreciation, the less net income = consumption + net investments)

•  windfall capital gains not accounted for in net income concept •  change in time preference, i.e. rate of discount or interest rate •  change in fiscal policy •  change in expectations regarding present vs. future income level

(today discussed as changes in permanent income)



•  Fundamental psychological law: increase in income => increase in consumption, but by less than the increase in income

•  ΔC < ΔY, i.e. 0 < dC/dY < 1 •  Capital and investments do not have

autonomous reason to exist (raison d’etre): •  "Consumption – to repeat the obvious – is the sole end and object of

all economic activity. Opportunities for employment are necessarily limited by the extent of aggregate demand. Aggregate demand can be derived only from present consumption or from present provisions for future consumption" (GT, Chapter 8, page 104).

•  i.e.: Y = C + I where I = f(Cexp,future)



•  => Problem of Malthusian dimensions: •  "All capital-investment is destined to result, sooner or later, in capital-

disinvestment. Thus the problem of providing that new capital-investment shall always outrun capital-disinvestment sufficiently to fill the gap between net income and consumption, presents a problem which is increasingly difficult as capital increases. New capital-investment can only take place in excess of current capital-disinvestment if future expenditure on consumption is expected to increase. Each time we secure to-day's equilibrium by increased investment we are aggravating the difficulty of securing equilibrium to-morrow" (GT, Chapter 8, page 105, my italics).

•  “All investment results in disinvestment”: ΔKI

t – ΔKAt+n = 0 where I is investment, A is

depreciation + user cost, n is future time •  “New investment shall outrun current

disinvestment”: ΔKIt – ΔKA

t > 0



•  But why if consumption is sole object of economic activity? Because:

•  “Can only take place if”: ΔCexp,future > 0 •  i.e. dI/dt > 0 or dKI/dn > 0 => dI/dr < 0, •  It is a time preference problem: the rate of

interest is a price on time, the longer time the higher interest, dampens investment

•  About irreversibility in decision-making introduced through the macro economy?

•  Chapter 9: On the propensity to consume and subjective factors, about social philosophy and sociology except:


55


•  Fundamental difference between Keynes and the classics: change in income adapts savings to investments:

•  "Incomes will have to fall (…) by just that amount which is required, with the existing propensity to consume, to decrease savings by the same amount by which the rise in the rate of interest will, with the existing marginal efficiency of capital, decrease investment. (…) The rise in the rate of interest might induce us to save more, if our incomes were unchanged. But if the higher rate of interest retards investment, our incomes will not, and cannot, be unchanged" (GT, Chapter 9, page 111, my italics).

•  I = I(r), dI/dr < 0 •  S = S(Y), dS/dY > 0 •  i.e. S ≡ I because adjustment runs through

change in incomes



•  Chapter 10: Marginal propensity to consume and the investment multiplier

•  dC/dY is, as psychology law, characterised by: ΔC < ΔY, i.e. 0 < dC/dY < 1

•  ΔY = ΔC + ΔI , i.e. ΔY = k ΔI , where 1-1/k = marginal propensity to consume and k is the investment multiplier

•  From Kahn, Keynes’ version: ΔN = k' ΔN2, N2 is employment in investment industry



•  Describes irreversible macro process: •  "An increment of investment (…) cannot occur unless the public are

prepared to increase their savings (…). The public will not do this unless their aggregate income (…) is increasing. Thus their effort to consume a part of their increased incomes will stimulate output until the new level (and distribution) of incomes provides a new margin of saving sufficient to correspond to the increased investment" (GT, Chapter 10, page 117).

•  I.e. I↑ => Y↑ => C↑ => S↑ •  Not from S to I, but always from I to S via

Y, i.e. describes by how much income and employment must increase for savings to correspond with the extra investments =

•  The foundations for all modern macro!



•  This completes theory of consumption (Chapters 8+9+10)

•  Remaining parts of General Theory: theory of investment, employment and labour market, and money

•  Chapter 11: Marginal efficiency of capital •  Investment: a capital asset = purchase of

entitlements to future annuities Q1, Q2, ..., Qr from sale of investment’s output => prospective yield of asset

•  Σ Qrdr = investment’s demand price, dr = discounted value of money



•  Investment’s supply price = replacement cost = price that would produce extra unit

•  Marginal efficiency of capital, MEC = the rate of discount that equilibrates investment’s prospective yield (present value of annuities) with its supply price

•  Asset investment ↑ => MEC ↓, aggregated for all investments = investment demand curve

•  Rate of investment pushed along curve until locus where aggregate MEC = market rate of interest



•  Point: interest rate determined elsewhere in a monetary economy

•  MEC: everything is in expectation terms i.e. only prospective, not current, returns count

•  Chapter 12: Animal spirits •  Long term expectations depend not on

most probable forecast, but on confidence with which forecast is made

•  Animal spirits ≠ mathematical expectations •  Usually relatively stable, or compensate for

change in mathematical expectations


56


•  Chapter 13: General theory of the rate of interest

•  Psychological time preference regarding two decisions: 1) propensity to consume, 2) command over future income held in money, or in assets that depend on market conditions?

