SUMMARY LECTURES DEC 22803
LECTURE 1: INTRODUCTION AND PHILOSOPHY OF SCIENCE
Economics is distinguished from other sciences by their methodology. It is about explaining what you see, and
people are rational. Economics in the philosophy of science: five stages
1. Logical positivism: observations are objective, and theories can be proven. This is what defines
science. If something cannot be proven, it is unscientific. No normative economics
2. Falsification: You can always get new data, so you can never be sure that your data is correct. People
should focus on how their theory can be falsified, not verified. This way you gradually approach the
truth.
3. Problems with falsificationism: You cannot falsify empirical theories, as you can always attribute
anomalies to noise. Researchers do not try to falsify their own theories.
4. Kuhn: paradigms. Scientists are solving problems (normal science). A paradigm is a core concept for
your theory to function, and in normal science this paradigm can be expanded to different areas.
Scientific revolutions are caused by increased findings of anomalies.
5. Even though anomalies cause a paradigm shift, a hard core of theory will remain, that is never tested
nor can be tested. Only possible anomalies will be tested, which can result in a new paradigm shift.
Example: the old theory of value said that value came from labour, but anomalies like diamond and water
caused the creation of a new theory of value: that of the marginalists. The focus on individuals had as a result
the disappearance of growth and development from the economist agenda until Harrod-Domar (1940s).
LECTURE 2: ADAM SMITH
Trading, saving or enterprising was sinful in the middle ages. This changed with the middle ages: those rich in
the current world are the ones that will go to heaven. Mercantilism: trade is a zero-sum game, and countries
should strive to get as much precious metals as possible using trade, allowing state intervention. Physiocracy:
natural laws govern the economy, and there is no role for the state (laissez faire).
Classical period 1776-1890
Adam Smith, David Ricardo and John Stuart Mill. (also, Malthus and Marx). Characteristics: Economy was
analysed as a whole, seen as harmonious despite being built up from individual actions, and focuses on the
long run. Concerns: Income distribution, role of the state (laissez faire). Using: labour theory of value.
Adam Smith was influenced by Newton: he believed the economy was governed by universal laws. He wrote
on what determines economic growth, and how to promote it. Humans are driven by self-interest, but an
invisible hand causes this to promote the interest of society. The government should not interfere, and
markets must be competitive. Government is needed to protect infant industries, destroy monopolies and
provide public goods. Growth depends on accumulation of capital, for which an unequal distribution in favour
of capitalists is needed. Workers earn subsistence wages because there are many workers and increased
wages increase fertility. Smith says trade is important because other countries can be absolutely cheaper->
focus on imports. In the short run, value is caused by demand and supply (market prices), and in the long run
by supply (problematic). Smith could not provide a consistent theory on productions costs.
LECTURE 3: BENTHAM, RICARDO AND MALTHUS
After Smith came the industrial revolution, bringing with it unprecedented economic growth, but also creating
huge inequalities. The idea of the economy as a harmonious, self-correcting system came under strain. There
came counter-voices:
Jeremy Bentham Famous for his utilitarianism: people want to maximise their happiness by achieving pleasure
and avoiding pain, but free markets do not achieve greatest happiness. The government should intervene to
maximise total utility.
Thomas Robert Malthus. Basic thesis: population grows exponentially, while food supply grows linearly. To
prevent a population explosion, there are two checks: Increase in death rate (war, illness, famine) and
decreases in fertility rate (postponing marriage, moral restraint). Did not mention diminishing returns, or the
possibilities for technological development.
David Ricardo. Three main contributions:
1. Deductive methodology. This was abstract, and purely theoretical.
2. Formulating laws that regulate income distribution. Iron law of wages: real wages will be equal to
subsistence levels. Theory of land rent: a first approach towards marginalism, and he looked at
diminishing returns
3. Theory of international trade. Comparative advantages. This was his lasting contribution to economy.
LECTURE 4: MILL AND MARX
Mill and Marx had a few things in common: they both started as philosophers, expanding their view of
economics. They accepted the economic foundations of the classics. They lived in a time when the problem of
food had been solved, but the development of a capitalist system brought urbanisation and exploitation. They
therefore focused more on income distribution.
