Lecture notes on the history of economic thought

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Lecture notes, lecture 1-8 - Notes History of Economic

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History of Economic Thought (Erasmus Universiteit Rotterdam)
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Notes History of Economic Thought

Lecture 1
Period Classical period Neoclassical period Modern economics

Main focus Wealth Allocation of scarce resources ‘Modeling’
Starting point 1776 1870 1940/50
Characteristi Wealth of Nations Marginal revolution
c
In the 19th century, the adequacy and importance of classical economics declined. The
alternatives were:
- Marx and socialism
- Historical economics
- Marginalism: mainstream of neoclassical period
- Institutionalism
- Keynesian economics
There are two types of explanation for the transition of economic ideas/schools.
- External factors: changes in societal circumstances.
- Internal factors: failure of consistency of theories; increasingly instruments and
techniques prove inadequate.
Change from classicism to marginalism: Industrial revolution, classical economics was not
appropriate for this.
Why did economics start as a science in 1776? What was so special about Adam Smith’s Wealth
of Nations?
The Wealth of Nations stated that the division of labor will make wealth grow. People are
constantly trying to improve their conditions. People advance together, yet primarily out of self-
interest. However, this self-interest does not mean that some people benefit while others are hurt.
Interdependence results in mutual adjustments in behavior, and such patterns channel passions in
socially desirable directions. Not all rules need to be imposed to reach an agreement and to
promote coordination. The main idea behind this is that people can’t live without social
interaction.
Smith: self-interest yields a better societal result than acting out of social interest. This is in
contradiction to the common opinion that wanted to suppress self-interest to promote the general
interest. Besides self-interest, appropriate institutions are required for advancement of
individuals:
- Directing behavior of individuals into a contribution to the general interest.
- Offer opportunities and limitations; not necessarily a positive outcome for everyone.
Goal: to improve one’s condition.

Means: wealth.
How to accumulate wealth: division of labor and thus trade/exchange.
We should all benefit: room for self-interest and institutions.

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Smith’s ideas were in complete contrast with previous ideas.
Before 1776: Pre-classical period.

Early pre-classical period: Greek philosophers and scholastic writers. Economics from an
ethical/religious point of view.
Later pre-classical period: 1500-1776: Mercantilists and forerunners of classical school.
In the middle ages, importance of the market, wage labor, and growth of economic activity
became more important. As a result, society transformed. Economics became subordinated to
political objectives, to increase state power.
Who? Greek philosophers and Mercantilists Smith/classical

scholastic writers school
Focus Community State Market
Objectives Ethical/religious Political Economic
Mercantilism
Political objectives were to increase wealth and power. Mercantilists were no longer
philosophers, but government officials and merchants. Growth of wealth and trade in a time of
increasing trade, emerging cities, and state building. Economics was the management of the
national household.
1. Wealth. Money = power. Wealth = stock of gold and silver. Wealth was strongly linked
to political/state power.
2. Sources of wealth.
- Natural resources
- Stealing from others
- Foreign trade: E > M (Thomas Mun)
3. Zero-sum game. Total world amount of wealth is fixed. One country’s gain is another
country’s loss. Economic warfare.
4. Government. Necessity of regulation
- Individual interest conflicts with national interest
- Market induces conflicts
- Advancing political objectives.
An important point of mercantilism is the regulation of the economy. Strengthening the economy
by a positive balance of trade.
1. Facilitating production, transport, and export
2. Measures to keep products cheap in comparison to foreign products. Low wages = low
cost of production = competitive advantage in foreign trade. Low wages also encourage
labor supply. How: large population, regulation of food prices. ‘Utility of poverty’
doctrine.
3. Improve tax revenues
4. Trading companies and colonies
5. Military.

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Mercantilism Classicism
Wealth Money Consumer goods
Sources Foreign trade Division of labor and
accumulation of capital
Economic game Zero-sum Positive-sum
Government and interests National interest and National interest is sum of
individual interests conflict individual interests
Why was mercantilism inadequate?

Transition feudal – commercial society.
- Shifts from services to goods
- Changes in level of aggregate demand
- Changes in patterns of production, distribution, and consumption
- Shift in power
- Profit as distinctive source of income.
Classical economics: Independence

1. Market as principle of organization
2. Economic process governed by laws of nature.
Forerunners classical economics

Charles Davenant: Wealth as money is an inadequate concept of wealth.
William Petty: Quantification of causal relationships between economic variables. Political
arithmetic. Importance of division of labor, effect on capital accumulation.
Dudley North: Trade as a positive-sum game. Plea for free trade.
David Hume: There is no need for jealousy of trade:
Price-specie flow mechanism: Trade surplus  inflow of gold and silver (specie)  prices
increase  prices in export sector increase  export decreases and import increases  trade
surplus turns into a deficit  outflow of gold and silver  quantity of money decreases 
prices decrease etc.
Richard Cantillon: role of entrepreneur, role of market. Abstraction as method. However: still a
large role for government.
Lecture 2
Analysis of Wealth of Nations

Paradox: In an advanced society, the worker and the landlord have to pay a large part of their
income to taxes. However, they’re better off in the advanced society compared to the primitive
society.

