Toward the birth of Political Economy
1500
1600
1700
1800
1900
Francis Bacon
1561 - 1626
Galileo
1564 - 1642
Descartes
1596 - 1650
Thomas Hobbes
1588 - 1679
John Locke
1632 - 1704
Isaac Newton
1642 - 1727
Hobbes
Locke
Richard Cantillon
1680 - 1734
Frances Hutcheson
1694 - 1746
Adam Smith
1723 - 1790
David Ricardo
1772 - 1823
Smith
Karl Marx
1818 - 1883
Marx
Mercantilism
Our ancestors took it for granted, almost throughout
English history, until the mid-nineteenth century, that
government should give a certain direction to national
industry and commerce…
Our earlier statesmen saw real merit in the old “mercantile
system.” According to this system an excess in the value
of exports over that of imports, and the consequent
attraction, as it was assumed, of a balance in coin or bullion
into the country, was a test of successful policy …
Thomas Mun
1571 – 1641
Jean Baptiste Colbert
1619 – 1683
William Petty
1623 – 1687
Adam Smith first shook the principle by lucid reasonings
intended to show that the “wealth of nations,” so far as that
was the object in view, was best secured not by control
and restrictions, but by perfect freedom of industry and
commerce.
Bernard Holland, The Fall of Protection, 1840 - 1850
Petty
Colbert and Mercantilism
Sire, it pleases Your Majesty to give some hours of his attention to
the establishment, or rather the re-establishment of trade in his
kingdom …
As for internal trade and trade between [French] ports:
The manufacture of cloths and serges and other textiles of this kind,
paper goods, ironware, silks, linens, soaps, and generally all other
manufactures were and are almost entirely ruined.
Jean Baptiste Colbert
1619 - 1683
The Dutch have inhibited them all and bring us these same
manufactures, drawing from us in exchange the commodities they
want for their own consumption and re-export. If these manufactures were well reestablished, not only would we have enough for our own needs, so that the Dutch would
have to pay us in cash for the commodities they desire, but we would even have enough
to send abroad, which would also bring us returns in money-and that, in one word, is the
only aim of trade and the sole means of increasing the greatness and power of this State.
Having summarized the condition of domestic and foreign trade, it will perhaps not be
inappropriate to say a few words about the advantages of trade … I believe everyone
will easily agree to this principle, that only the abundance of money in a State makes the
difference in its greatness and power.
Memorandum to Louis XIV on trade (1664)
The Physiocrats – The First Analytical Economists
The land has also furnished the whole amount of moveable
riches, or capitals, in existence, & these are formed only by
part of its produce being saved every year. Not only does
there not exist nor can there exist any other revenue than
the net produce of lands, but it is also the land which has
furnished all the capitals which make up the sum of all the
advances of agriculture and commerce.
Turgot, Reflections on the Formation and Distribution of Wealth
Anne-RobertJacques Turgot
1727 - 1781
But all these items of wealth, which are successively maintained
this annual product, may be destroyed or lose their value if an
agricultural nation falls into a state of decline, simply though the
wasting of the advances required for productive expenditure.
Quesnay, Tableau Economique
François Quesnay
1694 - 1774
Adam Smith and Classical Economics
An Inquiry Into
The Nature and Causes of
The Wealth of Nations
(1776)
From the “Introduction and Plan of Work”:
The annual labour of every nation is the fund
which originally supplies it with all the necessaries
and conveniencies of life which it annually consumes
and which consist always either in the immediate
produce of that labour, or in what is purchased
with that produce from other nations.
According therefore, as this produce, or what is purchased with it, bears a greater
or smaller proportion to the number of those who are to consume it, the nation will
be better or worse supplied with all the necessaries and conveniencies for which it
has occasion.
But this proportion must in every nation be regulated by two different circumstances;
first by the skill, dexterity, and judgment with which its labour is generally applied;
and secondly, by the proportion between the number of those who are emplolyed in
useful labour, and that of those who are not so employed.
David Ricardo and Classical Economics
The Principles of Political Economy
and Taxation
(1817)
From “Preface”:
The produce of the earth – all that is derived from its
David Ricardo
1772 - 1823
surface by the united application of labour, machinery, and
capital, is divided among three classes of the community,
namely, the proprietor of the land, the owner of the stock or capital necessary
for its cultivation, and the labourers by whose industry it is cultivated.
But in different stages of society, the proportion of the whole produce of the
earth will be allotted to each of these classes, under the names of rent, profit,
and wages, will be essentially different; depending mainly on the actual fertility
of the soil, on the accumulation of capital, and population, and on the skill,
ingenuity, and instruments employed in agriculture.