John Stuart Mill. He was supposed to carry on where Bentham stopped, but he couldn’t deal with the narrow
methodologies. Ricardo’s deductive approach was good in theory, but he agreed with popper’s idea of
falsification. Therefore proposed a more inductive approach. He agreed that production was governed by
natural laws, but personal income was shaped by social institutions, that can be affected by the government. A
better distribution was therefore possible through government intervention. Mill stopped somewhere halfway
between socialism and capitalism: with reforms the income distribution could be more equal, and then
individual freedoms would persist. He, other than Ricardo, thought that the stationary state was desirable, as
the relative calm would allow for income redistribution.
Karl Marx. A philosopher who advocated beyond change, but a fundamental revolution. Marx never really
discussed communism, only capitalism and how it would lead to communism. He said that the dynamics of an
economy are determined by the institutions, but the dynamics also affect the institutions. He used Hegel’s idea
of dialectical materialism: thesis (dominant view) + antithesis (contradiction) = synthesis (a mix of both). Marx
says that the dynamic forces of production (technology, accumulation of capital) change the static relations of
production (rules of the game). One of the sources of conflict that would lead to communism is alienation:
Alienation through labour division (workers are no longer connected to what they produce) and alienation
through commoditisation (everything is turned into a commodity, like health care). This urge leads to the
removal of private property. Marx believed there was a reserve army of unemployed, which caused wages to
be low. Marx said that surplus is the difference between revenues and labour costs, and this increased over
time. The investments in labour-saving technology cause barriers to entry, resulting in a few large firms. The
low wages of workers reduced consumption, which caused recessions to be more severe (and thus leading
faster to revolution). Marx clearly underestimated the opportunities for economic and social reform.
LECTURE 5: THE MARGINALISTS AND MARSHALL
Neoclassical economics
Characteristics: Focus on resource allocation, use of marginal analysis, a deductive approach (like Ricardo), no
attention given to time as a factor and a focus on consumers.
Marginalists (Jevons, Menger and Walras). Classical: supply determine prices. Jevons and Menger: demand
determines prices, Walras and Marshall: both determine prices (=New theory of value). With this new focus
on demand Bentham’s utility was back. Interpersonal comparisons of utility were possible (they said), so
allocating resources to the poor increased total utility, but it was an additive function (e.g. utility of one
product was independent from utility of another product, no complements or substitutes). They established
Gossen’s second law: the last euro you spend on each product should give you the same amount of utility.
Walras went further, saying how this resulted in a demand curve, and how all markets were therefore
interrelated(more expensive bread causes you to consume more potatoes): general equilibrium. But the
mathematics were not advanced enough to move this beyond a theoretical approach.
Alfred Marshall. He saw economics as an instrument to reach the truth and emphasised the relevance of other
social sciences (history, sociology). Developed the idea of ceteris paribus, which could be seen in his partial
equilibrium analysis (of only one market). Developed time analytically: Market period (supply is fixed, vertical
curve), Short run (variable costs can change), Long run and very long run (all costs are variable, curve is almost
horizontal then). This allowed him to look at both demand and supply, which were both relevant in the short
run (the Marshallian cross). Also introduced the idea of price elasticity, which depend on the length of the
period. He used Gossen’s second law to derive the demand curve.
LECTURE 6: JEVONS AN D RESOURCES
Jevons. said labour is entirely dependent on utility. In his book “the Coal Question” he examined how
important coal was for the industrial revolution, and how long coal could last the world. He discovered the
rebound effect: a productivity increase increases the profits in the sector, which attracts other players. This
leads to higher competition, and then lower prices. In the end, the productivity increase leads to increased
consumption. However, the rebound effect goes further: there is also a cohort effect. The later generations are
so used to the cheap consumption that they consume even more. In the case of coal, there was a backfire
effect: fuel usage actually increased because of productivity gains.
This can be extrapolated to the current debate on climate policies: do productivity gains really lower
the fossil fuels used? Also, if developed countries lower their usage the price of fossil fuels declines,
stimulating developing countries to consume more. This is an important contribution to China’s growth. There
was a debate on sustainability, the result being that there is weak sustainability (resources that are exhausted
but can be compensated with capital) and strong sustainability (cannot be compensated with capital, nature).
LECTURE 7: VEBLEN TO MODERN INSTUTIONAL E CONOMICS
First theorem of welfare economics: Trade will lead to an efficient (not equitable) distribution. Second
theorem: by changing the initial endowments (e.g. property rights) you can achieve a more equitable growth.
