1 Ph. D. DEPATMENT OF AGRICULTURAL ECONOMICS

1 EVOLUTION OF ECONOMIC THOUGHT Dr. J.S. AMARNATH, Ph. D.

DEPATMENT OF AGRICULTURAL ECONOMICS TAMIL NADU AGRICULTURAL UNIVERSITY AGRICULTURAL COLLEGE AND RESEARCH INSTITUTE, MADURAI 20142 CONTENTS LEC.NO. TOPIC PAGE.

NO. I. APPROACHES TO THE STUDY OF HISTORY OF ECONOMIC THOUGHT 3 II.

ANCIENT AND MEDIEVAL ECONOMIC THOUGHT 8 III. THE PHYSIOCRATS 12 IV. MERCANTILISM 16 V. FORERUNNERS OF CLASSICAL POLITICAL ECONOMY 20 VI. ADAM SMITH 25 VII. DAVID RICARDO 29 VIII.

THOMAS ROBERT MALTHUS 33 IX. HISTORICAL CRITICS 37 X. SOCIALISTIC ECONOMIC THOUGHT 46 XI. KARL MARX 52 XII. ORIGINS OF FORMAL MICRO ECONOMIC ANALYSIS 58 XIII. NEOCLASSICAL SCHOOL 63 XIV.

WALRAS 68 XV. WELFARE ECONOMICS 72 XVI. J.M.

KEYNES 77 XVII. INDIAN ECONOMIC THOUGHT 95 XVIII. ECONOMIC DEVELOPMENT THEORIES 101 XIX. GLOBALISATION 111 XX. INTERNATIONAL INSTITUTIONS 129 XXI. STRUCTURAL ADJUSTMENT PROGRAMMES 1623 CHAPTER- 1 APPROACHES TO THE STUDY OF HISTORY OF ECONOMIC THOUGHT History of economic thought deals with the origin and development of economic ideas. It provides a historical amount of how people viewed and understood the economic facts and tendencies.

It also deals with history of attempts to understand the orderly working of the market economy. As structure of the economics changes over time, theorists used different analytical methods and tools. HISTORY OF ECONOMIC THOUGHT AND ECNOMIC HISTORY Economic history concerns itself with the history of commerce, manufacture and other economic phenomena dealing objectively with the ways in which men get their living or it is the chronological study of objective economic phenomena. On the other hand, history of economic thought deals with the ideas men have concerning economic facts and forces or it deals with history of objective ideas regarding the economic phenomena. There also exists a close relationship between history of economic thought and economic history.

Men’s economic ideas are largely influenced or determined by the economic conditions in which he lives. But this relationship is reciprocal. The history of economic thought then is an essential part of general history, both explaining it and being explained by it.

HISTORY OF ECONOMIC THOUGHT AND HISTORY OF ECONOMIC ANALYSIS Schumpeter made a distinction between history of economic thought and history of economic analysis. History of economic thought is the history of sum total of all opinions and desires concerning economic subjects especially concerning public policy bearing upon these subjects that, at any give time and place, float in public mind. It is an attempt to a. Trace out the historical change of attitudes b. Display the close association that exists with in the attitudes of the public mind c.

From the general attitude or spirit in which they approach their problems. History of economic analysis or economic science is the history of intellectual efforts that men have made to understand the economic phenomena or it is the history of the analytic or scientific aspects of economic thought. Historians of economic thought because of his interest in changing attitudes towards public policy cannot speak of progress or regress in economics. On the other hand, the historian of economic analysis, who is primary concerned with increasing command of economic facts and interested in development of analytical ideas, can say whether there is scientific progress in economics or not.

4 METHODOLOGICAL APPROACHES TO ECONOMICS THOUGHT The Relativist approach Each economic theory is a true reflection of the conditions in which it is born. Their view is that the economic ideas are influenced by personal attitudes and motives of the thinkers on one hand and by the social, economic and political conditions in which the thinker lives on the other hand. These ideas cannot be understood until seen in their respective historical background.

Stark says that economic theories simply reflect the contemporary conditions and Roger says economic theory should be judged form its policy implications designed to solve practical problems. The Absolutist approach History of economics exhibits a progression of thought form error to truth. It is related to the scientific progress or to the development of analytical methods and tools for having a better understanding of economic phenomena.

Schumpeter, Mark Blaug, Robert B. Ekelund and Robert F. Hebert held absolutist positions.

Adam Smith had a faint idea of independent decisions of buyers and sellers coordinated through market mechanism. It took a century for economists like Walrus and Marshall to show a fundamental relationship between demand and price or between supply and price. Relativists recognized the historical aspect and absolutists considered the analytical aspect. Absolutions wanted to see how the science of economics has progressed, or how far it succeeded in understanding the working of economic system. Relativists pointed out that ideas are fused with attitudinal bases and affected by the socio- economic conditions.

Therefore the task of historian of economic thought is to a. to fully recognize the historical significance of political and ideological influences b. to separate economic theory from these influences c. to put economic theory to scientific tests of validity INFLUENCES ON ECONOMIC THOUGHT No economic idea has emerged in a vacuum; that the motives and circumstances played a crucial role in determining the nature of economic history.

1. Philosophical basis Laws of nature rule materialist views that matter exist independent of mind and mental as well as physical worlds. Men are naturally equal and act in similar manner.

Based on this, English classical or5 materialistic economics developed with individualistic and laissez – faire tendencies, which believed in natural law and opposed to man – made institutions. Idealist regards man or mind as independent of matter and not as product of matter. Believed that men are the creator of his own destiny and could be improved through institutions. Institutional Economists who advocated the achievement of socio-economic ideals by direct social planning and control were influenced by philosophy of idealism.

2. Method of analysis Classical political economists employed in deductive or abstract method of analysis. Historical economists interested in inductive- historical research. Marshall and Austrians combined deduction and induction in economic analysis. 3. Political bias Theories have been formulated to achieve political objectives like general welfare, population optimum, right or just or equitable distribution of taxation. All economic terms like principle, productivity, equilibrium, balance and adjustment are discussed in double meaning of what is and what ought to be. 4.

Metaphysical formation Doctrines of economics are based on metaphysical assumptions and describe ideology of each period. Such statement neither gives scientific intent or factual information. It reflects attitude of mind, certain political sympathies or moral values and has power to influence public opinion and human conduct in piratical life.

Concepts of natural harmony and greatest good of greatest number are based on metaphysical concepts. In actual life, it provides slogans for a particular class of society and implies policies benefiting that class. Physiocratic theory of ‘net product’ describes surplus produce over peasant’s consumption is due to exclusive productivity of land. Similarly classical concepts of value and neoclassical concept of utility are metaphysical concepts. 5.

Existing theories New advances in economic science depend on existing theories. No economic theory appeared in isolation and there exists a degree of continuity in evolution of economic science. Adam Smith’s wealth of nations came against mercantilism. Marx critique of capitalism grew out of classical political economy. Similarly, neo-classical paradigm appeared as a result of failure of classical paradigm. Similarly Keynesian paradigm emerged when classical mid neo-classical solution failed to show contemporary problems. 6. Socio – economic environment It deals with casual relation between economic theory and practice.

Economic structure, institutional arrangements, relation between social classes and groups determine economic thinking of a particular period. 7. Practical problems6 Practical problems of a particular period have gone a long way in influencing the economic thinking of that period. In first half of 19th century, macroeconomic problem of economic growth preoccupied the classical political economists’ .In second half of 19th century, micro economic problem of optimum allocation of scarce resources dominated the neoclassical era. Macroeconomic problem of employment led to Keynesian revolution in 20th century IMPORTANCE OF HISTORY OF ECONOMIC THOUGHT Schumpeter pointed out three gains from the study of history 1. Pedagogical advantage Any study without historical background lacks direction and meaning.

2. New ideas From history of science, we derive inspirations and widen our intellectual horizons. We also learn many useful lessons of life facility and fertility controversies, wasted efforts and blind alleys and about spells of arrested growth.

We learn what succeeds and why. 3. Insight into the ways of the human mind It provides insights into how men were able to analyze the economic problems over time. It displays logic in concrete, logic in action and logic to vision and to purpose. Haley presents the following agreements for the study of history of economic thought. 1. Continuity in economic thought The study revealed that there exists continuity in economic thinking of men form the ancient times to this day.

Economic ideas of a particular age are not product of that very age but roots lie in the literature of earlier times. 2. Understanding the nature and origin of economics Economics concerned with man’s efforts to earn his livelihood in association with his fellow beings. In this effort, political motives, ethical ideas, acetic judgments and other influences affect man. Thus all social sciences are interrelated and economic is an inseparable part of the group of social sciences. 3. The Relativist attitude Men not judge economic ideas with dogmatic absolutism and declare them good or bad. On the contrary, he adopts a realistic attitude that economic ideas are to be examined in the light of times and conditions in which they originate.

4. Broad basis for comparison The study provides a basis for comparison. After the study, the student feels his judgment broadened, and have a well – balanced and reasonable conservatism or a wise progressivism. 5. Objective point of view7 Economic as a science is a body of laws or generalizations, which does not belong to one economist not to any specific time or place but the result of the efforts of so many economists living in different periods and conditions. Therefore the task of economic scientist is to separate economics from the economist and study it objectively.8 CHAPTER- II ANCIENT AND MEDIEVAL ECONOMIC THOUGHT ANCIENT ECONOMIC THOUGHT Nature and Significance During ancient period, wants were few and simple. Food, clothing and shelter were their essential wants.

The community owned property. Barter was the rule. There was no much economic activity and society was custom bound and tradition oriented. No independent economic theories were found and for example, usury prohibited not on economical grounds but on ethical grounds.

Early thinkers did not realize the dignity of labor. Production was carried on mainly for consumption and they lived as self – sufficient units. Significance is that study is rewarding because it gives the readers the origin of science, its development and environment under which the science developed.

1. THE HEBREW ECONOMIC THOUGHT (2500 B.C.) Characteristics Economic philosophy is simple. Economic, political, ethical and philosophical ideas were intertwined. Common man life was regulated by code of conduct of priestly class.

Their philosophy was characterized by lack of individualism and materialism and static ideals dominated. Economic ideas 1. Usury (interest) Hebrew prophets thought it is unethical to charge high interest rate on loans borrowed by the poor.9 2.

Commerce and just price To safeguard the interests of the poor, laws were passed against adulteration and false weights and measures. Legislation was there to curb monopoly and export of food articles was forbidden. Hoarding of food grains was not permitted and ceiling put on profit margin of retailers 3. Labor Realized the dignity of labors especially agriculture and payment was made in kind. 4. Agriculture and industry: Agriculture was the main occupation of Hebrews and held in high esteem. Commerce and crafts were not in held high esteem.

5. The seventh year Hebrews observed seventh year or sabbatical year. They left the land fallow in seventh year after tilling for six years to conserve the soil fertility. Likewise, they extended this institution of seventh year to slaves and loans. 6.

The Jubilee year Land sold to someone revert to its owner in 50th year. They were interested in good life, just state and happy man. Word economics is of Greek origin and meant management of household. Plato (427 – 347 B.C) and Aristotle (384-322 B.C) were the two great thinkers of ancient Greece.

I. Plato (427-347 B.C) Main achievement is division of labor and origin of city – state is found in Republic and laws. Origin of city – state and division of labor Inequalities in human beings resulted in division of labor, which is the basis of social organization. City – state is built on division of labor. Adam smith said specialization results in improvement in productivity, advantageous to practicing people and explained it as cause of wealth of nations. The Ideal State has constant number of citizens with 5040 citizens because it is administratively convenient.

Since it is divisible by all numbers up to 10, they know each other. Ruler is an ideal one with 2 classes of rules or guardians and auxiliaries and latter, the artisans. Members of the ruling class, if pass the examination became the philosopher kings or otherwise, remain auxiliaries (soldiers). Plato believed in rule by elite and suggested a communistic way of life, for this elite group. Elites should not have any private property and family.

Money, interest and trade Supported aristocratic class and didn’t question slavery. He considered money as a symbol devised for the purpose of facilitating exchange. Citizens should not possess gold and silver and only should have money. Foreign trade is controlled and retail trade is forbidden.

10 II. Aristotle (384 – 322 B.C) Aristotle laid down the foundations of science of economics but justified slavery. He was the first analytical economist. State, family and village originate in bare needs of life. Aristotle, in his book ‘Politics’ attacked communistic elements of Plato and supported the institution of family and private property and justified slavery.

Rulers are classified into military class, statesman, magistrates and priests. Aristotle’s private property is superior to Plato’s communal property based on five grounds of progress, peace, pleasure, practice and philanthropy. Analytical ideas 1.

The scope of economics means management of the household and divided into 2 parts of a. Economy proper which deals with management of household and deals with development of city – state from village and household b. Science of supply, which is concerned with art of acquisition and deals with exchange through with needs of the household, are met. 2. Exchange Distinguished natural exchange at satisfaction of men’s natural wants and unnatural as the exchange for monetary gain. Thus he distinguished value – in use and value in exchange. 3. Money Distinguished money as measure of value and store of value and he condemned interest.

II. THE ROMAN THOUGHT Roman economic ideas were borrowed from Greece. Roman philosophers regarded money lending as a big crime. Seneca said money is the root of most evils. Pliny has condemned gold. In agriculture, they favored small farm. Roman law Roman law is the richest legacy of Rome to the world and plays an important role in the history of economic analysis.

Roman law dealt with institution of private property, which is absolute, and contracts including the right of the individual to dispose the property. Law was divorced from religion. Corporate assets were separated from owners of the corporation.

Contribution was also made on price, money and loans (interest).11 MEDIEVAL ECONOMIC THOUGHT Middle ages were described as a feudal system. People enjoyed status according to ranks. Medieval life was commercial and cooperative in character. There were merchant guilds and craft guilds for mutual benefit and protection of members and for regulation of trade.

Actual volume of trade is small. The church, the Bible and Aristotle exercised influence on the economic thought. Christianity 1.

Taught the universal brotherhood of man and slavery as a sinful institution 2. Life in this world is a preparation for another and so aim is salvation 3. Taught dignity of labor. Just price and prohibition of usury were the 2 economic ideas of middle ages. St. Thomas Aquinas (1225 – 1274) Economic ideas find in his book Summa Theologica and based on Bible and Aristotle. Private property is shared and regulated by sabbatical and Jubilee year. Property is private in possession and common in use.

Advocated charity and permitted theft in extreme cases. Trade justified moderate profit on grounds of support and charity. A fair-minded person determines just price and in exchange, it is to the common advantage of buyer and seller. There was price regulation of many commodities. Usury prohibited especially for consumption. Interest allowed if lender is suffered damage, lost an opportunity to gain, borrower failed to repay and lastly if risk is involved.

