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Presentation Notes
Mercantilism
Era: 15th to 18th centuries
Key Economists: Gerard de Malynes, Thomas Mun, and Josiah Child
Key Publications: England's Treasure by Forraign Trade, or the Balance of our Forraign Trade is The Rule of Our Treasure (1664)
Main Ideas: Increase the wealth (gold) of the home country by promoting trade with colonies, exporting goods to other countries, and limiting imports from other countries
Imperial nations: France, the Netherlands, England, Portugal, and Spain.
National wealth based on gold in the treasury
They thought that national wealth was based on how much gold was in the treasury, so they sought to increase the level of that gold through trade. They wanted to maximize exports out of the empire and imports into the empire through protectionism. They also used colonies as a source for raw materials and a market for finished goods
Classical
Era: 18th and 19th centuries
Key Economists: Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus, and John Stuart Mill
Key Publications: Wealth of Nations
Main Ideas: Gains from trade, specialization, supply and demand, Say’s Law, Malthusian Trap, factors of production, national income being a country’s wealth and not King’s treasury
There is no coincidence that the Declaration of Independence and the Wealth of Nations were both published in the same year, 1776. The American Revolution is at its most basic level a colonial rejection of mercantilism in favor of classical economics. The Wealth of Nations itself did not introduce the ideas of classical economics, of free trade, but it most effectively synthesized these enlightenment ideas enough to demonstrate a completely different way to look at the world.
The very first chapter in the Wealth of Nations is about specialization of labor in a pin factory. He claimed rightly that if 10 workers were to do just one particular aspect of making a pin, they could produce an enormous number of pins in excess of what the ten could do individually, demonstrating the power of not only division of labor in production, but also specialization in general. Since a pin factory worker does not produce food, he must trade for food, and infringing on the ability to trade will prevent the factory worker from being able to devote his time to producing pins. This logically follows to the notion that free trade and free markets should extend internationally, tearing down borders. Smith also introduces another important term called the Invisible Hand which basically means that self-interest leads to furthering society. Basically, it is better for society to have a bunch of selfish people than selfless people.
Say’s most important contribution to economics is Say’s Law that says that Supply creates its own Demand. More simply, more production leads to more consumption. Keynes successfully refuted this law in some contexts.
Ricardo probably made some of the most important contributions to classical economics aside from Adam Smith.
Ricardian equivalence: Consumers save money to help pay down their portion of the government debt, meaning that increased government spending does not increase overall spending, refuting Keynes’ future logic.
Ricardo invented the idea of labor theory of value which means that the value of a good depends on the amount of labor invested in it.
Ricardian socialism is basically the direct predecessor to Marxism. The labor theory of value indicates that all wealth is created through labor, so all income should be allocated via wages, not via interest, rate, or profit.
Ricardo invented the idea of comparative advantage and absolute advantage, providing the mathematical logic behind why trade is good.
Ricardo invented the law of diminishing marginal returns which says that as a factor of production is increased, its marginal output decreases, explaining the upward sloping nature of the supply curve.
Ricardian rent forms the basis of Georgism, through stipulating the Law of Rent, that as the value of rent is equal to the advantage of choosing a certain tract of land over a rent-free tract of land. Rent is defined as the income coming from natural resources—this is an important definition that later gets distorted in neoclassical economics.
Thomas Malthus’s main contribution was the idea of the Malthusian trap which basically said that an increase in agricultural production is necessary for an increase in standard of living. However, because increased standard of living increases birth rates, the population expands to reduce the per capita agricultural production to what it was previously, meaning that long-run standard of living remains low.
John Stuart Mill was a utilitarian who believed in a flat tax rate for everyone, including on inheritance. He supported the idea of the Malthusian trap and believed in worker cooperatives.
