History of economic thought

Ch 1 and 2
The history of economics
Paralleling the evolution of economy, economics also evolves. Economic theories always incorporate
ideas and values- they all aim to criticize/justify particular economic arrangements. Economics responds
to the controversies/issues that arise in experienced in economy.
The politics of economics
There is no objective truth in economics. Economic theory has tried to keep up with changes in
economy. Eco debates have always reflect real world struggles and conflicts.
Map of the course
Classical era- progress made in macro economics in studying the interconnections b/w various sectors of
the economy.
Marginalist era- progress made in microeconomics, in studying how rational behavior in consumers and
businesses looks like and this affects economy as a whole.
Current era- progress made in presenting mathematical precision as an acceptable way of making
economic argument.
Main Periods in the Economic History
Pre Classical
Classical
Marginal Revolution
Neoclassical Economics
Keynesian revolution
Formalist economics
Before Adam Smith: Pre Classical Economics
The economic knowledge that existed prior emergence to the Classical school:
Every day experience, scholastic philosophy, Mercantilist writings.
Pre-Classical Economics
Common place economics
Some econ ideas well known to people that no sense that to figure out who came up with them.
Examples Successive units of a commodity are less and less needed. Abundance reduces prices and
scarcity increases them. Demand is inversely related to price and supply is directly related. Fertile, better
located land earns more rent. Trade occurs because natural resource endowments vary from place to
place.
Scholastic Economics
In Middle Ages some economic thinking was carried out by Catholic priests and thinkers in the then
emerging universities. Initial motivation to address ethical issues such as interest payments. (forbidden
by church came to be regarded as unavoidable. The scholastics compromised with church doctrine by
legitimizing interest by justifying the lenders cost in terms of risk of default by the debtor.) Thus
philosophers considered not so much to describe how economy works but to provide advice on morally
acceptable behavior in economic relations.
Mercantilism
The school of thought arose in England during 16
th
to 18th century. Many of the member of this class
were merchants hence the name mercantilists. Most European economists who wrote b/w 1500 and
1750 gen considered mercantilists. Originally word mercantile system the word mercantilism came from
German to English in 19
th
century. Mercentilism dominated the econ policy of western Europe.
It includes national eco policy of accumulating monetary reserves through a positive balance of trade
esp for finished goods. Promotes governmental regulation of national econ for purpose of augmenting
state power at the expense of rival nations.
Main themes:-
Ultimate objective of policy is political power of the state both internal and external.
The power gained by one state is inevitably associated by the power lost by another state both internal
and external. Therefore interest nation states are perpetually in conflict. A nations power is measured
by its population or the stock of precious metals such as stock of gold and silver embodied in the money
at use at that time. High population could provide for soldiers. Money( in the governments coffers)
could be used to maintain large armies and navies. A rich treasury could only come from trade and
industry. This prosperity could be bought about if the economys stock of money was large.
An econ policy thought to be form of econ nationalism. The prosperity of nation dependent on supply of
capital and global wealth was fixed. Trade was therefore always going to produce winners and losers.
Mercantilist suggest that ruling government should advance these goals by protectionist measures of
encouraging exports and discouraging imports. Theory dominated western European economics b/w
1500s and 1700s.
Economic assets ( gold, silver, trade) held by the state. Increase through positive balance of trade with
other nations.
Policies
Colonization( market can only produce raw material, trade with Britain only)
Extensive Protectionism(to limit imports and increase exports)
Regulations on domestic production, focus on exchange.
Every inch of a countrys soil be utilized. All raw materials found in a country used in domestic
manufacture since finished goods have a higher value. Large working populations be encouraged. That
all export of gold and silver be prohibited. All imports foreign goods be discouraged as much as possible.
Imports should be confined to raw materials. If imports are indespansible then they be exchanged for
other goods instead of gold+silver. Oppurtunities be sought for selling a surplus of gold and silver. No
importation if such are supplied at home.
