Chapter 2. Economic Methodology and Normative Principles

Lecture Notes of Jovi Dacanay
CHAPTER 2. NORMATIVE AND POSITIVE PRINCIPLES IN ECONOMICS
2.1 NORMATIVE PRINCIPLES ON VALUE THEORY, JUST PRICE AND EXCHANGE-VALUE

DETERMINATION
Objective: This chapter has the following aims
1. To provide a basis for normative analysis parting from the mainstream economic results of value theory. The
basis for normative analysis tries or attempts to explain implications of the assumptions from mainstream
economics particularly along the line of allocative efficiency and fairness.
2. With a knowledge of the conclusions from mainstream economics, this chapter also attempts to link Catholic
social thought with the normative implications, especially from the point of view of a just price and a just
income, of value theory
2.1.1 VALUE THEORY (EXCHANGE-VALUE DETERMINATION) AND THE JUST PRICE
1. VALUE THEORY. Refers to that factor which any good can command when exchanged in the
market place. It is therefore an exchange-value determination when we view the value of a good in
economic theory.
 It is the price or valuation of a good derived from any form of exchange. Such an exchange
is ruled by commutative justice, that is, an exchange of goods and services mutually
considered as equal in value by the contracting parties in the act of exchange. It reflects the
significance of things exchanged in relation to need, i.e. desirability and utility as well as
fluctuations in supply, i.e. scarcity.
 Price is a value that reflects the significance attached to the good desired in relation to all other
uses of the money in the buyer’s assessment. In short, price makes possible the articulation of
the ineffable subjective evaluations in tangible terms. Price makes subjective evaluations
publicly accessible.
 In the absence of the price mechanism, as in barter, some other measure of value is employed.
The cost of inputs or tools employed in acquiring or producing a good plus the labor invested in
that activity is perhaps a good substitute for price in barter situations. But the main
consideration is a subjective evaluation based on the needs of each of the parties in the
exchange. Such a valuation includes very subjective factors such as risk and other costs borne
by the valuing party.
 Objective valuation: labor and other inputs
 Subjective valuation: reflects the significance attached to the good desired in relation to all
other uses of the money in the buyer’s assessment. Opportunity cost. Risk.
 Adam Smith was ambiguous in his definition of exchange value of a good. Adam Smith
characterized labor itself as a good deemed to have value for its own sake. Accordingly, the
gains of any exchange can be measured only by the labor expended in obtaining the good
that was given up in the exchange. This formulation of value, as a labor theory, was used
by Ricardo and provided Karl Marx ample room to transform it into the thesis that the labor
embodied in the final product is the ultimate and objective measure of value.
 Ricardo notes that not only the labor applied immediately to commodities affects their value, but
also that which is bestowed on the implements, tools and buildings with which such labor is
bestowed. He further notes that exchange values are in proportion to the labor bestowed on
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their production; not on their immediate production only, but on all those implements or
machines required to give effect to the particular labor to which they are applied.1
 Adam Smith, however, was just interpreting the added value to a good brought about by labor
expended on it.
 St. Thomas, through a study of his writings, has denoted how just price can be conceptualized.
His concept of the exchange value of a good is that price or valuation mutually achieved by
contracting parties, valued from the utilization of tangible measures such as labor and expenses,
within a framework of subjective economic value and ruled by commutative justice. This
concept of valuation of a good allows a market or economic exchange to occur even in the
absence of prices.2 Thus, Aquinas discussed exchange value in the context of commutative
justice so as to show analytically how price is determined. 3
 Thomistic value theory is more akin to the current or economic mainstream theory of value
expounded by Gerard Debreu and Kenneth Arrow. The Arrow-Debreu conceptualization of
value incorporates the marginalist and Marshallian theories of value. 4
 The marginalist (i.e. Carl Menger, Jeremy Bentham, Jevons, Leon Walras) school of
thought derives value solely from the satisfaction coming from consumption. The cost of
production does not determine exchange value. The price of factor inputs is set only after
the exchange value of the commodity has been determined; factor prices, therefore, are
merely derived fro the utility value of the goods. Exchange value is thus utility determined.
 Alfred Marshall, on the other hand, uses both the cost of production and consumer utility.
His original contribution is the introduction of time as an important parameter in value
determination. He proposes three time periods: the market time, the short term, and the
long term. Market time refers to a very short period where supplies are fixed and price is
determined subjectively by demand factors alone. In the short term, it is possible for
producers to increase the supply of goods, but only at a higher cost because resources
cannot be readily shifted between industries given the time constraint. In this case, the
supply curve is upward sloping, and both demand and supply factors determine the market
price. In the long run, all factors of production can be moved across industries; there are no
fixed costs as everything is variable. Consequently, value is determined chiefly by the cost
of production, that is the supply curve. Note that assuming a constant cost industry, the
supply curve is strictly horizontal and value is determine solely by the supply curve.
2. JUST PRICE. The heart of scholastic teaching on exchange-value determination is its notion of the
just price. The demands of justice in exchange are satisfied when the contracted price is equal to
the true economic value of the goods and services traded. Different types of goods are traded in
proportional reciprocation, that is, in proportion to their economic value. The difficult task, is
finding out what constitutes this true economic value. Is this value determined by the cost of
producing it or by the worth assigned to it by consumers given the satisfaction or use they derive
from the good?5
 Just price as cost of production.

1
Ricardo, David (1971). On the Principles of Political Economy and Taxation. Harmondsworth (England):
Penguin. pp. 65 and 67.
2
Zuñiga, Gloria L., Ph.D. (1997). “Scholastic Economics: Thomistic Value Theory. Religion and Liberty. A
Publication of the Acton Institute. Volume 7. Number 4.
3
Aquinas, Thomas (1947/48). Summa Theologica. II-II, q. 77.
4
Barrera, Albino, O.P. (2001). Modern Catholic Social Documents and Political Economy. Georgetown
University Press, Washington, D.C. pp. 62-63. A more thorough discussion of the development of economic
thought on exchange–value determination from the scholastic price theory approach can be read from Chapter 4 of
this reference.
5
Barrera, pp. 63 -71
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 Early scholarship links Aquinas’s just price with the cost of production. This cost of
production is in turn embedded within the larger setting of a hierarchical medieval
social order that has to maintained and preserved for the sake of the common good. It
would be appropriate to describe it as the social-status theory of the just price.
 The basis for this social-status theory is the principle of hierarchy where differences in
function, rank, and role among the members of society as acknowledged and reflected
in the requirements of both distributive and commutative justice. These differences
define the critical proportionality that governs relations of justice.
 The primary end of the social-status approach is to ensure that economic agents are
provided the necessary means to discharge their expected function in the hierarchical
order. Preserving the cohesion and viability of the fragile social order is given
paramount importance. However, the maintenance of this social order is dependent on
the pattern of income distribution among its members according to the division of roles
and responsibilities within the community. Consequently, the just price (i.e. the
normative price at which goods and services are exchanged) is necessarily tied to social
position. It stresses the distributive function of price.
 The social-status approach bridges the gap between the theory of pricing and theory of
income distribution. In this regard, the social-status technique to normative pricing lets
the structure of prices reflect the existing pattern of income distribution in the
community. The undesirable feature of such a method to pricing is that it locks the
community into a set pattern of resource distribution. Such an approach may be
applicable to a feudal economy, whose main objective is survival and the objective of
keeping the social order functioning by not upsetting a precarious status quo. Even in
such an economy, income redistribution is accorded a lower priority, if at all
considered.
 Just price as the market price

 The starting point of the medieval theologians’ writings on exchange value is the
Roman and Canon law thinking that just price is the current price whether arrived at in
the market or by regulation. Both Aquinas and Albert the Great follow Aristotle is
accepting want and human need as the primary determinants of exchange value. In
fact, price is viewed as the numerical expression and measure of the good’s ability to
satisfy human wants. However, Aquinas and Albert the Great go further by adding a
second set of factors that Aristotle never considers: labor. In fact, Aquinas views just
price as the market price instead of the cost of production.
 Aquinas’s reference to the cost of production is in his earlier commentary on Aristotle’s
Nicomachean Ethics. Nothing more is mentioned about it in his later writings in the
Summa Theologiae where only human need and want are presented as key to deriving the
exchange value.
 Aquinas’s discussion of labor and expenses is made in the context of justifying the
commercial profits of merchants who by then are acknowledged to fill an important role in
the economy by providing useful intermediary services.
 However, Aquinas’s just price should not be equated with the liberal, laissez-faire
competitive price because his acceptance of the market price is conditional. The
requirements of the common good, prudence and many other human virtues and values
impose limits on this price.
3. EXCHANGE-VALUE DETERMINATION IN MODERN CATHOLIC SOCIAL THOUGHT. Modern

Catholic social teaching (CST) uses two foundational notions to arrive at the key principle it deems
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essential to setting exchange value. First, it views the telos or end of all economic activity as the
critical starting point in specifying the functional role of human work. Second, it distinguishes the
two facets of work, defines their role and explains their hierarchical ordering. From these, a
cardinal principle is derived for ensuring a just exchange value.
 Work and Livelihood6

 Principal purpose of the economic order is to provide for the needs of the human person.
(Gaudium et Spes (GS) #67). A fundamental feature of the modern economy is wage labor.
Human services are exchanged for a contracted remuneration given either in cash or in kind.
In a monetized economy, this wage-labor arrangement also serves as an important mechanism
for the orderly distribution of society’s output (besides gifts and transfers). In other words,
wages have become the chief means by which people gain access to the goods of the earth
(Rerum Novarum (RN) #62).
 Individual access to these needed goods is dependent on how much people can produce and at
what price they can trade their output in the marketplace. Thus, productivity and market price
are two critical variables to consider. If the economy’s end is to provide for the needs of all,
exchange value should be set so as to amply compensate people’s work effort given the level of
their best productivity. However, the exchange value of their output or labor must be at least
sufficient to provide workers and their families with an adequate income. Herein lies the reason
for modern Catholic social thought’s interest in exchange-value determination. The value at
which goods and services are exchanged determine people’s ability to meet their needs in two
ways: through the income they receive (determined by the price their services or products can
fetch) and through the purchasing power of that income (determined by the price of their
consumption basket).
 Two Dimensions of Work

 Laborem Exercens (LE) highlights the difference between the objective and subjective
dimensions of work. The objective character of the work encompasses all the concrete
manifestations of the work process such as the type and difficulty of effort, the factor inputs
employed, the working conditions, the resulting product(s) or services(s), the production cost,
and the technology employed. The term “objective” is used in the broadest sense of the word
(LE #19). On the other hand, work has a subjective character because it is a human person that
organizes and puts together all the aforesaid objective elements of work.
 This distinction highlights the diverse roles played by the factor inputs in the production
process. In particular, it seeks to draw attention to the special role of the “human input.” It is
personal effort and ingenuity that initiate, plan, and implement the entire productive enterprise.
Furthermore, it is the human element that bears ultimate accountability for the conduct and
outcome of such activity. Consequently, whether in the form of brain power or brute muscle,
the worker enjoys a preeminent position over all the elements of production such as capital,
machinery, and materials. These objective factors of production should, therefore, be viewed
merely as instrumental, secondary and subordinate to the human worker. It is incorrect to refer
to the worker as factor of production; “subject of work” is more appropriate (LE #27). Besides,
the human person is the ultimate purpose of work. Thus, the subjective character of work takes
precedence over its objective dimension.
 Guiding Principle of Exchange-Value Determination