•  New concept: liquidity preference = curve for resources demanded in money

•  Rate of interest is not reward for waiting (for not-spending), money has no interest



•  Rate of interest is reward for spending (for not hoarding), a reflection of unwillingness to spend

•  Agents prefer, due to uncertainty, to hold command over future income in liquid assets = money

•  Interest rate balances desire to hold wealth in money with available money supply, i.e. M = L(r), dL/dr < 0

•  Transaction, precautionary and speculative motive in liquidity preference



•  Chapter 23: notes on mercantilism, etc. Keynes is famous for positive view on the mercantilist control of foreign trade:

•  "The weight of my criticism is directed against the inadequacy of the theoretical foundations of the laissez-faire doctrine upon which I was brought up and which for many years I taught; - against the notion that the rate of interest and the volume of investment are self-adjusting at the optimum level, so that preoccupations with the balance of trade is a waste of time" (GT, Chapter 23, page 339).

•  Mercantilism = the macroeconomic view: •  "There was wisdom in their intense preoccupation with keeping down

the rate of interest by means of usury laws (…), by maintaining the domestic stock of money and by discouraging rises in the wage-unit; and in their readiness in the last resort to restore the stock of money by devaluation" (GT, Chapter 23, page 340).



•  This view dominated macroeconomic theory and policies through the 1970s

•  Malthus’ theory on the insufficiency of demand acknowledged page 362-4

•  Chapter 24: Notes on the general theory’s social philosophy. Long digression on the social-liberal vision. Conclusion:

•  "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believes themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist" (GT, Chapter 24, page 383).

•  He was right, also re his own defunctness?


Lecture 13 Foundations © Niels Peter Hahnemann 2011 335

•  LECTURE 13: Foundations of modern economics

•  1) Does equilibrium exist? •  John von Neumann (1945), A Model of

General Economic Equilibrium •  Mechanism of supply and demand

embedded in a growth function •  Growth = replication of an economic system •  Circular system: commodities produced by

commodities, prices = relative quantities: cost price of one good valued in terms of good from which it is made (“intensities”)



•  For unchanged intensity ratios: uniform rate of expansion α of system in equilibrium equal to rate of interest β

•  Aggregate price level determined by the highest rate of interest, which the value of the production process at the lowest technically possible factor of expansion could afford to pay

•  A dual system of quantity and price that for all solutions uniquely determines α and β

•  Proof using Brouwer’s fixed-point theorem


57


•  L.E.J. Brouwer (1911), Über Abbildung von Mannigfaltigkeiten

•  A continuous endomap has a fixed point for which f(x) = x, that is:

•  From any x in a commodity space domain D there is one x in commodity codomain X by some operative procedure f

•  Invertibility necessary for equilibrium •  Generalised by Kakutani: correspondencies •  => “Bourbakism”



•  John F. Nash Jr. (1950), Equilibrium Points in n-Person Games

•  Equilibrium in strategic decisions ≈ equilibrium on markets for physical goods

•  Proof of equilibrium using Kakutani •  John F. Nash Jr. (1951), Non-cooperative

Games •  Price given = value of move in a game •  Move given move of all other, move either

accepted or declined => decision problem •  No prior communication, coalition building,

or umpire = non-cooperative game



•  ≈ Strategic decision-making, taking interdependencies and externalities into account (not these words)

•  Strategy = a mix si of exogenous pure strategies πi of player i and probabilities ci such that si = Σciπi with Σci = 1 summed over a number of α of pure strategies of each player

•  Equilibrium = total value of game (vector of pay-offs)

•  Pay-offs depend on choices made by all



•  Kenneth Arrow, Gerard Debreu (1954), Existence of an Equilibrium for a Competitive Economy

•  Prices given, non-negative, not all zero, obey law of supply and demand

•  Closed, convex production, consumption subsets of the set of real numbers R (=> contingent markets, no uncertainty)

•  Continuous, monotonous, convex utility function

•  Initial non-negative endowments



•  Equilibrium vector of consumption, output x*,y* that maximises p*y over production set and u(x) over consumption set p*x

•  Proof of existence using Nash i.e. Kakutani i.e. Brouwer

•  Convexity assumption ≡ no externalities or interdependencies (did not use these words), they upset market equilibrium

•  Paul M. Romer (1986), Increasing Returns and Long-Run Growth

•  Equilibrium in endogenously growing econ.