To determine the laws which regulate this distribution is the principle problem
in Political Economy …
David Ricardo and Classical Economics
The Principles of Political Economy
and Taxation
(1817)
From Chapter 1, “On Value”:
It has been observed by Adam Smith that “the word Value
David Ricardo
1772 - 1823
has two different meanings, and sometimes expresses the
utility of some particular object, and sometimes the power
of purchasing other goods which the possession of that object conveys. The
one may be called value in use; the other value in exchange …”
Possessing utility, commodities derive their exchangeable value from two
sources: from their scarcity, and from the quantity of labour required to obtain
them …
In speaking, then, of commodities, of their exchangeable value, and of the laws
which regulate their relative prices, we mean always such commodities only as
can be increased in quantity by the exertion of human industry, and on the
production of which competition operates without restraint.
Ricardo and Mill on rent
It is only, then, because land is not unlimited in
quantity and uniform in quality, and because, in the
progress of population, land of an inferior quality …
is called into cultivation, that rent is ever paid for the
use of it. When, in the progress of society, land of the
second degree of fertility is taken into cultivation,
rent immediately commences on that of the first
quality, and the amount of that rent will depend on the
difference in the quality of these two portions of land.
David Ricardo
1772 - 1823
Ricardo, The Principles of Political Economy and Taxation (1817)
The rent of land consists of the excess of its return
above the return to the worst land in cultivation.
Mill, Principles of Political Economy (1848)
John Stuart Mill
1806 - 1873
Economic Analysis – Key Contributors, 19th century
Adam Smith
(1723 – 1790)
1900
1800
David Ricardo (1772 – 1823)
John Stuart Mill (1806 – 1873)
Mill
Karl Marx (1818 – 1883)
August Cournot (1807 – 1877)
Johann von Thünen (1793 – 1850)
Hermann Gossen (1810 – 1858)
Cournot
Stanley Jevons (1835 – 1882)
Leon Walras (1834 – 1910)
Carl Menger (1840 – 1921)
Jevons
Walras
Alfred Marshall (1842 – 1924)
Marshall
Walras’ taxonomy of science, art and ethics
“Facts of the
Universe”
Natural Phenomena:
Those which result
from the blind forces of nature
Pure Natural Science
Human Phenomena:
Those which result
from the exercise of the human will
(a force that is free and cognitive)
Pure Moral Science
Science “observes, describes, and explains”
Art or Ethics
Art “advises,
prescribes
and directs”
Cournot
Economists understand by the term
Market, not any particular market place
in which things are bought and sold,
but the whole of any region in which
buyers and sellers are in such free
intercourse with one another that the
prices of the same goods tend to
equality easily and quickly
A Modern Diagram
Depicting of Cournot Equilibrium
q1
Q  a  bP, Q  q1  q2
 a  c1  1
q1*  
  q 2 
 2b  2
 a  c2  1
q 2*  
  q1 
 2b  2
.
 a  c1 


 2b 
Competitive Outcome
Cournot Outcome
q1*
1
August Cournot
1803 - 1877
q 2*
2
q2
The “second generation” of marginalists
Jevons saw the kettle boil and cried out with the
delighted voice of a child; Marshall too had seen
the kettle boil and sat down silently to build an engine.
John Maynard Keynes
Alfred Marshall
1842 - 1924
…The distribution of income to society is
controlled by a natural law, and this law, if it
worked without friction, would give to every agent
of production the amount of wealth which that
agent creates.
Clark, Distribution of Wealth (1899)
John Bates Clark
1847 - 1938
Marshall on value theory
We might as reasonably dispute whether it is the
upper or under blade of a pair of scissors that cuts a
piece of paper, as whether value is governed by utility
or costs of production. It is true that when one blade
is held still, and the cutting is effected by moving the
other, we may say with careless brevity that the
Alfred Marshall
1842 - 1924
cutting is done by the second; but the statement is
not strictly accurate, and is to be excused only so long as it claims to be
merely a popular and not a strictly scientific account of what happens.
Marshall, Principles of Economics (1890)
Marshall on method
I never read mathematics now; in fact I have
forgotten how to integrate a good many things…
But I know I had a growing feeling in the later years
of my work at the subject that a good mathematical
theorem dealing with economic hypotheses was very
unlikely to be good economics: and I went more
Alfred Marshall
1842 - 1924
and more on the rules – (1) Use mathematics as a
shorthand language, rather than as an engine of
inquiry. (2) Keep to them until you have done. (3) Translate into
English. (4) Then illustrate by examples that are important to real life.
(5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3).