 The subjective dimension is both the fundamental and ultimate basis for the value of work. The
primary basis of the value of work is man himself, who is its subject. The basis for determining
the value of human work is not primarily the kind of work being done but the fact that the one
who is doing it is a person. The sources of the dignity of work are to be sought primarily in the
subjective dimension, not in the objective (LE #27).
6
Barrera, p. 66
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 The provision of a living wage to the worker has been a perennial teaching of the modern
Catholic social documents. While scholastic just price concentrates on fairness in exchange in
the product market, this modern tradition devotes much attention to fairness in the exchange
value of inputs, that is, the labor market. It is a shift from a just price for the work output to a
just price for the work effort. The latter is aptly described as a valuation by the subject of work.
 With inroads into the economics of information due to differences in work capabilities,
there is indeed a move on the part of mainstream economics to shift attention from using
output as the basis of the salary to formulating a contract that will induce a high effort
level on the part of the workers.
 This mode was made in response to lack of information on the effort level of workers.
 More progressive economies have also institutionalized a system of benefits (i.e. health,
retirement, educational plans, pre-need plans, etc.) that will ensure that a satisfactory level
of human dignity be lived by the workers.
4. CONTRASTING MODERN CATHOLIC SOCIAL TEACHING WITH ECONOMIC THOUGHT
 Classical Approach7
 In stressing the central role of labor in the work process, modern Catholic social
thought (CST) appear to be no different from the labor theory of value espoused by
Locke, Ricardo and Marx. Is this similarity more apparent than real? CST and
Marxian theory both stress the importance of anchoring exchange value on something
more fundamental and stable than the vagaries of the market. This similarity, however,
does not go much further than this. CST and Marxian views on value are diametrically
and irreconcilably opposed to each other because:
 While Marx holds that all value is created by labor and capital has no rightful place
in the determination of value or a proper share in output distribution, CST
acknowledges the important contribution of capital in the work process and affirms
its legitimate claim to a share in output. This is a constant theme of the tradition
since Rerum Novarum.
Note the following excerpt from RN #15 - #16 as an example: “Moreover since man
expends his mental energy and his bodily strength in procuring the goods of nature, by
this very act he appropriates that part of physical nature to himself which he has
cultivated. On it he leaves impressed, as it were, a kind of image of his person …
would justice permit anyone to own and enjoy that upon which another has toiled? …
So it is just that the fruit of labor belongs precisely to those who have performed the
labor.”
Take note that Marx has observed that value has an objective property that had to be
rooted in something more substantial than the ‘superficial’ market forces of supply and
demand.”
But in Quadragesimo Anno (QA #55 and #68) note that the Marxist solution of giving
the entire social output to workers exclusively is an unjust claim. Furthermore, there
are numerous passages in the social documents that call for profit sharing with
workers. Such a call is an implicit affirmation that profits have a legitimate place in
the work order.
7
Barrera, p. 68 - 69
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 Marx’s view that capital is stolen labor implies an inherent conflict between the
working and capitalist classes. This is a claim that the economic order, as we know
it, necessarily leads to an adversarial relationship. CST disagrees with this view
and sees no inevitability in this class conflict. In fact, it finds such conflict to be an
aberration, rather than the norm (RN #28).
 There is far greater affinity between these theological documents and Ricardo’s labor
theory of value than Marx’s. Both CST and Ricardo see capital as accumulated past
labor (LE #55 - #56) with an important role to play in production. Hence, both accept
the rightful share of capital in output distribution. One major difference, however, is
the question of wages, Ricardo and CST both speak of a wage floor. In the case of
Ricardo, the wage floor is imposed by a “biological limit” – when it becomes
impossible for the worker to survive at wages below the subsistence level. In the case
of CST, the wage floor is imposed by a “moral limit” – when it becomes morally wrong
to pay workers less than is necessary for them and their families to lead a full life.
Naturally, this family wage is set at a higher level than Ricardo’s subsistence wage.
Furthermore, while Ricardo’s law of iron wages keeps the long-run wages at the
subsistence level, nothing prevents wage levels from rising above the family wage. In
conclusion, there are some points of similarity between CST’s notion of value and the
labor theory of value, but only in a limited Ricardian fashion and certainly not in the
Marxian sense.
Note Ricardo’s iron law of wages: A sizable labor pool, continuously fed by
population growth, ensures competition for the available jobs. This keeps wages down
to the subsistence level, just enough to keep employed workers alive.
 Consumer-Utility Approach (The sentences and phrases in italics are my comments)
 Modern Catholic social thought is highly critical of the marginalist theory of factor
payments where:
Wage level = {price of output} x {marginal product of labor}

= value of marginal product of labor
Under perfect competition, the resulting income distribution ensures that each factor
input receives a return to the value of its marginal product. This, it is argued, is an
ethical outcome because the reward to each factor of production corresponds to its
contribution to the social product.
 There are numerous objections to this claim.
First, this conclusion is contingent on perfectly competitive conditions. Hence, for this to be
truly operative, there must be at least complete information, frictionless mobility both for
economic agents and resources, and no monopoly power. These requirements are not satisfied
in practice, especially in situations where a market failure happens.
Second, the price of output is determined by how much satisfaction consumers get for the
product. Hence, remuneration for the worker’s effort is ultimately dependent on the utility
derived by consumers. In effect, consumer utility becomes a decisive criterion in judging the
contribution of a factor input to the social product. CST disagrees with this because there may
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in fact be a gap between real contributions to the good of society and the monetary reward
accorded by consumer satisfaction.
We have to keep in mind that this approach is based on the assumption of competitive of
markets. When the price mechanism fails, the marginal social rate of transformation may not
equal the marginal private rate of transformation, and, the marginal social rate of substitution
may not equal the private rate of substitution. In simpler terms, private returns may not equal
social returns, and, private costs may not equal social costs.
Third, the marginal productivity theory of factor payments treats labor no differently from
inanimate, material factor inputs. It does not distinguish the primary efficient cause (the human
person) from the instrumental cause (all other elements of production) (Gaudium et Spes (GS)
#67). Consequently, it disregards the preeminence of the subjective dimension over the
objective content of work for purposes of remunerating the various elements of the production
process.
The reason for this is that the marginal productivity theory descriptively gives a basis for
costing the productivity of labor, that is, in reference to another factor of production which is
capital. The marginalist approach does not attempt to give a normative basis on decisions
before the actual capital investment is made, i.e. does not provide a basis for planning out a
business before it actually operates. It gives an operational basis for costing labor.
However, capital has taken on a much broader meaning, i.e. human capital. The apparent
contradiction between marginal productivity theory and CST can be resolved once the
entrepreneur or the firm properly describes the nature of the job, and, the consequent skills (i.e.
manual, creative, managerial, analytical) needed to do the job well.
Fourth, should factor contribution be the only consideration? CST affirms the wisdom of
linking factor payments to productivity. In fact, it asserts the importance and the need to weigh
the productivity and contribution of workers in setting wage levels (GS #67; Mater et Magistra
(MM) #71). However, the distributional outcomes arising from this criterion alone need not be
automatically fair, not even under perfect competition. After all, there is no guarantee that the
workers’ remuneration will indeed be a living wage. The ethical standard is not simply whether
the factor gets its due reward in return for its contribution, but more importantly, it must also
consider whether labor gets paid enough to support a family. Distributive justice takes
precedence over commutative justice; the latter gives way to the more urgent consideration of
ensuring the physical well-being of workers and their dependents.
Modern Catholic social thought is opposed to a sole reliance on the marginal productivity
method of factor payments because it does not provide for any safety net in the event that the
resulting income is below the living wage. Productivity must certainly be taken into account.
However, it cannot be the only or the most important consideration. To do so, would be to leave
the worker at the mercy of an impersonal market process that treats human labor as a market
commodity. CST is adamant on this point.
Furthermore, a factor payment such as wage income is the outcome of demand and supply
interactions and is, consequently, the result not only of labor’s productivity and
contribution, but also of numerous other economic and sociological factors. In addition,
there is also the difficulty of disentangling and measuring the marginal product of a factor
from all the other factor inputs. Marshall notes that the marginal productivity postulate
cannot be used as a theory of wages or the same reason: “This doctrine (referring to the
marginal productivity theory) has sometimes been put forward as a theory of wages. But
there is no valid ground for any such pretension … since in order to estimate net product,
we have to take for granted all the expenses of production of the commodity on which he
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works, other than his own wages.”8 It is a heroic assumption, therefore to claim that factor
payments in a competitive economy automatically lead to ethical outcomes.
RN #31 notes: “It is shameful and inhuman, however, to use men as things for gain and to
put no more value on them than what they are worth in muscle and energy”. QA #83
observes: “Labor … is not a mere chattel, since the human dignity of the workingman must
be recognized init, and consequently it cannot be bought and sold like any piece of
merchandise.” MM #18 remarks: “Work, inasmuch as it is an expression of the human
person, can by no means be regarded as a mere commodity.”
Fifth, the productivity of workers is a function of many factors such as the type of equipment
used, the quality of technology employed, and the entrepreneurial competence available.
Laborers should not be deprived of a living wage simply on account of management’s failure to
provide the proper conditions for a level of productivity that leads to the payment of adequate
wages (QA #72).
Finally, the underlying dynamic behind the marginal productivity theory of factor payments is
the maximization of profits. This runs against CST’s view that the primary end of economic
activity is the promotion of both public and individual welfare by providing the necessary
means for the proper growth and development of the human person. This is not to say that
profits are unimportant. Profit is important, and CST acknowledges this (Centesimus Annus
(CA) #35c). However, it cannot be the sole consideration. Special attention must be given to
workers when it comes to dividing output from the common productive effort; unlike the
objective elements of production, laborers need to lead a full life.
MM #18 argues: “For the great majority of mankind, work is the only source from which
the means of livelihood are drawn. Hence, its remuneration is not to be thought of in terms
of merchandize, but rather according to the laws of justice and equity.”
 Marshallian Approach
 CST is keenly aware of the unique, essential, and timely service provided by the market
in letting supply and demand determine the exchange value of goods and services. In
setting wages, this theological tradition acknowledges the need to consider the
manifold conditions that affect the economic viability of the business enterprise (QA
#72; MM #71). It goes beyond partial equilibrium analysis to include the
interrelatedness of prices and wages throughout the whole economy (QA #75). As it
affirms the necessity of labor markets and their links to the rest of the economy, CST is
fully cognizant of economic realities and limitations when it comes to setting wage
levels: The effort to provide workers with a living wage must be balanced against the
risk of setting too high a wage level as to cause unemployment. It recognizes a tradeoff
between wage and employment levels (QA #74). Indeed, the market is important. It
can only be ignored at the risk of causing more problems. However, there are limits to
unfettered market operations inasmuch as price outcomes are not necessarily equitable
(Populorum Progresio (PP) #57 – #58). There is an important role for extra-market
mechanisms in the economic order.
8
Marshall, Alfred [1890] (1961). Principles of Economics. 9th ed., with annotations by C. W. Gulillebaud.
London: Royal Economic society, Macmillan and Co. p. 518.
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5. SUMMARY AND CONCLUSION9
 Scholastic teachings on exchange-value determination have evolved in modern Catholic social thought
where the question of a living wage for worker is now incorporated as a separate and significant concern
within the larger issue of issue of a just price. The attention accorded to commutative justice in
scholastic just price has shifted to a modern concern over distributive justice. Scholastics deal with the
morality of exchange at a personal level, while the modern social documents assess fairness at an
institutional level.
 In writing about the just price, medieval theologians are concerned with averting fraud on the part of
sellers who take advantage of the ignorance and need of buyers.10 These theologians are critical of
unequal exchanges and seek to arrive at proportionality I the value of goods and services. The object of
the scholastics is to identify the bounds of commutative justice that make for a fair exchange.
 In contrast, modern Catholic social thought is concerned with providing an adequate livelihood for
workers. As noted earlier, people are price takers in a modern competitive economy; the risk of fraud
where the seller takes advantage of the buyer is minimized given the inability of atomistic economic
actors to influence the price. Rather, the immediate issues for the modern tradition have been the dismal
working conditions for laborers, the inadequacy of wages, and the lopsided division of output in society
given the imbalance in labor-management relations. It is concerned with the unequal exchange between
workers and owners of capital in setting wage levels. Medieval theologians discuss these problems of
exchange at the level of personal morality, while modern theological reflections examine them at the
social level under the aegis of distributive justice where the adequacy of resources allocated to the
workers is appraised.
 A second shift can be observed in the allocative and enforcement mechanisms of the economy. This
follows in the wake of the change in focus from personal to institutional morality and from commutative
to distributive justice. In setting the communal estimate of the just price, the medieval economic unit is,
in effect, also taking into account the social status of its members and the expenses they incur in
discharging their function in the community. This communal estimation of the market price and the
distribution of factor payments that flow from it are enforced through informal channels of a social
convention that is held together by religion, family and community.
 In an industrial society characterized by larger economic units and more complex production processes,
the distribution of factor payments can no longer be based on sociocultural ties as in the feudal era. The
modern economy has devised new mechanisms of distribution such as the wage-labor market and the
marginalist approach to factor payments. Commodity and factor payments are no longer based on social
status but on economic agents’ contribution to the productive effort. More importantly, new channels of
accountability have arisen in a modern economy where market outcomes are largely due to impersonal
forces and where traditional bonds of community have been either lost or weakened. The informal
manner of enforcing social convention through religion and blood relations has given way to formal,
legal and institutional directives such as minimum wage laws and other labor legislation protecting union
activities and collective bargaining. Traditional social, personal and moral forms of suasion have given
way to the legal and impersonal safeguards of industrial society. 11
 In spite of the observed differences in the teachings on exchange value between scholasticism and the
modern Catholic social documents, an important point of continuity remains, namely: the central role of
the axiom of mutual advantage in validating any exchange. Medieval theologians develop the notion of a
9
Barrera, p. 81-82
10
Observe another shift. In the modern economy, it is now the seller that is viewed to be the vulnerable party that
needs protection from the relatively stronger position of buyers. This is particularly true not only in labor markets
but also in the exports of Third world commodities. Thus, there is a perceived need to protect disadvantaged
sellers in the modern era.
11
This is not to say that there are no provisions for price regulation in medieval social ethics. Scholastic thinkers
have always accepted the need to regulate market prices especially of essential commodities such as food.
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just price in order to ensure that all parties share equitably both in the burdens and the benefits of any
trade. This is achieved when goods and services are exchanged at relative prices that reflect their
proportional economic value.
 Mutual advantage is also the animating principle behind the modern social documents’ stress on the
living wage. Market transactions, including the hiring of workers, must profit all economic actors: the
consumers, the suppliers, the workers and the owners of capital (QA #53-#55).12 The burdens and the
benefits of exchange in the modern economy must be proportionately borne by everyone in the
community. Consequently, mutual advantage for all parties in the transactions is the ultimate yardstick
that morally validates the exchange.13 This is an essential point of continuity between the scholastics and
modern Catholic social thought on exchange-value determination. It should not be surprising, therefore,
to discern a pattern of defending the disadvantaged party in both traditions. Medieval theologians seek
to protect consumers from unscrupulous merchants who are considered to have the upper hand in trade in
a feudal economy. Modern Catholic social thought, on the other hand, has championed the cause of
workers who are viewed to be the weaker bargaining party in the modern wage-labor economy.
 Another correspondence must be noted. There are similarities in the starting point and in the common
opposition faced by scholastic and modern economic ethics. The medieval doctors argue against the
Roman canonists in their claim that a price which results from a freely negotiated contract is morally and
legally legitimate.14 Modern ethical reflection faces a similar starting point: Laissez-faire adherents
regard the mutual and voluntary nature of labor market exchange as sufficient grounds for assuming the
moral validity of these transactions’ outcomes. In both cases, there is the implicit assumption that no
exploitation can occur in markets because people will not enter into any exchange at all if they do not
reap benefits from such trading. Consequently, a completed market transaction is prima facie evidence of
mutual advantages for all parties concerned. The modern economy adds a further argument in support of
this position: The enormous benefits of allocative efficiency from free market operations cannot be
ignored. In both disagreements between scholastics and roman canonists, and between Catholic social
thinkers and laissez-faire proponents, the point of contention is the relative importance that should be
accorded the social gains of an unfettered market compared to the larger social goals that could only be
realized by curtailing its operations.
 For the scholastics, there is moral validity to the transaction only when there is equivalence in exchange
(commutative justice), when no one is exploited, and when all affected parties receive their due
according to their social roles (distributive justice). The satisfaction of these conditions (i.e. the payment
of a just price) takes precedence over whatever weight may be given to the freedom of contract. In the
modern Catholic social documents, market outcomes and processes are subjected to scrutiny and are
overridden whenever the economic structures undergirding the economy fall short of the standards of
justice. This is a very important summary of all the points mentioned and becomes the starting-point
from where the virtue of prudence, i.e. application of due order and due proportion, can help economic
thought attain a mutually advantageous exchange even in the face of a market failure.
The ideas expounded above are summarized in the following table.
TABLE 1. COMPARISON OF APPROACHES
12
This position is emphatically made by Rerum Novarum and Quadragesimo Anno in their critique of ideological
assertions that labor or the owners of capital have exclusive claim over the economic fruits of the modern
economy to the total disregard of the other party. The tenet of mutual advantage is invoked by Leo XIII and Pius
XI.
13
The problem here, of course, is choosing the criteria for what constitutes mutual advantage. This is similar to
the problem at arriving at due proportion in the common good.
14
Baldwin, John W. (1959). The Medieval Theories of the Just Price: Romanists, Canonists, and Theologians
in the Twelfth and Thirteenth Centuries. Transactions of the American Philosophical Society, Vol. 49, Part 4
(series paper). Philadelphia: American Philosophical Society.
Page 10 of 42
CONCEPT SCHOLASTIC ST. THOMAS AQUINAS CATHOLIC SOCIAL MAINSTREAM ECONOMIC