12 CHAPTER- III THE PHYSIOCRATS Physiocracy means ‘Rule of Nature’ and physiocrats developed economic theory in France in eighteenth century. Though they wrote for short period, their ideas had profound influence on economic thought. Quesney was the founder of Physiocratic School. The factor which gave rise to Physiocracy 1. Neglect of agriculture and governmental regulation of industry was taking place in France. 2. Tax system was corrupt, in efficient and unjust.

Nobles and clergy, who owned two-thirds of land exempted from direct taxation. 3. Unnecessary wars and luxurious life made government bankrupt. 4. Nobles exploited French peasants as land owners took large share of the produce, heavy taxes of government, and market was also restricted because mercantilist policies in favor of manufactured goods.

5. Economic situation in Britain was favorable as compared to France since agricultural revolution was taking place in England. 6. Economic thinking indicated the importance of individual and liberty. Main ideas of physiocrats 1. Natural order Physiocracy described as a ‘Science of the natural order’.

Society is governed by laws of nature is an ideal society. They believed god and considered the natural order the work of god. Natural order will increase the happiness of mankind. Prosperity, severity and liberty formed the basis of social order. They are not interested in the concept of equality. They believed in interdependence of classes and financial dependence upon nature. Government has minimum functions and restricted to protecting life and property.

They advocated laissez – faire. Individual interests are identical with the society. 2. Laissez- faire This concept is opposed to government restrictions. Government functions are limited to protecting life, liberty and property and there is lot of scope for individual efforts. 3. Net product This considered agriculture as the productive occupation as it produced a surplus, a net product above the costs of production. Industry, trade and profession were useful but sterile as it reproduced the value consumed in the form of raw materials and subsistence for workers.

Labor engaged in agriculture is13 productive and in all occupations, is unproductive. God gave fruits of earth and man brought products of arts. 4. The circulation of wealth Flow of income through society is found in Quesnay’s Tableau Economique (The Economic Table), which is a graphic representation of the way in which circulation of wealth takes place. Physiocratic system of division of society into three classes of productive class comprising farmers who pay rent to land lords, proprietary class including landlord and king and sterile class engaged in non – agricultural occupations of merchants, artisans, and domestic servants. Value of production = 5 million francs Farmers requirement for maintenance = 2 million francs Manufacturers purchase from sterile class = 1 million francs Pass to landowners and government in form of = 2 million francs Rent and taxes (and spend one million for food and one million for manufacture) Sterile class uses 2 million francs for buying necessaries of life and raw materials for industries from agriculturists and hence it returns to productive class. The cycle is complete. Value The problem of value was not treated in a systematic way.

When manufactured goods are exchanged, only equivalents were exchanged and no profit could arise Property They believed in private property. Aim is to bring lands under cultivation, dispose wealth in interest of society, workers not exploited, tenants are protected and bear burden of taxation. INFLUENCE OF PHYSIOCRATS ON APPLIED ECONOMICS 1. Trade: Physiocrats viewed exchange as unproductive. Mercantilists’ advocated favorable balance of trade and physiocrats favored free trade.

Foreign trade produced no wealth and countries get goods from other countries, which it cannot itself, produce and so foreign trade is considered as a necessary evil. They believed in free trade as with free competition, best possible price is secured which lead to increased wealth and maintain population in agriculture. 2. Function of the state Physiocrats wanted minimum of legislation with a maximum of authority. Duty of the state is to preserve natural order, to protect private property and foundation of that order.14 3. Taxation Physiocrats advocated a single tax system.

One third of net product was to be paid in taxes. They favored direct taxation. Representatives of physiocratic school 1. Quesnay (1694- 1774) Natural order, net product, circulation of wealth and single tax system are his ideas in article on farmers (1756), grains (1757) and the Tableau Economique (1753-1958). 2.

Turgot (1727-1781) Advocate of laissez – faire in Reflexions (1769). Individuals know his interest is best. Emphasized agricultural productivity and did not regard property as private institution. 3. Condillac He regarded value as foundation of science of economics. He laid foundation of marginal school as value increases with scarcity and diminishes with plenty.

Viewed production means giving new form to matter. He didn’t believe in Iron law of wages like wages equal to his subsistence but wage is a share of product, which is due to the workers as co-partners. Critical estimate of physiocrats Mercantilists Physiocrats Pre-occupied with gold Laid emphasis on real wealth in form of raw produce Maximum exports and minimum imports for favorable balance of trade Foreign trade as a necessary evil Believed regulation of trade and industry. Freedom of trade and industry. Physiocrats ignored commerce and industry, which is equally productive as agriculture. Production as creation of utilities is not understood. Regarded manufacture as unproductive, which is erroneous.

Erroneous classification of labor into productive and unproductive labor whether labors resulted in production of material or immaterial goods. There was absence of any reference to value. Regarded land as only source of wealth as it yielded a net product. So landed proprietors bear taxation, which is against15 agricultural class. Faculty in theory of distribution as rent is a free gift of nature but rent is because of niggardly (miser). Important contributions 1. Put economics on scientific basis and regarded as founders of political economy.

2. Economic development is promoted by transforming traditional to large-scale agriculture. 3. Realized capital formation in economic development. 4.

Advocated single tax an agriculture 5. Circulation of wealth among different classes 6. Government does minimum function of life, liberty and property. 7. Opposed all obstacles to economic development in advocating laissez-faire Meaning of physiocracy for under developed countries. 1. Emphasis on agriculture for economic development is applicable for India but industrial development should take place side by side. 2.

For mobilization of resources, direct as well as indirect taxation is required as against the physiocratic view of agriculture alone. 3. Believed in competition and opposed monopoly in all its forms.

Competition would result in best set of prices. 4. Not giving importance to external relations may be correct when country is self – sufficient but India reached self-sufficiency now only. 5. Physiocrats recommended increase of agricultural output and net product and not increase of population. 6.

Free trade is not possible now because even developing countries have to be given protection and developed nations also put high tariff. 7. Physiocrats advocated minimum functions to the state and favored laissez faire.

But Government interference is needed for economic development.16 CHAPTER- IV MERCANTILISM Wealth of a nation is increased by trade and followed by European statesmen from 15th century until the second half of eighteenth century. Also called as Bullionism, Colbertism (France) and Kameralism (Germany). War and exchange economy necessitated mercantilism. Fundamental aim of mercantilists is to make country strong by increasing the wealth of his country through storing gold and silver. Aim of the mercantilist is to maximize export and minimize import. Trade was the most important occupation followed by industry and manufacture and agriculture was the least important of all since it brought no money.

Mercantilist gave importance to national advantage. Their contributions lie in role of the state, money, rate of interest, population and balance of trade Role of the state State regulation of economic activity is done like imposing import duties, levying tax concessions for exports and fixed wages and prices to increase production. Role of the money They felt that adequate supply of gold and silver in form of bullion is essential for the safety of the nation. They regarded accumulation of precious metals as a sign of wealth and are aware of distinction between money and wealth. Rate of interest Mercantilist advocated low rate of interest on economic grounds.

Interest is low only if money supply was adequate through accumulation of precious metals. They opposed to any policy that caused falling prices and considered rising prices lesser evil than falling prices. Balance of Trade Mercantilists believed state intervention for favorable balance of trade and followed a policy of discrimination, regulation and protection in trade matters. Commodities with high labor content relative to value are preferred in exports. Raw materials, minerals, machines trade and workers emigration is considered as wasteful.

Ideal is Zero imports and exports are only in exchange for previous metals. Population Mercantilist popularized increased population, which led to increased sailors, soldiers and productive workers. Representative mercantilists 1. Thomas Mun (1571-1641)17 Wrote book ‘England’s Treasure by Foreign Trade’ (1664).

He suggested achieving balance of trade and for which he i. Recommended cultivation of waste lands to reduce imports of hemp flax and tobacco ii. Restrain on domestic consumption of foreign goods iii. Export requires attention to commodity prices. If necessities, it should be charged high.

iv. Value of export increased by confining to her own ships v. Frugal use of natural wealth is suggested so that more is left for export vi. Fishing in adjacent seas vii.

England should be a distributing centre to increase shipping and trade. viii. Encouraged trade with far off countries ix. Money begets trade and trade increases money x.

Velvets and silk exported free xi. Individual must endeavor to make the most of our own efforts He praised industry and condemned idleness and luxury. 2. Antonio Serra (1580-1650) Mercantilist’s preference of industry to agriculture because i.

Industry is safer than agriculture ii. Industry is subjected to law of increasing returns iii. Industry has a share market iv.

Industry is more profitable than agriculture. 3. Philip Von Hornick (1638-1712) Might of a country depend on accumulation of gold and silver. i.

Country’s soil should be used to maximum extent for mining gold and silver. ii. Commodities worked up in the country iii. Population encouraged iv. Gold and silver are not allowed out of country v. People content with domestic products vi.

Import payment should be in kind and not in gold and silver vii. Import is not allowed if sufficient supply is available in home. MERCANTILISM IN ACTION Mercantilism ruled three centuries in England and in Europe and it is a policy of power. In England, Corn Laws were in force until 1846. It encouraged corn imports above a given domestic price and allowed18 exports when domestic prices dropped beyond a certain level. This resulted in conflict among landlords, corn merchants, consumers and the state.

In France, Colbertism was followed which imposed detailed control on manufacture and imposed national uniformity of finished products. In Germany, Cameralism was followed. An appraisal of mercantilism Essential features i. Emphasis on gold and silver ii. Over estimated commerce and under estimated agriculture iii. Favorable balance of trade necessitated a benefit in long run iv. What was gain for one nation was loss for another. Mercantilism is an economic policy and state making on economic side.

Adam Smith’s idea of mercantilists is ‘little better than nonsense’. Adam Smith believed that wealth of nation is increased by division of labor, which is limited by size of market. Adam smith advocated free trade and it is absurd to believe that export exceed import in all countries as believed by mercantilists.

England, France, Germany and Spain became strong nation by following a policy of mercantilism. Mercantilist developed macro- economic approach to problems of society. Maximizing exports emphasized not only for accumulating gold and silver but also for employment. Trade depended on money. An increase in money supply resulted in low rate of interest, which induces to save and finally determines output level and employment. Money is only a medium of exchange but a store of value. Knut Wicksell developed interest theory based on mercantilist ideas. Keynes approved 2 mercantilist ideas of more money for business expansion and more money for lowering the interest.

Mercantilists have over emphasized trade and under estimated agriculture unlike physiocracy who emphasized agriculture. Mercantilists’ theory of international trade was that favorable balance of trade was faculty and not always benefi cial to economic development of a nation. Mercantilism enabled transformation from commercial capitalism to industrial capitalism and mercantilism is a phase in the history of economic policy. Decline of mercantilism 1. With Adam Smith, policy of plenty replaced the policy of power.

2. Development of banking both domestic and international reduced the importance of bullion 3. In market economy, real estates, factories and machinery were important items of wealth than gold and silver. 4. Economic growth during industrial revolution made possible for the society to rely on competitive forces and laissez faire rather than promoting and regulating monopolies.19 5. Country become richer not by impoverishing its neighbor but by mastering the forces of nature.

6. Regulations protecting the quality of goods became a barrier to progress. Neo-mercantilism Mercantilism of eighteenth century is followed by laissez faire policy of nineteenth century.

Twentieth century view is that government must assist and encourage industry and commerce. This policy of state encouragement and assistance to industry is neo-mercantilism. Thus neo-mercantilism envisaged assistance, support, defense of state control rather than regulation and control. After First World War, America, France, Germany and England followed typical mercantilist policies with emphasis on gold accumulation, or imposing high tariffs, fixed import quotas and formulated many exchange restrictions. It depended upon effective social planning of economic life through centralized dictatorship or democratic form of regimentation. Meaning of mercantilism for under developed countries 1.

In these countries, State plays a key role in process of economic growth. 2. Mercantilists considered non-agricultural sectors of foreign trade and manufacturing as strategic to economic growth of a nation with state regulation and assistance. But for under developed countries like India depend directly or indirectly on agriculture and if agriculture fails, our plan fails. 3. Recognized role of money in economic development but underestimated role of real factors. They failed to explain when money push up prices rather than increase employment.

More money lead to inflation 4. Capital deficiency is corrected by foreign exchange. So most countries follow the mercantilist policy of maximizing exports and minimizing imports and financial assistance to export and restriction on import. This mercantilist policy resulted in balance of payment problem for poor countries.

20 CHAPTER-V FORERUNNERS OF CLASSICAL POLITICAL ECONOMY Smith’s emphasis of self-interest is originated from Mandeville’s Fable of the Bees. Mandeville emphasized the multiplicity of wants and large numbers of individuals find their private interest in laboring for the good of others and united together compose one body. He also expressed the division of labor using production of watches and first used words divided and dividend in this connection. Hutcheson considered moral sense to be the most important. His thought was utilitarian in trend and proposed greatest happiness of greatest number as a standard. He distinguished utility and value.

Wealth differentiated from utility and limitation of supply makes a scarcity value. He justified interest on the ground that money invested in things naturally productive. Hume gave prominence to labor, changes or transitions, evidences of historical spirit and interrelation of economic and social facts. Everything in world is purchased by labor. Money is the representative of labor and commodities and its increase in supply may benefit the industry during interval between acquisition and resulting rise in prices. Interest depends on profits of industry. Josiah Trucker laid emphasis on significance of labor.

He believed in advantages of a large population and favored tax on celibacy. Advocated free trade policy and self-interest coincide with public interest if given free play. Hume and Tucker inaugurated cosmopolitanism in commercial policy. Adam Ferguson gave ideas on taxation, value and utility. Goods are valued not according to real use but in proportion to land, labor and skill required to produce them. From physiocrats, Adam Smith derived 1. Natural rights idea 2. Beneficent providence 3.

Idea of laissez fire derived from doctrine of self-interest and reaction against government interference 4. Principle of self-interest as the fundamental force in society 5. Idea of cosmopolitanism. Naturalist school of philosophy (Aristotle, Plato) influenced Adam Smith. Mercantilist shaped his ideas and prominent among them were Petty, Locke, Hume, North, Stewart and Cantillon. Petty, Cantillon and Stewart influenced Adam Smith’s ideas on value.

Hume, Locke and Stewart influenced his ideas on money. His ideas on public finance by Petty and Stewart and trade ideas were influenced by North and wages ideas of cantillon.21 Physiocrats believed in natural laws, which govern the human society. He opposed government interference and supported laissez-faire.