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Explanation: Division of labor, specialization. Condition: extent of the market, and the use of
money. Division of labor implies exchange and thus the question of relative value of
commodities.
Value
- Use value
- Exchange value: the focus is on this.
1 How to measure exchange value? Disutility of labor (effort): index of wealth, to know whether
wealth has increased. Money is not an appropriate measure of value, because it fluctuates.
2 What determines exchange vale?
- Market price: depends on supply and demand. However, only in the short run,
temporary prices.
- Natural price: Long run price.
Distinction between primitive and advanced society. Primitive society: only 1 factor of
production: labor. Commodities exchange on the basis of the ratio of labor costs.
Advanced society: 3 factors of production: wage, rent, and profit. Wage + rent + profit = value of
good (costs of production) = sum of average rewards of factors of production = natural price,
stable in the long run.
- Demand > Supply  Market price > natural price

- Demand < Supply  Market price < natural price
- Demand = Supply  Market price = natural price
As long as market price is not equal to the natural price, market adjustment process starts, driven
by self-interest of consumers/producers.
Suppose demand > supply

1. Price of good X increases
2. Higher reward for labor and capital
3. Profit opportunity arises, reallocation of resources
4. Supply of good X increases
5. Price of good X decreases
6. Lower reward for labor and capital
Results
- Equilibrium between market price and natural price is restored
- Natural rate of return on factors of production is equalized
- Supply = demand
- Efficient allocation of resources
- Price = real costs.
Driven by self-interest. Market power distorts market adjustments and accumulation of wealth.
Interplay of passions and institutions: trend of growth of liberty and wealth. Requires appropriate
institutions as interplay of interests and institutions may also have negative consequences.
Growth of wealth
- Division of labor  labor productivity increases.
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- Capital (accumulation): stock can be used in two ways

- As capital to make a profit
- For consumption purposes.
Productive labor (stock increases) vs. unproductive labor (stock decreases).
Growth of stock by productive labor: the larger the part of stock used as capital, the more labor
can be used productively, and the more the stock can be increased.
Labor production increases  surplus increases  capital accumulation  ratio of
productive/unproductive labor increases.
Growth: increasing rent/wage/profit income + falling prices. If wealth increases  population
increases  extent of market enlarges  division of labor increases  labor productivity
increases.
Appropriate laws and institutions are needed as to make efforts pay off. However, it is possible
that some groups do not gain from the growth of wealth.
3 classes in society
1. Capitalists: profit-income. Clever constructions at the expense of others, class interest
≠ interest of society.
2. Landowners: rent-income. Foolish and conservative, class interest = interest of society.
3. Laborers: wage-income. No power or notion, active and frugal, class interest =
interest of society.
Obstruction and inequalities

- Merchants with privileged position, backed by government
- Market hindrances
- Processes of adjustment in markets not optimal
- Inefficient allocation
- No incentive for innovation
- All detrimental to growth.
Wealth of nations: optimism on long-run trend of growth of productivity, which would improve
the position of laborers.
However, in the 19th century, a more negative view developed. Due to population growth, profits
declined, capital accumulation declined, growth declined. Labor supply increased, wages
decreased. Demand for food increased, prices increased, which would lead to poverty. The only
class to benefit from population growth were the land-owners.
Population factor: key factor in the development of societies: ratio between population size and
means of subsistence.
Thomas Malthus (1766-1834)
Malthus’ population theory

1. Size of population is always determined by the available means of subsistence.
2. Growth rate of population always outruns the growth rate of production.
Claim: if population growth is larger than growth means of subsistence, checks become active.
Checks
Population grows geometrically, food production arithmetically.
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Checks to balance these unequal forces.

1. Positive checks: food shortages, famines, epidemics, and wars.
2. Preventive checks: Vice, moral restraint.
The time it was published was the end of an era. The Industrial Revolution provided a new type
of economy: innovations, rising productivity, development of non-agrarian, industrial production,
and reallocation of resources.
Irish famine: seemed like evidence for Malthusian theory. However, this led to half-hearted
reactions, because they thought of it as something natural, inevitable.
Poor laws increased population size, which decreased wages, although food prices were rising,
leading to more poverty. According to Malthus, poor laws should be abolished.
David Ricardo (1772-1823)
His rent theory followed from the debate on Corn Laws, which were designed to regulate imports
in times of shortages.
The Corn Laws failed after 1790, because of Napoleonic wars, and population growth. However,
the debate started again in 1815.
Ricardo’s rent theory

1. Population growth: necessity for increase in food production.
2. More land exploitation / imports.
3. With further growth: there was a need to use less fertile land / more labor and capital =
diminishing returns.
4. Cost advantage on fertile land.
5. Competition among farmers for cost advantage.
6. Because of this competition, cost advantage or surplus was claimed by the landowners in
the form of rent.
7. Cost advantage = price – cost of production
8. Price = cost of production in last unit of corn on the least fertile land in exploitation (P =
MC).
9. On marginal (least fertile land in use) land: price – cost of production = 0.
10. On fertile land: price – costs of production = cost advantage/surplus = rent > 0.
11. If price of corn increases, the cost advantage increases and thus also rent increases.
Rent
- Originates in difference in cost of production as a consequence of differences in
fertility of land.
- It is not a reward for the use of a scarce resource.
- Is price-determined, not price-determining.
- If corn prices increase, rent increases.
- The Corn Laws created an artificial scarcity to the advantage of landowners.
Tutorial 1 – Physiocracy

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According to physiocrats, agriculture is the only source of wealth.

- Surplus is originated during production
- Laissez-faire, government intervention distorts the economy, agents should be able to
pursue their own interests.
- Wealth = production
- Natural order of economy (Tableau Economique – p. 41 Brue & Grant).
The emphasis was on agriculture, the only source of surplus. Landowners should be taxed,
because rents are the surplus the landowners get. All taxes imposed on others would be passed on
to the landowner anyway.
The physiocratic school was wrong to consider industry and trade as sterile, this led also to the
false belief that only landowners should be taxed because only land could yield a surplus.
However, by studying society as a whole and circulation of goods and wealth, they founded
economics as a social science. Quesnay’s tableau economique is a precursor to later economic
flow diagrams and national income accounting. The law of diminishing returns was stated first by
Turgot. Furthermore, they also originated the analysis of tax shifting and incidence. Finally, the
physiocrats turned the attention of economists to the question of the proper role of government in
the economy.
Physiocrats on low wages