Economic Analysis – Key Contributors, 20th century
2000
1900
Alfred Marshall (1842 – 1924)
Thorstein Veblen (1857 – 1929)
Arthur Cecil Pigou (1877 – 1959)
John Maynard Keynes (1883 – 1946)
Joseph Schumpeter (1883 – 1950)
Schumpeter
Friedrich Hayek (1889 – 1992)
Milton Friedman (1912 – )
Keynes
Paul Samuelson (1915 – )
Friedman
James Tobin (1918 – )
Kenneth Arrow (1921 – )
Robert Solow (1921 – )
Samuelson
Robert Lucas (1937 – )
Lucas
Keynes and Stiglitz on Laissez Faire
I abandon laissez-faire – not enthusiastically … but
because, whether we like it or not, the conditions of
its success have disappeared. It was a double
doctrine, -- it entrusted the public weal to private
enterprise unchecked and unaided. Private enterprise
is no longer unchecked … And if private enterprise is
John Maynard Keynes not unchecked, we cannot leave it unaided.”
1883 – 1946
The Nation (1924)
Today, there is no respectable intellectual
support for the proposition that markets, by
themselves, lead to efficient, let alone equitable
outcomes.”
Forward to Karl Polanyi’s The Great Transformation (2001)
Joseph Stiglitz
Keynes, The General Theory
-- Aggregate Demand
The idea that we can safely neglect the aggregate
demand function is fundamental to the Ricardian
economics ...
The celebrated optimum of traditional economic
theory, which has led to economists being looked
upon as Candide's ... is also to be traced, I think, to
their having neglected to take account of the drag on
prosperity which can be exercised by an insufficiency
of effective demand ...
It may well be that the classical theory represents
the way in which we should like our Economy to
behave. But to assume that it actually does so is to
assume our difficulties away.
The General Theory (pp. 32 – 34)
Keynes, The General Theory
-- The Propensity to Consume
The fundamental psychological law, upon which we
are entitled to depend with great confidence both a
priori from our knowledge of human nature and from
the detailed facts of experience, is that men are
disposed, as a rule and on the average, to increase
their consumption as their income increases, but not
by as much as the increase in their income. That is
to say, if Cw is the amount of consumption and Yw is
income (both measured in wage-units) Cw has the
same sign as Yw but is smaller in amount, i.e.
dC w
dYw
is
positive and less than unity.
The General Theory (p. 96)
Keynes, The General Theory
-- Investment
There will be an inducement to push the rate of
new investment to the point which forces the supplyprice of each type of capital asset to a figure which,
taken in conjunction with its prospective yield, brings
the marginal efficiency of capital in general to
approximate equality with the rate of interest. That
is to say, the physical conditions of supply in the
capital goods industries, the state of confidence
concerning the prospective yield, the psychological
attitude to liquidity and the quantity of money ...
determine, between them, the rate of new
investment.
The General Theory (p. 248)
Keynes, The General Theory
-- Animal Spirits
Even apart from the instability due to speculation, there
is the instability due to the characteristic of human nature
that a large proportion of our positive activities depend on
spontaneous optimism rather than mathematical
expectations, whether moral or hedonistic or economic.
Most, probably, of our decisions to do something positive,
the full consequences of which will be drawn out over
many days to come, can only be taken as the result of
animal spirits - a spontaneous urge to action rather than
inaction, and not as the outcome of a weighted average of
quantitative benefits multiplied by quantitative
probabilities.
... if the animal spirits are dimmed and the spontaneous
optimism falters, leaving us to depend on nothing but a
mathematical expectation, enterprise will fade and die;
The General Theory (p. 161)
Keynes on economic fluctuations
The “classical” view of the long-run macroeconomic adjustment process (as illustrated by
the standard AS/AD model) maintains that economies, after demand and supply shocks,
will naturally adjust back to full-employment or potential output. Reflecting on this
belief in the underlying stability of economies, Keynes said:
B
. . . ut this long run is a misleading guide
to current affairs. In the long run we are all
dead. Economists set themselves too easy,
too useless a task if in tempestuous seasons
they can only tell us that when the storm is
long past the ocean is flat again.
Tract on Monetary Reform (1923)
John Maynard Keynes
(1883 – 1946)
Keynesianism vs. Monetarism
Keynesianism is the view that
Monetarism is the view that
economies are inherently unstable,
that they may in fact settle at less-than
full employment equilibrium, that
Aggregate Demand is the primary
determinant of output and
employment, and that authorities can
intervene in an economy to stabilize
it. Keynesians generally express a
preference for fiscal policy as a
stabilizing tool.
economies are inherently stable, that
the quantity of money has a major
influence on economic activity and
the price level, and that the objectives
of monetary policy are best achieved
by targeting the rate of growth of the
money supply. Monetarists generally
express a preference for monetary
policy as a stabilizing tool relative to
prices only, being generally skeptical
of attempts to manage output.