Physiocrats are against the mercantilist regulatory system and Adam Smith has praise for them. But Adam Smith did not approve agriculture as the only productive industry. John Locke John Locke was traditional Mercantilist in his economics. Locke turned his attention to money and developed a theory of money in his 1692Considerations. Locke introduced concept of “money as convention” and notably the concept of “velocity”. Locke saw that the lowering of interest by legal means might very well lead to a collapse in trade because it would not reflect the “natural scarcity” of money. If money collapsed, then there would be, alternatively, a collapse in output or prices.

The collapse in prices would lead to relatively cheap English goods and relatively expensive foreign ones “both which will keep us poor” (Locke, 1692). Locke’s ideas on value inconsistent. In his 1690 Treatises, he proposes a quite explicit labor theory of value.

In his 1692 Consequences, Locke adheres to a demand-based theory of value. John Law (1705) did much to clarify the confusion between them. Finally, Locke also proposed a theory of property in his 1690 Treatises. The right to property, Locke claims, is derived from the labor of those who work it. More specifically, he perceives that as “labor” is naturally “owned” by the person in whom it is embodied and Locke’s “natural labor theory of property” . John Locke is considered one of the most significant philosophers of his era mainly for his critique of Thomas Hobbes’ defense of absolutism in Leviathan (1651) and the development of social contract theory. Locke believed that people contracted into society which was bound to protect their rights of property.

He defined property broadly to include people’s lives and liberties, as well as their wealth. When people combined their labour with their surroundings, then that created property rights. Locke was arguing that not only should the government cease interference with people’s property (or their “lives, liberties and estates”) but also that it should positively work to ensure their protection. His views on price and money was that the “price of any commodity rises or falls, by the proportion of the number of buyers and sellers,” a rule which “holds universally in all things that are to be bought and sold.

“22 Dudley North Dudley North argued that the results of mercantile policy would be undesirable. He argued that the assumption of needing a favourable trade balance was wrong. Trade, he argued, benefits both sides, it promotes specialisation, the division of labour and produces an increase in wealth for everyone.

Regulation of trade interfered with these benefits by reducing the flow of wealth. North shows that wealth may exist independently of gold or silver, its source being human industry, applied either to the cultivation of the soil or to manufactures. It is a mistake to suppose that stagnation of trade arises from want of money; it must arise either from a glut of the home market, or from a disturbance of foreign commerce, or from diminished consumption caused by poverty. The export of money in the course of traffic, instead of diminishing, increases the national wealth, trade being only an exchange of superfluities. Nations are related to the world just in the same way as cities to the state or as families to the city. North emphasizes more than his predecessors the value of the home trade. With respect to the interest of capital, he maintains that it depends, like the price of any commodity, on the proportion of supply and demand, and that a low rate is a result of the relative increase of capital, and cannot be brought about by arbitrary regulations. Prices must determine themselves, and cannot be fixed by law; and all forcible interference with them does harm instead of good.

No people can become rich by state regulations, only by peace, industry, freedom and unimpeded economic activity. It will be seen how closely North’s view of things approach to that embodied some eighty years, later in Adam Smith’s great work. North is named by Wilhelm Roscher as one of that great triumvirate which in the 17th century raised the English school of economists to the foremost place in Europe, the other members of the group being Locke and Petty.

23 Bernard Mandeville, or Bernard de Mandeville Fable of the Bees In The Grumbling HiveMandeville describes a bee community thriving until many of the bees decide to seek honesty and virtue. Without their desire for personal gain the colony loses the hive, thus implying that without private vices there exists no public benefit. Ideas Mandeville’s philosophy gave great offence at the time, and has always been stigmatized as false, cynical and degrading.

His main thesis is that the actions of men cannot be divided into lower and higher. The higher life of man is a mere fiction introduced by philosophers and rulers to simplify government and the relations of society. In fact, virtue (which he defined as “every performance by which man, contrary to the impulse of nature, should endeavour the benefit of others, or the conquest of his own passions, out of a rational ambition of being good”) is actually detrimental to the state in its commercial and intellectual progress. This is because it is the vices (i.e., the self-regarding actions of men) which alone, by means of inventions and the circulation of capital (economics) in connection with luxurious living, stimulate society into action and progress.

Private vice, public benefit Mandeville arrives at a very contemporaneously vile conclusion: vice as a necessary condition for economic prosperity. His viewpoint is more severe when juxtaposed to Adam Smith’s. Both Smith and Mandeville believed that individuals’ collective actions bring about a public benefit. However, what sets his philosophy apart from Smith’s is his catalyst to that public benefit. Smith believed in a virtuous self-interest which results in invisible cooperation. For the most part, Smith saw no need for a guide to garner that public benefit. On the other hand, Mandeville believed it was vicious greed which led to invisible cooperation if properly channeled.

Mandeville’s qualification of proper channeling further parts his philosophy from Smith’s laissez-faire attitude. Essentially, Mandeville called for politicians to ensure that the passions of man would result in a public benefit. It was his stated belief in the Fable of the Bees that "Private Vices by the dextrous Management of a skilful Politician may be turned into Publick Benefits” (Mandeville, 369). In the Fable he shows a society possessed of all the virtues “blest with content and honesty,” falling into apathy and utterly paralyzed. The absence of self-love (cf. Hobbes) is the death of progress. The so-24 called higher virtues are mere hypocrisy, and arise from the selfish desire to be superior to the brutes. “The moral virtues are the political offspring which flattery begot upon pride.