Due to low wages, poor farmers had a low income, therefore they had no means for investments,
or only for very small investments. Consequently, the production in agriculture didn’t grow at a
high rate. According to the physiocrats, agriculture was the sole source of wealth. Low wages
imply low investments, which implies low productivity growth in agriculture. Therefore low
wages had a negative effect on the growth of wealth.
Wealth Sources
Mercantilism Gold and silver Foreign trade
Physiocracy Consumption goods Agriculture (land)
Classicism Stock of (consumption) goods Labor, capital and land (total production)
Lecture 3
According to Ricardo, the aim of political economy is to determine the laws which regulate the
distribution of income.
Societal development  Distribution of income  Growth and distribution of wealth

Rent, wages, profit
Due to population growth and rising food prices, rent incomes increased. On marginal land: price
= cost of production = costs of labor + costs of capital = wages + profits, no rent is paid on
marginal land. Profit is a residue, the difference between the value of output of the last unit of
labor and the costs of that last unit of labor (costs of subsistence). Because of diminishing
marginal returns, the marginal output tends to fall to the level of subsistence, less and less room
for profits. Marginal output  marginal costs.

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Tendency of declining rate of profit

Population ↑  food prices ↑ (diminishing returns)  costs ↑  price of subsistence ↑
 wages ↑, rents ↑  profits ↓
Savings and investments ↓  rate of accumulation of capital ↓  economic growth ↓ 
stationary state of economy. In the long run there is a declining rate of profit due to population
growth.
Ricardo was against the Corn Laws for two reasons:

1. Income (in this case of landowners) should not be regulated by law. Prohibiting cheap
imports accumulates the stationary state.
2. Restrictions on foreign trade are always at the cost of the wealth of all trading partners
(comparative advantage).
General Glut controversy (Malthus)

There is a possibility of depression in effective demand is too low. Labor receives part of the
product of labor. Capitalists save, which leads to overproduction (deflation and depression as
consequence). Unproductive demand is very important, to prevent overproduction.
The economy needs a class that spends a lot to keep the economy going, the size of the effective
demand should be maintained. This is the task of landowners, rent incomes are thus important,
therefore the Corn Laws are a good thing to ensure the rent income for landowners, whose
unproductive demand keeps an economy going.
This theory was rejected after Say’s Law.
Say’s Law
- General overproduction is impossible
- Production creates income
- Production factors receive a reward and the sum of rewards = value of production
output
- Purchasing power = value of output
- ‘Supply creates its own demand’. Overproduction is no problem: rejection of Malthus’
theory.
However, Say’s Law does not account for savings.
After Ricardo
1. Ricardians: McCulloch, John Stuart Mill.
2. Anti-Ricardo: theoretical objections: value theory; objections regarding methods.
3. Ricardian socialists: distribution.
Development and refinement of classic system:

1. Utilitarianism
2. Value theory
3. Methodology
4. Distribution.
1 Utilitarianism

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Jeremy Bentham (1748-1832). Utilitarianism: ethical arithmetics. Consequentialism: the

consequences of an action determine whether an action was good or bad. Utilitarianism had an
egalitarian doctrine: everyone’s interests are equally important.
- Human action is motivated by the desire to obtain pleasure and to avoid pain.
- Principle of utility: tendency to promote happiness.
- Science of human happiness.
Bentham’s utilitarianism:
1. An action is not in itself good or bad
2. Consequences: how it affects happiness
3. Positive and negative consequences: pleasures and pains
4. Maximization of surplus: the principle of utility.
The focus is on social utility, it is the greatest happiness for the greatest number that is the
measure of right and wrong (example with saving 1 or 6 people from getting killed by a tram).
There is also diminishing marginal utility of money: redistribution from the rich to the poor
would increases social utility. However, in redistribution, the principle of security (being rich and
feeling secured by possessions) should come before equity, because there should be an incentive
to exert effort for everyone.
2 Value theory
Bentham anticipated marginalism.
Likewise John Stuart Mill: revision of Ricardo’s value theory. Importance of both utility and
costs in determining exchange value. Factors of supply and demand (elasticity).
3 Method
William Nassau Senior: in political economy there is a distinction between science and art. The
science of political economy should be purely positive, not normative.
John Stuart Mill: Economics is a separate science. Abstraction and empirical research should be
used as method.
4 Distribution
Mill was no advocate of equality of property of income, but that ‘all start fair’.
Task of government is to promote equality of opportunity.
Distribution ≠ law of nature.
The distinction between production and distribution is also important. Production is characterized
by laws and absolute character. Distribution depends on laws and customs and can thus be
changed. There are no economic requirements or absolute rules regarding the distribution of
wealth. However, there are conditions, equality must be compatible with growth and incentives.
Process of growth promotes equality and softens competition, therefore reform of society is not
necessary.
After 1850, the classical school declined. The alternative that arose were marginalism, the
historical school, and socialism: utopian writers and Marx.
Historical School

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- Approach to economics which rejects the abstract-deductive method of the classical

economists
- Emphasis on context of economic phenomena, changes in economy and structure are
always explained by societal factors, therefore not every economic law is applicable to
every country.
Three objections against classical approach:

Isolation of economic phenomena Economic phenomena inseparable from social phenomena
Universal validity of conclusions Abstraction does not produce conclusion with universal
validity
Laissez-faire policy Laissez-faire policy also depends on the societal structure,
it is not applicable to every country.
In the historical school, there were conflicting opinions on the methods of political economy.
Schmoller
1. Economic relationships can only be understood in their socio-historical context.
2. Economics is an empirical (and not an abstract) science.
3. Inductive method: facts as starting-point for discovery of interrelations.
Menger
1. Economics is an abstract science.
2. Builds from assumptions and essences to deduce conclusions.
3. Deductive method.
Socialism
Socialism has had several meanings:
- Capitalism has grave moral flaws (excesses, inequality of wealth, income, power) → need
for socio-economic reforms to remedy these flaws.
- Socialism as economic system: state property of means of production, directive control of
investments, more equality.
- Socialism as stage in the development of society.
In general:
- Free operation of the market not beneficent to society.
- Conflicting interests of individuals and society.
- Regulating function of government to protect interests of society.
- Crises and depressions
- View of man and society: a man’s character is formed by his environment (society).
Utopian socialist: Robert Owen

