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Questions and Answers
What does Smith believe higher wages will lead to?
What does Smith believe higher wages will lead to?
According to Efficiency Wage Theory, what is a potential consequence of paying efficiency wages during recessions?
According to Efficiency Wage Theory, what is a potential consequence of paying efficiency wages during recessions?
Which of the following factors is NOT included in the Theory of Equalizing Differences regarding wage rates?
Which of the following factors is NOT included in the Theory of Equalizing Differences regarding wage rates?
What is the relationship between rising profits and the demand for money?
What is the relationship between rising profits and the demand for money?
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How does Smith's view on wages contrast with Mercantilist thought?
How does Smith's view on wages contrast with Mercantilist thought?
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What does the Wage Fund Theory suggest?
What does the Wage Fund Theory suggest?
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Which statement accurately describes Market Price compared to Natural Price?
Which statement accurately describes Market Price compared to Natural Price?
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What does Efficiency Wage Theory aim to reduce?
What does Efficiency Wage Theory aim to reduce?
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Which of the following is a key implication of Compensating Wage Differentials?
Which of the following is a key implication of Compensating Wage Differentials?
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What is the primary benefit of the Division of Labor according to the text?
What is the primary benefit of the Division of Labor according to the text?
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In the context of self-interest, how does competition affect society?
In the context of self-interest, how does competition affect society?
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What role does government play according to the perspective presented?
What role does government play according to the perspective presented?
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What aspect does the moral faculties influence?
What aspect does the moral faculties influence?
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Why do richer individuals contribute to improving the lives of poorer individuals according to the mentioned theory?
Why do richer individuals contribute to improving the lives of poorer individuals according to the mentioned theory?
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What is the consequence of violating God's rules as per the moral faculties?
What is the consequence of violating God's rules as per the moral faculties?
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What principle is highlighted in the concept of Laissez-Faire policies?
What principle is highlighted in the concept of Laissez-Faire policies?
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Which of the following concepts is NOT associated with the emergent efficiencies of labor division?
Which of the following concepts is NOT associated with the emergent efficiencies of labor division?
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What does the Labor Commanded Theory of Value focus on in terms of exchange value?
What does the Labor Commanded Theory of Value focus on in terms of exchange value?
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Under the Wage Fund Theory, what determines the Average Annual Wage?
Under the Wage Fund Theory, what determines the Average Annual Wage?
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In Smith's differentiated view of market prices and natural prices, what defines the natural price?
In Smith's differentiated view of market prices and natural prices, what defines the natural price?
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Which assumption is made about land and capital in Smith's Labor Commanded Theory of Value?
Which assumption is made about land and capital in Smith's Labor Commanded Theory of Value?
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What is stated about doubling prices according to the context provided?
What is stated about doubling prices according to the context provided?
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Which element is critical for the exchange value, as suggested by Smith's theories?
Which element is critical for the exchange value, as suggested by Smith's theories?
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What is the minimum wage requirement according to Smith's wage theory?
What is the minimum wage requirement according to Smith's wage theory?
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What does Smith suggest about the relationship between labor and capital in an advanced economy?
What does Smith suggest about the relationship between labor and capital in an advanced economy?
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Study Notes
Adam Smith - The Classical School
- Adam Smith was born in Kirkcaldy, Scotland in 1723
- He attended Glasgow College at the age of 14
- He became a Logic professor in 1751
- His published works include The Theory of Moral Sentiments (1759) and An Inquiry into the Nature & Causes of the Wealth of Nations (1776)
- He died in 1790, and most of his unpublished works were destroyed as per his wishes
Adam Smith's Influences
- The Age of Enlightenment (The Age of Reason): Key influences included systematic reasoning and the natural order.
- The Physiocrats: Smith's ideas were influenced by the Physiocrats, including wealth as consumable goods produced annually by society, minimal government intervention, and the circular process of production and distribution.
Adam Smith's Influences - Specific Figures
- Francis Hutcheson (1694-1746): Believed people could discover what is ethically good through actions that serve humankind.
- David Hume (1711-1776): Influenced Smith's economic ideas and intellectual development through personal conversations.
The Theory of Moral Sentiments (1759) - On Sympathy
- Individuals derive happiness from seeing others happy.
- Sympathy for others' fortunes is essential.
The Theory of Moral Sentiments (1759) - On Work
- People are more prone to identify with joy than sorrow.