” Similarly he arrives at the greatparadox that “private vices are public benefits.” Among other things, Mandeville argues that the basest and vilest behaviors produce positive economic effects. A libertine, for example, is a vicious character, and yet his spending will employ tailors, servants, perfumers, cooks, and opportunist female and/or male prostitutes. These persons, in turn, will employ bakers, carpenters, and the like. Therefore, the rapaciousness and violence of the base passions of the libertine benefit society in general. Similar satirical arguments were made by the Restoration and Augustan satirists. The Division of Labour Mandeville was an early describer of the Division of labour, and Adam Smith makes use of some of his examples.7 Mandeville says: But if one will wholly apply himself to the making of Bows and Arrows, whilst another provides Food, a third builds Huts, a fourth makes Garments, and a fifth Utensils, they not only become useful to one another, but the Callings and Employments themselves will in the same Number of Years receive much greater Improvements, than if all had been promiscuously follow’d by every one of the Five…25 CHAPTER- VI ADAM SMITH Founder of classical school and described as ‘father of political economy’. His work is ‘An inquiry into the Nature and causes of the wealth of nations’ (1776). Essential features of classical school 1. Laissez – faire with minimum role of government. 2. Believed in market economy based on free and perfect competition. 3. Assumed conditions of full employment 4. Believed in harmony of interests of individual with society. 5. Emphasized the importance of economic activities especially industry and added industry to commerce and agriculture 6. Economic laws were of universal application 7. Paid attention to problems of economic growth and development 8. Adopted micro – economic approach 9. Believed in J.B. Say’s laws of markets which said that supply creates its own demand. Wealth of Nations was a challenge to mercantilism and wealth is increased by adopting ‘division of labor’ which is dependent on size of market. Size of market depends on volume of international trade. He advocated free trade as a mercantilist policy of maximizing export and minimizing import, which would result in shrinkage of international trade. Economic ideas 1. Division of labor Labor is the source of wealth and division of labor increases the productivity of labor and thereby wealth of nation. It refers to the specialization of labor in different industries and limited mainly by the size of the market. Advantages 1. Increased output 2. Increased dexterity (Skill)of worker 3. Saving in time 4. Introduction of machinery Disadvantages 1. Monotony of work26 2. Immobility of labor 3. Unemployment 2. Value Differentiated 2 kinds of value namely value in use (water) and value in exchange (diamond). He proposed labor theory of value wherein labor is the measure of the exchange value of all commodities. He distinguished natural price and market price. Natural price covers rent, wages and profits. Market price depends on supply and effectives demand which is the demand of those who willing to pay at natural price. When market price increases than natural supply, supply will increase and price brought down. Criticisms 1. All work are not of equal efficiency and less skilled may take longer 2. Misdirected labor cannot have value 3. Failed to explain value of rare things like art or antiques 4. Ignored influence of demand. 3. Wages Suggested subsistence, as the natural level of wages and observed market level might be higher than subsistence level. He has taken into account demand and supply of labor in wage determination. He has developed the principle of equal advantage to explain wage differences like 1. Agreeableness of the employment 2. Cost of learning the skill 3. Constancy of employment 4. Trust reposed in workman 5. Probability of success 4. Rent He describes as a monopoly price or determinant of product price or effect of high or low product price. Believed that interests of society coincided with interests of landlords and rents arise only when society was progressing. 5. Profits and interest Wages and profits move in opposite direction. As capital is accumulated, competition for investment will lower the profit. Interest varies with profit. 6. Capital27 Capital accumulation is essential for industrial development of a nation. Capital appear in three forms of 1. As an instrument of production 2. As a fund maintaining the workmen 3. As a source of revenue. He classified capital as for immediate consumption, fixed and circulating capital. Division of labor was limited by size of capital stock. He emphasized saving in capital accumulation. He favored labor – intensive investment especially in agriculture. 7. Role of money Money is for circulation of wealth and measurement of value rather than adding revenue to society. Smith preferred paper money than gold and silver. Banking saves labor of providing gold by providing paper money. 8. Laissez – faire and the harmony of interests Individual is led by an invisible hand to do well for the society and believed that interest of individuals coincided with interests of the society. Advocated free trade and believed in international harmony of interest. Businessman sacrifices the interest of others to promote their own. 9. Role of Government Minimum role is provided for government to protect society from foreign attack, administration of justice and erect and maintain public works. Justified legal control over interest rates, administration of post office, issue of paper money by bankers and compulsory education. Favored tariff to protect domestic industry and by imposing tariff on imports. 10. Taxation Based on principle of cannon of equity (principles of justice and ability to pay), canon of certainty, canon of convenience (after harvest) and canon of economy (minimum cost to government). Influence of physiocrats on Adam Smith 1. On naturalism, optimism and liberalism ideas of Smith 2. Laissez faire policy 3. Classification of labor into productive and unproductive and materialistic interpretation of wealth. 4. Free trade28 Wealth of nations is a most successful book on economics. He developed price system or value economics. Criticism 1. Essentially materialistic 2. Undue emphasis of individualism with much of economic man 3. Theory of distribution is sketchy and incomplete. 4. Emphasis of production from producer to consumer 5. Realized the importance of capital accumulation in economic development and Adam Smith’s labor theory of value was the foundation for Marx’s theory of surplus value.29 CHAPTER- VII DAVID RICARDO (1772-1823) Adam Smith is the founder of the classical school and David Ricardo is the leader of the school. His work is “On the principles of political economy and Taxation (1810)”. Social back ground Industrial revolution took place with population growth, rise in price, poverty and land rents were increasing. Corn Laws generated controversy. Landowners interested in high price for corn and consequently high rents. Manufacturing classes interested in repeal of Corn Laws as it could lead to fall in price of corn, fall in wages and cheap labor available. Ricardian system 1. Ricardian is an analytical genius and deductive thinker. 2. Believer in laissez- faire 3. Considered money as a veil and interested in analyzing economic problems in money – less world. 4. Approached the problem of value from cost of production side and accepted more or less the labor theory of value. 5. Incorporated pessimistic value of Malthus with respect to population and food supply. 6. Ricardian rent is based on law of diminishing returns. On the scope of political economy Adam Smith and Malthus developed ‘An inquiry into nature and causes of wealth’. Ricardo developed an inquiry into laws, which determine division of produce of the industry among classes. Produce of earth is divided into rent, profit and wages and such that law which regulates this distribution is the principle of political economy. Emphasis is shifted from production to distribution. Value Developed labor theory of value and concerned with relative values. He recognized value – in – use and value – in – exchange. Value of a commodity is dependent on scarcity and quantity of labor required obtaining them. Scarcity is applied to rare statues and pictures, scarce books and coins. Ricardo made distinction between natural and market price. Short – run price depends on supply and demand and long-run price depends on cost of production. RICARDIAN THEORY OF RENT30 Background Landowners asked for higher protection in the name of general welfare. Businessman and manufactures spoke against high tariff on grain imports and requested for repeal of Corn Laws. Ricardo demonstrated that all classes except the landlords injured by the increase in the price of corn. Improvement in agriculture and import of cheap grain reduces the rising rents. Theory Rent is the portion of produce of the earth, which is paid to the landlord for the use of the original and indestructible powers of the soil. Assumptions 1. Rent is peculiar to land alone. It arises because of inelastic supply and differing fertility. 2. Land has source original and indestructible powers. 3. Land is subjected to law of diminishing returns. 4. There is perfect competition When second grade lands are under cultivation, the first grade lands yield surplus over and above the cultivation expresses which is called rent. Rent also may arise on account of situational advantage. Relationship between rent and price Rent is high because price is high and price is high not because rent is high. Criticisms of Ricardian rent 1. According to Ricardo, best lands are cultivated first and for which, there is no proof 2. Objective is also for original and undesirable power of the soil. There are no original powers of the soil and powers are not indestructible as fertility is decreased by continuous cultivation. 3. For a single firm, rent enters price. 4. Ricardian theory is based on perfect composition but in real world, imperfect competition is the rule. 5. Rent is not for land alone but for labor and capital as well. Marshall explained the concept of quasi rent with reference to machines. Transfer earnings are the rent with reference to a particular industry. 6. Over emphasized the law of diminishing returns and hold well, if technology is kept constant. Implications 1. Physiocrats, Adam Smith and Ricardo considered rent as a surplus. Physiocrats and Adam Smith regarded rent as gift of nature and Ricardo argued rent for its niggardliness. 2. Adam Smith saw harmony of interests between landlords and the rest of society. Ricardo saw conflict between them. As population increases, the increased demand for food raises its price. Lands of inferior quality brought into cultivation. Rent raises and wages also raises to give labor their minimum of subsistence.31 Profits also fall and with population increase, all classes except the landlords are injured by increase in the price of corn. Believed in improvement in agriculture and import of cheap grains prevent rising rents and falling profits. So he opposed the Corn Laws. Rent did not enter into price has serious implications that even if high tax is imposed on rents, it could not raise the price of corn. Wages Labor has its natural price to meet subsidence level of labor and market price dependent on demand and supply. In long run, workers receive wages at minimum subsistence level called as Iron law of wages. When market price of labor rises above natural price, there is expansion in families of workers, population increases and wages will come down below natural price. Profits Wages and profits move in opposite direction. Interests of worker and employer always opposed and, interest of landlord to that of consumer and manufacturer is always opposed and advocated non-interventionism or laissez – faire. Money Explained why market price of gold was rising and attributed the printing of bank notes was the main cause for it. He believed that the gold standard as a check on over-issue of currency to curb inflation. But he advocated economy is use of gold and silver. The theory of comparative cost Adam Smiths’ theory of trade is based on difference in absolute costs. Every country would buy in cheapest market. Ricardo developed the theory of comparative cost that a country specializes in promotion of commodity that has a great comparative advantage and export. Import for those commodities, which has highest comparative cost. Wine cloth (Units of labor) Portugal 80 90 England 120 100 Portugal has absolute advantage for both the commodities Comparative advantage in terms of Opportunity cost Wine Cloth Portugal 8/9 9/8 England 12/10 10/12 Portugal specializes in wine and import cloth. England specializes cloth and import wine.32 Assumptions 1. Capital and labor did not flow between countries. Otherwise both wine and cloth produced in Portugal itself. 2. Assumed law of constant costs rather than increasing costs as output expanded. Otherwise, it is not possible to carry specialization to fullest extent. Criticism It is based on labor theory of value and based on assumption of full employment. Theory of stationary state In first stage, population is small and best lands are used for producing food, rent is small, income is shared between profits and wages. Everybody except the landlord is happy. In next stage, profit is high and capitalists accumulate more capital, which lead to more demand for laborers. Wages rises above subsistence level leading to increase in population. Society forced to cultivate lands of inferior quality, which lead to diminishing returns and increased rents. Wages and profits fail. In third stage, rents rise further. Wages and profits fall. This process goes on until population is so large, rents are so high, and wages at subsistence level and profit is low so those capitalists do not wish to accumulate more capital. Society reached the stationary state at this point. Since profits are low, there is no further capital accumulation. Since wages are at subsistence level, population will not grow He analyzed production, growth and distribution of income. Adam Smith regarded stationary state as a dim and distant prospect and Ricardo considered it as a real possibility. Ricardo regarded as economists’ economist. Conclusion 1. He has abstract reasoning and master of deduction in economics 2. Contribution to theory of value and distribution 3. Separated economics from other branches. 4. Laid down the foundation stone of socialism with his theory of value. Keynes criticized Ricardo for the assumption of full employment based on J.B. Say’s law of markets, which ruled out general over-production. Jervons viewed Ricardo as able but wrong-headed man. In spite of these criticisms, Ricardo’s teachings dominated political economy for nearly a century.33 CHAPTER- VIII THOMAS ROBERT MALTHUS (1766-1834) Main works 1. An essay on the principle of population (1978) 2. Principles of political Economy (1820) 3. Theory of market gluts – Inadequacy of aggregate demand Social background Unemployment, poverty and disease became serious problems. Landlords were described as an exploiting class. He attributed poverty and misery not to evil human institutions but to the fecundity of human race. Abolition of war would remove remedies of over – population. Godwin’s egalitarian, consumerist society would mean more food for masses and increases population. THE MALTHUSIAN THEORY OF POPULATION Malthusian theory discusses the relationship between population and food supply. It is based on the law of diminishing returns. Assumptions 1. Food is necessary for human existence 2. Passion between sexes is necessary and will remain nearly in its present state. Power of population is indefinitely greater than the power in the earth to produce subsistence for men. Population increases in a geometric ratio (2, 4, 6, 8, and 10…). Population if unchecked would double in twenty-five years. But food supply increases in arithmetic ratio (1, 2, and 3…) and less than population due to law of diminishing returns of land. Population outgrows food supply and suggested preventive and positive checks by nature. Preventive checks are the moral restraint (never marry), postponement of marriage which causes birth rate to fall. He has approved vices like prostitution and birth control to reduce birth rate but condemned contraception. War, famine and disease impose positive checks, which increase the death rate. If population were not checked by 2 methods, there would not be food supply leading to famine, starvation and death. He presented a dark and pessimistic feature of mankind. He condemned contraception because it is an improper act to conceal the consequences of irregular gratification. He also not approved birth control methods but it is required for developed countries like India. India has high birth rate typical of agrarian economies and low death rates characteristic of industrial economics. Until economic development cures this and also if there is voluntary limitation of families, Malthusian checks of famine and disease may operate. India should westernize not only death rate but also birth rate. Poor are responsible for poverty and misery because they fail to restrict their numbers.34 Government should not provide relief to poor by means of ‘Poor laws’ because more children survive and hunger aggravates. Criticism 1. Malthusian belief that once in twenty – five years, the population would double is proved wrong by history since in some countries, population actually declined. 2. In some countries, population increased at a rapid rate and also, food supply. Standard of living is much higher than a century ago 3. Malthusian theory is based on law of diminishing returns and he overlooked the possibility of scientific improvement in agriculture 4. Scope of international trade and commerce is ignored since India import during shortage. 5. Relationship between population and food supply is a problem of not numbers but wealth and its efficient production and equitable distribution. 6. Addition to population is harmful is not correct since every man is a labor, large numbers, great wealth, strength and power. Malthusian theory is relevant to underdeveloped countries like India and China where problem of over – population is a danger. Malthus is a prophet rather than a historian and an economist rather than a statistician. Optimum theory of population It looks population protection not as a question of numbers but from production and efficiency. Every country has optimum or ideal population where its output is highest. Optimum population is that population which combined with other available resources or means of production yield the maximum returns. When a country is reached optimum population, it gives maximum income per head. Optimum population is not fixed. It may have different optimum levels at different times. Neo- Malthusianism (Francis Place) Neo – Malthusian favored birth control measures as celibacy involved suffering even than want of food and late marriages make people immoral by encouraging prostitution and increasing the number of illegitimate births. The Malthusian Theory of Gluts Less known but made important contribution to economic theory. Ricardo was interested in theory of distribution of product in equilibrium conditions. Malthus discussed volume of output day by day in real world. Level of output at any time depended upon effective demand. Effective demand is a demand, which is high enough to ensure a continual supply or continual production. This is a demand, which enabled the35 producer to cover cost plus profit. Argued in favor of unproductive consumption to maintain and increase effective demand. Wages of workers is so low that they cannot demand many goods. Mode of living and habits of capitalists don’t give then room for unproductive spending and so argued for unproductive consumers. Adam Smith and Ricardo were in favor of saving and capital accumulation. Malthus was against it because it leads to reduction of unproductive consumption and in turn checks the wealth progress. He is not against saving as such but suggested a proper balance between saving and consumption. Among unproductive consumers, Malthus included landlords, menial servants, statesmen, judges and lawyers, physicians, surgeons and clergyman. Unless a large body of unproductive consumers maintained, there would be periodic over – production, glut in the market and stagnation. He pointed crises in the form of trade cycle because of the inherent defects of capitalist system. Rent Adam Smith and J.B. Say viewed rent as monopoly return and Ricardo viewed it as due to niggardliness. Malthus viewed it as a bounty of nature 1. There will be shortage of fertile land 2. This necessitated cultivation of lands of inferior quality 3. Produce in each case is sold at natural or necessary price. Price of poorest quality land is equal to cost of production and land with superior fertility, get rent. Thus Malthus anticipated the Ricardian theory of rent. Value He defined value as the amount of labor plus profits. It is the power to command other goods including labor. Contribution of Malthus to economic thought 1. He is the first to study principle of population and founder of modern demography. 