- Environment molds human nature
- Improving life/work circumstances improves character
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- New Lanark Mills:

- No child labor (until the age of 10)
- Free schooling
- Food, clothes, fuel sold at cost
- Shorter workdays, wages relatively high
- Payment during sickness, old age insurance,
- Recreational facilities
Even with this measures, which don’t seem profit-maximizing, he still made positive profits,
although his companions were not always satisfied with him.
Lecture 4
Karl Marx
Materialist theory of history: Forces of production determine relations of production. Relations of
production determine economic structure. Economic structure determines political, ideological,
and legal structure (superstructure).
Legal, social, political structures
Relations of production } ↑
Propertied class ← ↑ → non-propertied class } ↑
↑ } ↑
Forces of production → needs } ↑
- Labor } → Economic structure
- Capital }
- Land }
- Technology }
- Production techniques }
- Resources }
Forces of production constantly change due to changes in population, technology, education,

division of labor, and innovations. These forces of productions also influence relations of
productions, although these are less flexible to change.
Hegel: In society there is a thesis and an antithesis. The conflict between these two builds up until
it ‘explodes’ and a new ‘equilibrium’ develops. This new equilibrium is the synthesis.
Thesis: Forces of production } Synthesis: new superstructure
Antithesis: Relations of production }
In capitalism there is a conflict between capitalists and workers. Capitalists appropriate the fruits
of cooperation at the expense of workers, which have a weaker position. This conflict develops,
and as a result, there will be a new synthesis: socialist society.
Marx aimed to identify laws of motion (characteristics) of capitalism that lead to an ‘explosion of
the conflict’, which would lead to socialism and communism.
Influence of classicism:
- Labor theory of value
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- Law of declining rate of profit
Features of capitalism
1. Money-making
2. Labor is a commodity
1 Money-making
Natural exchange: commodity  money  commodity
Capitalism: money  commodity  new money new money > money
Production is the creation of exchange value for profit.
Exchange value = no intrinsic exchange value, value only exists in the comparison between
goods.
Exchange value = quantitative relationship between two different things which save something in
common of the same magnitude.
Common element in goods: labor (labor theory of value). Labor is what creates value, capital and
land are unproductive. This theory is somewhat similar to physiocracy, which also saw only one
factor which creates value. However, physiocrats thought it was land, Marx thought it was labor.
2 Labor as a commodity
- Labor is a marketable commodity.
- Capitalism is a perverted system, because it purchases labor to make money.
- Labor is abstract labor = average, homogeneous, simple labor = labor which only varies in
quantity, labor time.
- Value of a commodity is determined by labor time needed to produce a commodity under
normal conditions (socially necessary labor time).
Surplus value
Labor is the only commodity that creates value over own and above its own value (exchange
value = labor costs, use value = value of output of labor).
Surplus S = use value – exchange value = value of output of labor – wage costs
Workers work longer than necessary to produce value equal to wage costs, because the capitalists
appropriates surplus, it exploits labor.
Production depends on capital and labor

1. Constant capital C: resources, land, machines
2. Variable capital V: labor costs
Surplus value rate = S/V
Organic composition of capital = C/V
Increasing S:
- Hours worked ↑ (is limited, market-determined)
- Productivity of labor per hour ↑
Investments in C: machines, technologies, economies of scale, substitution of labor.
Organic composition of capital C/V ↑. Internal inconsistency of capitalism falling rate of profit.
Profit = S/(C + V) = (S/V)/(C/V + 1) = surplus value rate / organic composition of capital.
C/V ↑  Profits ↓
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Capitalists’ intention to increase S leads to a decrease in profits. Decreasing labor: decreasing

source of value. Why do capitalists do this? Marx: they have no choice, it’s a ‘law of motion’:
capital accumulation forces down rate of profit.
Why?
Competition between capitalists:
1. Labor market: drives up wages at expense of profits  substitution
2. Commodity markets: competition forces capitalists to reduce costs to sell at lower prices
 more efficient production techniques  organic composition of capital increases.
Capitalists have to follow (2), otherwise they lose market share. This in an internal contradiction
of capitalism.
However, this is not inevitable, falling wages: S/V ↑. This was acknowledged by Marx, but he
just assumed a falling rate of profit.
Laws of motion in capitalism

- Law of declining rate of profit
- Theory of business crises
- Concentration of capital
- Rise of the reserve army of the unemployed
- Law of increasing misery.
Smith: Marx:
Capital accumulation } Labor- Growth
Division of labor } productivity ↑  labor-
Innovation } productivity
↑
Limits +
Ricardo: Diminishing returns
due to the exhaustion  Wages at
of resources and land subsistence
as population increases level
with wages at subsistence-level
 Business crises and reserve army of the unemployed
Value theory
Aristotle: distinction between exchange value and use value.
Scholastic writers
1. Demand factors: indigentia, need, utility in relation to scarcity
2. Supply factor: costs of production (‘labor and expenses’)
Marginalism focusses on demand factors. Neoclassicism combined classicism (supply) and
marginalism (demand).
Classic value theory: value paradox

- Water is most useful but a free good, diamonds are pretty useless but expensive.
- Value cannot be a matter of usefulness
- Value is determined by relative scarcity. What determines relative scarcity?
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- Demand in relation to supply; ratio between quantities → price

