Physiocrats School PDF

1.1 PHYSIOCRATIC SCHOOL Failures of Feudalism and Mercantilism - On production, there are no improvements in production methods. There are no innovations. - On consumption, no change in consumer tastes The government retarded development. - Taxes, tolls, and tariffs were imposed....

1.1 PHYSIOCRATIC SCHOOL Failures of Feudalism and Mercantilism - On production, there are no improvements in production methods. There are no innovations. - On consumption, no change in consumer tastes The government retarded development. - Taxes, tolls, and tariffs were imposed. - The agricultural sector suffered because of - The land-owning ability of noblemen and clergymen - Corvée (Colbertism) - compulsory labor - Grain Trade - The export of grain from France was prohibited - Internal mobility of goods was regulated - Merchant and Craft Guilds - Restricted output - Impeded free entry of labor - Fixed prices - Killed competition 1.1.1 NATURAL ORDER The physiocrats introduced the idea of natural order to economic thinking. The term physiocrat itself means “rule of nature.” According to this idea, laws of nature govern human societies. In the economic sphere, the laws of nature conferred to individuals the natural right to enjoy the fruits of their own labor provided that such enjoyment was consistent with the rights of others. 1.1.2 LAISSEZ FAIRE ECONOMICS “Let people do as they please without government interference.” - Jacques Claude Marie Vincent de Gournay, 1712-1759 Governments should never extend their interference in economic affairs beyond the minimum absolutely essential to protect life and property and to maintain freedom of contract. - Free trade abroad - Free enterprise at home 1.1.3 EMPHASIS ON AGRICULTURE - Agricultural farmers and laborers were the productive class - Industrial workers, merchants, and artisans were the sterile class - Only agriculture yields a surplus. Manufacturing takes up as much value as inputs into production as it creates in output and consequently creates no net product. 1.1.4 TAXATION OF LANDOWNER - Landowners were the proprietor class who appropriated the net product as rents. - Only landowners should be taxed because only land could yield a surplus. 1.1.5 INTERRELATEDNESS - The interrelatedness of the economy - The circular flow of goods and money within the economy. 1.2 WHOM DID THE PHYSIOCRATIC SCHOOL BENEFIT OR SEEK TO BENEFIT? - The peasants ultimately would gain from the ideas of the physiocrats because onerous obligations to the landowners would end. - By advocating the doctrine of laissez-faire, the physiocrats were promoting industry, even though this was not their intention; - They were interested in encouraging free internal grain trade and stimulating the export of farm products and the import of manufactured goods. - Favored capitalistic farms employing wage labor and advanced techniques. - Big producers having surpluses for sale would be helped by the physiocratic emphasis on agriculture and free internal trade in grain. - The tax on the surplus produced in agriculture would have lowered land values and hurt the landowning nobility instead of the current or prospective farm entrepreneurs who paid rent. - The nobility and clergy were exempt from the multiplicity of taxes that burdened the commoner landowners. - The physiocrats tried to placate the nobility by genuinely defending their right to own land and receive rent. 1.3 HOW WAS THE PHYSIOCRATIC SCHOOL VALID, USEFUL, OR CORRECT IN ITS TIME? - Production of luxury items for the nobility in a miserably poor country, therefore, could easily appear to be “sterile.” - Farming, on the other hand, sometimes produced bountiful harvests in spite of the primitive methods of cultivation. - The physiocrats were opposing obstacles to capitalistic economic development. - Physiocrats emphasized production rather than exchange as a source of wealth. 1.4 WHICH TENETS OF THE PHYSIOCRATIC SCHOOL BECAME LASTING CONTRIBUTIONS - The school was wrong to consider industry and trade as sterile; - This fault led to another error—the belief that only landowners should be taxed because only land could yield a surplus. - Industrialists and laborers became the most important figures in the economic growth of the country, whereas the relative importance of agriculture declined. - Small peasant farmers rather than large farm entrepreneurs became typical in France. 1.4.1 CONTRIBUTIONS TO ECONOMICS 1. Society as a Whole a. Examining society as a whole b. Analyzing the laws that governed the circulation of wealth and goods c. They founded economics as a social science. d. Tableau Economique: Circular Flow Diagram of Quesnay i. the economic flow diagram ii. national income accounting. 2. Law of Diminishing Returns a. Returns - usually credited to Malthus and Ricardo  b. As stated earlier by the physiocrat Turgot. 3. Analysis of Tax Shifting and Incidence a. Analysis of tax shifting and its incidence today is an important part of applied microeconomics. 