Adam Smith PDF

THE CLASSICAL SCHOOL ADAM SMITH  Biography  Born in Kirkcaldy, Scotland (1723)  Attended Glasgow College at 14 years old  Was a Logic professor in 1751  Published works: The Theory of Moral Sentiments (1759); An Inquiry into the Nature & Cau...

THE CLASSICAL SCHOOL ADAM SMITH  Biography  Born in Kirkcaldy, Scotland (1723)  Attended Glasgow College at 14 years old  Was a Logic professor in 1751  Published works: The Theory of Moral Sentiments (1759); An Inquiry into the Nature & Causes of the Wealth of Nations (1776)  Died in 1790, most of his unpublished works were destroyed according to his wish  Adam Smith’s Influences The Age of Enlightenment 1. Systematic Reasoning (The Age of Ability Reason) 2. Natural Order Quesnay Ideas influenced by Physiocrats: 1. Wealth as “consumable goods The Physiocrats Annually produced by society” 2. Minimal government Intervention Physiocratic System for 3. Circular process of production Adam Smith: & distribution Turgot “…the nearest approximation to the truth that has yet been Published on the subject of Political Economy…” Adam Smith’s Influences Francis 1. Systematic Reasoning Hutcheson Ability (1694-1746) 2. Natural Order “ People themselves could discover What is ethically good (will of God) by Discovering the actions that serve the Good of humankind. “ Personal conversations with David Hume Hume influenced economic (1711-1776) Ideas and intellectual development  The Theory of Moral Sentiments (1759) On Sympathy Sympathy interests us We derive nothing from in the fortune of another’s happiness others and makes except the pleasure of their happiness seeing it. necessary to us The Theory of Moral Sentiments (1759) On Work People are disposed to identify more with our joy than with our sorrow, thus, we parade our riches and conceal our poverty People work not to supply their necessities, but to gratify their vanities The Theory of Moral Sentiments (1759) On Social Interest and Right to Justice This mutual People can exist only interdependence in society; is a result of self They are exposed to interested behavior mutual injuries and need one another’s assistance But the society is not always happy and agreeable thus we need a justice system  The Theory of Moral Sentiments (1759) On Social Interest and Right to Justice Moral faculties Violation of God’s rules prescribe rules of will lead to self- conduct that condemnation and inward restrain our shame actions of selfishness God promotes happiness of human beings because the rich improve lives of the poor for fear of self-condemnation and self interest. (invisible hand) The Wealth of Nations (1776) Of the Division of Labor Division of Labor increases output 1. Workers develop increased dexterity in performing one single task repeatedly 2. Time is saved because workers focus in one type of work only 3. Machines can be employed once tasks have already been simplified and made routine There’s emphasis in manufacturing production and productivity of labor Mercantilists – exchange of goods; Physiocrats – agricultural output The Wealth of Nations (1776) Harmony of Interest Goods Market Resources The pursuit of get SELF INTEREST, allocated restrained by to their Competition highest leads to a valued SOCIAL GOOD uses (Max.output & Labor Market (EFFICIENCY) Economic growth) The Wealth of Nations (1776) On Government (Laissez Faire) wasteful corrupt The Government But for Smith, the government Still has a significant role: inefficient 1. Protect society from foreign attack 2. Administer justice Detrimental 3. Erect and maintain public works to society and institutions (private sector can not do) The Wealth of Nations (1776) On State Interventions Issuance of paper money interest The Government rates Ensure laws Public works Patents and on that promote copyrights agricultural commerce, tenancy education, public Protectionist infrastructures Proportional tariffs Taxes The Wealth of Nations (1776) On International Trade ABSOLUTE ADVANTAGE The government should not Individuals and families should interfere in specialize in producing goods for international which they have an advantage, & trade trade goods for which other nations (Laissez faire have an advantage in International trade) FOREIGN TRADE CAN PROMOTE GREATER DIVISION OF LABOR (among countries) The Wealth of Nations (1776) Laws of a Competitive Economy: On Value “Value in use” THE (UTILITY) WATER-DIAMOND PARADOX Smith did not solve the paradox “Value in EXCHANGE VALUE: the power exchange” that the possession of a good (RELATIVE provides to purchase other PRICE) goods (“NATURAL PRICE” or RELATIVE PRICE) The