2. Darwin struggle for existence is the doctrine of Malthus applied with manifold force to the whole animal kingdom. 3. He is the founder of historical economics as he collected lot of historical and statistical data to illustrate his theory 4. Introduced a dynamic factor into economics that is population was always changing 5. Forerunner of under consumption theories of trade cycle. 6. Malthus is a pre-Keynesian since like Keynes he believed that employment level is depended on level of aggregate effective demand. But he doubted the classical assumption of full employment36 equilibrium based on J.B. Say’s ‘Law of markets’ But he is superior than that of Ricardo’s abstract logic.37 CHAPTER- IX HISTORICAL CRITICS Classical System includes a. Social and political philosophy – Doctrine of laissez – faire b. Method of analysis – abstract – deductive method c. a box of tools – economic generalizations. During 19th century, classical economic system attacked by historical critics, who criticized deductive method and endorsed inductive or historical method. They placed nation at the center of their thought. Germany is the homeland. Socialistic critics emphasized class rather than individual (classical) or national (historical economists) and emphasized the ameliorating conditions of the proletariat. France was the homeland. Both movements appeared in England I GERMAN HISTORICAL SCHOOL 1. Older school was primarily concerned with criticism of deductive method and represented by Roscher, Hildebrand and Knies. 2. In Younger school apart from criticism, made contributions to economics. Dominated by Gustav Schmoller. Critical ideas of historical school 1. Belief of classical writers that universality of their doctrines is not fulfilled. Historians pointed out that economic laws are relative and not absolute and cannot be applied everywhere and at all times. Economic laws can be applied in relation to stage of economic development. Free trade is useful to advanced countries while protection benefits poor countries. 2. The psychological assumptions of classicists were crude and inadequate. Classicists guided by self- interest but historians included variety of motives the vanity, love, pity, glory, pleasure, duty, benevolence and custom. The concept of economic man ignores all motives except the self-interest abandoned by modern economists. 3. This school made indiscriminate use of deductive or abstract method. Positive ideas of the historical school Classical economists concentrated on economic problems that could be explained by simple mechanized principles. Price fluctuations, interest rate, wages and rent are explained by mechanical interplay of free individuals guided by their self- interest and competition with each other for individual gains. Wage theory doesn’t tell about different classes of workers, well being in different historical periods38 or about legal and political conditions. Historical school approached from organic point of view and explained the variety of economic phenomena historically. Organic approach is based on 2 doctrines 1. Man’s economic activity studied in connection with his environment. 2. To understand present economic life, men must lave some knowledge of successive stages of economic development in the past. LIST List wrote National system of political economy (1841). He was against classical cosmopolitanism and individualism and his advocacy of projectionist system of national unity was directly based on history and experience. Country would prosper when it is strong and has free movement of goods within the nation. History is against individualism. Nationality List has criticized the individualistic approach of classical. Between every individual and humanity, there exists history of nations. With free exchange and universal unity among nations, exploitation of poor by rich and strong occurs. The stage theory of economic development List distinguished five stages of (a) savage (b) pastoral (c) agriculture (d) agricultural – manufacturing (e) agricultural – manufacturing – commercial. Last stage was normal with strong wavy, control over colonies, development of art and sciences, political power and independence. The theory of productive forces Wealth of nation lays not in exchange values but increase in productive forces that ensures greater exchange of values in feature. He preferred development of producer good industries than consumer good industries. Classical economists believed that economic development takes place in a natural manner but class emphasized planning for the purpose. The theory of protection 1. The aim is to provide protection to the countries with potential powers for economic growth such as vast resources, efficient labor and large population exists. 2. Protection is justified when industrial development of the nation is hampered by the competition of powerful industrial nation like Germany protected against English competition. 3. Protection should not be applied to agriculture because protection of industry indirectly benefits agriculture by ensuring market for raw materials and food. ROSCHER39 His work was “Principles of political economy”. Explained and introduced historical method in economic science. He has made economic generalizations through comparative investigation of national histories. HILDERBRAND Reflected the deductive method of classical economists and expressed faith in historical method. He has never mentioned any methodological rule to guide such historical approach to economics. He has advanced stage theory to distinguish three stages of economic evolution namely phase of natural economy, phase of money economy and phase of credit economy. KNIES published “Political Economy from the standpoint of the historical method” Questioned not only the natural law of classical political economists but also the existence of historical laws of economic development of nations as believed by his predecessors. Economic theory is relative and not absolute, applicable to specific historical circumstances and not every where and at all times. SCHMOLLER He is the leader of younger historical school. He has made ethnological, historical survey of psychological and environmental conditions influencing the economic behavior of people and determining the historical laws of economic development. He has considered both deductive and inductive methods as necessary for economic investigation. Economic theory neglecting the historical facts of economic life should be discarded altogether. It should included abstract theories like origin of economic institutions, their present behavior and psychology of social classes. II HISTORICAL MOVEMENT IN ENGLAND Jones (1790-1855) in his “Essay on the Distribution of wealth and on the Sources of Taxation” attacked classical economists on historical grounds. He attacked Ricardo’s hasty generalizations. He wanted to substitute abstract deductive method by an empirical method. On constructive side, he also distinguished between farmer and peasant rent. Farmer or economic rent is the concern of economic theorists while the peasant rent is the product of bargaining between landlords and laborers. Ingram (1823-1907) Criticized the classical political economy because i. Separated the economic aspect of society from its intellectual, moral and political aspects40 ii. it developed viciously abstract concepts iii. made use of deductive method iv. conclusions were absolute Leslie (1825-1882) Land systems (1870) and Essay in Moral and Political philosophy (1879), Leslie criticized concepts of classical economists like desire of money, wage fund, private interest as abstract and confusing. He has also criticized the classical economists for ignoring the theory of consumption. Bagehot Wrote economic studies (1880) i. It claimed to be universally applicable but it is practically useless in countries because the institutional setup varies from country to country. ii. It advocates the principle of laissez – faire but, in actual practice, government like to interfere. iii. It assumptions are verified and resulting theories are too abstract to be of practical use. Toynbee exposed the darker and uglier aspects of industrial revolution The impact of the historical economics Aimed to formulate economic generalizations through historical processes and in this aim, they failed miserably. Nowhere the historians succeeded in recreating the political economy on a purely socio-historical basis. Historical economists ideas had considerable impact on modern economics especially U.S. and started criticizing laissez – faire and had inclination towards social policy. In England, historical ideas of Ingram, Leslie, Bagehot and Toynbee had defined and positive impact on economic theory. III THE AUSTRIAN SCHOOL Manger, Wieser and Bohm – Bawerk are the founders of the Austrian school. i. Wieser accepted utility theory of value of Menger and further developed resource allocation and factor pricing. ii. Capital and interest developed by Bohm – Bawerk iii. All the three writers upheld the theory of imputation i.e., producer goods derive their value from the consumer goods they produce iv. Criticized the historical method and abstract method of analysis v. Preferred verbal and non-mathematical exposition of economic theory to mathematical analysis. vi. Because of non-mathematical approach, Austrians regarded economic functions as discontinuous functions expressible as sets of stair step rather than as smooth curves.41 MENGER Menger initiated marginal revolution and founder of Austrian school. Wrote Principles of Economics (1871), in which he developed the subjective theory of value. The theory of goods Good has four qualities i) it most have human need ii) good have properties of satisfying the need iii) Man recognize the want – satisfying capacity of the thing iv) Good possess the technical ability directed to the need satisfaction. Goods ranked according to the immediacy of need satisfaction. First order is in which human desires are satisfied directly and indirectly is higher order goods. Bread is first, flour is second and wheat is third. Two distinctive features are i. Goods of higher order (cotton spinners) cannot produce goods of lower order (cloth) without cooperation of complimentary goods (raw cotton). ii. Conversion of higher order to lower order needs time. Classification of goods is objectionable because same good utilized for domestic purpose (lower order) becomes higher order when used in smelting industry. The subjective theory of value Valuation arises due to scarcity of goods and related only to economic goods. Value is a subjective phenomenon and valued based on satisfaction of human needs. I II III IV V VI VII VIII IX X 10 9 8 7 6 5 4 3 2 1 9 8 7 6 5 4 3 2 1 0 8 7 6 5 4 3 2 1 0 7 6 5 4 3 2 1 0 6 5 4 3 2 1 0 5 4 3 2 1 0 4 3 2 1 0 3 2 1 0 2 1 0 1 0 0 Number in any column shows diminishing rate of satisfaction from consumption of units of a good. Consumer maximizes his satisfaction by spending money on different goods in such a way satisfaction are equal at the margin. If a consumer has Rs. 21 and unit price of all goods is Rs.1, than consumer maximizes satisfaction by spending Rs.6 on I , Rs.5 on II, Rs. 4 on III, Rs.3 on IV, Rs.2 on V, Rs.1 on VI. This is equi -marginal principle.42 Value of a good is determined by least important want satisfaction. If individual uses six units of good I, then satisfaction from sixth unit (i.e. 5) is the least important want satisfaction. Assuming all goods homogeneous, 5 will be the value of each unit. Manger explained the price determination is case of isolated exchange. Drawback is that he restricted the analysis to isolated exchange and he neglected the discussion of costs. The theory of Imputation Value of a good of higher order is imputed from the lower order. Value of a unit of a factor of production will be equal to its marginal product based on satisfaction. WIESER His chief work is ‘The origin and principal Laws of Economic value (1884)’, ‘Natural value (1889)’ and ‘Theory of social economics (1914)’. The theory of Alternative cost and Imputation Cost of a good is the other good, which might have been produced by the same resource. It productive agent X produce 2 goods A and B and marginal utility of B is greater than A, then according to the principle of maximum benefit, X will be employed in producing B rather than A . Cost means of production used in production of more than one product e.g. labor and capital. Specific means of production specific to particular product especially the land and the cost is rent. He criticized the Manger’s loss principle that the value of a unit of factor is determined by the loss of product if factor is withdrawn. Suppose the most efficient combination of 3 factors produces 10 units of product and if one factor is with drawn, remaining 2 factors produce 6 units of output. Value of removed unit is 4 units. Similarly other 2 have value of 4 each leading to 12 units which is overvalued. Wieser replaced the loss principle by his principle of Productive Contribution. Value is determined by the contribution to its production. He explained this with three equations representing three industries and three unknowns representing three productive inputs. Solving this, he is able to get productive combination of various inputs. He is able to determine the factor prices without entering into marginal productivity of factor. Marginal utility product theory of distribution is marginal physical product(MPP) of that factor multiplied by marginal utility of that product. Manger dealt with utility side of value while Wiser dealt both utility and cost. Marshall Value of a good is determined by the cost of production principle (Supply function) and on the other hand, by final utility principle (Demand function). Austrians viewed that cost of a commodity is determined by foregone utilities of other commodities, which could have been produced by the same resources. Thus the utility and utility alone determine value. Social Economists propounded his theory of welfare. Free market economy is socially unjust because competitive capitalism leads to unequal43 wealth distribution accentuate unemployment. So Weiser recommended the establishment and growth of trade unions. State required playing active role in promoting social welfare by protecting the weak and defending the nation by maintaining a system of police and law. He favored neither absolute competitive capitalism nor absolute socialism but a sort of middle path like a mixed economy. BOHM – BAWERK He is famous for his analysis of capital and interest. The theory of value He has introduced the concept of marginal pairs in explaining the price determination in market. One marginal pair included successful seller and buyer and the other included unsuccessful seller and buyer. Buyers Buyers valuation of one horse Sellers valuation of one horse Sellers B1 300 100 S1 B2 280 110 S2 B3 260 150 S3 B4 240 170 S4 B5 successful buyer 220 200 S5 successful seller B6unsuccessful buyer 210 215 S6 unsuccessful seller B7 200 250 S7 B8 180 260 S8 B9 170 B10 150 There are 10 buyers and 8 sellers. Strength of buyers’ decreases from B1 to B10 and sellers increases from S1 to S8. If bid is 210, there will be six buyers and only 5 sellers. If bid rises to 215, the buyers will be 5 and sellers will be 6. Price is fixed between 210 and 205. Marginal point of buyers and sellers is equal to intersection of ‘D’ and ‘S’ curves. The theory of capital or circulating capital or wage fund theory Land and labor are the primary or original factors while capital is the secondary or produced factor. Original factors of production are goods of highest order and consumption goods are goods of first order.44 Social capital refer to intermediate products and also called as productive capital. This is important in theory of production. Private capital refers to production and consumption goods and also subsistence advanced by entrepreneurs. It is important in theory of distribution. Capitalistic production or round – about method of production is more productive and involve the sacrifice of time. Assumptions are i. Involves diminishing rate of return ii. Extension of production period requites capital iii. Increased capital used to extend the period of production. More the capital, the older the average wage of the capital stock. Capital means circulating capital and used to support labor in productive process. Average period of production (?) denotes capital stock = K/ Nw Where N =Number of workers; W = Wage rate and Nw =rate at which K is consumed If input is continuously applied during production process ? = ½ t where t is the absolute length of production starting from t = 0 and then ? = ½ + = K/Nw Assumptions are inputs are not applied uniformly over the whole period of production. Made with an assumption of homogeneous labor input and input earns simple interest. The theory of interest Bohm – Bawerk claimed mastery over element of time and developed the theory of interest. His theory has 2 parts of why interest is paid? Or why there is a positive rate of interest? Bohm answer is that people prefer present goods rather than future goods of save quality and quantity. Three reasons of superiority of present over future are discussed below. 1. Different circumstances of want and provision in present and future. a. In conditions of disorder, people prefer present goods because of immediate necessity. b. In case of people looking for higher income and better conditions in future, people also prefer present goods because there is going to be increased goods in future because of higher future income. In latter case, people prefer present goods. He failed to examine strong cases in which people have opposite time preference like professional athletes who expect drop in their earnings, save now. 2. Irrational underestimate of future for three temperamental reasons a. Defective imagination b. limited will power c. future uncertainties 3. Technical superiority of present over future goods Increase in productivity of capital is achieved by adopting round about method but it has been criticized on grounds that this has meaning only when people have subjective preference of present over future goods. The first two reasons explain demand for consumption loan and third reason explains demand45 for production loan. All the three reasons explain that the rate of interest exists in both stationary and dynamic system. Determination of rate of interest Assumption 1. The economy consist of capitalists and workers 2. Labor is utilized uniformly 3. All productive functions are identical 4. Physical and value productivity are proportional In equilibrium, workers paid according to marginal productivity of labor discounted to the present. Total wages exhaust the subsistence fund. The marginal product of extending the period of production, which is economically permissible, determines rate of interest subject to available subsistence fund (or) rate of interest adjusts the length of production period. When rate of interest is zero, capitalists have unlimited demand for subsistence and strong desire to lengthen the period of production. As a result of scarcity of subsistence found, interest rate rise until the whole supply of subsistence goods exhausted in lengthening the production period. Equilibrium is stable when i) all labor employed ii) all capital utilized iii) period of production is chosen that minimizes rate of interest consistent with given wage rate. There is a unique wage level at which all above 3 conditions of stable equilibrium fulfilled. If wage level increases, the production period increases, existing capital is in sufficient to employ all labor and as a result wages fall. Conversely, if wage level decreases, production period decreases, capital is surplus and wages increases. Given the labor and supply of subsistence fund, Bohm – Bawerk’s theory determines simultaneously the optimum period of production, equilibrium interest rate and wage rate for the economy as a whole. Bohm – Bawerk summarized the basic relation of system as that the interest rate in a given economy rise in reverse ratio to subsistence fund and in direct ratio to working population and degree of productivity. Wicksell gave a mathematical treatment to Bohm – Bawerk’s interest theory.46 CHAPTER- X SOCIALISTIC ECONOMIC THOUGHT Socialism is protest against the injustice and inefficiency of capitalism. They opposed laissez-faire and advocated state intervention. They believed in class conflict. Forms of socialism 1. State socialism Government owns certain sectors of the economy for overall social objectives rather than for profit. Government of India adopted socialistic pattern of society or democratic socialism and its features are 1. Follow mixed economy 2. Role of public sector expanded 3. Commanding heights of economy is controlled by State like banking nationalization and wholesale trade in food grains. 4. Planned economy 5. Reduction of inequalities of income and wealth. After 2 decades of planning, land reform legislation, progressive taxation policies, there is wealth concentration in hands of few persons. 