Marxism
Era: 19th century (introduction), 20th-21st in practice
Key Economists: Karl Marx and Friedrich Engels
Key Publications: Das Kapital, Communist Manifesto
Main Ideas: Class struggle, exploitation of the worker, surplus value (bourgeois profit off the backs of workers), labor theory of value
From a historical perspective, it is important to understand that Marxism and the Communism put into place in the Soviet Union, China, and other countries are not the same thing. Marxism has never actually been put into place, so don’t dismiss Communism for its failure in the Soviet Union in 1991. (I do not support Marxism). The economic foundations of Marxism are theoretically sound. The late 19th century was a period of exploitation of workers. Wages were low and standard of living were low for workers—“the proletariat”—while business owner—“the bourgeois”—bathed in cash. The reason for this was because of the labor theory of value, which Ricardo invented. Marx knew that the bourgeois would pay the proletariat enough to keep them alive, not enough to compensate the workers for what they created. Therefore, if a worker creates enough to survive after 4 hours of worker, the remaining 8 hours of work on the shift would go to the bourgeois as “surplus value.” Marx thought that this system was not sustainable. That’s all there is to it. And he was right with the development of populist, socialist, and progressive movements throughout the Western world. What Marx got wrong was that he thought the change would come in revolution when it actually came from evolution.
Georgism
Era: 19th century
Key Economists: Henry George, Joseph Stiglitz
Key Publications: Progress and Poverty
Main Ideas: Unearned income, harms of inequality, Single Tax on land as the only efficient tax
A lot of you know that Henry George is my favorite economist and that I support—to an extent—many of his ideas. Henry George really is the last classical economist, but I separated him from the rest of the classical economists because of his emphasis on inequality and provision of a fix. He based his theory on the classical Ricardian idea of economic rent that income comes from owning land. Classical ideas held that this income is unearned and is a store of wealth and that a tax on rent would not cause economic inefficiency. Henry George was important because he was a crusader for a tax on rent, explaining to the public why it was an efficient tax and why it was important to reduce inequality.
Joseph Stiglitz introduced the Henry George Theorem which states that government spending increases land values and rent more than the amount of the spending, which means that since government increases land values, putting the burden of a tax on land values is logical and sustainable.
Neo-Classical Economics
Era: 19th and 20th Century
Key Economists: Carl Menger, John Bates Clark, William Stanley Jevons, Léon Walras, Vilfredo Pareto
Key Publications: William Stanley Jevons’s Theory of Political Economy (1871), Carl Menger’s Principles of Economics (1871), and Léon
Main Ideas: Rational choice, consumers maximize utility and producers maximize profits, modern microeconomics, supply and demand determine price, Pareto principle, Pareto efficiency
Neo-classical economics is basically modern microeconomics. In contrast to classical economics which thought that good value comes from the cost of production, neo-classical economics thought it came from supply and demand curves, emphasizing utility and demand in what is called the marginal revolution. Neo-classicists believed that consumers maximize utility and producers maximize profits.
Pareto was an Italian economist who invented two important notions. First is the Pareto principle which looks at distribution of wealth. Pareto thought that 20% of the Italian population held 80% of the land and therefore wealth. This leads to the 80/20 rule. Pareto also introduced Pareto efficiency which is the ideal state of production such that changing the allocation of resources to make someone better off will make someone worse off. A Pareto improvement is a reallocation that does not make someone worse off. Pareto efficiency is therefore the optimal level of efficiency such that no more Pareto improvements can be made—the allocation is at its best possible state.
Historical Schools
Era: 19th and 20th century
Key Economists: Gustav con Schmoller, Max Weber, and Joseph Schumpeter.
Main Ideas: History was the key source of knowledge, economics is culture-specific and not universal, social policy to cope with industrialization, creative destruction
Historical economists based their analysis from history, rejecting classical and neo-classical logic-based analyses. Most of these economists including von Schmoller mainly focused on policies to help workers cope with the changes resulting from industrialization.
Schumpeter looked at creative destruction which basically stipulated that when the economy changes due to innovation, the previous economic system—including business owners—gets destroyed. As a result, business owners have a reason to fear and politically oppose economic innovation that could result in a change of the entire system.