- Underneath price there is a natural value, long run-price determined by costs of
production. Classicism was interested in this ‘real’ long-run price.
Smith
1. Focus on exchange value
2. Distinction between a primitive (labor) and an advanced economy (rewards for the use of
the factor of production)
3. Two questions mixed up:
- How does value arise (production, costs, distinction market and natural prices)
- How to measure value? (Labor).
Ricardo
1. Distinction primitive/advanced artificial
2. Use value condition for exchange value
3. Exchange value determined by scarcity and labor:
- Non reproducible commodities: scarcity
- Reproducible commodities: labor
4. Labor theory of value: the value of a commodity is determined by the amount of labor
time necessary to produce that commodity
Ricardo was more aware of importance of use value, use value is necessary for exchange value to
exist: scarcity or labor.
Problems labor theory of value:

1. How to take into account that industries differ in the ratio between labor and capital?
- Influence of the rate of profit on relative prices relatively small
2. What about rent and profit?
- Rent is price determined
- Capital is stored-up labor
3. Heterogeneity of labor:
- Translation of differences in productivity to differences in labor time.
J.S. Mill had more a Smithian view on value: cost approach, focus on utility.
Classic value theory

- Value is created in production
- Wealth defined in terms of commodities
- Commodities embody value because production required effort/disutility/costs (objective
measure)
- Focus on the long-run; growth/distribution of wealth
 One-sided supply approach.
Marginalism
Consumption  exchange  distribution and production.
Focus on utility, satisfying wants. Utility or want is no condition for exchange value, utility is the
source of value. Utility, demand and price can be related, if a distinction is made between total
utility and marginal utility: X↑ → MUX↓ → P↓
Marginalism tried to model economics after natural sciences, to make it more scientific.
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Shortcoming of classic value theory: different value theories for different types of commodities,
no distinction between total and marginal utility, and prices are not determined by historical
costs.
Law of diminishing marginal utility: Gossen’s first law: X↑ → MUX (dTU/dX) ↓
Equimarginal rule (Jevons): Gossen’s second law: MUA/PA = MUB/PB = … = MUN/PN
Marginal revolution
1. Modeling of economics after the natural sciences
2. Consumers Producers
Demand → Prices → Supply → Allocation of means
↑
Wants/Income
3. In a way equally one-sided. Only second generation applies marginal analysis to supply-
side.
Tutorial 2
Age of Ricardo
1815-1848 Restoration period
- Aristocracy tried to restore traditional order against developments set in motion by the
Industrial Revolution.
- 18-15-1830: Age of Ricardo: conflict between landowners and industrialists + workers,
latter won, shared profits with landowners.
- Debate revolved around distribution of wealth; profit for capitalists vs. rent for
landowners.
Consequences of rent development

1. Ricardo argues that food production needs to be increased to feed the growing population.
Given the need to take land of inferior quality into cultivation, costs of production
increase and consequently food prices rise. As a consequence, the relative shares of
wages, profits, and rents in national income change, affecting further growth.
2. Rising costs and food prices push up both the relative share of rents and wages in the long
run (nominal wage at subsistence-level must rise in order to compensate for rising food
prices).
3. These relative shares of rents and wages increase at the expense of the share of profits,
which is squeezed between the two other shares. No profits, no capital accumulation, no
further growth.
Classical School Marginalist School

1 Aim/problem Economic growth & Allocation of means to maximize
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development utility
2 Level & time horizon Macro, long run Individual consumer/firm, micro
3 Focus, approach Policy issues, supply side Abstract/theoretical, demand side
4 Pricing theory Value = matter of production Value = utility through competition
Lecture 5
Marginal productivity theory

Marginal productivity theory (MPT) applies the marginal utility theory to the supply side.
Applying more units of a factor of production will lead to a decrease in marginal product. If the
marginal product of a production factor decreases, the price of the production factor will also
decrease.
According to the MPT, choice decisions regarding factors of production depend on their marginal
products. John Bates Clark asked: how many units of the variable input factor should be used?
- As long as MPL*P0 > PL: add more units of labor.
- As soon as MPL*P0 < PL: reduce number of units of labor.
- Equilibrium: MPL*P0 = PL
The MPL-curve is the demand curve for labor.
Edgeworth’s table displayed the diminishing returns and the distinction between average and
marginal product.
According to Clark, the MPT is also a distribution theory.
Total wage bill: ABCD

Total product: AEBD
Reward for capital: CEB
Debate following the MPT

1. The MPT is not a residual theory, since it doesn’t matter which factor is held constant of
variable. If in the graph labor was fixed, and capital was variable, it would still yield the
same distribution of income.
2. Adding-up problem (product exhaustion). TP = MPL*L + MPK*K?
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Wicksteed: sum of rewards of the production factors on the basis of their marginal
products = value of total product, under conditions of perfect competition and constant
returns to scale.
3. Profit-problem: reward for capital is interest. If profit ≠ reward for production factor, then
how is it explained? MPT: In perfectly competitive markets and long-run equilibrium: TR
= TC, there are no profits in the long run.
4. Ethical implication. Clark: ‘if under perfect competition each production factor gets paid
according to their value of marginal product, the distribution of income is fair’.
Objections: claims on fairness cannot be derived from a theory which explains relations
between variables.
Supply became equally important as demand. There was a need to review old theories.
Léon Walras
Had a different approach than Jevons and Menger. Walras emphasized the economy as a system
of interdependence of variables. Supply and demand are interdependent. This approach led to his
general equilibrium model.
↓ ← ← Supply of final goods ← ← ←

↓ → → Demand for final goods → ↓ ↑
↓ ↑ ↓ ↑
Households Firms
↓ ↑ ↓ ↑
↓ ↑ ← Demand for factors ← ← ← ↑
→ → → Supply of factors → → → ↑
Prices are simultaneously determined by supply and demand.
Alfred Marshal (1842-1924)

