The Classical Background

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The Classical Background. “Classical Economics” 1776-1870s: Adam Smith, David Ricardo, J. S. Mill Concerned with issues of long run growth and of maintaining growth Consequences of growth for distribution of income
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The Classical Background
  • “Classical Economics” 1776-1870s: Adam Smith, David Ricardo, J. S. Mill
  • Concerned with issues of long run growth and of maintaining growth
  • Consequences of growth for distribution of income
  • Policy concern with removing barriers to growth created by unwise government legislation
  • Major Components of Classical Economics
  • Theory of exchange value based on labour time or cost of production.
  • Water diamond paradox; use values not comparable.
  • Theory of Natural and Market Price and adjustment to Natural Price
  • Wage Fund Theory of Labour Demand
  • Population theory of labour supply and the subsistence wage
  • Major Components of Classical Economics
  • Theory of Rent and diminishing returns in agriculture
  • Ricardo’s corn model of falling rate of profit and eventual stationary state
  • Say’s Law
  • Tendency to equilibrium at full employment
  • Monetary factors as disturbing causes
  • Theory of gains from trade
  • Comparative advantage
  • Terms of trade
  • Challenges to Classicism:Internal Weaknesses
  • Theory of exchange value
  • Problems of cost side theories
  • J. S. Mill—cost of production of the most costly portion
  • Wage Fund Theory
  • J. S. Mill’s “recantation” of the wage fund theory
  • New Issues
  • Economies of scale and growth of industry
  • Business Cycles
  • Challenges to Classicism:German Historicism
  • Reaction against the non-historical nature of Ricardian economics
  • Different principles apply to different times and places
  • Evolutionary and theories of economic stages
  • Organic analogies
  • Importance of institutions, law, and ethics
  • German Historicism
  • National policy and role of the state
  • Historicism a major influence in Germany, America, and to a lesser extent in England
  • Historicism was a major influence from 1860-1880s
  • Economic History, empirical studies, social reform
  • Challenges to Classicism:Marxism
  • Marx used the labour theory of value to argue that profit came from the exploitation of labour
  • Labour was paid less than the value of its output
  • Elements of Classical economics used to cast a very negative light on capitalism
  • Marxism became influential in the 1880s, Socialist parties, labour unrest
  • Challenges to Classicism:Romanticism
  • The “romantic” critics of economics included Carlye and Ruskin
  • Saw economics as concerned only with material ends and not with anything “higher” or more spiritual--a narrow economic man
  • Concerned only with market valuations
  • Carlye and Mill and the “dismal science”
  • New Techniques: Forerunners of the Marginal Revolution
  • Marginalist ideas and analysis were being developed in Europe well before 1870 and the Marginal Revolution
  • Daniel Bernoulli (1700-1782)
  • Diminishing MU of income and the analysis of expected utility
  • William Gossen (1810-1854)
  • Gossen’s “First Law”: law of satiable wants. Implies diminishing MU
  • Gossen’s “Second Law” conditions for a utility maximum
  • Forerunners of the Marginal Revolution: Dupuit
  • Jules Dupuit (1804-1866)
  • Measurement of the utility of public works
  • Different people have different valuations of a good
  • Willingness to pay and consumer’s surplus
  • Setting of tolls to finance public utilities
  • DupuitPConsumer’s surplusPWillingness to payQQTollT x Q = cost of projectCS = benefitCSTQQForerunners of the Marginal Revolution: Cournot
  • Augustin Cournot (1801-1877)
  • Early pioneer of the mathematical approach
  • Law of demand expressed as a general mathematical function: D=F(P)
  • D varies inversely with P
  • Continuous function
  • Analysis of monopoly, marginal revenue and profit maximization
  • Cournot
  • Cournot’s analysis of duopoly
  • Each firm sets an output given the output of the other
  • Reaction functions leading to an equilibrium
  • Cournot equilibrium is where each firm is doing the best it can given the other firm’s output
  • Example of two mineral springs with zero production costs
  • Market demand function P=100-Y where Y is total output of both firms
  • Profit for firm 1 = PxQ1
  • or Q1(100-Q1-Q2)
  • Profit for firm 2 = Q2(100-Q1-Q2)
  • CournotP10050MRD50100Monopoly solution: Q1=50; P=50; Profit=250If second firm enters and takes Q1 as given It will produce where it max Q2(100-50-Q2)Which is at Q2=25.Given Q2=25 firm 1 will adjust in order to maxQ1(100-Q1-25)= 37.5These reactions continue until an equilibrium isreached CournotReaction functions and Cournot equilibriumQ2100Q1 given Q250Cournot equilibrium33.3Q2 given Q133.350100Q1Reasons for the Marginal Revolution
  • Decay of Classical economics
  • New techniques of marginal analysis
  • An answer to Romanticism
  • Utility maximization can accommodate ends other than purely material ones
  • An answer to Historicism
  • Menger and the “Methodenstreit”
  • An answer to Marx
  • Marginal productivity theory
  • Analogy to physics and use of calculus
  • Related Search
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