England began the first large scale integrative approach to mercantilism during Elizabeth era. The era
featured various disjointed efforts to develop a fleet capable challenging Spains dominance on trade.
These efforts organized national resources in defense of England against the larger and powerful
Spanish empire eventually helping Britain to establish a global empire(in 19
th
century).
Mercantilist thinkers
Thomas Mun-
Initiated a shift of focus from bilateral positive balance of trade to overall positive balance of trade.
Supporting foreign trade by means of more exporting than importing. Advocated use of wastelands and
idle labor to produce imports (import substitution).Lowering of duties on foreign raw materials. Exports
of goods with inelastic demand. One of first to recognize exportation of service or invisible item.
Sir William Petty
Major contribution that holds relevance for later thought is that he advocated use of statistical
techniques to measure social phenomena like population and income. He advocated the 10%
unemployment rate. Similar to Keynes believed government should intervene to generate employment.
Land and Labour Theory Value
Developed an input based theory. All things ought to be valued by natural denominations: land and
labour. What will be the price of a good? Unit Cost FOPs( land, labor, capital, raw material)
Capital and raw materials were themselves made out of raw materials so these could be regarded as
land and labor in disguised forms. So the long run price of a good is the cost of and labor used directly in
the production of the good. And the land and labor used to make the capital goods which were used to
make the good.
Numerous French authors made French policy regarding mercantilism. French mercantilism was best
articulated by Jean Baptiste Colbert. He implemented mercantilist policies in France, main goal to
increase power of king/state. Believed volume of world trade was fixed. So a gain in position of France
had to come at expense of England/Netherlands. Advocated state regulation, promotion of
manufacturing through subsidies and tariffs.
Under him French government heavily involved in econ to increase exports. Protectionist policies were
enacted that limited imports and favored exports. Industries were organized into monopolies.
Protection was regulated by the state through a series of over 1000 directives outlining how products
should be produced. To encourage industry foreign artisans and craftsmen were imported. Also worked
to reduce internal barriers of trade by lowering internal tariffs and building an extensive network of
roads and canals. Also encouraged population growth. Encouraged immigration of skilled workers,
discouraged emigration to keep wages low so that French exports would be cheap. (State heavily
regulated French businesses in order to boost quality of exports. Tax rates raised to pay for war). The
allocation of monopoly rights and use of tariffs was to favour political allies and increase power.)
Critics of mercantilism in France
(Pierre le Peasant)Seigneur de boisguilbert an important critic of mercantilism. He blamed the decline in
output in reign of Louis XIV due to high taxes. Pointed out taxes reduce the productivity of the economy
and more tax revenues for govt did not necessarily mean high after tax income for taxpayers. If tax
system is designed in such a way to take care of ve effects of taxes on productivity then gov can
increase revenues without decreasing after tax income of taxpayers. Idea now championed by taxpayers
called supply siders.
Boisguilbert for the free market. He also said that free market economy left to itself settles to a stable
outcome and does not become chaotic. So there was no for government to meddle. Though buyers and
sellers both motivated by profits the needs to buy and sell make them listen to reason. So the
governments role is only to provide security and justice.
Gregory King discussed the now widely used concept of price elasticity of demand and used data on
prices and sales of wheat to establish for the PED of wheat.
Giovanni Botero published a theory of population that was the same as the theory for which Thomas
Malthus gained fame. Population tends to grow without limit, food supply is however limited. Therefore
pop growth ultimately slowed through war, famine.
Building on the idea that countries trade because not all countries can grow everything mercantilists
built a theory that came close to principle of comparative advantage for which david Ricardo is famous.
Samuel fortery explained that we should produce what foreigners want if that would allow us to import
of more of what we need then we could produce at home.

What is value of a good?
Short run price of a commodity fluctuates around its long run level. Sudden changes in demand and
supply make the price diverge from the long run level.
The long run price of a commodity is the unit cost of production which in turn is the cost of land and
labour and other raw materials used in the production of the good.