Download Mathematical Interpretation for Classical Thoughts According to

Mathematical Interpretation for Classical Thoughts
According to classical thoughts, production function of an economy has described
as follows.
O= f (L, K, N, T)
O= Total Production
L= Labour Force
N= Natural Resources
T= Technology
It was based on following assumptions.
1) Capital accumulation depends on profit
K = f (P)
2) Improvements in technology depends on investment
T =f (I)
3) Investment depends on the rate of profits
I =∆K=f (R)
∆K =Net added to capital stock
R= Profits
4) Profits depend on labour supply and the level of technology
R =f (L, T)
P = Profit
L= Labour
T = Technology
5) The size of the labour force depends on the wage rates
L = f (W)
L = Labour
W = Wage
6) The wage rates depend on the level of investment
W = f (I)
W = wages
I = Level of investment
7) Total output is identical (equals) to profits, Wages and rents
O ≡ f (P, W, R)
O = Output
P = Profit
W = Wages
R = Rent
Criticisms for Classical Thoughts
Classical thoughts of economic growth was critiqued due to some limitations of
fundamentals (Pathirage, J. M. P. 2011).
 Ignorance of the middle class
 Neglecting the role of state sector
 Pessimistic thinking and unrealistic laws
 Wrong notions on profits and wages
However it is accepted that classical thoughts of economic growth were based on
the macroeconomic perspectives rather than micro viewpoints focused as in neo
classical economic thoughts.
Session 3
CLASSICAL ECONOMISTS
Thoughts presented during 18 and 19 centuries were viewed as classical thoughts.
These thoughts were presented by leading classical economists namely as Adam
Smith, Thomas Malthus, Jean Baptist Say, and David Ricardo and John Stuart Mill.
Adam Smith
Scottish Philosopher and political economist Adam Smith is honored as the father
of modern economics. It presumed that his ideas were influenced by the views of
Physiocrats in France who believed that “Government of nature” and trade and
industry were not sources for wealth but agriculture is the real economic movers.
According to Wikipedia, the free encyclopedia, his biography was summarized as
follows.
Adam Smith
16 June 1723 NS
Born
(5 June 1723 OS)
Kirkcaldy, Fife, Scotland
17 July 1790 (aged 67)
Died
Edinburgh, Scotland
Nationality Scottish[1]
University of Glasgow
Alma mater
Balliol College, Oxford
Notable work
The Wealth of Nations, The Theory of
Moral Sentiments
Western philosophy
Classical economics
Political philosophy, ethics,
Main interests economics
Classical economics,
modern free market,
Notable ideas division of labour,
the "invisible hand"
Region
School
Signature
Source: From Wikipedia, the free encyclopedia,
www.adamsmith.com
Smith laid the foundations of classical free market economic theory from his wellknown book, An Inquiry into Nature and Causes of The Wealth of Nations
published in 1776. He wrote his first classic book on “The Theory of Moral
Sentiments in 1759 and attempted to explain human behavior and ethical values.
As a precursor to the modern academic discipline of economics, Smith explained
the hidden secret of public welfare, through the analysis of price mechanism
acted as an invisible hand to solve basic economic questions I. e. what?, how? and
for whom. He also explained how rational self-interest and competition can lead
to economic prosperity. Smith’s views on economic growth and development has
presented on key notions as Follows:
Laissez Faire
Smith argued that Laissez faire or the less governance or less intervention by the
government is required factor for economic development.
Invisible Hand
Smith explains how self-interest or the selfish is worked for the benefit
of the society. He argued that whole society is benefitted inevitably
when butcher, brewer and baker made their products on their selfinterest. Thus self- interest that motivated on profit maximization is
invisibly determined the sanctity’s needs i. e. what produce? how
produce and what quantity etc. Finally he showed that price mechanism
that determine on the demand and supply will solve the basic economic
questions of the society,
Free Trade
Smith said that trade restrictions advocated by mercantilists would limit
the world production, consumption and public welfare. Therefore, he
advised to promote free trade among nations by specializing products
which have the absolute advantage by each country.
Division of labour
Smith advocates division of labour and specialization as the key factor of growth,
enhanced by machinery and international trade. Division of labour and
specialization would increase productivity and reduce per unit costs. According to
his example of pin industry, if one person produce everything, he is able to
produce few units but the factory divided to 18 sections and persons asked to
produce a part or a component more products could be manufactured. It increases
due to three reasons.