- This leads to people showcasing their wealth and concealing poverty.
- Work often serves vanity rather than simple necessity.
The Theory of Moral Sentiments (1759) - On Social Interest and Right to Justice
- Society's existence relies on people living together.
- People are exposed to mutual injuries and require each other's support.
- Mutual interdependence is a result of self-interest.
- A just society is necessary to maintain harmony.
The Theory of Moral Sentiments (1759) - On Social Interest and Right to Justice - Continued
- Moral faculties establish guidelines for conduct.
- Adherence to these rules prevents self-serving actions.
- Violation of these rules leads to self-condemnation and shame.
- God promotes human happiness by encouraging the rich to improve the lives of the poor. (Invisible Hand)
The Wealth of Nations (1776) - Division of Labor
- Division of labor increases output.
- Workers gain dexterity through specialization in a single task.
- Time is saved by focusing on a particular task.
- Machinery can facilitate simplified tasks.
- Emphasis is placed on manufacturing production and labor productivity.
- Mercantilists view exchange of goods, Physiocrats see agricultural output
The Wealth of Nations (1776) - Harmony of Interest
- Self-interest, restrained by competition, leads to social good and economic growth.
- Goods and labor markets ensure resources are directed toward their highest-valued uses (efficiency).
The Wealth of Nations (1776) - On Government (Laissez-Faire)
- The government has a limited role: protecting society, administering justice and maintaining necessary public works and institutions.
- Government involvement is minimized; free enterprise is encouraged.
The Wealth of Nations (1776) - On State Intervention
- The government is responsible for issuing paper money, setting interest rates, creating laws for agricultural tenancy, and levying proportional taxes.
- Patents and copyrights should be established for innovation.
- Public works are necessary to promote commerce, education and overall public infrastructure.
The Wealth of Nations (1776) - On International Trade
- Individuals/families should specialize in products where they have an advantage.
- Trade with other countries should focus on comparative advantage.
- Foreign trade promotes greater division of labor across countries.
The Wealth of Nations (1776) - On Value
- "Value in use" (utility) vs. "Value in exchange" (relative price).
- The "water-diamond paradox" highlights the difference between a good's usefulness and its exchange value.
- Exchange value is determined by the cost of production.
- Later economists debated whether price is driven by utility (value) or production costs
The Wealth of Nations (1776) - Labor Commanded Theory of Value
- In a primitive society, value = f(quantity of labor).
- Labor is the fundamental measure of economic value.
- Land and capital are considered free goods in this scenario.
The Wealth of Nations (1776) - Value Theory in an Advanced Economy
- Goods are exchanged at a price sufficient to cover wages, rent, and profits.
- Land and capital are important factors.
- Value is determined by costs of production and demand.
- Applies to a competitive market.
The Wealth of Nations (1776) - On Market Price
- Natural/intrinsic price is the long-run price that maintains a firm in the market.
- Market price reflects the actual price at which goods are traded.
- Nominal prices might not necessarily equate to real gain
The Wealth of Nations (1776) - On Aggregate Wages & Wage Growth
- Wage fund theory: wages derived from a pre-existing fund.
- Minimum wage must allow families to survive.
- Higher wages lead to improved worker health and productivity.
- Smith opposed mercantilist views
The Wealth of Nations (1776) - On Efficiency Wages
- Efficiency wages reduce shirking and labor turnover.
- These policies are put in place to incentivize workers and prevent lost production.
- Efficiency wage policies help maintain employment during recessions
The Wealth of Nations (1776) - On Compensating Wage Differentials
- Wage differentials depend on factors like occupation difficulty, skills acquisition, job regularity, responsibility, and success probability.
The Wealth of Nations (1776) - On Profit
- Profit must cover risk and the entrepreneur's compensation.
- Rising profits attract borrowing and higher interest rates.
The Wealth of Nations (1776) - On Rent
- Rent is a function of produced goods' prices.
- A single comprehensive rent theory is not found in Adam Smith
The Wealth of Nations (1776) - On the Role of Money and Debt
- Money is a medium of exchange, not a store of wealth.
- Smith opposed mercantilist views on wealth accumulation.
- High taxes to support debt repayment may discourage investment.
The Wealth of Nations (1776) - On Economic Development
- Economic advancement begins with a division of labor which leads to capital accumulation and productivity.
- Smith distinguished between productive and unproductive labor.
- National output depends on societal wealth to sustain consumers.
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