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LCEconomicswww.thebusinessguys.ie© HistoryofEconomicThought Throughouthistory,wehavehadmanyexplana>onsofhowtheeconomy works.Whypeoplebuythings,howthingsarevalued,whogenerates wealthintheeconomy,howthiswealthshouldbedistributedandwhat thegovernmentshoulddotoimprovethestandardoflivingforeveryone. In1848,KarlMarxandFriedrichEngelspublished“TheCommunist Manefesto”whichincorrectlyarguedthatthevalueofsomethingwas whatwasputintoit;andthatlabourcontrolledthemeansofproduc>on. Weknowthatitistheintersec>onofdemandandsupplythat determinesthevalue(orprice)ofsomethingandthatiswhy entrepreneurscanmakealoss.Alsoweknowthatenterpriseisthefactor ofproduc>onthatcombinestheotherthreetoproducegoodsand services.Itisforthisreasonthatwesaythatenterprisecontrolsthe meansofproduc>on.ThetheoryofCommunismhassincebeen disproved,evens>lltherearecountries,likeVenezuela,thattrytoadopt thisfailedideology. BeforeWorldWarII,Keynesianeconomicsbecameverypopular,tothe pointwherealaterAmericanPresident,RichardNixon,said“Weareall Keynesiansnow.”Keynesarguedforhugegovernmentexpenditure during>mesofrecessioninordertos>mulatetheprivatesectorinto growth.Almosteverygovernmentaroundtheworldinthe70’sadopted thisstrategy. Aswemovedintothe80’s,theideathatAdamSmithtalkedabout“The InvisibleHandoftheFreeMarket”cameverymuchintofashion.This calledforasliZlegovernmentaspossibleandjustallowtheprivate interac>onsofconsumersandsellerstooccur;anditbelievedthatthis wouldincreasethestandardoflivingofthepopulacemorethan Keynesian,interven>onalistpolicies.TheAmericanPresident,Ronald Reagan,triedtoreducedthelevelofgovernmentinvolvementinthe economy(howeverheincreasedgovernmentexpenditurebutremoved manyregula>onswhicharetherulesthatgoverncertainsectorsofthe economylikethebankingsector).ThisledtogreatprosperityinAmerica inthe80’sandwasseenasthewayforward. The2000’sinAmericawasadifferentstorywitheconomicstagna>onand hugeunemployment,andeconomistslikeJosephS>glitz,proposedthat theeconomicrecessionoflate2001wastheresultofthelackof regula>oninthe80’sand90’sandgeneraleconomica`tudestartedto moveawayfromFreeMarketprinciples. JonathanTraynor LCEconomicswww.thebusinessguys.ie© TheprinciplesofFreeMarketCapitalismhavebeenblamedfortherecent financialcrisisastheyhadcomebackintofashioninthelate1990’sand early2000’sinthiscountry. Wewillnowtakealookatthedevelopmentofeconomicthought throughouthistoryandthemainpeoplethatwereassociatedwiththem. TheMercan5lists(1500-1780) 1) TheMercan>listsbelievedthatwealthconsistedofpreciousmetals likegoldandsilver. 2) Theybelievedthatcountriesshouldtrytoachieveafavourable balanceoftrade(exportmoregoodsthantheyimported)by increasingexportsandloweringimports. 3) TheythoughtthatEuropeancountriesshouldacquirecoloniesand stealnaturalresources(goldandsilver)fromthesecolonies,exportit andachieveamorefavourablebalanceoftrade. 4) Theythoughtthatcountriesshouldtrytobecomeselfsufficient(not relyontheimportsofothercountries).Theythoughtthatcountries shouldachievethisbypursuingprotec>onistpolicies. 5) Theyfeltthatthegovernmentshouldintervenetotrytoachievea favourablebalanceoftrade. Physiocrats(1750-1800) 1) Theyfeltthatagriculturewasthemainsourceofacountry’sincome (wealth). 2) Theyfeltthatstateinterferencemadetheeconomyworseoffandas suchwantedtokeepstateinterferencetoaminimum.Theypromoted laissez-fairepolicies. 3) Theyfeltthatindividualpropertyrightswasexcep>onallyimportant toachieveeconomicgrowth. ClassicalSchool(1780-1800) 1) TheClassicalschoolisthebirthofrealmoderndayeconomics,which s>lllaststodayandisbeingmoreandmorepromotedrecently. 