10 per cent of cultivators own more than 50 percent and one percent own nearly one-fifth because we erect a socialistic superstructure on capitalist base. 2. Utopian Socialism This was the prominent social philosophy. Saint – Simon, Charles Fourier and Robert Owen are founders. This developed when workers are weak, have no vote and trade unionism was not developed. They considered competitive system of capitalist society as unjust and irrational. Also, they have not approved class struggle. They worked out schemes of perfect social arrangement and appealed to workers to adopt them. They appealed capitalists to cooperate with them and provide finance to implement their programs. They set up model co-operative communities. Advocated associations with limited membership and known as “Associationists” 3. Christian Socialism47 This was developed in England and Germany after 1848. Charles Kingley was the leading advocate. They spoke of Bible, religion and god’s message to offer solace to suffering masses. They appealed rich to use their property as a trust for the benefit of everybody. They didn’t believe in violence and class struggle. They advocated education for workers, factory reforms and co-operation. Gandhi’s ideas of trusteeship are similar to Christian socialists. 4. Anarchism Pradhan is the leading advocate. According to him, Government is coercive and should be abolished. State and its institutions corrupt essential goodness of human nature. Collective ownership replaces private property. There should be mutual understanding, cooperation, and complete liberty. 5. Marxian Socialism It was referred as scientific socialism based on labor theory of value and materialistic interpretation of history. The struggle between capitalists and workers lead to revolution. Capitalist system was overthrown and dictatorship of proletariat was setup. Public ownership of means of production was followed. Private property was allowed only for consumer goods. Planned economy, elimination of private property and price system has secondary role. “From each according to his ability, to each according to his work” was the slogan. 6. Communism It is the next higher stage of society. “From each according to his ability to each according to his need “was the slogan. He wanted to end money because they considered this as an intervention by capitalist class for exploitation of workers. In ultimate stage, there won’t be class conflict and no communism. So called communistic countries (Russia, China) are the only socialistic societies. 7. Revisionism or Fabian Socialism This was developed in England and didn’t approve class struggle, revolution and violence. They are for reduction of inequalities of income and wealth and believed in gradual change by education, persuasion and parliamentary reform. Not for total abolition of capitalist institutions but on ownership and management of public utilities by public authorities and called as gas and water socialism. 8. Syndicalism48 Trade unionism and promoted by George Sorel (1847-1922). It didn’t believe in parliamentary reforms. Strikes resorted to promote revolutionary spirit among workers; overthrow capitalism and industry come under the control of workers. It advocated private property abolition. 9. Guild socialism Cole was a great economist of this school (1889-1959). It believed in gradual change and reform. State is needed to promote the interest of citizens by having economic policies. Control of industry is by the workers and wanted every worker to be a partner in the firm. This called as ‘industrial democracy’. Society is divided into producers and consumers. Guild is the national association of workers and Government is the national association of consumers. Consumers and producers form partnership of equals. 10. Utopian socialists Saint – Simon, Charles Fourier and Robert Owen were the founders and Proudhon and Louis Blank were included. They had no knowledge of proletariat, appealed to the whole of society and dreamed fantastic dreams of new society. They appealed to morality. According to Marx, from a scientific standpoint, the appeal to morality and justice does not help an inch further. Utopian socialists did not have a philosophy of history and Marxian socialism is a necessary product of historical development. SAINT – SIMON (1760-1825) His writings are Industry (1817), Organizer (1819), Industrial system (1821) and Questions on Industries (1823). He was the father of utopian socialism and advocated industrialization. Considered idleness as a sin and work is worship for him. For industrial growth, competition and self-interest are the motive forces. Saint-Simon had a collectivist view according to which classes are principal agents of industrialization. Role of Government Society is organized for promoting industry. Role of Government is to direct and not to command people; to promote welfare of members and not to increase power. Industrial parliament has three chambers looking after invention, review and execution. Invention clamber has artists and engineers who plan public works. Review chamber consists of scientists who review projects and control education. Execution chamber consists of leaders who carry the project and control the budgets. It is an example of a centrally planned economy run by an educated elite. He felt class of interests between workers and wanted to be dealt in a humane way. He has opposed private property because it made rich idle and advocated collective ownership of property. Government has a limited role and run by voluntary subscriptions. Science, fine arts and49 professions contribute to the prosperity of France rather than Prince, Nobles, Bishops, Marshals and idle landowners. As a socialist, Saint Simon believed in social change, equality of opportunity, new social order with no room for idler, believed in greatest good of greatest numbers that is giving workers the responsibility in administration and transforming private property. He has applied property to landed property and not movable property (capital). This is the most diluted socialism. Saint – Simonians are the followers of Saint-Simon and important among them were Augustus Comte (1718-1857), Saint – Arnand Bazard (1791-1832) and Barthemy Enfantin (1798-1864). He has criticized private property from the point of distribution, production and wealth and from justice and utility. Private property made property owners idle and it is the source of exploitation. He has advocated collective system instead of people property. To each according to his capacity was their slogan. Doctrine of saint – Simonians is a mixture of realism and utopianism. He has encouraged large-scale industry, institution of credit and profit sharing. SISMONDI Founder of socialistic economics and wrote the Commercial Wealth (1803) and The New Principles of Political Economy (1819). With method of economics, he rejected the abstract method of Ricardo, emphasized historical school and a balanced use of induction and deduction. Aim of economics is distribution or welfare side of wealth as against wealth of Adam Smith. Attack on the practical conclusions 1. Over production: Classical economists believed that general expansion of production caused no inconvenience in the system because the spontaneous mechanism corrected the production errors of the entrepreneur. Sismondi said that automatic mechanism was full of social suffering and inconvenience. 2. Machinery: Classical writers considered machinery introduction as beneficial while Sismondi said that immediate effect of machinery is unemployment of labor and reduction of wages. Machinery increased employment only in long run and Sismondi considered with short period. 3. Competition: He has criticized classical assumption of competition is beneficial to people only when producers increase production in response to an increase in demand. Otherwise, it lowers the price, cost and finally wages. 4. Harmony of interests: Society has a clash of interests between capitalists and proletariat. Suffering of worker is due to separation of property and labor. 5. Crisis: There is unequal revenue distribution between two classes of society. Industries producing necessaries of life decay and industries producing luxury goods flourish but slow. Expansion of new industry fails to offset decay of old industry and there is crisis.50 UTOPIAN SOCIALISTS FOURIER (1772-1837) Commerce is the root of all corruption. Cooperative communities called Phalanxes or Phalansteres could solve social problems. Each Phalanx comprises 300 families with 1800 members and has nine square miles of land. He gave importance to agriculture and handicrafts with co-operative enterprise. He has described advantage of common kitchen and apartments. It is like a grant hotel with proper surroundings. He has emphasized production, distribution and dignity of labor. Over work made labor unpleasant. He classified labor into necessary, useful and agreeable. The first 2 received the highest reward. Surplus was distributed between labor, capital and talent at five – twelfths, four – twelfths and three – twelfths respectively. Phalanxes resemble china but Fourier opposed large – scale production and emphasized voluntary cooperation. China focused on large scale production and centralized planning ROBERT OWEN He was the most famous utopian socialist. An improved environment resting on improved education provides path to progress. Greatest happiness occurs only by serving the society as against classical that self-interest promoted the general interest. Private property, religion and marriage act as barriers in creation of ideal communal order. He demanded abolition of profit, speculation and money like communistic. Villages of Co-Operation He has established communistic settlements of parallelograms or villages of co-operation and wanted to do away with capitalism. Allowed fixed interest rate on capital (Fourier allowed profit on capital). National equitable labor exchange He has opposed money and profits. Founded National equitable labor exchange as a market where goods exchanged on basis of notes representing labor time. LOUIS BLANC He is the founder of state socialism and published ‘organization of work’ in 1839. He has dependent on state for implementation of ideal programs and regarded as advocate of proletarian socialism. Advocated social or national workshops where men in similar industries co-operate and such workshops were financed by the state. Advocated producers’ associations, received fixed rate of interest and drove capitalists out of business. Aim was to abolish individualism, competition and private property. He was in favor of large-51 scale enterprise. Competition was the root cause of all economic and social evils. Competition means continuous fall in wages, which brings poverty, and in term brings crimes. PROUDHON Advocate of anarchism and champion of individual liberty and justice. Anarchism does not mean disorder but only absence of master. Attack on Government Government was biased towards the richest and most educated class as against the more numerous and poorest class. Property was theft since it earned income in form of rent, interest and profit. Property owners robbed the labor of their due share in production. Bank of exchange He has favored abolition of gold standard and advocated bank of exchange. Paper money issued proportional to gross output of subscribers and negotiable among themselves. Banks buy from members at 50 and 100 per cent of cost of production. Provide free credit to workers with a small commission. He has emphasized social or collective production. An estimate of utopian socialism 1. It is an unscientific socialism. It is not based on scientific economic theory. It is ethical in character, bourgeois in its origin. 2. Raised the question of distributive justice. Reduction of inequalities through abolition of private property and advocated state intervention. 3. Robert Owen is a pioneer of co-operative movement. They lacked historical sense as they failed to appreciate private property, marriage and religion.52 CHAPTER- XI KARL MARX (1818-1883) Founder of scientific socialism and aim was to demonstrate socialism as a necessary product of historical development. Marx and Engels wrote Communist Manifesto (1848), which has essential ideas on communism. He Wrote “The Poverty of Philosophy” which was an attack of Proudhon book “The Philosophy of Poverty”. Published The Critique of Political Economy in 1859 and Das Capital was the major work. Philosophy It was dialectical materialism, which is a Hegelian philosophy with modification. Change is a development and takes place in stages. An initial situation is thesis followed by antithesis and third situation of synthesis. Change is a continuous process. Dialectical process is explained by certain rules. 1. Unity of opposites: Capitalists and workers temporarily co-exist in a capitalistic society. 2. Negation of negation: Explains mechanism of change and fells that no system is permanent. Feudalism gave place for capitalism and capitalism in turn to socialism. 3. Change of quantity into quality: When capitalists exploit the working masses, there will be a qualitative change and labor revolt against existing order. For Hegel, human mind was important and Marx gave the materialistic interpretation and said that changes in the material world influenced the mind and thoughts. Materialistic Interpretation of History Classical economists discussed rent, wages and profit under capitalism, which is a permanent one. For Marx, capitalism is a transient phases in evolution of society. Classical economists viewed economic laws are natural law. For Marx, it are relative laws and valid for particular stage of economic development. Emphasis is on historical evolution of social, political and economic institutions. Mode of production in material life determines the general character of the social, political and spiritual processes of life. Underlying all social changes, there is a continuing development. The existing institutions outline their usefulness and become replaced by another set suited to higher stage of economic development. This is materialistic interpretation of history. Class struggle All history is the history of class struggles while classicists believed in harmony of interests. In ancient time, it is the struggle between master and slaves. In feudalism, it is the struggle between lord and serf and in Capitalism; it is between bourgeois and proletariat. As exploitation of workers by low wages,53 long work hours and women employment increases, society is polarized into capitalists and proletariat. The condition has become ripe for over throw of capitalism by united proletariat. Therefore capitalism creates conditions for its destruction and socialism will be the new order. Marx the economist This describes how economic theory is turned into historical analysis like his work on “Theories of surplus value”. Marxian and classicism 1. Marxian surplus value was developed from Ricardian labor theory of value 2. Marxian surplus value was similar to net product developed by Quesnay 3. Marxian theory of unemployment with “Industrial Reserve Army” was based on Ricardian technological unemployment. 4. Falling profit was similar to classicists. 5. Conflict between wage and profits was discussed by Ricardo 6. Marx’s abstract, deductive method was essentially Ricardian. Marxian Economic Analysis 1. Labor was the source of all value 2. Labor was paid in wages its own value, which was the amount of labor required to rear, train and maintain the laborer 3. Surplus value: Capitalists employs workers for more hours than necessary to maintain him and here he was able to secure a surplus value which was in form of profit. 4. Capitalists interested in increase of surplus value 5. Capitalists increase the surplus value by capital accumulation. Marx classifies the capital into variable (labor) and constant (machinery) 6. Employment of constant capital increases total production but causes technological unemployment and creates industrial reserve army of unemployed, which makes. Capitalists tried to keep down wages. Variable capital alone was the source of value. Recognized the importance of machinery in industrial production but displaces labor and creates technological unemployment. So wages are at subsistence land. Falling rote of profit54 In long run, there is increase in organic composition of capital or increase in constant capital in relation to variable capital. C O = ———– C+V Increase in constant capital takes place because of the desire of capitalist to accumulate more and more capital and also to keep wages low. Fro capitalists, is results in a falling rate of profit. Concentration of capital is in large-scale production, small-scale capitalists thrown out of business and society was polarized into 2 classes of capitalists and proletariat. Economic crisis Marx believed that cyclical fluctuations were in form of prosperity and depression inherent in capitalist system. Average period of trade cycle was ten years. Trade cycle was a under – consumption theory. Aim of the capitalist was introduction of machinery to increase productive powers of society and at the same time, interested in surplus value. This implied that there were large sections without purchasing power, which resulted in a crisis. Mechanization, misery of laborer, decline in rate of profit, crises and concentration of capital intensified the class struggle. Laborers unite to make revolutionary action and capitalists concerned with falling rate of profit, tried to exploit labor as mach as possible. Expropriators are expropriated and a new society is born. Marxian theory of value This is essentially the labor theory of value. Skilled work was a multiple of unskilled average labor. Value of product was measured in units of simple average labor. Marx used the labor theory of value as the basis of exploitation. Marxian theory of surplus value Simple commodity production of C -M-C, in which producer sells the commodity for money and with that money, he buys commodities of other producers for consumption purposes. In capitalistic production of M-C-M, money is used to buy other commodities including labor and power. Commodities are turned into other commodities, which are sold for a great sum of money so that capitalist makes a profit of M-M and this profit is surplus value. Rate of exploitation is Surplus Value (or) Worker work for capitalist Variable capital. Worker work for himself. Capitalist increases the surplus value by increasing the number of working hours, reducing the number of hours for workers sustenance and by employing women and children. Criticism of Marxism 1. Marx’s materialistic interpretation of history is inadequate and over-sided. In shaping history, other factors apart from economic forces play important role.55 2. Generalization of history as a history of class struggle is only partially true because classes refused to polarize. 3. Labor theory of value is outmoded because utility, demand and supply plays important role in determination of value. Even if value depends on cost of production, all costs cannot be reduced to labor and also labor is not homogeneous. Time element was not taken into account. 4. No proof that labor always creates surplus value. If labor theory of value is overthrown, theory of surplus value falls to ground. 5. No historical proof for Marxian theory of Industrial reserve army. It brings historical, social, political and economic events into a single grand scheme Historical Materialism 1. Mode of production 2. Dialectics of mode of production 3. Various form of mode of production in the historical evolution of society. 1. Mode of production . Means of production refers to total material conditions for production and this along with labor form forces of production. 2. Dialectics of mode of production Society develops in accordance with the dialectical principle. Three laws govern it. 1. Laws of unity – Productive forces and production relations are linked by an inner unity. Mode of Production Forces of production (organization, skill of labor, techniques, geographical conditions) Relations of Production Ownership of means of production Labour Means of production Objects of labor (Things to which human labor applied like raw materials of timber, coal, iron, cotton) Means of labor (things used by man to act upon objects of labor Included Instruments of labor (Machines, tools) and also industrial buildings, transport also industrial buildings, transport buildings, transport Position of social groups (Dominating/subordinate) Relation between social groups (exploitative/ cooperative) Distribution of material wealth.56 2. Law of correspondence – Production relations tends to correspond with productive forces. Change in production force induces adjustment in production relation. 3. Law of conflict – Production relations and production forces are in conflict. Productive forces are most mobile while relations are more stable. Hence contradiction between 2 becomes acute leading to conflict. History is a record of class straggle. 3. Forms of mode of production or socio-economic formations Production relations form the economic basis of society, while political and legal views and ideology, and appropriate institutions make up its superstructure. These two components along with productive forces were the key components of any socio-economic formation or particular type of mode of production. Critical Appraisal of Marxian Philosophy 1. Cause of historical changes was not carried on to its logical extent. His argument was based on theological ground and built on economic structure of society which itself changes. 