THOUGHT THOUGHT (CST) THOUGHT
POINTS OF AGREEMENT
In any economic exchange, the mutual advantage incurred by the parties involved in the exchange
is pivotal or central to the terms of the exchange. The act of the exchange is mutually done and is
voluntary. The parties involved in the exchange foresee a reaping of benefits from such a trade.
Otherwise, they will not involve themselves in the act of exchange.
Just price. Based on the mutual Base it on something Classical thought such
Demands of exchange of parties more real than the mere as that of Locke,
justice in supply-demand Ricardo, Marx
exchange are relationship in a market
satisfied when exchange
the contracted Wages approach the
price is equal subsistence level (as
to the true explained by Ricardo’s
economic iron law of wages)
value of the
goods and
EXCHANGE-
VALUE services
DETERMINATION traded.
POINTS OF DISAGREEMENT
 Conditionally CST and Ricardo see For Marx, value is
accepts the capital as accumulated created by labor alone.
competitive price as past labor and therefore Capital and labor are
the just price. There has to be incorporated in constant conflict.
are limits to the in the determination of
competitive price the value of a good
based on the Subjective dimension
requirements of the of the good is more
common good, important, that is, based
prudence and other on human wants and
human virtues. needs. This is also
expounded by St.
Thomas
POINTS OF AGREEMENT
 Under perfect competition, the resulting income distribution ensures that each factor input
receives a return to the value of its marginal product.
 The object of  Link factor payments to productivity
the scholastics  Marshall notes that the marginal productivity
is to identify postulate cannot be used as a theory of wages
the bounds of  Mutual advantage is also the animating principle
commutative behind the modern social documents. Living wage
VALUE OF justice that defined as that wage that will allow market
LABOR make for a fair transactions to profit all economic actors:
exchange consumers, suppliers, workers and the owners of
capital. But burdens and benefits of the exchange
must be proportionately borne by everyone in the
community.
TABLE 1. COMPARISON OF APPROACHES (CONTINUED)
Page 11 of 42
CONCEPT SCHOLASTIC ST. THOMAS AQUINAS CATHOLIC SOCIAL MAINSTREAM ECONOMIC

THOUGHT THOUGHT (CST) THOUGHT
POINTS OF DISAGREEMENT
In situations where  Criteria for living wage  Mainstream economics
people are price is to arrive at a due provides frameworks
takers in a modern proportion in the to bring back
competitive common good to all allocative efficiency
economy, the risk of agents in the economy. through the price
fraud may occur. Workers are constantly mechanism. But there
the weaker bargaining is no guarantee that
party fairness will indeed
 Laborers should not be occur.
deprived of a living  One may have to
wage simply on argue on achieving a
account of Rawlsian criterion for
VALUE OF management’s failure certain sectors.
LABOR to provide the proper
conditions for a level of
productivity that leads
to the payment of
adequate wages.
 Profits are important
but it cannot be the sole
consideration. Special
attention must be given
to workers when it
comes to dividing
output from the
common productive
effort.
Page 12 of 42
2.1.2. IMPLICATIONS OF VALUE THEORY TO LABOR AND THE ROLE OF HUMAN CAPITAL
(a) The Achievement of the Living Wage via an increase in the Marginal Productivity of
Labor
 There are many routes to achieve a partial equilibrium result: the occurrence of multiple
equilibria, from which either at least one or two may be Pareto optimal. Multiple equilibria
happens when the major assumptions (i.e. price taking behavior, zero economic profits, no
missing markets, no excess demand and supply, free entry and exit) of competitive markets
are relaxed.
 The best result is when the demand for labor shifts upwards thereby allowing an increase in
wage levels and the supply of labor that can be absorbed by the economy. This happens,
when capacities increase.
(b) Obstacles to the Achievement of the Living Wage
 Some empirical observations

 Effort levels among individuals change. Empirically, effort levels have been measured
using the level of education as indicator. Studies have also studied the effect of
training but the results are not robust.
 Comment on Tables and their implications:
Table 2. Relative Earnings of the Population with Income from Employment: Males
By Level of Educational attainment for the Population 25 to 64 years of age
(Upper Secondary Education = 100)
Males Lower Males Higher Education Males Higher Education
Country Secondary and Below Non-University University
Australia 87 120 144
Canada 84 109 148
Czeck Republic 75 177 178
Denmark 87 122 148
Finland 94 128 186
France 88 128 178
Germany 77 105 149
Hungary 72 240 218
Ireland 72 100 149
Italy 54
Korea 88 105 143
Netherlands 86 142 138
New Zealand 76
Norway 85 125 133
Portugal 61 149 188
Spain 75 96 178
Sweden 87
Switzerland 81 122 144
United Kingdom 73 126 159
United States 65 119 183
Country Mean 78 130 163
Source: Hanushek, Eric A. (2002). "Publicly Provided Education. " National Bureau of Economic Research. WP 8799.
February. pp. 96-100. Basic Data was sourced from the Organization of Economic Cooperation and Development (OECD),
2001)
Page 13 of 42
Table 3. Relative Earnings of the Population with Income from Employment: Females
By Level of Educational attainment for the Population 25 to 64 years of age
(Upper Secondary Education = 100)
Females Lower Secondary Females Higher Education Females Higher
and Below Non-University Education University
Australia 85 113 154
Canada 76 116 164
Czeck Republic 72 127 172
Denmark 89 118 144
Finland 100 122 176
France 79 131 158
Germany 85 104 160
Hungary 67 138 159
Ireland 57 129 171
Italy 61
Korea 69 118 160
Netherlands 71 128 145
New Zealand 74
Norway 84 142 136
Portugal 62 131 190
Spain 68 82 155
Sweden 89
Switzerland 73 131 154
United Kingdom 68 139 193
United States 63 120 170
Country Mean 75 123 162
Source: Hanushek, Eric A. (2002). "Publicly Provided Education. " National Bureau of Economic Research. WP 8799.
February. pp. 96-100
 For Tables 2 and 3:
 The observations shown in Tables 2 and 3 show that earnings, when higher
education has been reached, are about 2 to 2.5 more than when only secondary
education has been reached.
 Earnings of males and females do not differ much when higher education,
university education has been reached. From here, we can infer that the data
shows that higher university education gives an equalizing effect on the level
of earnings by sex.
 Slight differences by sex can be observed on the level of earnings for higher
education non-university
 For males:
 Czeck Republic, Hungary and Portugal are higher than average earnings
when individuals have received higher education at either a university or
non-university education institution. Finland, France, Spain and the US
give higher than average earnings when individuals attain higher education
at a university level. Countries which give higher than average earnings to
individuals with lower secondary education and below are also consistently
giving a lower than average earnings for higher education whether attained
in a university or a non-university educational institution.
 For females:
Page 14 of 42
 Czeck Republic, Ireland, Portugal and the United Kingdom give higher
than average earnings to individuals who have attained higher education at
either a university or a non-university educational institution. Canada,
Finland and the United States give higher than average earnings to females
who have attained higher education at the university. Note that Ireland,
Germany, Korea, Netherlands, Norway, Portugal, Switzerland and United
Kingdom give higher earnings to females than males when higher
university education have been attained.
 In 13 out of 20 cases are women paid lower than men when they have only
attained lower secondary and below education. Ireland (15 index points)
and Korea (17 index points) show the highest level of earnings difference
when individuals have attained lower secondary and below educational
level.
 For Figure 1:
 The OECD mean for percentage of population attaining upper secondary

education or more for those aged 25 to 64 is 62% and for those aged 25 to 34 is
72%.
 From these countries, the United States, United Kingdom, Switzerland,
Sweden, Norway, New Zealand, Korea, Hungary, Germany, France, Finland,
Denmark, Czeck Republic and Canada all have a percentage share higher than
the average. From those aged 25 to 34, the US, Switzerland, Sweden, Norway,
Korea, Germany, Finland, Denmark, Czeck Republic and Canada all have a
significantly higher than average percentage.
 For OECD countries there seems to be a higher percentage among those aged
25 to 34 to attain upper secondary education or more.
 For Figure 2:
 Developing countries have a substantially lower average of those aged 25 to 34

aiming for upper secondary or more levels of education in comparison to
OECD countries. Jordan, Philippines, Peru and Chile are the countries whose
average percentage of population aged 25 to 64 and 25 to 34 is greater than
those of other developing countries.
 Schooling seems to be valued greater in these countries.
 For the Philippines, the 44% of the population aged 25 to 64 attaining at least
upper secondary educations constitutes about 28 million. This means that,
under the assumption that all educational institutions have the same quality of
education level, only 28 million of the population would have the capacity to
get better paying jobs.
Page 15 of 42
Source: Hanushek, pp. 96 - 100