By increasing per head production
By saving time through reducing labour movements from one work to
another work
By using machineries
He also advocated that division of labour and specialization could promote at
international level through the international trade.
Labour theory of Value
Classical thoughts were essentially based on the Smith’s concept of labour
theory of value, which was based on following notions.
1. Labour is the only factor of production and is homogeneous (no
quality difference)
2. The cost or the price of goods depends exclusively on the amount of
labour. For instance if USA could produce cloth using less number
of labour units than UK, USA has the cost efficiency in making cloth
than UK
The theory of Absolute Advantage and International Trade
Smith’s trading principle is the principle of absolute advantage. Trade on
Smith’s absolute advantage principle was based on division of labour,
which means specialization in the production of only few goods by
nations will lead to increase the efficiency and production. In a two
country, two goods model, specialization and trade would benefit when
one nation has absolute cost advantage in producing one good and the
other nation would also has the similar advantage in producing other
good.
Smith mentioned that productivity of factor inputs are the major
determinant of production cost and thereby productivity are based on
natural and acquired (man-made) advantages. The natural advantage
refers to natural resources such as climate, land, soil and locations etc. and
acquired resources refer to special abilities and human skills of nations.
Thus, under given natural or acquired advantages in the production of
goods, a country could get the absolute cost advantage and access to
international market through specialization the respective good at lower
cost, becoming more competitive than the trading partner.
Economic Growth
According to supply driven model of growth presented by Smith, output
is related to inputs of labour, land and capital. Thus, economic growth
which is the increase of output is related to population growth,
investment, land growth and increase in the productivity.
Smith believes that the society is dependent on the economy’s ability to
sustain its increasing workforce (population), investment that rely on the
rate of savings and Land growth that dependent on the ability to acquire
more lands or increasing productivity.
Smith’s model suggests that an economy will increase the growth
permanently in the long run due to division of labor, specialization and
technological progress. Smith assumed that accumulated resources and
technology in the past, permits to maintain a level of per capita income
at the zero time. Specialization with research and development, learning
by doing and innovations cause to increase per capita income from y (a)
to y© in the long run (see figure3.1).
Figure 3.1: Smiths’ Long Run Growth
However, he also thought that in spite of increasing returns and
technological development, an economy would ultimately become
stagnation or stationary position by shrinking profits and savings of
capitalists due to increased labour rates to be paid labourers.
Thus Smith’s vision of a free market economy was based on three principles i. e.
secure property, capital accumulation, market extension and division of labour
(www.economic thoughts, Wikipedia, 2016).
Though Smith criticized the government intervention and regulate human actions,
he believed that the government have to play there legitimate functions.
Erecting and maintaining certain public works and public institutions. (Provide
public goods)
Avoid creating cartels because of their tendency to limit production and quality of
goods and services
Avoid monopoly and monopolistic competition which could distort the benefits of
free market.
Though Smith’s vision of economic development was presented in in 18th century,
his thoughts are still practiced by many economists and countries due to its validity
and practicability. Liberalism and neo liberalism spread over the world today is
entirely based on the thoughts of Adam Smith.
David Ricardo
David Ricardo (18 April 1772 – 11 September 1823) was an English political
economist. He was one of the most influential of the classical economists, along
with Thomas Malthus, Adam Smith, and John Stuart Mill (www.David Ricardo,
Wikipedia. 2016). He had become a wealthy stock market trader and a member of
the British Parliament. He also live at the time of industrialization and the France
revolution. Ricardo’s biography was summarized as follows.
David Ricardo
Portrait of David Ricardo by Thomas Phillips, circa 1821. This
painting shows Ricardo, aged 49, just two years before his
death.