•  Production is produced by production = production by knowledge

•  In von Neumann α is given by technology, in Romer it is given by knowledge

•  Production of knowledge: usual decreasing returns, convexity

•  Output from knowledge: increasing returns, nonconvexity, nonrival inputs, knowledge belongs to everybody i.e. is an externality

•  Proof of existence using fixed-point theorem i.e. Brouwer


58


•  2) Is it a good equilibrium? •  Does self-interested behaviour correspond

to the common good? •  Walrasian market equilibrium: choice of

appropriate set of prices that eliminates excess demand under conditions of ordinal utility (self-interested human action)

•  Pareto optimum: choice of appropriate set of prices that can only be altered by making at least one person worse off (common gd.)



•  Welfare theory: are the two states equivalent? Discussed by 3 theorems

•  1st theorem: on the conditions for market equilibrium to be optimal

•  Proposed by Pareto, proved in: Oscar Lange (1942), The Foundations of Welfare Economics

•  Total welfare not sum of individual’s utilities represented by a scalar, but a vector u = (u1,u2,...,ui), i = individual

•  Max u = impossible to increase any ui without decreasing that of others



•  Problem solved by keeping all side relations (utility of other individuals) constant

•  BUT: done without prices, in relative quantities only => need to keep individual’s money income Mi constant

•  Necessitates a price concept because Mi = Σpn,ixn,i , n = commodity, pn = relative price

•  Aggregate income needs to be constant => income distribution & set of prices arbitrary

•  Society would have to choose between u vectors ordered by a social scalar W(u)



•  Lange started discussion of 2nd theorem: a social valuation function was needed for equilibrium to be good, but no proof

•  2nd theorem: on the conditions for the existence of a set of prices so that an optimal state is an equilibrium state

•  Kenneth J. Arrow (1951), An Extension of the Basic Theorems of Classical Welfare Economics

•  Reformulated 1st and 2nd theorems using mathematical topology, gave proofs



•  2nd theorem consequence of deficiencies of 1st, concerned mainly with problem of initial endowments

•  Assumption of closed and convex set A of commodity space assures that a set of prices (p1,...,pn) can be found, such that:

•  Σpnxn ≤ Σpnxn+ where xn

+ is a boundary point of A

•  BUT: prices are prior to marginal utility, individuals are price takers = no externalities exist (did not use the word)



•  Problem concerns all commodities but discussed as a special commodity: the existence of free goods not allowed => 2nd theorem less general

•  On this assumption proof that optimal distribution is efficient i.e. there exists a set of prices supported by redistributive policies that makes equilibrium good

•  BUT: Arrow recognised that determination of social value function still outstanding


59


•  How to achieve the common good? It depends on conditions for individual choice; many impossibilities and “cannot do”s here

•  3rd theorem: on the conditions for the existence of a social choice function, the impossibility theorem

•  Kenneth J. Arrow (1950), A Difficulty in the Concept of Social Welfare, and Kenneth J. Arrow (1963), Social Choice and Individual Values

•  Social choice = any decision evaluated from its social dimensionality



•  Several methods: political (voting), economic (markets), dictatorship (single individual), convention (tradition, religion)

•  Can decisions with many wills of people involved be consistent and rational?

•  No: aggregation do not imply consistent preference ordering, says Arrow

•  Impossible for social preferences to both compare alternatives and be transitive

•  Goes for economics and politics when social choice depends on individual tastes



•  No difference in principle between politics and economics

•  Arrow: social good should not have independent existence = anti-Platonic philosophy

•  Irrelevant alternatives (≈ interdependencies and externalities, did not use these words) not allowed, impossibility theorem confirmed this for individual orderings

•  3) What are the obstacles to equilibrium?