Wealth of Nations (1776) Laws of a Competitive Economy: On Value Later economists posted: “ Do pearls have value because people dive for them, or do people dive for pearls because pearls have value? “PEARLS “PEOPLE HAVE VALUE DIVE FOR BECAUSE PEARLS PEOPLE DIVE BECAUSE FOR THEM” PEARLS HAVE (RELATIVE VALUE” PRICE) (UTILITY) SMITH: exchange value = f (costs of producing) The Wealth of Nations (1776) Laws of a Competitive Economy: Labor Commanded Theory of Value (labor theory of value in a primitive society) Relative value/price Natural price = f (Quantity of labor) Exchange value Labor is a source (Labor cost theory) and measure (Labor Commanded Theory) of exchange value Assumption: land and capital are either non- existent or free goods The Wealth of Nations (1776) Laws of a Competitive Economy: Value Theory in an Advanced Economy Goods will be exchanged at a price HIGH enough to cover wages, rent and profits. Assumption: land and capital are IMPORTANT ✓ Value = f (cost ofproduction  Value = f (demand) Assumption: perfectly competitive industry The Wealth of Nations (1776) Laws of a Competitive Economy: On Market Price NATURAL/ MARKET INTRINSIC PRICE PRICE A long run price below which Actual price at which any the firm no longer would commodity is sold continue to sell their goods Real price Nominal price Doubling of prices will not increase a good’s command over labor if wages also double. The Wealth of Nations (1776) Laws of a Competitive Economy: On Aggregate Wages & Wage Growth WAGE FUND THEORY: There is a stock of circulating capital out of which present wages are paid Ave. Annual Wage = Wages fund/Q of labor MINIMUM WAGES must be that which will enable a worker with a family to survive & perpetuate the labor supply. The Wealth of Nations (1776) Laws of a Competitive Economy: On Aggregate Wages & Wage Growth DL - W … W=f(DL,SL) … DL,SL=f(Y) So Smith focused on capital accumulation and economic growth because… Y - DL  - W - Smith opposed Mercantilists! Smith believed that HIGHER WAGES will lead to improved health and strength of workers, thus greater productivity (Contemporary economists:ECONOMIES OF HIGH WAGES or EFFICIENCY WAGES) The Wealth of Nations (1776) Laws of a Competitive Economy: On Aggregate Wages & Wage Growth DL - W … W=f(DL,SL) … DL,SL=f(Y) So Smith focused on capital accumulation and economic growth because… Y - DL  - W - Smith opposed Mercantilists! Smith believed that HIGHER WAGES will lead to improved health and strength of workers, thus greater productivity (Contemporary economists: ECONOMIES OF HIGH WAGES or EFFICIENCY WAGES) The Wealth of Nations (1776) Laws of a Competitive Economy: On Efficiency Wages w Reduce shirking (avoidance or neglect Reduce labor turnover of responsibility) Efficiency Wage Theories explain Frictional (wait unemployment)and Cyclical unemployment People remain UE until During recessions, firms jobs paying efficiency wages lay off workers rather become available lhan reduce efficiency wages The Wealth of Nations (1776) Laws of a Competitive Economy: On Compensating Wage Differentials THE THEORY OF EQUALIZING DIFFERENCES Advantages and disadvantages of every type of employment would be equal or tend toward equality Actual wage rates for different jobs would vary according to the following: 1. Agreeableness of occupation – difficulty 2. Cost of acquiring the necessary skills/knowledge (Theory of Human Capital) 3. Regularity of Employment 4. Level of trust and responsibility 5. Probability or improbability of success The Wealth of Nations (1776) Laws of a Competitive Economy: On Profit The lowest rate of profit should be high enough to compensate for the risk of losses and still leave a surplus for the businessman As profits rise --- borrowers seek more money (Dmoney) Dmoney --- interest rates The Wealth of Nations (1776) Laws of a Competitive Economy: On Rent Rent = f (prices of goods produced) Not a single rent theory of Adam Smith is complete or entirely accurate. The Wealth of Nations (1776) Laws of a Competitive Economy: On the Role of Money and Debt Money is just a medium of exchange Smith opposed Mercantilists who claimed that goods are soon destroyed whereas gold and silver are durable thus should be measurements of wealth. Money just facilitates the circulation of goods But production of goods is what constitutes wealth Heavy taxes needed to pay interests on debts will induce firms to invest capital abroad. The Wealth of Nations (1776) Laws of a Competitive Economy: On Economic Development Smith distinguished Productive & Unproductive labor (service and showcasing of talents are unproductive acts)