2) Theybelievedthatlaissez-faireeconomicpolicieswerethekeyto economicgrowthandassuchwantedgovernmentinvolvementkept toaminimum. JonathanTraynor2 LCEconomicswww.thebusinessguys.ie© 3) TheycontributedtotheideaofwhatisknownastheLabourTheoryof value.Theincorrectassump>onthatthevalueofacommidityisthe valueofthelabour(hourlywageX>metakentoproducethegood) thatwasputintoit. 4) TheybelievedthatinterestratesseZledwhensavingsequals investment.Thisiss>lltrueintheLongRunbutJohnMaynardKeynes provedituntrueintheShortRun. 5) Theybelievedthatfreetrade(Notraderestric>onsliketariffs,quotas orembargoes)ensuredahigherlevelofNa>onalIncome. 6) Thebelievedinthefreemarket.Theideathatthegovernmentshould notinterfereineconomicpolicies.Letthepricemechanismbringthe marketintoequilibrium. Marxists 1) Theybelievedthattherewasastrugglebetweenclassesonewhich theworkerswouldeventuallywin. 2) Theybelievedthatlabourwasthemeansofproduc>on,that producedandexcessvaluewhichwastakenbythecapitalists(the ownersofcapitalwhoweretheownersofthecompany).Thisexcess valuewaswhatcapitalistscalledprofits. 3) Theybelievedthatsocialismandlatercommunismwouldeventually replacecapitalismaroundtheworld. Neo-ClassicalSchool 1) Thecontributedtothe“U>lityTheoryofValue”.Thevalueof somethingintheshortrunisdeterminedbyitu>lityintheshortrun anditscostsofproduc>oninthelongrun. 2) Theythoughtthatgovernmentcouldtakeposi>veeconomicac>onby preven>ngthegrowthofmonopolies.Remember,monopoliesarea formofmarketfailure. 3) Theyintroducedtheideaofelas>city. 4) TheypromotedtheMRPofWagestheory 5) Theirmaininterestwasonthehouseholdandthefirmandassuch thestudyofmicroeconomicsbegan JonathanTraynor3 LCEconomicswww.thebusinessguys.ie© KeynesianSchool 1) Hesuggestedthatna>onalincomecouldbeinequilibrium(Aggregate DemandequalsAggregateSupply)withoutfullemployment 2) HeopposedtheClassicalSchoolideathatinarecession,wageswould fall,thedemandforlabourwouldthenriseandarecoverywould follow.Keynessaidthatifwagesfell,consump>onwouldfall(asreal incomefell)whichwouldleadtoaworserecession. 3) Keynesfavouredgovernmentinterven>onintheformoffiscal s>mulus(loweringtaxesandincreasegovernmentspending)inorder totrytos>mulatedemand.Thisbecameknownas“spendingyour wayoutofarecession”. 4) HewastheonethatintroducedtheideaoftheMul>plier. 5) HeopposedtheClassicalSchooltheoryofinterestratedetermina>on intheshortrun(LoanableFundsTheory)andcameupwithhisown theoryofinterestratedetermina>onintheShortRun.Liquidity PreferenceTheory.Thisstatesthatinterestratesintheshortrunare determinedbythedesireofpeopletoholdtheirwealthincashform. 6) Keynesproposedthatthelevelofinvestmentwasinfluencedmoreby theexpecta>onsofbusinesspeoplethantherateofinterest. Monetarists 1) MonetaryPolicy:shouldbethemaininstrumentusedbythe governmenttomanagetheeconomyandnotfiscalpolicy.Increased governmentexpenditurewouldonlyleadtohigherpricesandnot increasedoutputandemploymentasadvocatedbyKeynes. 2) ControlofMoneySupply:Monetaristssuggeststrictcontrolofthe moneysupplysoastocontrolinfla>on.Limi>ngcreditavailability, keepinginterestrateshighwouldcontrolconsumerborrowing. 3) Infla5on:Reduc>onininfla>onincreasescompe>>venesswhichmay leadtorela>velycheaperexports,increasedexportsandjobcrea>on inthelongrun.Companiesshouldkeepwageincreasestoaminimum inordertoavoidcost-pushinfla>on. 4) LaissezFairePrinciples:Monetaristsfavourareturntolaissezfaire principles:minimumstateinterven>on;de-regula>onofmarkets; priva>sa>onofstatebodies. 5) SupplySidePolicies:Monetaristsfavouredanypolicieswhichimprove marketefficiency/boostsupply/reducetheabilityoftradeunionsto interferewiththelabourmarket. JonathanTraynor4 LCEconomicswww.thebusinessguys.ie© SupplySiders 1) TheyagreedwithSay’sLaw(wewilllookatthislater),whichsaidthat supplycreatesitsowndemand.Therefore,theyadvocatedan expansionofsupplyandnotofdemandasasolu>ontoeconomic problems.Remember,itisthequan>tyandquality(orvalue)ofwhat isproducedinaneconomythatdefinesthewealthofana>on. 2) Theyadvocatedlowtaxesastheywouldencourageproduc>on(orat leastremoveadisincen>vetoproducegoodsandservices)which wouldcreateemployment. 