2. No logical connection between Marx’s dialectical and historical materialism 3. Ignores reality because not only economic factor plays important role in historical change. 4. Historical materialism says that manner in which a man earns his living influence one’s thinking was false because a. Bread was not the sole end of human life b. Person earning their living in same manner will not think alike 5. Socio-economic development does not take place in stages. 6. Marx’s theory of history neither explains the past correctly, nor predicts the future accurately. The theory of prices or the transformation problem Principle of equal profitability states that under competitive conditions, the rate of profit equal in all employment. This invalidates 2 propositions of the theory of value that is i) relative prices correspond to relative labor values (labor theory of value) ii) surplus value is a function of variable capital alone (theory of surplus value). Marx solved the problem by transforming the values into prices of production. The transformation was made possible by setting the total surplus value (?s) equal to total profits (?). The theory of development Laws of motion causing a capitalistic society to grow and then to fall are i. Decreasing wage rate, extending working hour and increasing labor productivity increases capital accumulation and technological progress.57 ii. Competition forces capitalists to cheapen their products by inducing capital intensive technology and by increasing the labor productivity. In the competition, small industries thrown out and concentration of capital is with big capitalists. iii. Growing misery of working class is due to an industrial reserve among of unemployed. iv. Falling rate of profit r = ? /q +1 Where r = rate of profit ? = Constant rate of surplus value q = increased capital per man or organic composition of capital. With capital accumulation, capitalists try to get maximum production with minimum costs through the use of capital intensive technology. The theory of Business cycles He has never attempted a specific theory of business cycles. Three crises pointed out (i) Disproportionality that works without a plan and so there is disproportionate growth of various branches of economy. (ii) Declining rate of profit (iii) Under consumption tendency to accumulate, expand capital and produce surplus value, which increased production and consumption lags behind. Reproduction Schema All products are divided into producer goods and consumer goods. Products are divided into three value components of constant capital, variable capital and surplus value. Imperialism refers to foreign policy of an advanced capitalist country that aims at political and economics control over backward areas. This is to ensure that home country is an outlet for ideal savings and surplus manufactured goods in exchange of necessary raw materials. A policy of monopoly capitalism and export of capital is practiced. Marx and the underdeveloped countries 1. Theory of surplus value says that economies with lower organic composition of capital or high variable capital reap high surplus value, which was unproved for India. 2. With regard to theory of under consumption, in developed countries, it is the problem of high production potential and in developing countries, it is the problem of low output level due to low production potential 3. In case of theory of industrial reserve army, in developing economy, it is a problem of demography rather than technological.58 CHAPTER- XII ORIGINS OF FORMAL MICRO ECONOMIC ANALYSIS- JEVONS, COURNOT AND DUPIT I. JEVONS He has applied marginal principle to economic theory and viewed economic problems in neoclassical manner as problems of valuation and optimal allocation. On logic and scientific method He has advocated hypothetical- deductive method and wanted economic science as certain like physical science. Interested in pure theory but did not ignore statistical methods. The utility theory of value and exchange Economics is concerned with ordinal estimates. Utility is a subjective phenomenon and aim was to maximize utility. He has formulated law of diminishing marginal utility and equi-marginal utility. It resolved the age-old water-diamond paradox. Diamond is highly valued because of scarcity. Equation of exchange requires that in equilibrium, ratios at which 2 commodities exchanged must be inversely proportional to final degrees of utility. MUx MUy ——— = ——— Where x and y are two commodities. Px Py Contract curve is obtained by joining the points of tangency of 2 sets of indifference curves. Final contract between traders A and B takes place on this curve. X2 II2 Io C II1 I1 II0 I2 C1 O X159 The theory of labor supply + B Utility of labor Marginal Utility A O amount of output C disutility of labor – Labor has utility because it was rewarding in terms of wages. It has disutility become it is painful exertion of mind and body. Labor is supplied as long as utility is more than disutility and supplied up to point where utility and disutility equal. Labor supply that produce OA units of output will be the equilibrium labor supply because utility equals disutility of labor (AB=AC). Theory of capital and interest Capital means wages fund and regarded it a matter consuming time. A time lag separates labor employment in production and final commodity production. Capital was required to maintain labor during time lag. Amount of investment capital was determined by amount of capital invested multiplied by the average time. Production process involved construction of durable goods by investing capital and utilization of durable goods, which represents disinvestment of capital. Capital or labor Purchase OB represents continuous investment through time, BC represents continuous disinvestment through time and AB is the greatest amount of capital invested. The area OBC shows amount of investment capital and that is equal to ½ AB.OC. Empirical Studies and Economic Policy Jevons contributed to the science of Statistics in ‘A serious fall in the value of Gold (1863)’. Here he examined methodological problems in construction of price index namely the problem of weighing, choosing between arithmetic and geometric mean, problem of elimination of commodity with abnormal B O A C Time60 movements and the problem of selection of sample commodity. Other statistical investigation was coal question, which stated that rapid development of British industries would mean demand for coal in a geometric progression. Jevons sunspot of trade cycle states that rhythmic changes in temperature as a result of solar activity bring changes in agricultural production and affect general economic activity. Jevons called for a systematic study of economic policy instead of the single rule of laissez-faire. Appraisal His analysis was sketchy and incomplete. It was for the latter economists like Walrus, Wicksteel, Marshall, and Bohm-Bawerk to elaborate these ideas and examine their implications. DUPUIT Jules Dupuit (18 May 1804 – 5 September 1866) was a French civil engineer and economist. Engineering questions led to his interest in economics, a subject in which he was self-taught. His 1844 article was concerned with deciding the optimum toll for a bridge. It was here that he introduced his curve of diminishing marginal utility. As the quantity of a good consumed rises, the marginal utility of the good declines for the user. So the lower the toll (lower marginal utility), the more people who would use the bridge (higher consumption). Conversely as the quantity rises (people allowed on the bridge), the willingness of a person to pay for that good (the price) declines. Thus, the concept of diminishing marginal utility should translate itself into a downward-sloping demand function. In this way he identified the demand curve as the marginal utility curve. This was the first time an economist had put forward a theory of demand derived from marginal utility. Although not the first time that the demand curve had been drawn, it was the first time that it had been proved rather than asserted. Dupuit, however, did not include a supply curve in his theory. Dupuit went on to define “relative utility” as the area under the demand/marginal utility curve above the price and used it as a measure of the welfare effects of different prices — concluding that public welfare is maximized when the price (or bridge toll) is zero. This was later known as Marshall’s “consumer surplus”. Dupuit’s reputation as an economist does not rest on his advocacy of laissez-faire economics (he wrote “Commercial Freedom” in 1861) but on frequent contributions to periodicals. Wanting to evaluate the net economic benefit of public services, Dupuit analysed capacities for economic development, and attempted to construct a framework for utility theory and measuring the prosperity derived with public works. He also wrote on monopoly and price discrimination.61 Dupuit also considered the groundwater flow equation, which governs the flow of groundwater. He assumed that the equation could be simplified for analytical solutions by assuming that groundwater is hydrostatic and flows horizontally. This assumption is regularly used today, and is known by hydrogeologists as the Dupuit assumption. Cournot He has extensively used mathematics in economics. He was a pioneer in showing relationship between small increments in commodities and those in price. Duopoly He assumed monopoly as his starting point. D= F(P) where quantity demanded is a function of price. Maximum total value is obtained by multiplying QD with price. Taken another monopoly firm (more specifically monopolistic, the less perfect condition of monopoly), the case of duopoly and attempted a determinate solution. Concluded that price will be lowered and price lie between monopoly price and pure competition price. With joint demand of copper and zinc (to produce brass) assuming no other use for two raw materials and each supplied by a monopoly, concluded that price will be higher (as a result of increased units costs) but hardly determinate. Criticism is that if two monopolies are sellers, price will be unstable possibly falling to zero if supply increased infinitely. Cournot competition Cournot competition is an economic model used to describe an industry structure in which companies compete on the amount of output they will produce, which they decide on independently of each other and at the same time. It is named after Antoine Augustin Cournot (1801-1877) after he observed competition in a spring water duopoly. It has the following features: ? There is more than one firm and all firms produce a homogeneous product, i.e. there is no product differentiation; ? Firms do not cooperate, i.e. there is no collusion; ? Firms have market power, i.e. each firm’s output decision affects the good’s price; ? The number of firms is fixed; ? Firms compete in quantities, and choose quantities simultaneously; ? The firms are economically rational and act strategically, usually seeking to maximize profit given their competitors’ decisions.62 An essential assumption of this model is the “Cournot conjecture” that each firm aims to maximize profits, based on the expectation that its own output decision will not have an effect on the decisions of its rivals. Price is a commonly known decreasing function of total output. All firms know N, the total number of firms in the market, and take the output of the others as given. Each firm has a cost function ci(qi). Normally the cost functions are treated as common knowledge. The cost functions may be the same or different among firms. The market price is set at a level such that demand equals the total quantity produced by all firms. Each firm takes the quantity set by its competitors as a given, evaluates its residual demand, and then behaves as a monopoly. ? Cournot duopoly equilibrium This section presents an analysis of the model with 2 firms and constant marginal cost. p1 = firm 1 price, p2 = firm 2 price q1 = firm 1 quantity, q2 = firm 2 quantity c = marginal cost, identical for both firms Equilibrium prices will be: p1 = p2 = P(q1 + q2) This implies that firm 1’s profit is given by ?1 = q1(P(q1 + q2) ? c) Implications ? Output is greater with Cournot duopoly than monopoly, but lower than perfect competition. ? Price is lower with Cournot duopoly than monopoly, but not as low as with perfect competition. ? According to this model the firms have an incentive to form a cartel, effectively turning the Cournot model into a Monopoly. Cartels are usually illegal, so firms might instead tacitly collude using self-imposing strategies to reduce output which, ceteris paribus will raise the price and thus increase profits for all firms involved.63 CHAPTER- XIII NEOCLASSICAL SCHOOL Important feature was introduction of marginal analysis. Classical was concerned with increasing the wealth of a nation with limited land and unlimited labor, which was a dynamic system. Neoclassical was concerned with short run problem of allocation of given resources with maximum benefit, which was a static system. Marginal analysis An action will be performed only if it adds benefits more than the effort made on it. Necessary condition is based on equimarginal principle which states that a resource allocated among competing uses in such a may it yields same marginal return in all cases. Sufficient condition was based on law of diminishing returns, which says that process of allocating a unit of resource to one use producing diminishing results. Production MPP = MIC Consumption MV= MC Mathematically necessary condition is dy/dx=0 and sufficient condition is negative d2y/dx2 Theory of value and distribution Classical economists separated the theory of distribution from theory of value. Price of commodities in product market is determined by natural prices of three factors of production namely land, labor and capital. Rent was the differentiated surplus over and above marginal unit of cultivation. Wages were explained by long run substitutive theory and profit was the residual element that is total product less rent and wages. Neoclassical Economics 1. Theory of distribution is a part of theory. Value of factors is derived from value of their products. 2. Classical economists emphasized cost of production or supply aspect of valuation. Neoclassical emphasized utility or demand side while Marshall emphasized the role of time element. In short period, supply is inelastic and price is influenced by demand. In long run, supply changes and influences price. 3. Classical economists viewed demand determines commodity prices, neoclassical viewed price of commodities determines price of factors of64 production and Walrus said that both are mutually and simultaneously determined. Classical Neoclassical Individual Collective agents like classes Linked to natural science Scarcity is an eternal problem Objective Subjective because it is a problem of choice ALFRED MARSHALL (1842-1924) Masterpiece is Principles of Economics, which appeared in 1890 and sought a synthesis of utility theory of Austrian Economists and cost of production theory of Classical economists. Nature and scope of economics welfare Economics is study of mankind in ordinary business of life. Examine that part of individual and social actions for attainment of material requisites of well being. Economics is not a body of concrete truth but an engine for discovery of concrete truth. Economic laws are statements of tendencies. He has followed diagrammatic approach to illustrate theories. Marginal utility and demand Marginal utility of a thing diminishes with every increase in amount of it a person already has. Assumptions 1. Refers to given moment in time 2. No changes in habits and tastes 3. All units of good are homogenous. Also, amount demanded increases with fall in price and decreases with increases in price. Law of equi-marginal utility explains that consumer spent his money on different goods in such a way that their marginal utilities are proportionate to their prices. Marginal utility is measured by money and economics is the most exact of social sciences. Consumer’s surplus is the difference between potential price and actual price. The excess of a price, which a person would be willing to pay for a thing rather than go without the thing over that which is actually does pay, is the economic measure of this surplus satisfaction. It became the basis of welfare economics. Elasticity of demand = % change in Quantity demanded65 ————————————– % Change in price. This gives rate of change of demand. This is helpful in studying problem of value under monopoly. Monopolist fixes high price for commodities with inelastic demand rather than elastic demand. Supply and cost of production. Supply increases when price increases. Supply curve slopes upward to right. Distinguished real cost and expenses of production. Marshalian theory of value and time element Classical said cost of production or supply determines value. Marginal school said demand was based on marginal utility, determined value. Marshall said both demand (Marginal utility) and supply (real cost) at margin determine value, which is dual theory of value Classified value into four kinds 1. Market value 2. Short – period value 3. Long period value 4. Secular value Market value: Supply is fixed and it is vertical straight line and price depends on demand e.g. fish. Short period value: Demand and Supply determine price. Only the variable inputs increases or decreases. Long period value: Supply or cost of production determines price where plant size is changed Secular value: population, tastes, capital and organization cause Secular changes. Prime costs are variable and supplementary costs are fixed. External economies Internal economies Economies possible to an industry Economies possible to a single firm or group of firms’ localization of due to economy of skill, machinery industry. Develop hereditary skill, and materials e.g. federations, cartels subsidiary and specialized industry. and co-operative organization. Representative firm: Supply price of commodity depend on cost of representative firm It has fairy long life, fair success, managed with normal ability and has normal access to economies of external and internal and it represents an average firm. Law of diminishing returns66 An increase in capital and labor applied in cultivation of land causes in general a less than proportionate increase is amount of produce raised unless it happens to coincide with an improvement in art of agriculture. Agriculture has diminishing returns while manufacturing industry has increasing returns Distribution Quasi rent is the income derived from machines and other appliances for production made by man. Supply is inelastic in short run and quasi rent disappears in long run. Rent is the income from a factor whose supply is permanently inelastic. It is fixed both in short and long run. Wages depend on demand and supply. Demand is a derived demand, which depend on demand by consumers for final products. Supply increases when marginal labor productivity and wages decreases. Interest explained by abstinence theory of interest of Nassau senior. Marshall preferred the term waiting which is sacrifice of present pleasure for future. Marshall’s contribution to monetary economics 1. Money is a function of demand and supply 2. Made distinction between real and money rate of interest 3. Purchasing power parity which explains rate of exchange between countries with mutually inconvertible currencies 4. Index no is complied by chain method. 5. Symmetalism: Government is ready to buy or sell wedded pair of bars for a fixed amount of currency. Symmetalism method by which bar of silver say 2000g is wedded to a bar of gold l00g. 6. Explained how increase in supply of money reflected in prices. Conclusion: Devoted his life to make subject as a separate science, standing on its own foundations with high standards of scientific accuracy as physical or biological sciences. Contributions 1. Clear distinction between long and short period 2. Doctrine consumer’s surplus. 3. Doctrine of quasi-rent 4. Expansion and refinement of rent concept INDIFFERENCE CURVE ANALYSIS The analysis is developed by English Economist Edgeworth (1845-1926) and Italian Economist, Pareto (1848-1923) to analyze consumer demand, which is, alternative to Marshalian utility analysis of demand.67 Utility Indifference curve 1. Cardinal approach Ordinal Approach 2. One commodity is consumed Individual consumes 2 or more goods. Each indifference curve represents satisfaction level. It is impossible to measure satisfaction. Only say one IC represents high or low satisfaction level. Consumer is indifferent between different combinations as long as he remains on IC curve. Shape of IC: It Slopes downward from left to right; IC convex to origin; No IC cut each other. Consumer’s equilibrium is studied through IC with following assumptions of 1. Scale of consumer preference remained same 2. Consumer spends entire amount on one good or other 3. He is one of many buyers 4. Homogenous goods 5. Rational consumer. Equilibrium is attained where price line is tangent to Indifference curve. Price line shows opportunities to consumer available in market and Indifference curve shows his tastes. Income, Substitution and price effect Income effect is produced with income changes but price remains constant. So consumer is better or worse off. Substitution effect is with price change but consumers’ money income also changes and so he is neither better nor worse off. He buys more goods for which the price has fallen. Price effect gives price change but money income remains constant and result is change of real income. Substitution also takes place. Price effect is a combination of income effect on one hand and substitution effect on other Criticism 1. Based on unrealistic assumption like assumption of perfect composition which is unrealistic 2. IC analysis assumed absence of institutional price controls, which is important during war and in planned countries. 