Born
18 April 1772
London, England
Died
11 September 1823 (aged 51)
Gloucestershire, England
Nationality
British
Ethnicity
Jewish
School or
tradition
Classical economics
Influences
Smith · Bentham
Influenced
Ricardian Socialists · George ·John
Stuart
Mill · Sraffa ·Wicksell · Barro · Joh
n Ramsay McCulloch · Karl
Marx · Franz Oppenheimer
Contributions
Ricardian equivalence, labour
theory of value, comparative
advantage, law of diminishing
returns, Economic rent[1]
Quoted From Wikipedia, the free encyclopedia, www.adamsmith.com
Economic Thoughts of Ricardo were influenced by the views of Adam Smith
(1723-1790) and Jeremy Bentham (1748-1832) who famous as a radical thinker
at that time. Ricardo’s main publication is known as “principles of political
economy and Taxation”, which contains critique of barriers to international
trade and distribution of national income. Ricardo’s contribution to classical
economic thoughts is outlined as follows.
Diminishing Return to Land Cultivation
It is assumed that labour is only variable input to fixed extent of land and when
increase the additional amount of labor, productivity will decrease after certain
units as long as technology is fixed. He believed that land is fixed and population
grows relative to land and therefore productivity of labor will decrease.
Distribution of Income
According to Ricardo national income of the country distributes among three
parties as follows:
Workers who receive wages fixed to a level at which they can survive
Landlords who earn a rent
Capitalists who own capital and receive a profit
Factors of Production
Ricardo mention that economic activities determine on three production factors
such as land, labor and capital.
Labour theory of value
As explained by Ricardo, cost or price of a commodity is determined by
exclusively from its labour content. Thus Ricardo said that value of a good or
services is determined on the labour cost or the wage rates rather than land or
capital which he assumed as fixed. Ricardo modified Smith’s views in this regard.
Likewise, the size of the labour force depends on the wage rates L = f (W).
Ricardo shows two level of wages such as natural wage that equal to subsistence
level and actual wage that equal to market price.
Iron law of wages: Ricardo also agrees with views of Robert Malthus and a
subsistence wage to be paid labours just for their survival because increasing
wages will cause to increase food prices and to decrease the profits of landlords
Rent
Ricardo said that rental value is the payment to be paid to landlords by cultivator
for the quality and fertility of the land. He said fertility and productivity vary
between land and the quality of the land change the productivity.
The principle of Comparative Advantage and Gains from International Trade
According to Ricardo countries can mutually gain from international trade which
based on the principle of comparative advantage. According to him, comparative
advantage is determined either on greatest relative cost advantage or least
absolute cost disadvantage. Ricardo believed that gains from trade would offset
by perceived gain from trade protection. Ricardo also believed that countries can
improve both production and consumption through mutually beneficial Trade.
Steady Growth
Ricardo’s growth and development model like Smith’s model is function of
capital accumulation, Capital accumulation depends on reinvestment of profits.
Ricardo believed that when population grows relative to land productivity of the
labour on land will diminish and consequently food will become relatively scare
leading to increase the price. Wages will need to increase if labours are to
survive. Rental of lands is also increased as fixed asset. All these factors caused
to decline profits of investors (Landlords). Thus economy become steady state
as investment decline. According to Ricardo, the only way to avert stagnation is
to promote international trade as he advocated by the principle of comparative
advantage. International trade will increase the prices of commodity leading to
increase wages, rents and profits of investors.
According to Thirwall (2008) Ricardo has thought economy as one big farm, in
which food (corn) and manufactures are consumed in fixed proportion. Thus the
Ricardo’s model of the economy could be illustrated as follows.
Figure 3.2: Ricardo’s model of the economy
Corn
R
Z
Average product
P
Y
W
X
MP
O
L L2
Labor
Subsistence wage
The figure 3.2 shows that with an employment of L, total output is ORZL. The
rent is determined by the difference between the average and marginal product
(MP) of the labour as indicated in PRZY. Wages are equal to WPYX. When output
increase and marginal product (MP) of labour falls to the subsistence wage level
and profit will disappear. As profit falls in farm capital will move to industries.
Thomas Robert Malthus
Thomas Robert Malthus
Born
13 February 1766
Westcott, Surrey,
England
Died
29 December 1834
(aged 68)
Bath, Somerset,
England
Nationality
Field
School or
tradition
English
demography,
macroeconomics
Classical economics
Alma mater
Jesus College,
Cambridge
Influences
David Ricardo, Jean
Charles Léonard de
Sismondi
Influenced
Charles Darwin, John
Maynard Keynes,
Alfred Russel Wallace
Contributions
Malthusian growth
model
Quoted From Wikipedia, the free encyclopedia, www.adamsmith.com