3) Theypromotedthederegula>onofmarkets(theremovaloflegal restric>onsonhowcompaniesareallowedtoact)andthe priva>sa>onofstatecompanies. Economist MainIdeas ThomusMun EncouragedTradeSurplusandSelf Sufficiency JamesStuart GovernmentInterven>on Agricultureisthesourceofwealth FrançoisQuesnay JacquesTurgot TableauÉconomique-Similartothe CircularFlowofIncome LawofDiminishingMarginalReturnsas appliedtoagriculture AgainstGovernmentInterference DivisionofLabour(Specialisa>on) AdamSmith LabourTheoryofValue AgainstGovernmentInterference CanonsofTaxa>on ThomasRobertMalthus Popula>ongrowsfasterthanfoodsupply IronLawofWages JonathanTraynor5 LCEconomicswww.thebusinessguys.ie© Economist DavidRicardo JohnBap>steSay JohnStuartMill MainIdeas LawofCompara>veAdvantage (Interna>onalTrade) TheoryofRent(Rewardtotheownersof land) Produc>oncreateditsowndemandand thereforeeconomiccrisescouldnotexist Iden>fiedEnterpriseasthe4thFactorof Produc>on WagesFundTheory AdvocatedFreeTrade MRP U>lityTheoryofValue AlfredMarshall QuasiRent Elas>city,ConsumerSurplus,Longand ShortRun JohnBatesClark MRPTheoryofWages TheAcceleratorPrinciple Favouredgovernmentinterven>onin economicaffairsbywayoffiscalpolicy JohnMaynardKeynes LiquidityPreferenceTheory Na>onalIncomecouldbeatequilibriumat lessthenfullemployment Mul>plier AdvocatedtheuseofMonetaryPolicy MiltonFriedman ControlofMoneySupply Priceswillstabiliseleadingtoan environmentofeconomicgrowth. JonathanTraynor6 LCEconomicswww.thebusinessguys.ie© DavidRicardo 1) LawofCompara5veCosts:Ricardosupportedtheideaoffreetrade anddevelopedthelawofcompara>vecostswhichstatesthata countryshouldspecialiseintheproduc>onofthosecommodi>esin whichitisrela>velymostefficientandtradefortheremainderofits requirements. 2) TheoryofEconomicRent:Ifpopula>onincreaseditwasnecessaryto useinferior/moreremoteland.Foruseofthislandrentwaspaid.As aresultthepriceoffoodrose.Costofproducingonthebestlandwas lowerthereforefoodproducedonthislandearnedasurplusoverthat producedoninferiorland.Thissurplusledtoanincreaseinrent payablefortheuseofgoodland. 3) AcceptedtheSubsistenceWagesTheory:Hebelievedthatany increaseinwagesabovethesubsistencelevelwouldcauseanincrease inpopula>onwhichwouldinturncausewagelevelstofall. AdamSmith 1) ThePursuitofSelfInterest:Thisbestbenefitedtheindividualand hencebestbenefitedsociety. 2) DivisionofLabour:Increasedproduc>vityandacountry’swealth.His example-themanufactureofpinsillustratedthebenefitsofthe divisionoflabour. 3) LabourTheoryofValue:Thevalueofanitemwasequaltothe amountoflabourthatwentintoproducingtheproduct. 4) StateProtec5onofPropertyRights:Encouragestheaccumula>onof personalwealth. 5) InvisibleHandofCompe55on:Allowsaselfregula>ngmarketto operatethusensuringeconomicprogressisachieved. 6) PerfectCompe55on:Freeentryintomarkets;profitssufficientto rewardentrepreneurs;inefficiencypenalisedandpricewouldbe basedonthecostofproduc>on.Monopolieswouldnotpersist. 7) Laissez-Faire:Nojus>fica>onforgovernmentinterven>oninthe economyexceptfordefence/jus>ce. 8) CanonsofTaxa5on:Tofundthestate’sdefence/jus>cesystems taxa>onwasnecessaryandhedevisedthefourprinciplesofafairtax system:equity,economy,certaintyandconvenience. 9) ParadoxofValue:Hedis>nguishedbetween‘valueinuse’and‘value inexchange’.Someitemshadavastu>lity(air,water)butarenot JonathanTraynor7 LCEconomicswww.thebusinessguys.ie© exchanged,whileothers(diamonds)possessedliZleu>litybutcould commandagreatvalueinexchange. 