4. Laissez-Faire a. the physiocrats turned the attention of economists to the question of the proper role of government in the economy. 1.5 FRANCOIS QUESNAY | 1694-1774 - The founder and the leader of the Physiocratic thought - Favored large farms managed by entrepreneurs because small farmers are incapable of using more productive methods. - The circulation of wealth and hoods in the economy is like the circulation of blood in the body. Both conformed to the natural order. - Laws made by people should be in harmony with natural laws. Therefore, natural law governs economic activity, not the government. A free market (Laissez Faire) can lead the market to a “just price.” 1.5.1 TABLEAU ECONOMIQUE His Famous Tableau Economique (1766) depicted the circular flow of goods and money in an ideal, freely competitive economy. - The product that the tenant farmers create has to satisfy not only their own needs but also the needs of the landowners (including the king, the church, the public servants, and others who depend on the income of the landowners). - The output of the farmers provides for the needs of the sterile class (manufacturers and merchants). Tableau Economique Francois Quesnay Quesnay’s Tableau Economique foreshadowed national income analysis and laid the foundation for statistical work to describe an economy. The table also explicitly conveyed the concept of equilibrium within the economy as a whole because if one of the interdependent variables changed, others would change also.  - Although Quesnay called nonagricultural production “sterile,” he did not question the right of the proprietors to receive rent. - The landowner, therefore, has a right to the surplus product, which goes with the title to the land. - Quesnay also favored the idea of a “just price,” but he felt that a free market rather than regulation by authority would best achieve it. 1.6 ANNE ROBERT JAQUES TURGOT - After less than two years in office, he introduced anti-feudal and anti-mercantilist measures in keeping with physiocratic ideas. - He ended the oppressive corvée - the twelve or fifteen days of unpaid labor required of peasants yearly to maintain roads, bridges, and canals; in its place, he enacted a tax that all landowners had to pay. - Turgot cut government spending drastically. - Annual government interest payments were reduced by almost two-thirds. - Turgot advocated a tax on the nobility, freedom of all people to choose their occupations, universal education, religious liberty, and the creation of a central bank, which Napoleon would later establish in 1800. Controversies - The nobility hated him because he wanted to levy all taxes upon the land. - The clergy distrusted him as an unbeliever who not only rarely went to mass but also urged religious liberty. - The financiers resented his getting loans abroad at lower rates of interest than they charged. - The members of the king’s entourage were angered by Turgot’s opposition to their extravagance, - The tax farmers who paid lump sums to the government for the right to collect as much taxes as they could were infuriated because he wanted to replace them with government tax collectors. - The rich and entrenched bourgeoisie objected to his interference with their monopolies. - Louis XVI dismissed Turgot because of the protests of the court, Marie Antoinette, and the other powerful people who were losing privileges because of his policies. Thoughts - Turgot, like other physiocrats, believed in enlightened absolutism, and he looked to the king to carry through all reforms. - Turgot developed a theory of wages in which he held that competition among workers lowers the wage to the minimum subsistence level. - Turgot said that the rich capitalist tenant farmers are most capable of efficient farming because they have the capital to invest in the soil. - Entrepreneurs reinvest most of their profits and savings, but the landlords do not. - Turgot stated that taxes imposed on other groups were passed on to the landowner. - Wages at the minimum subsistence level could not be lowered by taxes because workers had to earn enough to survive. 2.1 THE CLASSICAL SCHOOL - It began in 1776 (Adam Smith’s Wealth of Nations) - Ends in 1871 (Jevons’, Menger’s, and Walras’ demand-based theories) Neoclassical Economics 2.1.1 HISTORICAL BACKGROUND OF THE CLASSICAL SCHOOL - Experimental Evidence (experience) - Natural Law - Nothing changes over time; the motion and nature of the universe continue in endless repetition. - Newtonian Science furnished a nature as fully effective as the earlier will of God. - The Divine Will had created a mechanism that worked harmoniously and automatically without interference (self-interest) - Laissez Faire 2.1.2 MAJOR TENETS OF THE CLASSICAL SCHOOL Economic Liberalism - Minimal government intervention - The economy was held to be self-adjusting and tending toward full employment without government intervention. - Self-interested Economic Behavior - Producers and merchants provided goods and services out of a desire to make profits; workers offered their labor services to obtain wages and consumers purchased products as a way to satisfy their wants. - Harmony of interests - By pursuing their own individual interests, people serve the best interests of society. - Importance of all Economic Resources and Activities - The classicists pointed out that all economic resources contribute to a nation’s wealth. - Economic Laws - The classical school made tremendous contributions to economics by focusing analysis upon explicit economic theories or “laws.” 2.2. WHOM DID THE CLASSICAL SCHOOL BENEFIT OF SEEK TO BENEFIT - It gave business people respectability in a world that previously had directed honors and income toward the nobility and the gentry. - Merchants and industrialists achieved a new status and dignity as promoters of the nation’s wealth, and entrepreneurs were assured that by seeking profit, they were serving society. 2.3 HOW WAS THE CLASSICAL SCHOOL VALID, USEFUL, OR CORRECT IN ITS TIME - Classical economics rationalized the practices being engaged in by enterprising people. - Competition was a growing phenomenon, and reliance upon it as the great regulator of the economy was a tenable viewpoint. - Society’s greatest need was to concentrate resources on the maximum possible expansion of production. 2.4 WHICH TENETS OF THE CLASSICAL SCHOOL BECAME LASTING CONTRIBUTIONS - They laid the foundation of modern economics as a social science, - The law of diminishing returns  - The law of comparative advantage - The notion of consumer sovereignty - The importance of capital accumulation to economic growth, - The market is a mechanism for reconciling the interests of individuals with those of society. 2.5 THE FORERUNNERS OF CLASSICAL SCHOOL 2.5.1 SIR DUDLEY NORTH | 1641-1691 - Discourses upon Trade, 1691 - Trade is an act of mutual advantage. - Refused to accept the fact that wealth should be measured by precious metals (a division of labor and international trade will promote wealth -> Goods) - International trade distributes money supply. - Laissez-faire maximizes gains from intra (same products in the same industry) and international trade. - Disagreed with the concept of war and conquest to enrich a country–no actual production. 2.5.2 RICHARD CANTILLION | 1680-1735 - Wealth banker and speculator of stock/foreign currencies - Robbed and murdered - “Essai sur Nature du Commerce en General” (Essay on Economic Theory) - Talks about the circulation of money a generation before Quesnay - Entrepreneurs as an economic resource - Developed a theory of value and price - P = ƒ(S,D); S & D = ƒ(Land and Labor) - Analyzed interest as a reward for the risk taken in lending - Bankers create credit - “Men multiply like mice in a bard if they have unlimited means of subsistence.” - Focused on productivity of resources (monks and nobles are not productive) - There is no perpetual export surplus (subsequent events will wipe it out). Should focus more on the sale of goods rather than gold accumulation) - Discovery and exploitation of rich mines of gold and silver and effect on: - Domestic prices - Wages - Rents - Domestic Supply - Imports - Exports 2.5.3 DAVID HUME | 1711-1776 - Friend of Adam Smith - He entered the University of Edinburgh at 12 years old and left at 15 without a degree. - Unorthodox thinking and skeptical - Adam Smith was nearly expelled from Oxford because a copy of Hume’s book was found in his room (A Treatise of Human Nature) - Economic Essay: Political Discourses (1752) - Historian: The History of England - Price Specie-Flow Mechanism - In the Western world, a prevalent term for coin money has been specie, stemming from Latin in specie, meaning ‘in kind.’ - Mercantilists promoted export surplus to accumulate species (gold), but this is self-defeating.  - Exchange rates between nations and currencies are free to fluctuate, and imbalance of trade tends to correct itself Hume’s Ideas Right Wrong International trade increases wealth and improves International Equilibrium: all countries will become standards of living (evidence: South Korea, Taiwan, equally wealthy because of international trade Singapore) (“International harmony of interest”) - Recognized that the strategy of cooperation may be optimal in situations where future interactions among two parties are likely. - Imports more than it exports; eventually, it will experience a decline in the value of its currency relative to others. - Wealth leads to improvements in health and education, increased social overhead capital, larger markets, and other benefits, which in turn result in the further expansion of wealth and income. Duopoly is a “repeated game.” - If X takes advantage of Y today, Y will take advantage of X in the future - Recognized that the strategy of cooperation may be optimal in situations where future interactions among two parties are likely. 