Marshall’s emphasis was on the interdependence of demand (wants) and supply (activities).
Marshall is considered to be the father of neoclassical economics.
Bridging differences:
- Abstract theory vs. empirics/induction
- Static vs. dynamic analysis
- Focus on money/wealth as an instrument.
Attempt at synthesis, in showing the complementarity of utility (marginalist) and cost (classical)
approaches.
According to Marshall, poverty is an obstacle in growth and development. Economics was an
instrument to improve well-being and character of individuals, and thus of society.
Demand
- People aim to satisfy their wants.
- Law of diminishing marginal utility.
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- Individuals take decisions at the margin: not whether he wants any but whether he wants a
bit more, comparing marginal utility with the price of an additional unit.
- Hence downward-sloping demand curve, since people insist on paying less for something
that yields less satisfaction (marginal utility). How much less people wanted to pay,
depends on the price elasticity of demand.
Consumer surplus
1. Downward-sloping demand curve, each next unit yields less marginal utility than the
previous unit.
2. If MUX decreases  Price of good X also decreases.
3. This leads to the market price P.
4. Consumers were willing to pay more for the first units of consumption. They were willing
to pay above market price P.
5. The sum of these advantages of consumers = consumer surplus.
Maximization
Substitution at the margin. The assumption of rationality is important: resources are allocated
between commodities such that ratios of marginal utilities to prices of commodities are equal for
each commodity  Equimarginal rule or Gossen’s second law.
Theory of demand
Time period is sufficiently short to allow for ceteris paribus assumption. This involves the
problem of aggregation. Again, the assumption of rationality is important. Preferences, person’s
wealth, purchasing power of money, and prices of substitutes are all constant.
Supply
- Supply curves slope upwards to the right: additional efforts or costs to increase production
requires extra incentives.
- Supply curve = marginal cost curve with nature of costs subjective: real costs. Marshall
spoke in terms of “real costs” when considering costs of production. By “real” he meant
ultimately the disutility of both the labor and the waiting involved in producing and
bringing a commodity to market. However, Marshall just assumed equality of real costs
and money costs.
- Supply price: sum of money to be paid for these extra efforts.
- Supply schedule: a locus of points linking in each case supply price to exertions necessary
for producing a given amount of a commodity.
- Distinction between prime (variable) and supplementary (fixed) costs.
- Time is the chief problem in economics: market period (very short run), short run, and
long run. The time periods are differentiated on the basis of the price elasticity of supply.
Market period: Price elasticity of supply = 0. Value is demand-driven, costs of production are
irrelevant.
Short run: Upward-sloping supply curve, supply can be adjusted, decisions depend on variable
costs.
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Long run: Supply is perfectly elastic and all costs are variable. Supply price depends exclusively
of costs of production.
Distribution
- Four inputs: land, labor, capital and organization.
- One unified theory of inputs/outputs.
- Decisions are taken at the margin: comparing the marginal product of an input to its costs,
adding units of inputs until marginal costs equal marginal product.
- Prices of factors of production are determined at the margin, entrepreneurs compare the
relative efficiency of factors of production, substituting to produce at lowest costs.
- Next to these pecuniary motives:
- Customs (wage rigidities).
- Duty (moral imperatives).
- Environment (influence of climate, race, geographical location and national
character on motives/desires).
- Approbation (people not only do things for money but also for esteem and
admiration).
What did Marshall know and have we forgotten?

Dynamics of time
- Time key problem
- Consequences of decisions and actions become only apparent in the course of time.
- Method of isolation useful but also of limited use.
- Need for dynamic analysis
Consumption and progress
- Importance of growth of wealth but also of the composition of output.
- Rather than satisfaction of material wants: progress in terms of behavior and character.
Three classes of needs
- Biological needs: food, clothes, shelter.
- Wants which afford strength and increases efficiency.
- Artificial/superficial wants.
The point is to use increased opportunities for consumption productively.
Distinction between standards:
- Standard of comfort
- Standard of life.
Increasing consumer expenditures  Standard of life ↑  Health, physical and mental strength,
and moral ↑  Efficiency of labor ↑  Production ↑  Income ↑  Increasing consumer
expenditures etc.
Lecture 6
According to Marshall, economics was an instrument for social progress.
Welfare economics
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Welfare economics arose out of concern for the persistence of poverty, how to increase and better
distribute wealth? What is welfare optimality/condition? What factors impede achievement of
maximal welfare? Role of government and how to determine the welfare effects of a policy?
English version of welfare economics/Pigou

Economics is about collecting knowledge to bring about social progress. Self-interest does not
necessarily result in maximal welfare. Pigou followed in the footsteps of Marshall. Economics
needs practical usefulness, it should be ‘fruit bearing rather than light bringing’. Pigou was in
some aspects utilitarian, concerned with the greatest happiness of the greatest number. Pigou had
a normative perspective, in contrast to Pareto, who focused more on theoretical, positive
economics.
Wealth and welfare (1912)

- Welfare cannot be defined.
- Economics is confined to economic welfare, the part of social welfare which can be
measured in terms of money. Economic welfare itself is not complete in explaining social
welfare, but it is reasonable to assume that it’s a good measure. Numbers may differ, but
economic and social welfare move in the same direction.
- Changes in economic welfare through national product.
- Society is to ensure that:
- Size of national product is maximized.
- More equal distribution of national product is realized.
- Fluctuations in size of the national product is tempered.
- Pigou made the distinction between private and social product. Maximal private product ≠
maximal social product.
- This leads to a justification of government intervention. Self-interest creates conditions
for which the invisible hand leads to maximal social welfare, but this is different in
practice. Self-interest only benefits the social interest if there is an agreement between
private and social ends, otherwise government intervention is necessary.
- Pigou was looking for disharmonies between private and social interests. There are three
types:
- Production or size of national product (monopolies, external effects).
- Distribution: desirability of redistribution.
- Fluctuations: uncertainty and irregularity. This diminishes social welfare and
increases poverty  public production progress, social security, welfare state.
- There should be no government intervention in economic incentives and property rights,
the value of security weighs more than value of equity (Bentham).
Continental variant/Pareto
Pareto follows Walras’ general equilibrium model.
Conditions for maximizing welfare (Pareto-optimum):
- Optimal allocation of resources
- Optimal level of output
- Optimal distribution of goods.
This is seen as proof that perfectly competitive markets will bring about Pareto optimal
allocation, leading to maximal social welfare. This is proof of Adam Smith’s theory of free
market and invisible hand.
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Pareto followed a theoretical approach to economics: theoretical abstraction, without much