10)FreeTrade:Headvocatedinterna>onalfreetradeunhinderedbythe imposi>onoftariffssothatmarketscouldoperateeffec>velyand allowthegainsfromtradetobespreadbetweenna>ons. AlfredMarshall 1) TheoryofValue:Thevalueofacommoditywasdeterminedinthe short-runbyitsu>lityanddemandandinthelong-runwas determinedbyitscostofproduc>on. 2) Distribu5onofWealth:Thereturntoeachofthefactorsof produc>onwasdeterminedbytheirmarginalproduc>vity. 3) Compe55onRegulatedEconomicAc5vity:Governmentinterven>on andinter-businessco-opera>oncouldregulateeconomicac>vityand enhanceeconomicfreedom. 4) GrowthofMonopoliescouldbePrevented:Regula>onby government;consumerinforma>on;increasednumberofsmall investors/moreaccountability. 5) QuasiRent:Theeconomicrentearnedbyfactorsofproduc>oninthe shortrunwhendemandexceededsupply. 6) Developedconceptsofprice-elas5cityofdemand/consumer surplus/howmarketsadjustedtochangesinD&Sover5me: quan>fyingbuyers’sensi>vitytoprice;thesurplusvalueoru>litya consumerenjoys;Marketperiod,shortperiodandlongperiod. JohnMaynardKeynes 1) Na5onalIncomeatLessthanFullEmployment:Keynesobservedthat na>onalincomecouldreachequilibriumwithoutreachingfull employmentandhencehesuggestedgovernmentinterven>onto helpcreatejobswhenrequired. 2) OutputisDemandDetermined:Thesizeofna>onalincomedepends onexpenditurei.e.C=I+G+X−M 3) FavouredGovernmentInterven5onintheEconomy:Thejobofthe governmentistomanagetheeconomy.Thegovernmentcanusefiscal policytocreatefullemployment. 4) InvestmentDecisionsbyEntrepreneurs:Hestatedthatinvestmentby entrepreneursdependedmoreonbusinessmen’sexpecta>onsthan ontherateofinterest. JonathanTraynor8 LCEconomicswww.thebusinessguys.ie© 5) InvestmentcouldbelessthanSavings:Thiscouldresultinaleakage inspendingwhichdecreasesna>onalincomeandemployment. 6) NewEconomicConcepts–TheMul5plier:Hedevelopednewtoolsto explainhistheoriesincludingthemul>plier:Anyini>alincreasein spendingwillcauseagreatermuchgreaterincreaseinGNPduetothe factthatoneperson’sexpenditureisanotherperson’sincome.He developedconceptssuchas:-MPC,MPM,etc. 7) LiquidityPreferenceTheory:Peoplemayprefertoholdtheirwealth inmoneyformforthreereasons:transac>onary;precau>onaryand specula>vereasons. 8) ManagedsystemofExchangeRates:Hefavouredasystemofforeign exchangerateswhichcouldbe‘managed’bythestateratherthanthe goldstandard. MiltonFriedman 1) MonetaryPolicy:Shouldbethemaininstrumentusedbythe governmenttomanagetheeconomy. 2) ControlofMoneySupply:Monetaristssuggeststrictcontrolofthe moneysupplysoastocontrolinfla>on. 3) ReduceInfla5on:Thisincreasescompe>>venesswhichmayleadto increasedexportsandjobcrea>oninthelogrun.. 4) LaissezFairePrinciples:Hefavouredareturntolaissezfaireprinciples -withminimumstateinterven>on;de-regula>onofmarkets; priva>sa>onofstatebodies. 5) SupplySidePolicies:Hefavouredanypolicieswhichimprovedmarket efficiency/boostedsupply:de-regula>onofmarkets;reducingthe abilityoftradeunionstointerferewiththelabourmarket. KarlMarx 1) Marxarguedthatworkerswerepaidsubsistence/minimumwages bytheiremployers. 2) Thevalueofthegoodsproducedbyaworkerwasmorethanthe wagespaidtotheworker.(Thedifferencebetweenthetwohecalled the‘surplusvalue’orprofittotheemployer).Thisillustratedthat workerswereexploitedandin>mewouldbereplacedbycapital resul>ngintheirunemployment. JonathanTraynor9 LCEconomicswww.thebusinessguys.ie© ThomasRobertMalthus 1) Malthusstatedthatpopula>onincreasesinageometricprogression (i.e.2,4,8,16etc)whilefoodsupplyincreasesinanarithme>c progression(i.e.2,3,4,5etc). 2) Popula>onwouldoutgrowthemeansofsubsistence.Theoutcome wouldbefamine,diseaseetc. No Histheoryisnotrelevanttoday POPULATION 1) Extensivepopula>oncontrolmeasuresareinplaceworldwidewhich arehelpingcontrolpopula>ongrowth. 2) Somecountriesimposestrictpopula>oncontrolse.g.China’s‘One ChildPolicy’. FOODPRODUCTION 1) Becauseofthedevelopmentofhighyieldingcrops/Gene>c modifica>onmeansthatfoodproduc>onisbeingincreased. 2) Theavailabilityofcheaperimportsfromdevelopedna>ons(EU; NorthAmerica)ishelpingthedistribu>onoffoodworldwide. JonathanTraynor10