F ig u re 1. P e rce n tag e o f P o p u lation attain in g U p p e r S e co n d ary

E d u catio n o r M o re (1999)
88
U n ite d S ta te s 87
66
U n ite d K in g d o m 62
89
S w itz e rla n d 82
87
Sw e de n 77
55
S p a in 35
30
P o rtu g a l 21
94
N o rw a y 85
79
N e w Ze a la n d 74
93
K o re a 66
55 S ch o o lin g 2 5-3 4
Ita ly 42
S ch o o lin g 2 5-6 4
67
Ire la n d 51
80
H u n g a ry 67
85
G e rm a n y 81
76
F ra n ce 62
86
F in la n d 72 Source: Hanushek,
pp. 96 to 100;
87
D e n m a rk 80 Reference year is
1998, basic data is
93 sourced from
C z e c k R e p u b lic 86
OECD, 2001
87
Ca na da 79
65
A u stra lia 57
0 20 40 60 80 10 0
Page 16 of 42
Figure 2. Percentage of Population Attaining Upper Secondary Education or More

(1999)
Developing C ountries 42
Mean 32
OECD Mean 72
62
Zimbabwe
51
29
Uruguay 39
32
Tunisia
11
8
Thailand
23
16
S ri Lanka
46
36 Schooling 25-34
55 Schooling 25-64
P hilippines
44
P eru 58
46
Malaysia 50
35
J ordan 55
51
Indonesia
33
22
C hile
55 Source: Hanushek, pp. 96 to
43 100; Reference year is 1998,
basic data is sourced from
29
Braz il
24 OECD, 2001
0 10 20 30 40 50 60 70 80
 For Figure 3 (Data sourced from Table 4):
 No strong linear relationship exists between the percentage share to GDP of

public school spending by the government to the percentage of those aged 25
to 64 who are attaining at least upper secondary education. Thus, the
frequency of schooling is not dependent on the level of fiscal spending on
education for OECD countries.
 For Figure 4 (Data sourced from Table 5)
 No strong linear relationship. Thus, the frequency of schooling is not

dependent on the actual level of government expenditure on secondary
education.
Page 17 of 42
Table 4. Educational Spending by the Government Relative to

GDP and Percentage of Population aged 25 to 64 Attaining at
Least Upper Secondary Education (1998)
Page 18 of 42
Expenditure Relative to
GDP Schooling 25 to 64
Australia 3.8 57
Canada 4.1 79
Czeck Republic 3.1 86
Denmark 4.3 80
Finland 3.7 72
France 4.4 62
Germany 3.7 81
Hungary 3.1 67
Ireland 3.3 51
Italy 3.5 42
Korea 4 66
New Zealand 74
Norway 4.4 85
Portugal 4.2 21
Spain 3.7 35
Sweden 4.5 77
Switzerland 4.5 82
United Kingdom 62
United States 3.7 87
Note: Expenditure Relative to GDP refers to the expenditure per student in
US dollars converted using PPP.
Source: OECD, 2001 in Hanushek pp. 96 to 100
Figure 3. Schooling vs. Public School Expenditure
100
90
Attaining Upper Secondary Education or
Percentage of Population Aged 25 to 64
80
70
60
More (1999)
50
40
30
20
10
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Percent Expenditure per Student and Spending Relative to GDP (1998)
Page 19 of 42
Table 5. Actual Expenditure per Student on Secondary

Education and Percentage of Population Aged 25 to 64
Attaining at Least Upper Secondary Education (1998)
Secondary Education Schooling 25-64
Australia 5,830 57
Canada 79
Czeck Republic 3,182 86
Denmark 7,200 80
Finland 5,111 72
France 6,605 62
Germany 6,209 81
Hungary 2,140 67
Ireland 3,934 51
Italy 6,458 42
Korea 3,544 66
New Zealand 74
Norway 7,343 85
Portugal 4,636 21
Spain 4,274 35
Sweden 5,648 77
Switzerland 9,348 82
United Kingdom 5,230 62
United States 7,764 87
Note: Expenditure Relative to GDP refers to the expenditure
per student in US dollars converted using PPP.
Figure 4. Schooling vs. Actual Expenditure per Student on

Secondary Education (1998)
100
90
Percentage of Population Attaining
Upper Seondary Education or More
80
70
60
50
40
30
20
10
0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000
Secondary Education Expenditure per Student (in US Dollars)
Page 20 of 42
Table 6. Actual Expenditure for Secondary Education per Student

and Percentage of Population attaining at Least Upper Secondary
Education (1998) for Selected Developing Countries
Actual Secondary Schooling Schooling for
Expenditure per Student Aged 25 to 64
Brazil 1,076 24
Chile 1,713 43
Indonesia 497 22
Malaysia 1,469 35
Peru 671 46
Philippines 726 44
Thailand 1,177 16
Tunisia 1,633 8
Uruguay 1,246 32
Zimbabwe 1,179 29
 For Figure 5:
 Peru and the Philippines relatively spend less than other countries but have a higher
incidence of the population attaining at least upper secondary education
 The data also shows that there is no assurance that though the actual expenditure per
student by the government doubles, i.e. approaching the level of Chile, that the number
of individuals attaining upper secondary education would increase. The most that can
be said is that the percentage may be sustained but there can be a higher incidence of
individuals finishing higher education.
Figure 5. Schooling vs. Actual Expenditure per Student on Secondary

Education (1998) for Selected Developing Countries
50
Percentage of Population Aged
Peru
Secondary Education or More
45 Chile
Philippines
25 to 64 Attaining Upper
40
35 Uruguay
30 Malaysia
Zim babw e
25
20 Indonesia Brazil
15
Thailand
10 Tunisia
5
0
- 200 400 600 800 1,000 1,200 1,400 1,600 1,800
Secondary Education Expenditure per Student (in US dollars)
Page 21 of 42
Table 7. Expenditure by the Government on Education as a

Percent of GDP vs. Percentage of Population Aged 25 to 64
Attaining at Least Upper Secondary Education (1998) for Selected
Developing Countries
Expenditure Schooling
Relative to GDP 25 to 64
Chile 3.9 43
Indonesia 1.4 22
Peru 3.3 46
Philippines 4.9 44
Thailand 3.8 16
 For Figure 6:
 Peru, Chile and the Philippines have the same frequency of population aged 25 to
64 attaining at least upper secondary education. In fact, relative to other
developing countries, the government Philippines is spending the most for
education. This percentage share is comparable to some OECD countries. See
Figure 3.
Figure 6. Schooling vs. Public School Expenditure

50
Percentage of Population Aged 25
to 64 Attaining Upper Seondary
45 Peru
Education or More (1999)
40
Chile Philippines
35
30
25
20
15 Indonesia
10 Thailand
5
0
0 1 2 3 4 5 6
Percent Expenditure per Student and Spending Relative to GDP (1998)
Page 22 of 42
(c) Philosophical Implications
 In a knowledge-based economy, the motor behind the economy is the entrepreneurial spirit.
This has come to be known as human capital or the capacity of each person to learn, be
trained. In economic terms, this concept is also summarized in terms of effort.
 Ingenuity therefore takes center stage in the knowledge-based economy. The reason is
that persons are seen not only from their use and function, i.e. bonum utile, but also in
terms of their true worth, i.e. bonum honestum. Thus, one’s being becomes a function
not only of having (taken in the form of consumption in a market economy, but also in
one’s doing, taken in the form of freedom and capabilities in the market economy.
 A lot of importance is given to human productivity. Education is seen as a signaling
device to give information on one’s work capacity.
 The advantage of this focus is that when work attitudes or effort level can be
distinguished as being either high or low levels (i.e. only 2 types), an optimal result can
arise under an environment of perfect information. The result is a sub-game perfect
Nash equilibrium. It results under a Bayesian perfect information market environment.
The results are a first-best Pareto optima for high and low effort levels. The
disadvantage is that a perfect information case is usually difficult to attain. A second-
best result can occur. Why? A high effort level is signaled via a high educational level
which can be costly, and usually the cost is absorbed by the individual. The individual
may opt for an equilibrium wage level that is below the optimal level. This makes the
contract offered for the low and high effort individuals to be almost similar. A pooling
equilibrium may result. This result is not optimal and may result to be a disincentive
for high effort individuals.
 A Market Solution to the Imperfect Information Case: Screening. Look at notes

on the Screening Problem or Signaling Case where the Principal has private
information
(d) Normative Response
 Due to the ability of education to increase capacities, access to education by a

greater percentage of the population may be considered as a priority
 This provision may be done through a participative engagement between the
government and the private sector.
2.1.3. GENERAL EQUILIBRIUM AND THE ROLE OF PARTICIPATION
 WALRASIAN AND ARROW-DEBREU GENERAL EQUILIBRIUM: A Review (See