Keynes
Samuelson
Friedman
Lucas
Fiscal and Monetary Policy with IS – LM analysis
Typical “Keynesian” View
Typical “Monetarist” View
If d is “large”, IS is flat
If h is “small”, LM is steep
F Monetary policy is relatively strong
INTEREST
RATE
If d is “small”, IS is steep
If h is “large”, LM is flat
F Fiscal policy is relatively strong
INTEREST
RATE
(i)
(i)
LM
LM’
Illustrating equal magnitude
Shifts of IS and LM
LM
IS
LM’
IS’
IS
GNP(Y)
For equal magnitude changes in fiscal or monetary policy,
monetary policy is relatively more effective in influencing output.
IS’
GNP(Y)
For equal magnitude changes in fiscal or monetary policy,
fiscal policy is relatively more effective in influencing output.
Friedman on the “Chicago” school of economics
In discussions of economic policy, "Chicago"
stands for belief in the efficiency of the free market
as a means of organizing resources, for skepticism
about government affairs, and for emphasis on the
quantity of money as a key factor in producing
inflation.
Milton Friedman
(1912 – )
In discussion of economic science, "Chicago" stands for an
approach that takes seriously the use of economic theory as a tool
for analyzing a startlingly wide range of concrete problems, rather
than as an abstract mathematical structure of great beauty but little
power; for an approach that insists on the empirical testing of
theoretical generalizations and that rejects alike facts without theory
and theory without facts.
Some Recent Nobel Laureates in Economics
2002 Daniel Khaneman
Vernon Smith
for having integrated insights from psychological research
into economic science, and for having established laboratory
experiments as a tool in empirical economic analysis.
2001 George Akerloff
Michael Spence
Joseph Stiglitz
for their analyses of markets with asymmetric information.
1998 Amartya Sen
for his contributions to welfare economics.
1994 John Harsanyi
John Nash
Reinhard Selten
for their pioneering analysis of equilibria in the theory of
non-cooperative games.
1993 Robert Fogel
Douglass North
for having renewed research in economic history by
applying economic theory and quantitative methods in order
to explain economic and institutional change.
1992 Gary Becker
for having extended the domain of microeconomic analysis
to a wide range of human behaviour and interaction.
Economic Methodology – The “Deductive” Approach
The propositions of
economic theory, like all scientific
theory, are obviously deductions from a series of
postulates … These are not postulates the existence
of whose counterpart in reality admits of extensive
dispute once their nature is fully realized. We do not
need controlled experiments to establish their validity:
they are so much the stuff of our everyday experience
that they have only to be stated to be recognized as
obvious.
An Essay on the Nature and Significance
of Economic Science (1935)
Lionel Robbins
Economic Methodology – The “Modernist” Approach
The ultimate goal of
a positive science is the
development of a “theory” or “hypothesis” that yields
valid and meaningful predictions about phenomena
not yet observed …
Factual evidence can never “prove” a hypothesis; it can
only fail to disprove it, which is what we generally mean
when we say, somewhat inexactly, that the hypothesis
has been “confirmed” by experience …
Milton Friedman
… the relevant question to ask about the “assumptions”
of a theory is not whether they are descriptively “realistic,”
for they never are, but whether they are sufficiently good
approximations for the purpose in hand. And this question
can be answered only by seeing whether the theory works,
Which means whether it yields sufficiently accurate predictions.
The Methodology of positive economics (1953)
Economic Methodology – The “Functional” Approach
The view that the worth of
a theory is to be judged
solely by the extent and accuracy of its predictions
seems to me wrong ... a theory is not like an airline
or bus timetable We are not interested simply in the
accuracy of its predictions. A theory also serves as
a base for thinking. It helps us to understand what is
going on by enabling us to organize our thoughts.
Faced with a choice between a theory which predicts
well but gives us little insight into how the system
works and one which gives us this insight but predicts
badly, I would choose the latter, and I am inclined to
think that most economists would do the same.
How Should Economists Choose? (1981)
Ronald Coase
Economists on Economic Methodology – Selected References
John Stuart Mill, “On the definition and method of political economy” (1836)
Henry Sidgewick, “The scope and method of economic science” (1885)
Thorestein Veblen, “Why is economics not an evolutionary science?” (1898)
Lionel Robbins, “The nature and significance of economic science” (1935)
Milton Friedman, “The methodology of positive economics” (1956)
James Buchanan, “What should economists do?” (1964)
Donald McCloskey, “The rhetoric of economics” (1983)
Ronald Coase, “How should economists choose?” (1994)