3.1 ADAM SMITH - Born in Kirkcaldy, Scotland (1793) - Attended Glasglow College at 14 years old - Was a Logic Professor in 1751 - Published works: The Theory of Moral Sentiments (1759); An Inquiry into the Nature and Causes of the Wealth of Nations (1776) - He died in 1790, and most of his unpublished works were destroyed according to his wish. Adam Smith 3.1.1 ADAM SMITH’S INFLUENCES - The Age of Enlightenment (The Age of Reason) - Systematic Reasoning Ability - Natural Order - Ideas Influenced by the Physiocrats: - Wealth is “consumable goods annually produced by society.” - Minimal government intervention - Circular process of production and distribution - Physiocratic System for Adam Smith: “the nearest approximation to the truth that has yet been published on the subject of Political Economy.” Francis Hutcheson | 1694-1746 - Systematic Reasoning Ability - Natural Order - “People themselves could discover What is ethically good (will of God) by discovering the actions that serve the good of humankind.” David Hume | 1711-1776 Personal conversation with Hume influenced economic ideas and intellectual development. 3.2 THE THEORY OF MORAL SENTIMENTS | 1759 3.2.1 ON SYMPATHY We derive nothing from another’s happiness except Sympathy interests us in the fortune of others and the pleasure of seeing it. makes their happiness necessary to us. 3.2.2 ON WORK People are disposed to identify more with our joy People work not to supply their necessities but to than with our sorrow; thus, we parade our riches and gratify their vanities. conceal our poverty. 3.2.3 ON SOCIAL INTEREST AND RIGHT TO JUSTICE People can exist only in society; They are exposed to Mutual interdependence is a result of self-interest. mutual injuries and need one another’s assistance. But society is not always happy and agreeable. Thus, we need a justice system Moral faculties prescribe rules of conduct that restrain Violation of God’s rules will lead to self-condemnation our actions of selfishness. and inward shame. God promotes the happiness of human beings because the rich improve the lives of the poor for fear of self-condemnation and self-interest (invisible hand) 3.3 WEALTH OF NATIONS | 1776 | LAWS OF A COMPETITIVE ECONOMY 3.3.1 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 on one type of work only 3. Machines can be employed once tasks have already been simplified and made routine There’s an emphasis on manufacturing production and productivity of labor. - Mercantilists - exchange of goods - Physiocrats - agricultural output 3.3.2 HARMONY OF INTEREST Goods Market Labor Market The pursuit of self-interest, restrained by competition, Resources get allocated to their highest-valued uses leads to a social good (Max. output and economic (efficiency) growth) 3.3.3 ON GOVERNMENT (LAISSEZ-FAIRE) But for Smith, the government still has a significant - Wasteful role: - Corrupt  - Protect society from foreign attack - Inefficient - Administer justice - Detrimental to Society - Erect and maintain public works and institutions (private sector can not do) 3.3.4 ON STATE INTERVENTIONS - Patents and copyrights - Protectionist tariffs - Public works that promote commerce, education, etc. - Issuance of paper money - Interest rates - Ensure laws on agricultural tenancy - Proportional Taxes 3.3.5 ON INTERNATIONAL TRADE Absolute Advantage The government should not interfere in international Individuals and families should specialize in producing trade (Laissez Faire in International Trade) goods for which they have an advantage and trade goods for which other nations have an advantage. Foreign trade can promote greater division of labor (among countries) 3.3.6 ON VALUE “Value in use” (utility) “Value in exchange” (relative price) The Water-Diamond Paradox Smith did not solve the paradox of exchange value: the power that the possession of good provides to purchase other goods (“natural price” or relative price) Later, economists posted: “Do pearls have value because people dive for them (relative price), or do people dive for pearls because pearls have value (utility)?” Smith: exchange value = f (costs of producing) 3.3.7 LAWS OF A COMPETITIVE ECONOMY Labor Commanded Theory of Value (labor theory of value in a primitive society) - Relative value/price Labor is a source (labor cost theory) and measure - Natural price (Labor commanded theory) of exchange value. - Exchange value Assumption: land and capital are either non-existent = f (Quantity of labor) or free goods 3.3.8 VALUE THEORY IN AN ADVANCED ECONOMY Goods will be exchanged at a price high enough to ✓ Value = f (cost of production) cover wages, rents, and profits. X Value = f (demand) Assumption: land and capital are important Assumption: A perfectly competitive industry 3.3.9 ON MARKET PRICE Natural/Intrinsic Price - Long run price below which Market Price - Actual price at which any commodity is the firm no longer would continue to sell their goods sold Real Price Nominal Price Doubling prices will not increase a good command over labor if wages