3. Rationalizes human behavior too much 4. Old wine in new bottle. Marginal rate of substitution is nothing but translation of marginal utility. Other neo-classical economists are Knut Wicksell, J.B. Clark, Irving Fisher and Taussig.68 CHAPTER-XIV WALRAS Walras is a great mathematical economist. His greatest contribution is general equilibrium method in contrast with ceteris paribus method of Marshall’s partial equilibrium analysis. Both are concerned with equilibrium price and quantity determined by intersection of demand and supply. Marshall related Qd or Qs with price of that good. Price of goods or substitutes and other factors enter into ceteris paribus assumption. This is partial equilibrium method because he ignored the interrelation of different markets. Walras economic system is a unified system in which all markets are interlinked and prices in different markets are determined simultaneously. According to general equilibrium approach, economic system as a whole is in equilibrium and valuation problem is solved only when all demands in economy become equal to all supplies in economy simultaneously. Marshall wanted to write for ordinary businessmen while Walras was interested in convincing his professional colleagues and mathematical analysis came to importance. The Walrasian General Equilibrium System 1. The consumer goods ‘m’ in number (A,B,C) 2. The productive services ‘n’ in number of Land, Labor ,Capital (T,P,Q) 3. The price of consumer goods (Pa, Pb, Pc) 4. The price of productive services (Pt,Pp,Pq) 5. Initial quantities of productive services possessed by the individuals qt, qp,qq 6. Quantities demanded and supplied Ot, Op,Oq of services offered (if positive) or demanded (if negative) da, db, dc consumer goods demanded. Based on following 2 parameters 1. Technical coefficients of production ‘mn’ in number at, ap, aq ; bt, bp, bq and ct, cp, cq. Technical co efficient of production refers to quantities of ‘n’ productive services of land, labour, capital (T, P, and Q) required to produce ‘m’ finished products (A, B, C) i.e. n column of m rows. 2. Utility functions mn in number r = Ø (q) – marginal utility function Individual in order to be in equilibrium satisfy the following 2 conditions of exchange 1. Budget equation requires that total expenditure equal to total receipts Ot Pt + Op Pp + Oq Pq + …… = da Pa+ db Pb + dc Pc + ….69 2. Principle of equi-marginal utility requires that marginal utility of various goods and services are proportional to their prices. We have M equations for productive services of each individual and m-1 equation for consumer goods. Thus there are n+m-1 equations for n unknown individual supply functions for productive services and m unknown individual demand functions for consumer goods. When we add individual ‘D’ ad ‘S’ fns, we get four sets of equations defining the general market equilibrium 1. Equation representing the market supply for productive services (n in number) 2. Equation representing the market demand for finished goods (m in number) 3. Equation representing market clearing conditions for factor markets (n in number) 4. Equation representing equality of unit cost and prices for finished goods (m in number) Unknown quantities of productive services offered (n), quantities of finished goods demanded (m), ‘P’ of productive services (n), ‘P’ of finished goods (m-1) Total number of unknowns 2 m+ 2m-1. Thus number of equations exactly equal number of unknowns and general equilibrium is possible. The existence of a unique solution Walrus equilibrium provides a unique and positive solution since number of unknowns equal to equations. But mathematically shown that this equality is neither a sufficient not a necessary condition for existence of unique solution. 1. You can have a system of 2 equations with 2 unknowns for which no solution in terms of real number exists. q2 + p2 =0 q2 – p2 =1 solves for q = ?½ and p = z ?½ where z satisfies q2= -1 2. It is not a necessary condition because a single equation with two unknowns q2+p2=0, a unique meaningful solution exists where q = 0 and p =0 3. Again in 2 equations with one unknown, a unique positive solution exists q=3 q2-6q= -9 q3-3q = 18 Wald demonstrated Walrasian system providing a unique non-negative solution if the assumptions are satisfied 1. Supplies of productive resources are positive 2. Technological co-efficient of production are zero or positive 3. At least one productive service enters production of each commodity 4. Demand function for every commodity is positive, continuous and monotonically decreasing70 The theory of Tatonnement and Question of stability Walras then explained how equilibrium is established empirically in market by mechanism of competition. This is the problem of economic dynamics and Walras discussed in theory of Tatonnement. This is the process of trial and error by which a system with disequilibrium moves towards equilibrium, which is explained with concept of excess demand, which is the difference between QD and QS. When QD > QS, E.D. is positive QD < QS, E.D. is negative disequilibrium QD = QS, E.D. is zero – equilibrium The theory of tatonnenment provides solution to the problem of determinacy and the problem of stability is attached when 1. Negatively sloping ‘D’ curve intersects positively sloping ‘S’ curve 2. Negatively sloping ‘D’ curve intersects negative sloping ‘S’ but steeper ‘S’ curve. The theory of capital and Interest He distinguished fixed capital, which is not used immediately, and circulating capital, which is used immediately. ?= p – (u+v) P where P = price of capital good ? =Net value of capital good p = Annual gross value of capital good u =Depreciation v = Insurance Rate of interest i= p+(u-v)P P ————— or P = ————— P i+u+v Two unknowns cannot be determined in one equation. Problem of determinacy is not a problem in stationary situation. His theory is simple ad empty in substance because i. Not analyzed trace nature of ‘D’ and ‘S’. Supply of capital was not related to price alone. ii. Time preference was important influencing saving but Walrus ignored. iii. Didn’t say why capital goods were demanded and failed to relate marginal productivity theory iv. No theory on capital accumulation The theory of money71 Recognized four types of circulating capital namely stocks of consumption goods and cash balances held by consumers; Inventions of goods and cash balances held by entrepreneurs; Price of four kinds of circulating capital is related to price of its service ? = pi ? =Price of service p = price of money i = Rate of interest At equilibrium, money rate of interest equals to real rates of interest i = ?. It is significant because it is logically integrated into general equilibrium system On applied economics and social economics He believed in close relationship between pure and applied theory. Pure economics provides logical proof for proposition. He felt that applied economics points to the disturbing causes in achieving the goal in accordance with the guiding principle. He believed that perfect competition is not always beneficial. He advocated state intervention for monetary stability, to provide public services for justice and education, to control natural monopoly. Social economics describes general social conditions and particularly personal position. Income form personal goes to individual while land and rent goes to state. Walrus strikes a balance between individualism and communism.72 CHAPTER – XV WELFARE ECONOMICS Pigou is the father of welfare economics. In views of Reader, welfare economics is the branch of economic science that attempts to establish and apply criteria of propriety to economic policies. Oscar Lange says welfare economics is concerned with conditions, which determine total economic welfare of a community. Leading questions about welfare economics Is economy functioning well? Is society’s system of distribution is good? What should be done about improving total welfare? What government intervention is needed to promote economic welfare? Welfare in evolution Adam Smith considered index of welfare as larger per capita output as a result of larger production. Bentham considered greatest happiness of greatest number as goal of happiness. Marshall considered Consumer’s surplus as an engine of economics analysis ad not a program of social welfare. J.A. HOBSTON (1858 – 1940) His idea of welfare economic is found in BookWork and wealth. He advocated moderate radical reform to promote economic welfare and advocated government intervention. He has rejected classical economist’s assumption of 1. Perfect competition 2. Harmony of interest 3. Laissez-faire policy He has developed under consumption theory of trade cycle. Under consumption and over saving results in over investment leading to over production and glut on market. Inability of capitalist economy to keep economy fully employed lead to imperialism. It should find new economies as market for goods and sold in home market. Reducing inequalities of income attains economic welfare. If there is proper distribution of income in society, then home market is capable of infinite expansion and there is no over – production and no need for exploiting colonies by following policy of imperialism. Income was redistributed through trade union action to raise wages and pension He has suggested state intervention for regulation of industry and taxation on monopoly gains, high rent and interest. Revenue was used for provision of social services like health and education and to undertake public works program.73 PIGOU (1877-1959) He was the father of welfare economics. His ideas on welfare economics were found in his Economics of welfare (1920). He has attempted to provide theoretical basis for social reform to promote welfare. Extended law of diminishing utility to money and assumed marginal utility of money diminishes as more and money acquired. Pigou rejected classical economists’ assumption of harmony of interests. He has not believed in societal welfare as a sum of welfare of individuals. Pigou rejected the idea of classicists and distinguished between social and marginal private costs and benefits. Private marginal cost is the cost of producing additional unit and social marginal cost is the expense or damage to society as consequence of producing that commodity. Social cost is greater than private costs 1. Alcoholic drinks sales against policing required 2. Environmental pollution. Social benefit is greater than private benefit 1. Research 2. Pollination by Bees. Problems of society arise out of people’s attitude to future. People prefer present satisfaction to future satisfaction. Therefore government avoids tax on saving to encourage savings. Hobston attacked over – saving while Pigou increases saving to promote economic growth. Pigou assumed interpersonal comparison of utilities, which is impossible. New Welfare Economics PARETO (1848-1923) It is not possible to make interpersonal comparison of utility since utility is not measurable. He made the use of concept of social optimum or Pareto Optimum, which is reached when one cannot make some one better off without mating some one else worse off. Demerit 1. Applied to unambiguous cases. If government policy harm some and benefit some, then this not applicable. 2. If adopted, it leads to status – quoism and non-intervention by Government. J.P. HICKS He pointed out weaknesses of Pigou’s approach as 1. Pigou correlated economic and general welfare 2. Made interpersonal utility comparisons 3. Identified sum of consumer surpluses with real value of national dividend.74 Hicks introduced compensation and reorganization principle. Changes in tax structure are the reorganization principle, which helped some and affected some. Compensation principle is that society’s economic welfare increased if people gained form reorganization compensates those who lost. SAMULESON Social welfare function is to explain ideas of welfare economics. Social welfare function is the method by which social scale of preferences derived from individual scale of preferences, which done either voluntarily or by dictator in centrally planned economy. WELFARE ECONOMICS – SOME MORE INSIGHTS PARETO OPTIMALITY Objective of welfare economics is evaluation of social desirability of alternative economic states. Different resource allocation and different distribution of rewards for economic activity characterize each state. Welfare of a society depends in broad sense upon the satisfaction level of all its consumers. Welfare comparisons are simple if aggregate utilities of individuals are captured in a single utility function. This is not possible since interpersonal comparisons of utilities are not possible. Pareto optimality and the efficiency of perfect competition Pareto optimality was attained if production and distribution can’t be reorganized to increase utility of one or more individuals without decreasing utility of others. Pareto – non-optimal is if some one’s utility is increased without harming anyone else. But welfare is increased, if one person’s position improves with no change in position of others. Pareto conditions achieved under perfect competition i. Second order conditions satisfied for each consumer and producer ii. No consumer is satiated iii. No external effects in either production or consumption. Pareto optimality for consumption A distribution of consumption goods are pareto – optimal if every possible reallocation of goods that increases utility of one or more consumers result in utility reduction for at least one other consumer. Pareto optimality is achieved if each consumer’s utility is highest given the utility level of all other consumers. Pareto optimality for consumption is attained when rate of commodity substitution of consumers is equal. Pareto optimality for production is attained when rate of technical substitution of producers is equal. Pareto optimality in general is attained when 1. RCS for all consumers and RPT for all producers equal for every pair of produced goods. 2.RCS for all consumers and RTS for all producers equal for every pair of primary goods.75 3. RCS between factors and commodities equal the corresponding marginal products. Thus the Pareto optimal state is described as the state that it is not possible to increase the utility of one or more consumers without diminishing utility of others by discontinuing production of one or more goods. Social welfare functions It is the ordinal index of society’s welfare and function of utility levels of all individuals. Not unique and its form depend upon value of judgment of persons for whom it is a desirable welfare function. W = W (U1, U2 … Un) Where Un is the level of utility index of with individual. A welfare optimum is completely determined as a result of introduction of value judgments in form of social welfare function. The resulting allocation is Pareto – optimal. RCS is same for both consumers and equal corresponding RPT. The rate at which consumers substitute leisure for commodities equals marginal productivity of labor. This proves Pareto optimality if second – order conditions are satisfied. Social preference and indifference This is to create social analog to individual indifference curve. Economists derived contour lines on commodity space, which represent alternative combinations of aggregate quantities of commodities along which society as a whole indifferent. In a two – person society, social welfare function is W = W (U1, U2). Find Scitovsky contours corresponding to all distributions of utility (U1, U2) for which W (V1, V2) = W0. Least ordinate corresponding to any value of q1 represents minimum amount of q2 to ensure welfare level W0. Envelope B of Scitovsky contour is locus of minimum combinations of q1 and q2 necessary to ensure welfare level W0 which is Bergson contour. Arrow possibility theorem Arrow investigated formulation of social preferences. He describes individual and social preferences in terms of rankings of alternative states by relation are at least, as we liked as. Arrow stated 5 axioms, which he believed social preference structures must satisfy to be minimally acceptable. Complete ordering: Social preferences are completely ordered by relation is at least as well liked as socially as and satisfy conditions of completeness, relativity and transitivity. Responsiveness to individual preferences If individual rankings change so one or more individuals revise A to a higher rank and no one lower A in a rank. Also, this axiom is violated. Non imposition76 Social preference not imposed independently of individual preferences. If no individual prefers B to A and at least one individual prefers A to B, society must prefer A to B. Nondictorship Social preference not reflects preferences of any single individual. Society prefers A to B if ith individual prefers A to B. Independence of irrelevant alternatives Most preferred state in a set of alternatives independent of existence of other alternatives. If society prefers A to B to C and if C is no longer available, then it must not true that society prefers B to A.77 CHAPTER- XVI J.M. KEYNES Keynes analysis was aggregative analysis and he was inventor of macroeconomics method. Employment = output = Income Effective demand Aggregate supply function Aggregate demand function Consumption Investment Size of income Propensity to consume Marginal efficiency Rate of interest Of capital Prospective yield Supply price Quantity of Liquidity Money preference Future expectations and so marginal efficiency of capital and investment expenditure fluctuates Transaction Precautionary Speculative Motive motive motive The General theory of employment, Interest and money is the most scientist and revolutionary work. THEORY OF EMPLOYMENT 1. Employment = Output = Income. As employment increases, output and income increases proportionately 2. Volume of employment depends on effective demand which was determined by aggregate supply function (representing cost of entrepreneurs) and aggregate demand function (representing receipts of entrepreneurs). Aggregate ‘S’ function was taken as given in short period. 3. Aggregate ‘D’ function was governed by consumption and investment expenditure 4. Consumption expenditure. 5. Investment expenditure 6. Marginal efficiency of capital78 7. Rate of interest The General Theory of Employment, Interest and Money Keynes was the first to develop systematic theory of employment and classical and neoclassical economists neglected the problem of unemployment. Unemployment was due to deficiency of effective demand and believed as short-run problem and employment = output=income. Effective Demand means desire plus ability and willingness to buy i.e. actual expenditure. Effective demand depends on aggregate ‘D’ and ‘S’ function. Aggregate demand function represents different amount of money which entrepreneurs expect to get from sale of output at varying expenditure levels. Planned or intended expenditure at different income level. It comprises of consumption and investment demand C= f(Y). As income increases, consumption expenditure also increases. O Aggregate ‘S’ function represents different amounts of money which entrepreneurs get from output sale at varying employment levels. It represents different income levels (output and employment) which entrepreneurs supply at different levels of expenditure (C+I). SS (45 line) is aggregate ‘S’ Schedule which indicate given level of total expenditure (C+I) equal total income offered. Intersection of aggregate ‘D’ and ‘S’ function determine effective demand. E is effective demand and Oyo is equilibrium level of income and expenditure at this level, Y=C+I. 1. Y = C=I does not indicate full employment level. So less than full employment occurs and ‘I’ generally inadequate to fill gap between, income and consumption. 2. Aggregate ‘S’ function can’t be manipulated and so is not of practical importance. Therefore theory of employment is theory of aggregate demand. Consumption function or the psychological law of consumption C = f (y) © SS (Y=c+1) C+I (Agg.demand ) E0(B) A C C+I 450 Y0 INCOME O Y0 Income79 The psychological law of consumption 1. When aggregate income increases, aggregate consumption also increases but by a somewhat smaller amount 2. Increment of income is divided in some ratio between ‘S’ and ‘C’ 3. Both saving and consumption increases as a result of increase in income. Three technical attributes 1. Marginal propensity to consumer (MPC) = ?C/?Y. This gives slope of ‘C’ curve. MPC of Poor is greater than MPC of rich. 2. Marginal propensity to save (MPS) is complement of MPC so that MPC + MPS =1 It is ?S/?Y S = Y –C ?S = ?Y – ?C ?S 1- ?C —– = ———- ?Y ?Y MPS = 1-MPC 3. Average propensity to consumer (APC) = C/Y (or) consumption level at a given income level. MPC is positive but less that unity. ?C 0< ———