History of Economic Thought
Monday 26/03/2022 Newsletter Edition: 001
Adam Smith: The Father of Economics
Table of contents
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Introduction Law of Population
01 Smith: The Economist 04 Growth Theory
Government and The
Law of the Market
02 How Free Market Works 05 Economy
Smith and the Government
Law of Motion
03 Growth Theory
06 Value Theory
The Daily News
Monday 26/03/2022 Newsletter Edition: 001
01
Introduction
Smith: The Economist
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Typical early economic writers – he was not exclusively
an economist.
He was an academic, this allow him to a degree of
detachment and objectivity – as opposed to the
mercantilist writers.
His great strength as an economist lay in his visions:
Of the interdependence of the segments of the economy –
Law of the Market
Of the policies to be followed to promote the wealth of a
nation – Law of Motion
Smith: The Economist
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● It is in no sense a textbook.
● AS is expounding a doctrine that is important in
running an empire.
● It is a revolutionary one.
● AS interest: promoting wealth of the entire nation.
● Wealth: consists of the goods that all the people of
society consume, although not in equal amount.
His Methodology
● AS adopted a contextual approach.
● Based on his observations of the existing historical and institutional circumstances.
● Advocacy of laissez-faire is rooted in the approach that asked this question:
○ Does experience show that government intervention will produce better results than will free markets?
The Daily News
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02
Law of the Market
Law of the Market
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● Issue: what is the
mechanism by which
society hangs together?
○ Everybody is following his
own self interest
○ No central planning ● How the drive of individual self-interest in an
environment of similarly motivated
authority
individuals will result in competition;
○ No influence of age-old ● Competition leads to provisions of goods that
tradition society wants, at the desired quantities; at the
right prices.
“A picture is worth a
thousand words”
COMPETITION
Insights PRICE REGULATOR
Producers that overcharged will be crowded
out of the market. Only the efficient ones
survive. Collusion? Others will come in.
• How prices are kept from
ranging arbitrarily from the
cost of production.
• How society can induce its
producers of commodities
to produce what it wants
• Why high prices is a self-
curing disease.
QUANTITY REGULATOR
• AS has found in the .Higher prices mean more demand. Resources
will move into the highly demanded sector.
mechanism of the market a
self-regulating system for
society’s orderly
INCOME REGULATOR
provisioning. Businessmen will rush into the industry that
provide unduly large profits Competition then
will lower surpluses.
Workers – flock into occupations that pay
greater than average; till it pays no more than
comparable jobs of similar skills and training.
Price: Market vs Natural
● The actual price at which any commodity is commonly sold is called its market price.
● Market prices are just a descriptive category, they can go up or down for a variety of reasons.
● Adam Smith: natural price - price that is adequate to pay workers, capitalists and landlords their natural wages, profits and
rents, respectively.
● ‘natural’ signifies a result that emerges from the operation of free competition and it is found to be in conflict with self-
interest.
● central price towards which the market prices are continuously gravitating.
● When a commodity is sold at its natural price, there will be a quantity of that commodity that will be in demand (‘effectual
demand’)·
● The role of effectual demand in Smith is to interpret the attraction of the market price of commodities to its natural price
and not to determine the natural price.
Smith: The Economist
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Smith: The Economist
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Does the world really work this way?
○ It did at least during AS days.
○ Atomistic competition
○ No agents could resist the pressure of
competition
○ Average factory was small, prices did rise and
fall as demand changes
○ Changes in prices did change output level and
employment.
The Daily News
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03
Law of Motion
Law of Motion
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Law of Accumulation Law of Population
What is it that drives society to the multiplication of Surmounting the hurdle of accumulation
wealth and riches?
AS’s era: rising industrial capitalist could and did realize
a fortune from his investment.
Example: Richard Arkwright (500,000), Samuel Walker
(200,000), Josiah Wedgwood (240,000)
Charity contribution considered as unproductive
Wealth
Monday 26/03/2022 Newsletter Edition: 001
Wealth: goods that all the people of the society consume,
although not, of course, in equal amounts.
Gone is the notion of gold, treasures, prerogatives of
merchants and working guilt.
It is the flow of goods and services consumed by everyone
that constitutes the ultimate aim and end of economic life.
Smith defines wealth as the per capita provision of
“necessaries and conveniences”
Wealth of Nation
Productive Labor Unproductive Labor
Division of Labor Capital Accumulation
Capital
Extent of the Market
Accumulation
Capital
Accumulation
Division of Labor
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● The greatest increases in productivity of labour seem
to have been the result of the division of labour.
● Example of a pin factory—Smith is talking about vast
productivity increases (output per worker from 20 to
4800 pins a day)
● Division of labour increases productivity by:
○ Learning by doing
○ Time saving
○ Possibility of the introduction of machine
Limits of Division of Labor
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● The division of labor is limited by the extent of the market
and level of capital accumulation.
● Division of labor is taken further in large towns than in
small villages.
● The larger the market, the greater the volume that could be
sold and the greater the opportunity for division of labor.
● Importance of transportation and of trade for the extension
of the division of labor
● Geographic isolation and sparse population reduces scope of
the division of labor.
● Extols virtues of waterways, canals and growth of
transportation as increasing the extent of the market and, so,
enhancing the Division of Labor.
Role of Capital Accumulation
● Capital provides means to support consumption
between the time when production begins and
production ends. Capital
● Production is a time consuming process. Accumulation
● Function of the capitalists.
● Thus the extent of specialization also depends on
the amount of capital available.