Handwritten notes and Technical Notes at the end of this chapter 15). These notes attempt to
make the reader intuitively understand the general equilibrium: certainty (Walrasian and
Paretian) and uncertainty (Arrow-Debreu) framework
 Assumes that all agents (i.e. educated and sufficiently healthy workforce) are able to transact in
the market economy, i.e. have the capacity to change work place in case wage levels increase or
decrease in certain sectors, able to buy or sell property which also implies that there is a clear
15
See http://cepa.newschool.edu/het/essays/get/walcass.htm
Page 23 of 42
assignment and enforcement of property rights, have the capacity to assess risk levels in
different states of the economy so that decisions, expectations and plans can be made in cases of
uncertainty. All these presuppose that individual agents have a minimum level of human assets
or capital, i.e. talents, skills, knowledge, education and health.
 Such stock of human capital is what enables individuals to detect opportunities to gain or
achieve net benefits from any market exchange. This means that they are able to give reap value
to commodities and services exchanged or transacted in the market economy. Examples of
these would be employees who have opted for an early retirement and have joined the business
sector by setting up their own business. Human and financial capital are needed to make this
possible: services that can be offered by the business which come from the person’s varied
experiences, and, savings and other forms of earnings garnered while he was still employed.
 In the case of the Philippines, we may only be looking at or considering 28 out of the 76 million
Filipinos (these are Filipinos aged 25 to 64) who, in 1998, have been pursuing upper secondary
education and higher. They are the ones able to achieve more gainful employment. Filipinos
who are living below the poverty line, i.e. 40% of the population as of 2000, may not be in a
position to achieve gainful employment. These Filipinos may have only reached up to Grade 5,
or have not completed elementary education.
 For these Filipinos, a general utility possibilities frontier (GUPF) may have these
characteristics: The dashed line refers to the general utility possibilities frontier constituted
by the utility possibility frontiers of both agents A and B. (See Figure 1) This GUPF gives
way to having a Bernoulli-Nash Social Welfare Function, a social welfare function that
incorporates differences among agents and has, at the same time, the properties of the
utilitarian social welfare function. The disadvantage of this social welfare function is that
when individual B dominates transactions in the market economy, then prices will move
towards greater utility for them. The social optima may be at a point higher than point S in
Figure 2. A Rawlsian criteria may opt for S as this point is almost at the egalitarian or 45°
line.
 Thus, a market-based social welfare solution to Filipinos who are able to participate in the
market economy, i.e. those who are able to have gainful employment, or a potential of 28
million Filipinos, may mean a social choice criteria which is either Bernoulli-Nash which is
sensitive to distortions in the market economy due to market power, or, the Rawlsian
criterion which maximizes the welfare of the least endowed. If a net social welfare gain is
to be the goal of policymakers, then, a Rawlsian criterion may be invoked but under the
premise that the net social welfare gain corresponds to a basic need such as housing,
health, assuming that the 28 million Filipinos are able to finance (public or privately
sourced) their own education.
Page 24 of 42
FIGURE 1. Utility Possibility Frontier for Individuals A and B Represented by the Utility Possibility Frontier D
and F.
FIGURE 2. Bernoulli-Nash Social Welfare Function (W*) and Social Optimum (S)
 There is no assurance, however, that the social choice will indeed be implemented. In fact,
there may even be a great difference between the social optima and the implementing
mechanism that will arise in actual policy making. What social choice and equilibrium
theory provides is a normative and positive criteria to arrive at a market-based solution.
 These 28 million Filipinos may come from income class A to D. We can take note that a
Rawlsian criterion maximizes the net benefits accruing to the least endowed class. This
means that this criterion best enables the least endowed to have greater participation in the
market economy.
 A different criteria, however, may be appropriate for the proportion of Filipinos living below the
poverty line (i.e. E to F income class). Assuming that A and B correspond to 2 different groups
among those living below the poverty line and that GUPF corresponds to their combined utility
possibility frontiers, then the social optimum corresponds to point R. The utility possibility
Page 25 of 42
frontier may correspond to the net social welfare gains in terms of very basic necessities such as
food and health, i.e. commodities and services which are indispensable for survival.
 The Rawlsian criteria may be used in such cases as it ensures that the maximum benefit of
the 2 groups, both of whom are least endowed, shall be the societal objective.
 This objective is implemented with the use cost-benefit or cost-effectiveness analysis. The
programs or projects using such methods are targeted to specific groups. These groups
belong to the marginalized and therefore the usual price mechanism which enables the
market economy to achieve a net welfare gain is not applicable to them.
 The poor can be either: poverty due to discrimination, poverty due to sickness, enabled or
capable poor. Discrimination can be due to sex, race or age, they are poor as the means to
social is not easily accessible or made difficult to these groups. The poor due to sickness
are those who are disenabled to gain employment due to health unfitness.16 The capable or
enabled poor are those lack the opportunity to gain access to education and health.
However, they are mentally and physically fit to be educated and to eventually gain
employment when given the opportunity. The causes of poverty can due to several
pathways: metabolic, ecological and socio-economic and poverty traps (causality not clear
and a positive feedback mechanism is seen among these variables: pollution and ecological
problems or environmental degradation, population or the inability to make use of the
demographic window stage of their demographic transition, poor health and metabolic
causes).
 The causes of poverty have to clearly identified in order to understand the nature of poverty
for certain groups and to identify the appropriate interventions.
FIGURE 3. A Benthamite and Rawlsian Criteria
16
This may be reflected by a low earnings ability due to pathologically dysfunctional life styles such as constant
addiction to harmful substances such as drugs and alcohol, mental illness. Policies that deal with these specific
problems, if they are successful, will do much to reduce human suffering as well as to alleviate poverty.
Page 26 of 42
 Figure 4 refers to the general utility possibility frontier of the entire society where A’
individuals belong to the 60% of the population having an income that is above the poverty
line (utility possibility frontier is that with a solid line) and A’ refers to the group with an
income below the poverty line (represented by a dashed line). The GUPF is represented by
the utility possibility frontier of the B’ group. Notice that the A’ group can participate in
only a limited amount of market activities in the economy as the optimum social welfare
functions will only allow them a short interval of utility levels. If the B’ group practices
altruism, then the A’ group would be allowed a level of utility ranging from X to Y.
Otherwise, if the B’ group does not practice altruism, then only a more limited level of
utility, from X’ to Y would be made accessible to the A’ group. Our social welfare criteria
will reach the points bounded by R to R’, and all of these points achieve a net welfare
improvement for the A’ group.
 A Rawlsian criteria may be the best option to allow the A’ group to increase their capacities,
as it is the only criteria that maximizes the benefits of the A’ group. With this policy option,
the A’ group is enabled to participate in the market economy. Through time the GUPF
moves to the right, becomes more convex which signifies that the A’ group more fully
participates in the market economy as the number of commodities they can exchange, or
substitute for other goods, in the economy increases. This corresponds to a GUPF that
moves to the right, towards the dotted GUPF.
R’
UB’
GUPF with
R an increase in
utility possibilities
X’ UA’
X Y
FIGURE 4. General Utility Possibilities Frontier Given “Rich” and “Poor” Groups
 JUST WAGE AS “JUST REMUNERATION” OVER A WORKERS’ LIFETIME (SEE

ACCOMPANYING ARTICLE)
Page 27 of 42
 SOCIAL CAPITAL AS A MEANS TO ATTAIN A PARTICIPATIVE ROLE FOR THE POOR.
 Social capital enters as an economic concept when transactions are governed by trust.
Relationships or networks are established on the basis of trust. Trust occurs when individual
actions are done on the basis of what should or ought to be done, but there is no way for either
agents or principals to observe whether or not the action which has to be done is indeed actually
done.
 Relationships of trust are carried out when appropriate institutions allow for the following
circumstances to occur. These institutions (i.e. natural-family, friendships, church, government;
created by society-associations, financial, health, education) are present in society.
 A suitable punishment and sanction is given to an erring party, there is credibility among
the individuals carrying out the transaction, there is credible punishment, the enforcement
agency is the society at large, trustworthy dispositions can be made known, trust and
confidence among persons are interconnected, it is possible to look at the world from the
perspective of each of the agents participating in the relationship, trust is based on
reputation, the extent of the trust depends on the extent to which actions of persons are
observable, even if trust cannot be measured there is a way by which mutual benefits can be
observed and realized. These mutual benefits have a corresponding value, both intrinsically
and instrumentally.
 Trust works in the same manner as a network externality17 but the effects are felt via civic
cooperation and working through health and education or the main components of human
capital. It can be denoted by the following formulation:
Yi  Aif ( Ki , NihiLi )
where Yi aggregate output

Ai Productivity or the scale factor of the production function but
that the scale refers to the contribution of each if the I
communities or groups
Ki stock of physical assets
Ni Population
hi Traditional Forms of Human Capital such as education and
health
Li number of hours worked
i groups or communities
Note that with this formulation, improvements in civic cooperation are reflected by
increases in Ai and hi. We cannot assume a Cobb-Douglas form for the function which
formalizes the effect of social capital. The reason is that we cannot outrightly assume that
physical assets can be separated from human capital effects. In the usual Cobb-Douglas
formulation, K and H are separable.
Contrast this function from the usual formulation of a production function incorporating
human capital:
Y  AF ( K , H )
where H = Σj (hjLj) for j products. H is a variable to depict aggregate human capital
17
Dasgupta, Partha (2002). “Social Capital and Economic Performance: Analytics.” Working Paper. pp. 30-31.
Written for Elinor Ostrom and Toh-Kyeong Ahn, eds. (2002). Social Capital: A Reader. Edward Elgar:
Cheltenham, U.K.
Page 28 of 42
 NORMATIVE IMPLICATIONS OF A GENERAL EQUILIBRIUM FRAMEWORK18
 GENERAL IMPLICATIONS
 Economic decision-making has to satisfy simultaneously the demands of product, place, time
utility with minimum expenditure. In other words, modern economic agents have to make the
right calls with respect to specializing the appropriate goods or services, producing them in
exact quantities required while employing least-cost methods and inputs, and then, exchanging
them at the proper time and in the right place. The role of punctual, accurate and useful data for
such involved decisions takes on greater importance, and providing such can be adequately met
by only one medium-the market price.
 Only price can convey information quickly, efficiently and effectively over widely dispersed
geographic areas to a large number of interested parties in a timely way. This is a service
rendered by the modern market that no other institution or mechanism could yet replace.
 Modern price serves to allocate joint social resources optimally. Demand and supply are
matched to achieve the most productive disposition of scarce resources to their optimum uses,
that is, allocative efficiency. The market, however, is more concerned with efficiency rather
than equity.
 ADVANTAGES OF THE MARKET MECHANISM VIA PRICES19. The following are the advantages
of the market mechanism:
 (1) Economic agents select their occupation and can improve their social standing and
prestige via wealth accumulation. This is a fundamental human right-choose a place of
domicile and degree of participation in social life; (2) Sustenance of market participants
attained by joining the contractual wage-labor market. The existence of a contractual wage-
labor market is also the basis for the social safety-nets society eventually establishes; (3)
There is a dynamism inherent in the market system. Industry and services create an
increasing stream of new demands and uses for society’s limited means thereby heightening
even further the importance of flexibility in optimizing the use of common resources; (4)
There is a shift in attitudes on public institutions-personal freedom becomes very important-
these provide the means, confidence, opportunities and stimulus for the community through
private initiative.
 The market mechanism works best under a competitive equilibrium. Under competitive
equilibrium, allocative efficiency is achieved. In imperfect markets, there is no sure
pathway. Self-reinforced growth in the economy does not certify that distributive justice
will be achieved and that moral structures will be attained during the market exchange. 20
 NORMATIVE RESPONSE.
 FLEXIBILITY in the market exchange is best achieved when agents in the economy
deliberate on obligations owed by the community to the individual. These are obligations
to rights and entitlements. The state may have to explicitly state the need to respect basic
human rights.21
 PARTICIPATION. Each agent in the economy must have the right to at least a minimum
amount of interpersonal engagements.
18
Barrera (2001), p. 93
19
Barrera (2001), p. 99
20
Barrera (2001), p. 101-103
21
Pacem in Terris (PT). #18-22.
Page 29 of 42
 RELATIVE EQUALITY. Refers to the attainment of a lower threshold of benefits accruing to

the individual. There may be instances of agents in the economy possessing superfluous
income, or that part of earnings not needed to maintain one’s social standing in the
community.22
 THE ROLE OF PRICES. It provides timely information essential to the efficient allocation of
scarce resources to their competing uses (allocative efficiency). But prices also influence
the distribution of factor income through the revenues that goods and services can generate
(distributive function). The main question focuses on how the market economy can restore
distributive justice.
 APPLICATIONS TO SOLVING THE PROBLEM OF POVERTY. When speaking about the enabled
poor, that is, that segment of the population who may not have access to sufficient education
and health, when given an opportunity to obtain these aspects of human capital may be able to
improve their social standing. Such a goal can come about through the improvement of social
capital, i.e. initiatives of private groups to improve technical-vocational education,
volunteerism, microfinance, health services, cooperatives, the promotion of corporate social
responsibility. There may be a segment of the population who have great difficulty improving
their social standing as they may be affected by the population-pollution-resource degradation
nexus. This is a situation of a poverty trap. These circumstances may need a policy shift from
the highest levels of government.
 A POSSIBLE FRAMEWORK IS AS FOLLOWS.23
 Keep in mind that in spite of the fact that we have a framework that is based on a closed
and deterministic (competitive equilibrium) economy with population growth that is
constant, we still arrive at a non-local measure of sustainable well-being.
 Economic sustainability is made as a goal, rather than the achievement of an optimum level
of net social well-being.
 The value of the social welfare function is composed of the following variables:
consumption, resource flows (i.e. rates of extraction of natural resources, expenditure on
health and education) and capital assets (physical and human, i.e. education and health
assets). All these three variables can be represented or mapped into society’s stock of
capital assets. This means that consumption, resource flows and capital assets are all
productive and are sources of society’s stock of wealth.
 The three variables can be translated into an economic program that is implementable
in an infinite time horizon, over a sustainable development path. This means that the
economic program is not dependent on a particular government or administration
alone but becomes a goal for several time periods. This economic program is also not
unique as the program involves several states of nature over an infinite time horizon.
Lastly, it implies that there is a number of technologically and ecologically feasible
economic programs where a wide substitution among capital assets is possible.
Otherwise, the economy’s capacity to achieve a sustainable development path is
limited and technological advances would unlikely occur. Under this regime, a
government may opt for optimizing social well-being as the subjective discount rate
may be too high. Under this scenario, the optimum social welfare or well-being path
may decline after some time but increase thereafter. This growth path does not
correspond to a locally sustainable development path.
22
RN 36; GS footnote 10, Chapter 3, Part II
23
Dasgupta, Partha (2002). “Sustainable Development in the World of Today’s Poor.” A paper prepared for a
conference held at Resources for the Future, Washington, D.C., November 18-19, 2002. pp. 12-14.
Page 30 of 42
 The result is that: (a) at any particular date the rate of change of social well-being is
equal to the rate of change of genuine investment (refers to THEOREM 1), and, (b)
whether or not there are net social well-being gains, there must be an increase in
capital, that is, there are capital gains over the time period this policy was
implemented (refers to THEOREM 2).
 Theorem 1 gives the policymaker a normative framework for a sustainable development

path, that is, the rate of increase in well-being is equal to the rate of increase of returns from
physical and human capital investments. Note that if the policy on resource allocation
(denoted by α in the model) is autonomous (not changing nor is prone to a bias), and the
subjective discount rate is not too high, then the economy is likely to get a solution that is
both optimal and sustainable. Theorem 2 shows that in assessing whether or not social
welfare has increased between two dates, the capital gains on the assets that have accrued
over the interval should be deducted from the difference in wealth between the dates.
Theorem 2 gives us a guideline ensuring when the productive base in the economy is
constantly increasing, and which results into a rightward shift in the general utility
possibilities frontier. If the policy on resource allocation is not autonomous, then the
economy has to ensure that the result for Theorem 2 is positive.
 Other implications of the model. The first result refers to a need to improve the measure
used for human capital productivity as GNP is not a measure of this stock of wealth, and, to
measure properly resource allocation flows (i.e. proper costing of externalities). The
second result gives a guideline as to when the capital base is increasing and links an
increase in the capital base with a net welfare gain. Both results make the framework
applicable to different types and systems of government.
 The framework can be represented by Figures 5 and 6:24

 The economic program ξ (t) is defined only along the curve bounded by t to τ.
 A depiction of a time-consistent and therefore autonomous resource allocation program is
one that is continuous over K (t). This means that the resource allocation program is one
which can be reviewed and easily evaluated over a continuous time period. A gap on K (t)
may denote a non-autonomous resource allocation program as depicted in Figure 2.
 It is possible that no welfare improvement is achieved at time period T. This can occur
when the subjective discount rate for capital assets suddenly became too high as in the case
of Figure 6.
 Note that for Figures 5 and 6:
24
Refer to Dasgupta (2002). pp. 12 -14
Page 31 of 42
   dp ( ) / d  K ( )d
T
OA' B ' CT  i
i i
0
V(T) – V(0) = AA’BB’C
V(K(t), α, t) B
C
A
B’
K(t)
A’
0 t τ=T T
FIGURE 5. Welfare Gains given an Autonomous Policy Framework for a Mechanism on Resource Allocation
V(K(t), α, t) C
A B
A’
B’
K(t)
0 t τ=T T
FIGURE 6. Welfare Gains given a Non-Autonomous Policy Framework for a Mechanism on Resource Allocation
Page 32 of 42
2.2 ETHICS AND ECONOMICS: PHILOSOPHY OF ECONOMICS
OBJECTIVE OF THE LECTURE:
1. To understand the view of philosophers on economics and its methodology.