practical value.
Austrian economics
Austrian economics was close to neoclassical economics, but became more distant later on.
First generation: Menger, Von Böhm-Bawerk, Wieser.
Second generation: Ludwig von Mises, Friedrich Hayek, Joseph Schumpeter.
Austrian school rejected formalism, use of mathematics in economics.
Austrian approach
- Model of explanation is based on individual plans and motives in which disequilibria in
the economy are emphasized.
- Objections against description of market process in terms of a static equilibrium model.
The economy is dynamic.
- Against the mathematical formalization of economic phenomena.
- Economic behavior takes place in a world of imperfect knowledge and uncertainty:
disequilibrium is the rule.
- And yet market works better than regulation.
The socialist debate was on the question if economic efficiency is achievable in an stated planned
system.
Mises: Common property of capital (goods) means no (factor) market, no pricing mechanism, no
efficient allocation of means.
Oscar Lange: Prices are indeed essential, but why would a central planning board be unable to
set prices and assume the role of the market? Lange used Walras’ general equilibrium model with
an auctioneer who sets the price.
Socialists seem to win the debate after this strong argument by Oscar Lange. However…
Friedrich Hayek
1. Central planning board is unable to solve the problem of information. Prices also convey
information, it is a mechanism of translating information into prices. The social planning
board is unable to perform this task, which is performed by the market.
2. Socialism is incompatible with liberty. Social planning begins with economic choices,
distorts individual choices and wants, and will eventually control the entire society, it will
turn into a totalitarian state.
Joseph Schumpeter
Agreed with Marx that capitalism will collapse and will be replaced with socialism. In his book
Capitalism, Socialism, and Democracy he describes three factors that will contribute to the fall of
capitalism.
1. Entrepreneurial function grows obsolete. Entrepreneur will be replaced by a manager,
who wants to consolidate the business, there will be less innovation.
2. Destruction of the political strata.
3. Destruction of the institutional framework of capitalism.
Society moves to socialism, Schumpeter described long-run economic developments.
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Institutionalism
Institutionalism originated in the United States around 1900. It arose in times with robber
capitalism and labor conflicts. There was a challenge to laissez-faire policy in the face of
monopolies, depression, and poverty. This contributed to the debate on the reorganization of
society (socialism) and reforms.
Institutionalism built from the ideas of the Historical school. It criticized (neo)classical thought
for the explanation of economic phenomena:
- From abstracting individual choices.
- With given objections and preferences.
- With given institutions.
This method abstracts from what really matters in the economy.
Individual choices are not fully rational, but are influenced by character, environment, society,
and institutions.
1. Preferences, behavior etc. are determined by social or institutional context.
2. Institutions as starting-point of economic analysis.
3. Rejection of the notion of equilibrium.
The economy is a process of continuous structural adjustments to changing societal and
technological circumstances.
Thorstein Veblen
Veblen started the economic analysis from institutions.
Institutions: patterns of behavior which we unconsciously adopt as we are socialized as
members of our society.
Criticism on (neo)classicism
1. Simplistic view of man: choice behavior ≠ utility maximizing. But social process:
institutions determine how people act and choose.
2. Outdated concept of change is assuming some end-state.
3. Assumption of harmony of interests and equilibrium.
4. Notion that capitalists produce socially desirable results.
Economics is the study of the evolving institutional structure → individual behavior

Structure = complex of habits of thought and behavioral patterns or instincts:
1. The parental instinct (caring) }
2. Workmanship (pride) } social orientation
3. Idle curiosity (ideas for innovation }
4. Acquisitiveness  selfish instinct
There is a tension between these instincts. The self-regarding instinct gets the upper hand. There
is a drive to gain at the expense of others. This drive tends to reduce social welfare.
Industrial or technological activities and institutions

↑ ↑ ↓
Socially-oriented instincts
↑ ↕ ↓
Self-regarding instincts
↑ ↓ ↓
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Ceremonial activities and institutions
Theory of the leisure class

Rejection of the view of consumption as a means to happiness; cultural theory. Important purpose
of consumption is to impress others. Spending money has not to do with utility but with keeping
up and outdoing others.
Theory of the business enterprise

Business activities: capitalist, marking profits, predator, does not produces (social) welfare.
Machines process: engineer (making goods), technological procedures to produce goods,
productivity, serviceability, and efficiency.
Formalist revolution
1. Growing use of mathematical techniques and tools.
2. Emphasis on theory and development of theory.
3. Institutional context disappears.
4. Interest in Walras’ general equilibrium model and condition and stability of equilibrium.
The contrast between neoclassicism and the Austrian school became more pronounced due to this
formalization of economics.
Developments in microeconomics
- Shift from Marshallian (partial equilibrium) economics to Walrasian (general equilibrium)
economics.
- Less attention for historical and institutional factors and policy issues.
- Mathematical formalization.
- Market process in terms of equilibrium.
Tutorial 3
Neoclassicism
- Static system of general equilibrium
- Individual interests culminate in harmonious outcome. Positive approach to interest, there
is no need for government intervention.
- Laissez-faire, free markets, limited government intervention. Although Pigou was in favor
of government intervention in some cases.
- Alfred Marshall (his view is more radical), Milton Friedman.
Institutionalism
- Dynamic, evolutionary perspective.
- Society is characterized by conflicts of interest and power structures. Negative approach
to interests.
- Thorstein Veblen.
- Sum of individual interests ≠ social interest.
Disequilibrium Equilibrium
Market Austrian School Neoclassicism
Government Institutionalism Keynesianism
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Marshall combined a formalist/deductive approach with a historical institutional approach.