Austrian:
Era: 19th and 20th century
Key Economists: Carl Menger, Eugen Bohm von Bawerk, Friedrich von Wieser, and Fredrich Hayek
Main Ideas: Marginalism, methodological individualism and subjectivism, tastes and preferences, opportunity costs, consumer sovereignty, and political individualism
There is a lot of overlap between the neo-classical and Austrian schools, especially when it comes down to marginalism, of which Carl Menger was extremely influential. Menger’s work in marginalism not only sparked neo-classicism, but also led him to be considered the founder of Austrian economics.
Methodological individualism and subjectivism is the idea that groups do not make choices—individuals make choices based on judgements derived from knowledge, expectations, time, tastes and preferences, and opportunity costs.
Consumer sovereignty means that consumers decide what should be produced because consumers are the ones who buy stuff.
Political individualism means that economic freedom leads to political freedom.
Keynes introduced and popularized the notion of macroeconomics. It is important to understand that his work came during the Great Depression. Keynes wanted to preserve capitalism and free markets and knew that without an improvement in the economy, the free world may turn to fascism or communism like Italy, Germany, Spain, and the Soviet Union.
Keynes’s most important invention was the AD-AS model which looked at the total demand and supply across the economy. Keynes held that there can be an equilibrium production below potential output as long as short-run AS intersected with AD at a value less than long-run AS, meaning that the economy could theoretically stay in a depressed state for a long time until wages shifted. As Keynes so eloquently put it, waiting for AS to shift toward its long-run spot takes too long and we are all dead in the long-run. As such, Keynes proposed that government can spend money in fiscal policy to bring the economy out of depression and toward equilibrium. The government spending turned had a larger effect on AD than the spending itself because of the Keynesian multiplier which is 1/MPS. The reason that depressions result in unemployment is because wages are sticky—workers oppose wage cuts. Since employers can no longer afford to pay so many workers, they fire some workers.
Keynes also looked at the origin of depressions. He thought that they result from a decrease in investment spending compared to saving, meaning that money was sitting in the bank instead of being put to use consuming. Therefore, consumption decreases and there is unemployment.
Monetarism
Era: 20th century
Key Economists: Milton Friedman
Key Publications: Capital and Freedom, A Monetary History of the US
Main Ideas: Monetary policy should target growth of money supply, MV=PQ
The money supply equation is essential to monetarism. PQ (price times quantity) basically means the country’s GDP. It is apparent that money needs to buy that GDP, but there is a) not enough money in circulation to buy the GDP, and b) money gets reused over the course of a year. Therefore, GDP equals the total amount of money supply (M) times the number of times each unit of money gets reused (velocity of money or V). Since velocity is typically stable, monetarists thought that the central bank should increase the money supply based on the expected increase in quantity produced plus the target inflation rate, be it 0% or 2%. For example, if a 3% increase in quantity of goods is expected and the Fed wants to keep to its 2% inflation target, the Federal Reserve should expand the money supply by 2%+3%=5%.
Behavioral Economics
Era: 20th and 21st century
Key Economists: Richard Thaler, Amos Tversky, Daniel Kahneman, Robert Shiller, Dan Ariely
Before behavioral economics, economists generally thought that actors in a market were rational beings. Behavioral economists know that people are not rational, so this school developed to propose how psychology effects economic reasoning.
Three main subjects of behavioral economics include heuristics which are basically rules of thumb, framing which is the idea that anecdotes can filter how actors can view data, and market inefficiencies based on mispricing and non-rational decision making.
Bounded rationality is basically the idea that depending on the situation, people do not have the ability to be rational, especially depending on available time and cognitive limitation. Prospect theory is basically how people view risk. For example, losses hurt more than gains reward. Intertemporal choice is about how people make decisions based on when the effects of the decisions occur. For example, people are less likely to save for retirement in their twenties than they are in their sixties because later in life, the idea of retirement is more immediate.