2. To detect what philosophical views have been a subject of debate and improvements on the part of
economic theorists
3. To link the findings of Dr. Crespo and Dr. Zuñiga on their ontology of economics and see a way to
incorporate ethical concepts.
PHILOSOPHY OF ECONOMICS25
Daniel M. Hausman
University of Wisconsin-Madison
Like many of the social sciences, economics grew out of philosophy, and the concerns of economists continue to
intersect with those of philosophers. Philosophical reflections on (a) scientific method and social ontology, on (b)
the nature of rationality, self-interest, and preference; and on (c) welfare, justice, equality, and freedom are of
abiding significance to economists and other social scientists.
1. ECONOMIC METHODOLOGY
Philosophical reflection on economics is ancient, but the conception of 'the economy' as a distinct object of study
dates back only to the 18th century. Aristotle addresses some problems of economics mainly as problems of
household management. Scholastic philosophers addressed ethical questions concerning economic behavior, and
they condemned 'usury' -- that is, the taking of interest on money. With the increasing importance of trade and of
nation-states in the early modern period, 'mercantilist' philosophers and pamphleteers addressed questions
concerning the balance of trade and the regulation of the currency. Only in the work of the physiocrats and
especially of Adam Smith do scholars begin to think of the economy as an object of study with its own principles
and laws.
18th-century philosophers wrote in the shadow of Newton's towering accomplishments. David Hume is unabashed
about his hopes to develop a science of mind and society in the image of Newton's science of the solar system. To
that end, he seeks out general laws of individual thought and action, out of which larger-scale orderly relations
will arise, in just the way that patterns in planetary motion arise from the laws of motion and gravitation
governing individual bodies. Thus Hume traces the rise in prices and the temporary increase in economic activity
that follow an increase in currency to the perceptions and actions of individuals who first spend the additional
currency.
25
http://philosophy.wisc.edu/hausman/papers/enc-617.htm
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It then lay to Adam Smith to extend such a method to a systematic Inquiry into the Nature and Causes of the
Wealth of Nations and to make explicit an implication of previous causal inquiries such as those of Hume, the
physiocrats and of many of the mercantilists. That implication (which is arguably the foundation for all social
science) is that the social, aggregative implications of individual choices are often unintended. In spending their
additional gold imported from abroad, traders do not intend to increase the price level. But that is what they do
nevertheless. In this way unintended regularities that arise from the intentional choices of individuals can rule
those individuals just as surely as the regularities of nature, and, like nature, societies can be objects of scientific
investigation.
1.1 Classical economics and the method a priori
Although Adam Smith made some general comments about scientific method in his History of Astronomy and
other essays, he wrote little explicitly about the method of economics. The first extended reflections on economic
methodology had to wait until Nassau Senior (1836) and John Stuart Mill (1836). Their essays must be understood
against the background of the prevailing economic theory. Like Smith's economics (to which it owed a great deal)
and modern economics, the 'classical' economics of the middle decades of the 19th century traced economic
regularities to the choices of individuals facing social and natural constraints. But, as compared to Smith, more
reliance was placed on severely simplified models. In David Ricardo's Principles of Political Economy, a portrait
is drawn in which wages above the subsistence level lead to an expanding labor force, which in turn requires more
intensive agriculture or cultivation of inferior land. The extension of cultivation leads to lower profits and higher
rents; and the whole tale of economic development leads to a gloomy stationary state in which profits are too low
to command any net investment, wages return to subsistence levels, and only the landlords are affluent. From the
time Ricardo's Principles was published (1819) the data available to classical economists was never in accordance
with the trends the theory predicted. Yet the theory continued to hold sway for more than half a century, and the
unfavorable data were explained away as due to various 'disturbing causes.'
It is not surprising then that Mill's account of the method of economics would emphasize the relative autonomy of
theory. Mill distinguishes between two main kinds of inductive methods. The method a posteriori is a method of
direct experience. It is only suitable to phenomena in which few causal factors are operating or in which
experimental controls are possible. Mill's famous methods of induction are detailed specifications of the method a
posteriori. In his method of difference, for example, one holds fixed every causal factor except one and checks to
see whether the effect ceases to obtain when that one factor is removed.
Unfortunately, such direct inductive methods cannot be used to study phenomena in which many causal factors are
in play. If, for example, one attempts to investigate whether tariffs enhance or impede prosperity by comparing the
prosperity with and without tariffs, the results will be irregular and unreliable because other causes besides tariffs
will also differ across societies and times. So one needs instead to employ the method a priori. Despite its name,
this is an inductive method, but it is an indirect inductive method. One first determines the laws governing
individual causal factors in domains in which direct inductive methods are applicable. Having then determined the
laws of the individual causes, one investigates their combined consequences deductively. Finally, there is a role
for 'verification' of the combined consequences, but owing to the causal complications, this testing has
comparatively little weight. The testing of the conclusions serves only as a check on one's deductions and as a
indicator of whether there are significant disturbing causes that one has not yet accounted for. Mill gives the
example of the science of the tides. One determines the law of gravitation by studying planetary motion, in which
gravity is the only significant causal factor. Then one develops the theory of tides deductively from that law and
information concerning the positions and motions of the moon and sun. The implications of the theory will be
inexact and sometimes badly mistaken, because many subsidiary causal factors influence tides. By testing the
theory one can uncover mistakes in one's deductions and evidence concerning the role of the subsidiary factors.
Because of the causal complexity such testing does little or nothing to confirm or disconfirm the law of
gravitation, which has already been established.
Because economic theory includes only the most important causes and necessarily ignores many minor causes, its
claims, like claims concerning tides, are inexact. Its predictions will be imprecise, and sometimes dead wrong. But
it is possible nevertheless to develop and confirm economic theory by first establishing in simpler domains the
laws governing the major causal factors and then deducing their consequences in different circumstances. For
Page 34 of 42
example, statistical data tell a mixed story about the relationship between minimum wages and unemployment;
and there is no data at all about what the consequences for employment would be of an extremely high minimum
wage. On the other hand, everyday experience teaches one that firms can choose among more or less labor-
intensive processes and that a high minimum wage will make more labor-intensive processes more expensive.
Since one also has good reason to believe that firms try to keep their costs down, one has good reason to believe
that a high minimum wage will increase unemployment.
According to Mill, economics is not only inexact and committed to the method a priori. In addition, he maintains
that it is a separate science. What distinguishes economics as a discipline is not only its concern for a certain
domain of phenomena, but also its limitation to a particular set of causal factors, which predominate in this
domain. With respect to this domain, one can (at a certain level of approximation) ignore the myriad causal factors
that influence all social phenomena and which are the subject matter for sociology and develop economics
separately. In defending a view of economics as in this way inexact and separate and a view of economists as
following the method a priori, Mill was able to reconcile his empiricism and his commitment to Ricardo's
economics.
Although Mill's views on economic methodology were challenged later in the 19th century by dissident
economists who believed that the theory was too remote from the contingencies of policy and history, Mill's
methodological views dominated the mainstream of economic theory for well over a century. Mill's vision
survived the transformation of economics from classical to neoclassical and is clearly discernable in the most
important methodological treatises concerning neoclassical economics, such as John Neville Keynes' The Scope
and Method of Political Economy (1891) or Lionel Robbins' An Essay on the Nature and Significance of
Economic Science (1935). Indeed Hausman (1992) argues that current methodological practice closely resembles
Mill's methodology.
1.2 20th-century philosophy of science and economic method
Beginning in the 1930s, mainstream economists began to have a bad conscience about their traditional
methodology, which some saw as insufficiently empiricist. Robbins is a transitional figure, because at the same
time that he clung to Mill's methodology (1935, chap. 4) and to the identification of the domain of economics with
the predominance of particular causal factors (the allocation of scarce means that have alternative uses -- 1935,
chap. 1), he also offered his apparently empiricist critique of interpersonal utility comparisons as untestable value
judgments (1935, chap. 6). Terence Hutchison argued that the propositions of pure theory were so hedged with
ceteris paribus conditions that they were not testable (1938). Paul Samuelson argued for a need to separate the
'operationally significant' economic wheat from the chaff, and in his theory of revealed preference he provided a
model for how to do so (1947). Other economists cited survey data to argue that the theoretical propositions of
economics were false. The confusing methodological situation stabilized in the 1950s with arguments by Fritz
Machlup (1955) and especially Milton Friedman (1953) that economists need be concerned to fit only data
concerning prices and quantities and that the 'realism of assumptions' is irrelevant.
Although confused, mistaken, and inconsistent with the practice of mainstream economists--including his own
practice--Friedman's views have dominated the methodological conceptions of mainstream economists over the
past two generations. His views are confused because they conflate many different kinds of 'assumptions' and
'realism'. Basic generalizations, propositions concerning initial conditions, and antecedents of conditional claims
are all called 'assumptions'. Assumptions are called 'unrealistic' if they are false, incomplete, or not approximately
true. Friedman's views are mistaken, because (as Mill already emphasized) market data are generated by too many
causal factors to provide effective tests of economic theory. And the eclecticism that Friedman's official
methodological position counsels--'don't worry about what theory says, just ask whether it fits market data'--
contradicts the firm and narrow commitment to a specific theory that characterizes mainstream economics,
including Friedman's own work. Nevertheless Friedman's views were warmly embraced because they freed
mainstream economists to ignore criticisms of their theories and to abandon all empirical work apart from
econometrics.
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In the 1970s and 1980s other streams of contemporary philosophy of science began to influence the
methodological reflections of economists. Karl Popper's view that scientific theories must be falsifiable, which
had been defended by Hutchison was taken up and emphasized by Mark Blaug (1992). According to Popper, the
hallmark of science is to formulate theories so that they can be exposed to empirical testing and to reject theories
that fail tests. Hutchison and Blaug object that mainstream economic theories are not harshly tested and that
mainstream economists are unwilling to surrender them when they fail the few tests they are subjected to. In his
extensive publications, Lawrence Boland (1982) has also emphasized the relevance of Popper's views to economic
methodology, although Boland's interpretation of Popper is rather different than Blaug's or Hutchison's.
Imre Lakatos' methodology of scientific research programmes (which represented a wedding of some of Thomas
Kuhn's insights to Popper's philosophy of science) was for a while widely discussed (Latsis 1976, deMarchi and
Blaug 1993). Although still emphasizing the importance of empirical criticism, Lakatos insisted that theories
should not be abandoned until superior alternatives are found, and his emphasis on heuristics struck a responsive
chord.
A spate of prominent contemporary writers on methodology: Roger Backhouse, Bruce Caldwell, Neil deMarchi,
D. Wade Hands, and E. Roy Weintraub have a more ambivalent relationship to Popper's and Lakatos' philosophy.
Caldwell wrote a series of searching, though charitable criticisms of Popperian views. Backhouse, DeMarchi,
Hands, and Weintraub were all at one time enthusiastic about Lakatos' views, though to differing degrees all have
moved away from them now. Backhouse and deMarchi remain the closest. Hands has become a proponent of the
application to economics of new work on the sociology of science, while Weintraub's work on the stabilization of
concepts in economics has been more influenced by literary theorists
More recently, alternatives to philosophy of science influenced by work in literary theory and sociology have also
developed a following among economists. In a series of stylistically brilliant works, Deirdre McCloskey has
criticized the whole project of exploring a normative methodology for economics and has urged instead that
economists attend to their rhetoric--that is, to their ways of persuading one another (1985). This work has been
highly controversial, because many of McCloskey's formulations apparently reduce questions about the
correctness or incorrectness of economic claims to questions about what most economists accept. Such a view
would imply that minority views are always mistaken. McCloskey denies such a radical reading of her position,
but it is not clear how to avoid it without incorporating normative methodological commitments into the rhetoric
of economics.
Philip Mirowski's work on methodology is heavily historical and less radical epistemologically than McCloskey's.
He has explored the influence on economics of the formal analogy between utility theory and physics (1990).
More recently, his work has shown increasing concern with sociological influences. For other work that tests the
boundaries of conventional methodology, see Mäki, Gustafsson and Knudsen 1993.
Over the last fifteen years, economic methodology has become a large field. It has its own Journal of Economic
Methodology and occupies a large part of the journal, Economics and Philosophy. Dozens of monographs on
economic methodology have been published. Graduate programs in the field have been established (including a
Ph.D. program at Erasmus University in Rotterdam), and there are regular sessions on economic methodology at
meetings of economists and philosophers. The field is very diverse, and each of its leading figures has a
distinctive approach. Although one can roughly identify Popperian-Lakatosian and sociological-literary schools,
there is no easy way to categorize contemporary methodology.
Several methodologists have been particularly interested in the role of explicitly causal notions in economics (see
Causes and laws; Causation: physical, mental and social). Nancy Cartwright (1989), who is also a distinguished
philosopher of physics, has (unlike most philosophers writing on economics) paid a great deal of attention to
econometrics. She has defended the importance of specifically causal considerations in science, and she has
argued that econometricians have made important contributions to a philosophical understanding of causation.
Cartwright holds that economists should be understood as attempting to identify causal capacities and that the
work of econometricians can be understood as contributing to this task.
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Daniel Hausman (1992) defends a modernized variant of Mill's methodology that depicts economics as
inexact and permits the plausibility of the basic principles of economics to count in the assessment of
economic theories. But he is skeptical of the view that a small set of causal factors do indeed predominate in
the domain of economics and defends a greater attention to the results of experiments, surveys, and field
work. He has increasingly emphasized the role of causal generalizations in mainstream microeconomic
theory. 26
Kevin Hoover (2000)-- unlike most methodologists -- has written on problems concerning macroeconomics.
Although he has addressed technical issues in econometrics, his main interest has been in causality. Like
Cartwright, Hoover has placed particular emphasis of what one can learn about causation by studying the work of
economists.
Tony Lawson (1997) finds his inspiration in the 'transcendental realism' of Roy Bhaskar. Lawson sees himself not
merely as enunciating a distinctive approach to methodology, but as laying the foundations for a new economics.
Crucial to the approach and to his methodological views is a strongly realist ontology (see Realism,
instrumentalism, fictionalism), which takes the objects of scientific investigation to be causal mechanisms and
tendencies that lie as it were 'beneath' the irregularity of phenomena. This realist ontology leads him, like
Cartwright, Mäki and increasingly Hausman, to regard economic theories as identifying causal mechanisms and
tendencies.
Uskali Mäki is harder to categorize. Like Lawson, he is concerned with realism, but whereas Lawson
attempts to redirect economics and its methodology on the basis of a specific realist ontology, Mäki
elucidates versions of realism to which economists have been implicitly committed. Like Cartwright,
Hausman and Hoover, Mäki emphasizes the importance of causal notions in economics. Like Hands and
Mirowski, Mäki also applies insights from the sociology of science to the understanding of economics.
There is a great deal of other work, too. A number of economists and philosophers have attempted to apply to
economics the structuralist view of scientific theories developed by Patrick Suppes, Joseph Sneed, and Wolfgang
Stegmüller. (See for example Hands 1985 and Balzer and Hamminga 1989.) Alexander Rosenberg, who is also a
distinguished philosopher of biology, has pursued a number of different themes. His Microeconomic Laws: A
Philosophical Analysis (1976) was one of the first philosophical treatments of the methodological problems of
economics. In that book Rosenberg argues that economics fits reasonably well within a standard philosophical
model of the natural sciences. But shortly afterwards Rosenberg changed his views radically, and he now defends