•  Francis Bator (1958), The Anatomy of Market Failure

•  Destructive relationship between “duality theorem” (1st and 2nd theorems) and externalities => market failure

•  Theoretical assumption necessary to avoid market failure: convexity

•  Real world = second best due to lumpiness, public goods, non-appropriability => increasing returns to scale, zero-price problems



•  R. H. Coase (1960), The Problem of Social Cost

•  Transaction costs => internalisation and reduction of incidence of social cost

•  No externality problem at zero transaction costs (but transaction costs played no role in welfare theorems)

•  James Buchanan, Craig Stubblebine (1962), Externality

•  Utility of i ui = ui(x1,x2,…,xn,z1,z2,…,zn), xn controlled by i, zn by j => externality exists



•  Efficiency if cross effect of z on x is zero => marginal utility not affected

•  If δx/δy ≠ 0 externality is present •  Utility of j only depends on own activities uj

= uj(z1,z2,…,zn) i.e. it is an argument about asymmetry

•  James Buchanan, Gordon Tullock (1962), The Calculus of Consent. Logical Foundations of Constitutional Democracy

•  Public choice theory: interdependence costs from non-market decision-making


60


•  Supply of non-market “constitution” increasing function of number of people↑ because costs of coming to an agreement↑

•  Demand for non-market “constitution” decreasing function of number of people↑ because opportunity costs of a “dictator”↑

•  Kenneth J. Arrow (1969), The Organization of Economic Activity. Issues Pertinent to the Choice of Market Versus Non-market Allocation

•  Externality = a commodity without a market



•  David A. Starrett (1972), Fundamental Nonconvexities in the Theory of Externalities

•  If markets exist for all externalities, this would lead to non-convexities

•  Commodity space vectors yijk = net output of commodity k by firm j as observed by firm i

•  Firm i is affected by firm j, yijk i ≠ j is external effect on i from j’s production of k

•  Traditional markets yiik, artificial markets yijk i ≠ j



•  Convexity assumption => rent exists, which makes income transfers possible that correct for inefficiencies

•  BUT: rent => non-convexity => non-existence of equilibrium

•  Conclusion: artificial markets impossible, inefficiency caused by externality cannot be corrected, externalities are externalities

•  4) How do we find equilibrium? •  J. R. Hicks (1936), Mr Keynes and the

Classics



•  IS-LM framework = interdependence between real and monetary economy, between Y and i

•  Rate of interest has impact on general equilibrium of the economy => forward markets i.e. information and uncertainty

•  Harold Hotelling (1931), The Economics of Exhaustible Resources

•  Price of exhaustible resources follows the rate of interest

•  Resources are commodities that produce commodities, like capital goods



•  In equilibrium, expected returns to capital must be equal to expected returns to resources-in-the-ground such as oil

•  Piero Sraffa (1932), Dr Hayek on Money and Capital

•  All commodities have own rate of interest •  Comes from the role of money in any

forward exchange of commodities •  Price increases of commodities converge

towards an equilibrium real rate of interest



•  Chapter 17 in J. M. Keynes (1936), General Theory of Employment Interest and Money

•  Referred to Sraffa, defined own rate on money like own rate on any commodity

•  Percentage surplus over the spot price of a sum of money supplied forward

•  Highest of all own rates (commodities and money) will always be the rate of interest on money

•  A financial and macro aspect to any trade in commodities due to trade’s time dimension


61


•  Due to time preference, present price falls relative to expected future price

•  Normal shape of forward curve for any commodity or investment object is so-called backwardation i.e. decreasing

•  Rate of discount must then increase with maturity

•  Frank Ramsey (1928), A Mathematical Theory of Saving

•  Transversality condition necessary for discounting: value of infinite but bounded future (= “price of time”) equal to zero



•  Full information and no uncertainty at the infinite but bounded final date in future

•  Kenneth J. Arrow (1963), Uncertainty and the Welfare Economics of Medical Care

•  Uncertainty is caused by allocation of decisions over time

•  With uncertainty information becomes a commodity

•  But markets cannot fully handle uncertainty due to elusive character of information as a commodity => externalities occur



•  James A. Mirrlees (1974), Notes on Welfare Economics, Information, and Uncertainty

•  With imperfect and unreliable information Arrow’s welfare theory is unsatisfactory

•  Utility function of households u(x,h), x = trades with rest of economy, h = probability density of output y given labour input z

•  Utility depends on possible states of nature •  1st and 2nd welfare theorems only

equivalent if suitable budget distribution b(h) exists



•  Necessitates that households i.e. consumers reveal necessary information about themselves without regard to self-interest

•  No incentive for this => informational asymmetry => externality => principal-agent problem => “moral hazard” & “adverse selection”

•  Govt. intervention = second best equilibrium

•  Most subsequent micro & macroeconomic theory are elaborations on this!



THAT IS ALL FOLKS! THE END!

I THANK YOU ALL!


Documents

Lectures in the history of economic thought PURPOSE …nielspeterhahnemann.com/download/LecturesHistEcoThought.pdfeconomics as a science by A. Smith to the first comprehensive macroeconomic