Neoclassical economics in the USA
John Bates Clark. Said that Pareto efficiency will also lead to equity. He critiqued neoclassical economics: the
mechanistic working of the economy denied agents free will, and the view of the market system as
harmonious socially. Clark was inspired by the
German Historical School
Proposed a historical, inductive method. Older school: there is no universal theory possible for economy.
Younger school: historical case studies
Neoclassical economics in the USA
Thorstein Veblen. Wanted to build a unified theory of social sciences, and criticised the marginalist approach
(calling it neoclassical). Founded institutionalism. Veblen disagreed with several parts of neoclassicism: It is
teleological and pre-darwinian (it leads to a perfect market, and is moving towards a socially beneficial
equilibrium e.g. disagreed with general equilibrium), Static (though the economy and its institutions are
subject to change), non-empirical (competition leads to monopolistic concentration, he saw this in the US) and
assumes rationality (not true, according to Veblen). Veblen says people also act according to instincts:
workmanship, curiosity but also greed. There is a dichotomy between culture (static, irrational behaviour) and
the economy (dynamic, creative behaviour). This lead to the development of New Institutional economics:
institutions are there to reduce transaction costs.
LECTURE 8: AUSTRIAN ECONOMICS, SCHUMPETE R AND EVOLUTIONARY E CONOMICS
The Austrian school of Economics
Used a different methodology: theory and abstracting. They also believed in a subjective theory of value. Did
not look at only the equilibrium achieved, but also how you get to the equilibrium. Most ideas have been
absorbed into the mainstream. Opportunity costs also work over time. They also developed the idea of having
to search for products and prices: no perfect information. They were against the state, and tried to understand
the market as a process.
Economics system questions
Markets versus planning/ capitalism versus socialism, what is the best approach? Barone believed that
planning could mimic the market by setting prices just right (MC=AC). Prices were used to show that
something is going on in a firm. Veblen and Galbraith both saw economic power moving into the hands of
businesspeople, who only care about their own advantage. Veblen envisioned that they would fail and power
would move back to the engineers and workers.
Neoclassical economics
Classics: look at growth and change, neoclassicals not so much.
Joseph Schumpeter. Was an exception. Made the distinction between growth (more of the same) and
development (spontaneous, large changes, creative destruction, also changing the social organisation and its
institutions). Emphasises the role of the entrepreneur, who was neglected in neoclassical economics, who
takes risks and causes development. In the end capitalism will break down because innovation becomes
normal. Induced innovation: high prices cause large spending in R&D-> bringing prices down. Also lead to
evolutionary economics: capitalism is always changing and can never be stationary.
LECTURE 9: THE BIRTH OF DEVELOPMENT ECONO MICS
Development economics
Economics was segregated by discipline: Marginalists vs. German historical school, after WW2 development
studies separated. This can have the negative effect of parallel developments
Rosenstein-Rodan. There was a problem in eastern Europe: there were too many agricultural workers. These
could not all be employed there, so there were two solutions: emigration or industrial employment. As
western countries would not be able to handle that much in-migration, these countries should be helped to
industrialise (development aid!). Planning is necessary for this. The hold-up problem: employers do not want
to train their workers, as they might leave the company: role for the government.
Tinbergen. Said that growth in rich countries comes at the expense of poor countries (other than mainstream
economics, who believe in trickle down effects). Famous for his cobweb models of instability: the economy
can go in circles around the equilibrium.
Boserup. Looked at population growth, against the (neo)Malthusians: population pressure may trigger
technological change and growth.
Hirschman. Did not think laissez-faire can lead to development. Stressed case by case studies: you cannot
extrapolate theories to other societies. One of the first to stress the importance of institutions.
Sen. The usual answer to famines is agricultural intensification. Sen found that famines happen when the
harvest is slightly up. This had an income effect, causing people to consume much more, thus raising the
prices. People starve not because of lack of food, but lack of money.
Development economics has grown more micro: looking at asymmetric information (gains from trade can
disappear), game theory and social choice theory. This looked at how poverty should be measured:
independent from the rich, but also with eye for the difference between the poor. Foster-Greer-Thorbecke
index achieved this by measuring the distance from the poverty line. Another way: HDI.