the position that mainstream economics is best understood either as applied mathematics or as a normative social
and political theory (1992).
Contemporary economic methodology thus moves in many directions. Although some of it is directed toward the
conduct of economics, one regularly finds a sort of methodological schizophrenia whereby in theory economists
cling to positivist or Popperian philosophical views that are radically at odds with their practice, which is roughly
Millian. Other work in methodology is oriented toward philosophy of science, and it appears that the study of
economic methodology has made significant contributions to philosophical investigations of causation and
explanation. It is controversial whether methodology can or should be a distinct and relatively self-contained field
rather than addressing itself toward economists or toward philosophers.
2. METHODOLOGY, RATIONALITY, PREFERENCE, AND SELF-INTEREST
The study of rationality, preference, and self-interest is a second area of overlap between economics and
philosophy. Mainstream economic theory is built around a variant of 'folk psychology'. According to folk
psychology, human actions are the consequence of beliefs, desires, and circumstances that determine the
feasibility and consequences of actions. The same elements figure in economic theories of choice. Sometimes
economists suppose that agents have complete knowledge and thereby avoid having to refer specifically to beliefs,
26
The emphasis is made by Jovi Dacanay
Page 37 of 42
but in other contexts beliefs are explicitly modeled--most typically as subjective probability judgments. In place of
desires, economists postulate that economic agents possess stable, complete, and transitive preferences. Given
additional technical conditions, such preferences can be represented by a continuous 'utility function' such that
UP(A) > UP(B) if and only if an agent P prefers A to B. 'Utility' is simply a way of indicating how an alternative is
ranked by an agent. It is not a substantive object of choice, and indeed it makes no sense to regard an agent as
seeking or preferring utility. Mainstream economic models relate choice to preference by maintaining that, subject
to the constraints, agents maximize utility -- which means merely that among the feasible alternatives agents
choose whatever they most prefer.
The previous paragraph presents the standard theory of choice as an empirical theory purporting to describe,
predict, and explain how agents choose in fact. But the same theory also functions as a theory of rationality:
Preferences are rational if they are complete and transitive (and perhaps satisfy other axioms, too). Degrees of
belief are rational if they satisfy the axioms of the calculus of probability. Choices are rational if they are utility
maximizing. Given this model of rationality, the empirical claim of the standard theory of rational choice can be
restated simply as the claim that economic agents are in fact rational.
According to this theory of rationality, it is irrational to choose one feasible option over another when one prefers
the second and according to this theory of choice people will in fact never choose one feasible option over another
if they prefer the second. Since according to these theories choice is and ought (rationally) to be determined by the
agent's preferences, it is easy mistakenly to infer that these theories maintain that agents are and ought to be self-
interested. But whether a choice is self-interested depends on the content of the preferences that lead to it, not on
whether the choice is determined by preferences. People who prefer to sacrifice their interests to others are not
self-interested, and that fact that their choices result from these preferences does not make their choices self-
interested. Unlike the standard theories of choice and rationality, the views that it is rational to pursue one's own
interest and that people in fact do so are 'substantive' theories of choice and rationality. Unlike the standard
'formal' theory, which merely specifies a certain structure of choice and preference, self-interest theories specify
an objective that agents do or ought rationally to have.
Theories of rationality are normative theories. They prescribe what one ought to do--not, to be sure, as a matter of
morality, but as a matter of rationality or prudence. (Irrationality is foolish rather than evil.) Incorporating as it
does a normative theory, economics is unlike any of the natural sciences. The reason why economics incorporates
a theory of rationality is that human actions, unlike the actions of oak trees or potassium, can be criticized or
justified as well as explained. This fact has important methodological consequences and indeed (as just argued)
establishes one important distinction between the social and the natural sciences.
The first and perhaps most important methodological consequence is that explanations of individual choices cite
the reasons why the agent acted. Although a number of philosophers in the 1950s, who were influenced by
Wittgenstein, argued that such explanations that cite an agent's reasons could not be causal explanations,
nowadays most philosophers are persuaded by Donald Davidson's argument (1963) that satisfactory explanations
that cite an agents reasons must also be causal explanations. Agents may reasons for performing an agent that are
not in fact responsible for the action. Davidson argued that the distinction between the reasons that are 'effective'
and those that are merely rationalizations is that the first unlike the second are causes of the action.
So the fact that the explanations economists offer of individual choices cite reasons for those choices does not
imply that economists are not giving causal explanations, and it does not imply a strong anti-naturalist distinction
between the structure of the natural and social sciences. But the fact that the causal explanations economists offer
also cite reasons is nevertheless of great interest. It explains why economists must hold that agents are to some
extent rational. (If they weren't then they couldn't have reasons for their actions.) Furthermore, it implies that the
actions of economic agents are subject to rational appraisal. Were the agent's reasons good reasons? Was the
action justified? And once one begins appraising choices, one is just one step away from ethical questions.
Readers should be aware that the standard theories of rationality and choice are controversial. For more detail on
the theories and these controversies, see Intentionality and rationality; and Rational choice explanations.)
Page 38 of 42
3. WELFARE, JUSTICE, EQUALITY, AND FREEDOM
Economists have an ambivalent attitude toward ethics. On the one hand, many have been concerned to insist that
mainstream economics is a 'positive' science, whose conclusions are entirely independent of any moral
commitments. On the other hand, economists freely give out normative policy advice. Some of this advice is
purely technical, like the advice that a civil engineer might offer on where to locate a bridge, but much of it is not.
Most mainstream economists are in fact committed to a specific view of ethics that emphasizes welfare, and they
also adopt a distinctive theory of welfare. (When economists emphasize efficiency they are virtually always
concerned with efficiency at promoting individual welfare.) These features of normative economics are not
entailed by positive economics or the theory of rationality, but they are heavily influenced by them.
There are a variety of different ethical bases for assessing social arrangements. In addition to considering the
welfare of the members, one can also ask whether the rights of the members are protected and whether procedures
and the distribution are just, whether the members are treated equally, and what sorts of freedoms and
opportunities people enjoy (see Rights; Justice; Equality; Liberty/freedom). All of these considerations are
important, but in economic policy pronouncements and normative theory (which indeed is called 'welfare
economics') typically only considerations of welfare enter.
The reason for this narrow normative focus is that welfare can be tied tightly to the standard models of rationality
and choice. Suppose that individuals are rational and--in addition--that they are self-interested. As already pointed
out, the standard theory of rationality does not imply self-interest, but self-interest is also commonly assumed in
most economic models. It follows that individuals will prefer alternative A to B if and only if they believe that A
serves their interests better than B. If individuals have perfect knowledge, which is again a common assumption in
economic models, it follows that individuals will prefer A to B if and only if A in fact serves their interests better.
Finally, if one identifies an individual's welfare with whatever is in the individual's interest, it follows that A is
better for and individual than B if and only if the individual prefers A to B--or in other words that welfare is the
satisfaction of preference. This view of welfare has the additional advantage that it prevents concerns about
paternalism--to which many economists are opposed--from even arising, since by definition it could never be
good for individuals to overrule their preferences.
Most normative economics is thus doubly narrow. Not only is it characterized by an almost exclusive
preoccupation with welfare, but it is also committed to a particular view of welfare as the satisfaction of
preferences. This double narrowness is doubly unfortunate. The limitation to considerations of welfare
means that in policy discussions economists treated non-welfarist ethical criteria as exogenous constraints
to be left for someone else to worry about. The commitment to a preference satisfaction view of welfare has
the drawback that this view of welfare is false. Because individuals are not always self-interested and
because their beliefs are not always true, individuals do not always prefer what is good for them. There are
a variety of good reasons to be hesitant about paternalism, but the view that individuals are always perfect
judges of their own good is not one of them. There is some work, particularly by Amartya Sen (see for
example his 1992), that stretches these limits on normative economics, but such work is the exception to the
welfarist rule (see also Hausman and McPherson 1996; Economics and ethics and Welfare).
4. CONCLUSIONS
Mainstream economists, whether engaged with positive theory, the theory of rationality, or with normative and
policy investigations, are overwhelmingly committed to an exaggerated simplification of a plausible view of
individual agents as possessing stable and consistent preference rankings, which, given the constraints, determine
their choices. Market outcomes are the unintended consequences of these choices. Rationality is defined by this
structure of choice. Welfare, like choice, is determined by these same preference rankings. Although there are
philosophical issues concerning economics that have no particular connection to this core commitment, most work
in philosophy of economics has attempted to comprehend and evaluate the basic model of choice and its
applications in positive economics, normative economics, and the theory of rationality.
Page 39 of 42
BIBLIOGRAPHY
Backhouse R 1997 Truth and Progress in Economic Knowledge. Edward Elgar, Cheltenham.
Balzer W, Hamminga B eds. 1989 Philosophy of Economics. Kluwer-Nijhoff, Dordrecht.
Blaug M 1992 The Methodology of Economics, 2nd. ed. Cambridge University Press, Cambridge.
Boland L 1982 The Foundations of Economic Method. Allen & Unwin, London.
Caldwell B 1982 Beyond Positivism: Economic Methodology in the Twentieth Century. Allen & Unwin, London.
Cartwright N 1989 Nature's Capacities and their Measurement. Clarendon Press, Oxford.
Davidson D 1963 Actions, reasons and causes. J. Phil. 60: 685-700.
de Marchi N, Blaug M eds. 1991 Appraising Economic Theories: Studies in the Methodology of Research
Programs. Edward Elgar, Cheltenham.
Friedman M 1953 The methodology of positive economics. In: Essays in Positive Economics. University of
Chicago Press, Chicago, pp. 3-43.
Hands D W 1985 The structuralist view of economic theories: the case of general equilibrium in particular. Econ.
Phil. 1: 303-35.
Hands D W 1993 Testing, Rationality, and Progress: Essays on the Popperian Tradition in Economic
Methodology. Rowman & Littlefield, Lanham, MD.
Hausman D 1992 The Inexact and Separate Science of Economics. Cambridge University Press, Cambridge.
Hausman D, McPherson M 1996 Economic Analysis and Moral Philosophy. Cambridge University Press,
Cambridge.
Hoover K 2000 Causality in Macroeconomics. Cambridge University Press, Cambridge.
Hutchison T 1938 The Significance and Basic Postulates of Economic Theory. Repr. A. M. Kelley, New York,
1960.
Latsis S ed. 1976 Method and Appraisal in Economics. Cambridge University Press, Cambridge.
Lawson T 1997 Economics and Reality. Routledge, London.
McCloskey D 1985 The Rhetoric of Economics. University of Wisconsin Press. Madison.
Machlup F 1955 The problem of verification in economics. Southern Economic Journal 22: 1-21.
Mäki U, Gustafsson B, Knudsen C eds. 1993 Rationality, Institutions and Economic Methodology. Routledge,
London.
Mill, J. S. 1836. On the definition of political economy and the method of investigation proper to it. Repr.
Collected Works of John Stuart Mill, vol. 4. University of Toronto Press, Toronto, 1967.
Mirowski P 1990 More Heat Than Light. Cambridge University Press, Cambridge.
Robbins L 1935 An Essay on the Nature and Significance of Economic Science, 2nd. ed. Macmillan, London.
Rosenberg A 1992 Economics--Mathematical Politics or Science of Diminishing
Returns, University of Chicago Press, Chicago.
Samuelson P 1947 Foundations of Economic Analysis. Harvard University Press., Cambridge, MA:
Sen 1992 Inequality Reexamined. Harvard University Press, Cambridge, MA.
Senior N 1836 Outline of the Science of Political Economy. Repr. A. M. Kelley, New York, 1965.
Weintraub E R Stabilizing Dynamics. Cambridge University Press, Cambridge
Page 40 of 42
2.3 EXAMINING SELF-INTEREST
January 3, 2007 | Acton Commentary
Self Interest, Rightly Understood
by Samuel Gregg, D.Phil.
Any system of social and economic life that aspires to be truly humane needs to reflect the nature of human
beings. Communism imploded, at least in part, because it denied certain truths about humans, most notably
the fact that we possess the unique ability to make free choices. By attempting to replace market mechanisms
of supply and demand with a top-down command approach, both socialist and communist economic theory
ascribed abilities to humans that are possessed by no individual or group. One was the assumption that any
one of us can look ahead and foresee all the possible needs of an entire society at any one point of time in the
near or distant future. No matter how sophisticated the available methods of economic modeling, such
foresight is beyond any human intelligence. There are good reasons why economic forecasting is often
described as more of an art than a science.
Another failure of real socialism to comprehend human nature was its inability to appreciate the observable
fact that at most times, the vast majority of people prefer to place the ownership of things in private hands.
This is not to claim that people are never willing to ascribe ownership of certain things to wider associations
of people (such as businesses with multiple shareholders) or even the state. In some situations, such as
wartime, people are willing to accept certain restrictions on their ownership. Nonetheless, private ownership
remains the preferred norm in virtually all societies. With its in-principle opposition to private ownership,
communism was unable to account for this reality.
Why then do people tend to favor private over communal ownership? One reason is that they are aware, as
Aristotle and Aquinas witnessed long ago, that when things are owned in common, the responsibility and
accountability for their use disappears, precisely because few are willing to assume responsibility for things
that they do not own. Our everyday experience reminds us of the tragedy of the commons. The early
advocates of socialism were well aware of these objections. Their response was to hold that all that was
needed was a change of mind and heart on the part of people as well as profound structural change: a change
that would not only produce a new system of ownership, but also a “new man” -- the socialist man much
trumpeted by the former Soviet Union.
Commercial society rejects this vision of man as well as the means proposed for realizing such an economic
order. For the understanding of humans that pervades commercial society is one of realism. It does not
assume that human beings can always be other-regarding when it comes to acts of economic exchange. Many
of commercial society’s legal and economic structures are thus predicated on a decidedly non-altruistic
understanding of humans and their world. Contracts exist, in part, because there will always be some people
who will unreasonably decide not to fulfill their promises. Likewise, the network of free exchange assumes
that people normally engage in exchanges in order to meet their own needs rather than from a specific
concern for the well-being of those with whom they are exchanging goods and services. The type of exchange
characteristic of commercial society thus differs from the system of mutual obligation from that which existed
in some medieval societies whereby peasants, for instance, were required to pay money to the nobility in
return for the protection accorded by the nobility against brigands and foreign invaders. Commercial society
Page 41 of 42
requires free exchanges into which people enter in pursuit of their own interests.
Commercial society does not therefore attempt to eliminate human fallibility. Instead it holds that there is
nothing unnatural about self-interest. To speak about self-interest, as the political philosopher Pierre Manent
notes, is to “designate a powerful and universal resort of human action.” It is not an abstract principle without
grounding in reality. Those who followed commercial society’s early development noted its ability to align
human weakness and self-regard with a society’s overall progress toward a more prosperous state of well-
being. Adam Smith’s reference to the “invisible hand” perplexes some, but is simply a metaphor for the idea
that through allowing people to pursue their self-interest, unintended but beneficial social consequences for
others will follow.
As individuals pursue profit, they unintentionally add to the sum total of the wealth in society, unintentionally
allow people from different nations to come to know each other, unintentionally promote civility and peace,
unintentionally allow others to benefit from more and better jobs, and unintentionally contribute to
technological development. None of this means that commercial society does not afford opportunities for
people to act altruistically. Rather, it is precisely because increasingly large numbers of people in commercial
society are able to accumulate sums of capital that exceed their immediate needs and acquired
responsibilities, they begin to develop opportunities to be generous to others.
This article was excerpted from Samuel Gregg’s The Commercial Society – Foundations and Challenges in a
Global Age, a new book published this month by Lexington Books. Samuel Gregg is the director of research
at the Acton Institute. The Commercial Society is available for purchase through the Acton Book Shoppe
(www.acton.org/bookshoppe)
Dr. Samuel Gregg is Director of Research at the Acton Institute and author of On Ordered Liberty (2003), A
Theory of Corruption (2004), and Banking, Justice and the Common Good (2005).
Source: http://www.acton.org/ppolicy/comment/article.php?id=360
© Acton Institute 2003