also double 3.3.10 ON AGGREGATE WAGES AND WAGE GROWTH Wage Fund Theory - There is a stock of circulating DL↑ - W↑, therefore, W= f(DL ,SL ) and DL ,SL=f(Y) capital out of which present wages are paid So Smith focused on capital accumulation and Ave. Annual Wage = Wages fund/Q of labor economic growth because… Minimum wages must be that which will enable a Y↑ - DL↑ - W↑ - Smith opposed Mercantilists worker with a family to survive and perpetuate the labor supply. Smith believes that higher wages will lead to improved health and strength of workers, thus greater productivity. Contemporary Economists: Economies of High Wages or Efficiency Wages 3.3.11 ON EFFICIENCY WAGES Higher wages result in: - Reduce shirking (avoidance or neglect of responsibility) - Reduce labor turnover Efficiency Wage Theories explain Frictional (wait unemployment) and Cyclical unemployment. Frictional - People remain UE until jobs paying Cyclical - During recessions, firms may lay off workers efficiency wages become available. rather than reduce efficiency wages. 3.3.12 ON COMPENSATING WAGE DIFFERENTIALS The Theory of Equalizing Differences - Advantages Actual wage rates for different jobs would vary and disadvantages of every type of employment would according to the following: be equal or tend toward equality - Agreeableness of occupation–difficulty - Cost of acquiring the necessary skills/knowledge (Theory of Human Capital) - Regularity of Employment - Level of trust and responsibility - Probability or improbability of success Blast Furnaces of Vizcaya Juan Luna 3.3.13 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↑ 3.3.14 ON RENT Rent = f (prices of goods produced) Not a single rent theory of Adam Smith is complete or entirely accurate. 3.3.15 ON THE ROLE OF MONEY AND DEBT Money is just a medium of exchange Money just facilitates the circulation of goods, but the production of goods is what constitutes wealth. Heavy Smith opposed mercantilists who claims that goods are taxes needed to pay interest on debts will induce firms soon destroyed, whereas gold and silver are durable to invest capital abroad. and should be measurements of wealth. 3.3.16 ON ECONOMIC DEVELOPMENT Smith distinguished productive and unproductive labor (service and showcasing of talents are unproductive acts) 3.4 ROBERT MALTHUS: A PESSIMISTIC VIEW OF POPULATION AND RESOURCES Robert Malthus was an English economist and demographer whose ideas on population growth and resource scarcity have had a lasting impact on economic thought. Thomas Robert Malthus 3.4.1 CLASSICAL VIEW Central Argument The human population grows geometrically while food production grows arithmetically. This imbalance inevitably leads to misery, famine, and disease as population outstrips resources - Positive Checks - These checks increase mortality rates: Famine, pestilence (disease), war, infanticide, later marriage - Negative Check - These reduce fertility rates: - Moral restraint: postponing marriage or limiting family size - Vice: prostitution contraception - Preventive Check - Actions taken to limit family size are seen as a more desirable way to control population growth than positive checks The Poor Law Debate Malthus opposes the poor laws, arguing that aid to the poor encourages population growth and dependency. He advocated for policies that discouraged large families. Subsistence Level The minimum level of food and necessities needed for survival. Malthus believes populations naturally gravitate toward subsistence levels. 3.4.2 IMPACT AND CRITICISMS Influence: Malthus’ ideas influence economic policy debates, social welfare discussions, and debates about resource management. Criticism: technological progress and innovation can increase food production. - Malthus underestimated the potential for human agency to control population growth. - His focus on subsistence living neglected the potential for economic development and improved standards of living Malthus also wrote about economic topics like rent and taxation. His ideas were controversial in his time and remain debated today. 3.5 DAVID RICARDO | 1772-1823 | CLASSICAL ECONOMICS AND DISTRIBUTION David Ricardo 3.5.1 CLASSICAL VIEWS Central Argument Ricardo focused on the distribution of income among landowners, capitalists, and workers. He believed that as society progressed, profits would fall and rents would rise, squeezing wages. Labor Theory of Value Ricardo subscribed to the labor theory of value, which argued that the value of a good is determined by the amount of labor required to produce it Theory of Rent Rent is the surplus value generated by land about the average return of capital invested in agriculture. As the population grows and less fertile land is cultivated, rents rise. Comparative Advantage Ricardo's theory of comparative advantage demonstrated the benefits of free trade, even when one country has an absolute advantage in producing all goods. Countries should specialize in what they produce most efficiently.