Economic Division of
● The major constraint on economic growth is Growth Labor
capital accumulation
● Capital has to be accumulated before division of
labor can take place
● Importance of security of property for capital
accumulation
Increased
Productivity
Capital Accumulation and Productive Labor
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● Large part of capital accumulation is in the form of the “ A man grows rich by employing a multitude of
wage fund and is used to hire labor manufacturers, he grows poor by maintaining a
multitude of menial servants.”
● Productive labor produces a return and “replaces a
capital” “Capitals are increased by parsimony and
diminished by prodigality and misconduct”.
● Unproductive labor does not produce a return and
“consumes a capital”
Affected Smith’s views of the role of the government
● Labor used in agriculture, manufacturing or trade is in the economy.
productive
● Labor such as servants, musicians, clerics, soldiers,
even teachers are unproductive
“The annual produce of the land and labor of any nation can be increased in its value by no other
means, but by increasing either the number of its productive laborers, or the productive powers of
those laborers who had before been employed. The number of its productive laborers, it is evident,
can never be much increased, but in consequence of an increase of capital, or of the funds destined
for maintaining them. The productive powers of the same number of laborers cannot be increased,
but in consequence either of some addition and improvement to those machines and instruments
which facilitate and abridge labor; or of a more proper division and distribution of employment. In
either case an additional capital is almost always required”.
Limits of Accumulation
How is this hurdle surmounted? Capital Accumulation
Law of Population
Increase
Increased Demand
for Resources
Higher Wages
Profit Reduced
Law of Population
Monday 26/03/2022 Newsletter Edition: 001
● Labors, like other commodity, could be produced according to demand.
● If wages were high, number of labors would multiply. If wages fell, the number of the working class would
decrease.
● Smith’s days: infant mortality was shockingly high.
○ It is common for a mother who has borne 20 children not to have 2 alive.
○ In many places in England, half of the children died before they were 4. Almost everywhere, half of
them live to they age of 9 or 10.
○ Due to malnutrition, evil living conditions, cold and disease.
● Higher wages: considerable impact on children who would survive until working age.
Law of Population
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Capital
Accumulation
● Immediate impact of accumulation: wage Increase
increase.
Demand for
Profit
Labor
Restored
● This would lead to an increase in the Increase
number of workers.
● Market mechanism took over.
● Downwards pressure on wages.
● Population is a self-curing disease as far as
wages are concerned. Wage Wage
Decrease Increase
Population
(Labor)
Increase
Growth in the Long Run
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● Growth would come to a halt. ● What happen after that?
● When?
○ When society had run out of unused ○ Working class and the wages: Wages at
resources and introduced as fine a subsistence level but working class
division of labor as possible. would improve its lot.
○ Economy had extended its boundaries ○ Capitalists: Very modest profit of a
to their limits and then fully utilized stable market
its increased economic space. ○ Landlords: Might enjoy higher income
○ 200 years as the longest period over as food production remained at the
which society could flourish. levels required by a larger population.
History of Economic Thought
Monday 26/03/2022 Newsletter Edition: 001
04
Government and the Economy
Government in the Economy
Monday 26/03/2022 Newsletter Edition: 001
● Smith’s idea was well-received by the rising ● 3 things that the government should do:
capitalists. ○ Protect society against the violence and
● They found the theoretical justification they invasion of other societies.
○ Provide an exact administration of
needed to block government intervention in
justice for all citizens.
the market.
○ Erecting and maintaining those public
● Adam Smith’s laissez faire doctrine:
institutions and those public works
● Least government is certainly the best:
which may be in the highest degree
governments are spendthrift, irresponsible advantageous to a great society,
and unproductive. ○ Education and roads.
Government in the Economy
Monday 26/03/2022 Newsletter Edition: 001
● ● Great enemy to Adam Smith’s system:
What Smith is against:
○ Restraints on imports and ○ Monopoly
bounties on exports
■ Impede the fluid of the market
○ Laws that shelter industry from
competition
■ Lowers social welfare
○ Spending for unproductive ends
■ Monopolies of foreign trade
History of Economic Thought
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05
Value Theory
Value Theory
Monday 26/03/2022 Newsletter Edition: 001
Labor Cost Theory Labor Command Theory
● If goods are produced with only a single
● Primitive society, cost of capital and type of labour and with no capital or
land is zero. private property in land—exchange
values will be determined by relative
● Price of a good = quantity of labor quantities of labour
required to produce it.
● If it takes “twice the labour to kill a
beaver than a deer” then 1 beaver will
● How is the issue of skill differential exchange for 2 deers
could be addressed?
● 2 hours to capture 1 beaver. 2 hours to
● Fail to resolve the issue, just a capture 2 deers. Than, the price of a
restatement of the existing problem. beaver = 2 deers.
Value Theory
Monday 26/03/2022 Newsletter Edition: 001
● Cost of Production Theory
○ LCT is not suitable for his time of an advanced economy, where capital has been accumulated
and land has been appropriated.
○ Final price has to include profits to capitalists as well as rent to landlords.
○ Final prices = income made up of the factors payments.
○ Value of goods = payments to all factors of productions, including land and capital in addition
to labor.
○ The term profits include profit as understood today and interest.
Smith: A Summary
Monday 26/03/2022 Newsletter Edition: 001
● Smith – economist of preindustrial capitalism. The great panorama of the market remains as a major
achievement.
○ Market system threatened by giant
corporations He was not the first to discover the market – but he was
the first to understand the full philosophy of action that
○ Law of accumulation and population
such a conception demanded.
upset by sociological developments
He was the first to formulate the entire scheme in a wide
and systematic fashion.
● The world he wrote really existed – he presented
a brilliant analysis of its expansive propensities. He was much more than just an economist.
He was a philosopher – psychologist – historian –
sociologist.
Included human motives, historic stages and economic
mechanism in his Great Architecture of Nature.