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2.4 SUMMARY: WHYS SHOULD ECONOMISTS BE INTERESTED IN MORAL QUESTIONS?
(See slides on Ethics, Moral Philosophy and Economics)
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Chapter 2. Economic Methodology and Normative Principles

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Chapter 2. Economic Methodology and Normative Principles

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Lecture Notes of Jovi Dacanay

CHAPTER 2. NORMATIVE AND POSITIVE PRINCIPLES IN ECONOMICS

2.1 NORMATIVE PRINCIPLES ON VALUE THEORY, JUST PRICE AND EXCHANGE-VALUE

Objective: This chapter has the following aims

2.1.1 VALUE THEORY (EXCHANGE-VALUE DETERMINATION) AND THE JUST PRICE

 Just price as cost of production.

 Just price as the market price

3. EXCHANGE-VALUE DETERMINATION IN MODERN CATHOLIC SOCIAL THOUGHT. Modern

 Work and Livelihood6

 Two Dimensions of Work

 Guiding Principle of Exchange-Value Determination

4. CONTRASTING MODERN CATHOLIC SOCIAL TEACHING WITH ECONOMIC THOUGHT

 Consumer-Utility Approach (The sentences and phrases in italics are my comments)

Wage level = {price of output} x {marginal product of labor}

 There are numerous objections to this claim.

5. SUMMARY AND CONCLUSION9

The ideas expounded above are summarized in the following table.

TABLE 1. COMPARISON OF APPROACHES

CONCEPT SCHOLASTIC ST. THOMAS AQUINAS CATHOLIC SOCIAL MAINSTREAM ECONOMIC

TABLE 1. COMPARISON OF APPROACHES (CONTINUED)

CONCEPT SCHOLASTIC ST. THOMAS AQUINAS CATHOLIC SOCIAL MAINSTREAM ECONOMIC

(b) Obstacles to the Achievement of the Living Wage

 Some empirical observations

 For Tables 2 and 3:

 The OECD mean for percentage of population attaining upper secondary

 Developing countries have a substantially lower average of those aged 25 to 34

Source: Hanushek, pp. 96 - 100

F ig u re 1. P e rce n tag e o f P o p u lation attain in g U p p e r S e co n d ary

Figure 2. Percentage of Population Attaining Upper Secondary Education or More

 For Figure 3 (Data sourced from Table 4):

 No strong linear relationship exists between the percentage share to GDP of

 For Figure 4 (Data sourced from Table 5)

 No strong linear relationship. Thus, the frequency of schooling is not

Table 4. Educational Spending by the Government Relative to

Figure 3. Schooling vs. Public School Expenditure

Table 5. Actual Expenditure per Student on Secondary

Figure 4. Schooling vs. Actual Expenditure per Student on

Table 6. Actual Expenditure for Secondary Education per Student

Figure 5. Schooling vs. Actual Expenditure per Student on Secondary

Table 7. Expenditure by the Government on Education as a

Figure 6. Schooling vs. Public School Expenditure

Percent Expenditure per Student and Spending Relative to GDP (1998)

(c) Philosophical Implications

 A Market Solution to the Imperfect Information Case: Screening. Look at notes

(d) Normative Response

 Due to the ability of education to increase capacities, access to education by a

2.1.3. GENERAL EQUILIBRIUM AND THE ROLE OF PARTICIPATION

 WALRASIAN AND ARROW-DEBREU GENERAL EQUILIBRIUM: A Review (See

FIGURE 3. A Benthamite and Rawlsian Criteria

 JUST WAGE AS “JUST REMUNERATION” OVER A WORKERS’ LIFETIME (SEE

 SOCIAL CAPITAL AS A MEANS TO ATTAIN A PARTICIPATIVE ROLE FOR THE POOR.

where Yi aggregate output

where H = Σj (hjLj) for j products. H is a variable to depict aggregate human capital

 NORMATIVE IMPLICATIONS OF A GENERAL EQUILIBRIUM FRAMEWORK18

 RELATIVE EQUALITY. Refers to the attainment of a lower threshold of benefits accruing to

 A POSSIBLE FRAMEWORK IS AS FOLLOWS.23

 Theorem 1 gives the policymaker a normative framework for a sustainable development

 The framework can be represented by Figures 5 and 6:24

 Note that for Figures 5 and 6:

2.2 ETHICS AND ECONOMICS: PHILOSOPHY OF ECONOMICS

OBJECTIVE OF THE LECTURE:

1. To understand the view of philosophers on economics and its methodology.

1.1 Classical economics and the method a priori

1.2 20th-century philosophy of science and economic method