Adoption of positivism: claim the need for a strict distinction between facts and values.
Formalism: mathematical approach to economics, optimal use of resources, mathematical
modelling, quantifiable methods.
Austrian School
Uncertainty, subjectivity (no perfect foresight, personal opinions play a role), evolutionary
approach. Coordination problem: economic science is too complex. Government should not want
to think that it can replace the economic system, government intervention is undesirable.
Knowledge can be incomplete and imperfect, this leads to a disequilibrium.
Keynesianism
Focus is on the demand-side of the economy.
Animal spirits: urge to consume pushes economic activities forward: effective demand is the
most important determinant of national income, output, and unemployment.
Instability: producers and consumers are either too optimistic or too pessimistic about
consumption, savings, and investments  Business cycle. This instability is an argument for
government intervention.
Government intervention: government needs to smoothen/stabilize erratic expectations and
sentiments through active fiscal and monetary policies.
Chicago school
- Originates from neoclassical, Marshallian economics, with its emphasis on
microeconomics, equilibrium approach, rational choice, and optimizing behavior.
- Belief in the efficiency of free markets, to allocate resources and distribute income.
- Skepticism about government intervention.
Monetarism
Keynes: fight depression by fiscal and monetary policy, pumping money into the economy.
Friedman: quantity of money is the key factor in producing inflation.
Monetarism (Friedman)
1. Change in money supply is the only systematic factor influencing overall level of
spending and economic activity 
2. Only action required to ensure prosperity and price stability is for the central bank to stick
to the golden rule: rate of growth of money supply = real state of economic growth.
Monetarism was motivated by a dislike of Keynesian economics and its interventionist
policies. In general, stabilization policies either don’t work or make things worse.
Lecture 7
In the first decades of the 20th century, Marshallian economics was dominant. It became even
more dominant when American institutionalism lost support. This dominance of Marshallian
economics led to a formalization of economics, and an increasing use of mathematics. The focus
was on equilibrium, especially on the Walrasian general equilibrium model. However, business
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cycles also gained interest from the academic community. This interest firstly was of empirical
nature (Mitchell), but later on it was also of theoretical interest (Austrian School, which focused
on uncertainty and disequilibrium). Keynes combined the business cycle with neoclassical
economics.
Explanations of fluctuations
1. Overinvestment theories: fluctuations in investments, a disequilibrium between the
production of capital goods and the production of consumer goods. There are two types of
arguments explaining why these fluctuations arise.
- Monetary factors (Mises, Hayek): interest rates.
- Discoveries and innovations (Schumpeter).
2. Underconsumption (Keynes): insufficiency of consumer expenditures/demand (which is
to some extent in line with Malthus’ theory). Keynes combined the underconsumption
with
3. Psychological explanation: emphasizing changes in expectations.
Böhm-Bawerk’s interest theory

Problem of interest: if only land and labor are original factors of production, the reward for
capital = rewards for land and labor to produce capital. How to explain interest, the additional
reward for the use of factors of production?
Capital is a derived factor, it needs to be produced by land and labor. In the long-run equilibrium:
all revenues of the sale of consumer goods = sum of rewards for factors of production, therefore
reward for capital = reward for land and labor.
Existence of interest: higher values of present goods as compared to future goods. A ‘premium’
for not delaying consumption.
- Increase of flow of income in the future → marginal utility of present goods is higher,
therefore they have a higher value.
- Positive time preference: future is uncertain, therefore people want to consume as soon as
possible.
- Roundabout production: use of capital in production, money is ‘locked up’ in the process.
The producer is compensated for not using his money by interest.
Interest is the reward for postponing consumption.
Consumers make a decision what to do with their income, determined by the interest rate:
1. Present consumption?
2. Or postpone consumption and save?
Producers make a decision what to do with their investments, determined by the interest rate.
1. Production processes which yield a direct return?
2. Or production processes which are more productive, but yield a (higher) return later?
Knut Wicksell
Wicksell used Böhm-Bawerk’s theory of interest to show the influence of changes in the rate of
interest on the real economy.
Natural interest rate: the interest rate at which savings = investments.
Market interest rate: the interest rate at which the banking system lends/creates credit.
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Natural interest rate ≠ market interest rate.
Situation I: natural rate > market rate

→ Process of expansion: rising demand for investment goods; factors of production withdrawn
from consumer industry → scarcity ↑ and prices consumer goods ↑ → profits ↑ →
expansion/investments → process of expansion, rising investments and prices.
The expected return on investments > costs of investments (market rate). Investments are
attractive, this leads to more investments, which leads to an expansion of the economy, resulting
in a rising demand for investment goods.
Situation II: natural rate < market rate

→ No investments → production and employment ↓ → consumer expenditures ↓ → prices fall
→ profits ↓ → cumulative process of declining prices and depression.
The expected return on investments < cost of investments (market rate). Investments are not
attractive, which leads to a contraction of output and employment, resulting in a depression.
The bank should ensure that market rate = natural rate.
Whether the economy is in situation I, II, or in equilibrium, is observable by changes in the price
level.
Inflation: natural rate > market rate.
Deflation: natural rate < market rate.
Equilibrium: natural rate = market rate.
Mises combined these two theories of interest.

1 Wicksell’s two movements of the economy
Natural rate ↔ market rate
↓ ↓
Expansion Depression
Inflation Deflation
2 Böhm-Bawerk’s changes in the structure of capital.
Mises’ theory of interest

- Natural rate > market rate → producers are induced to choose longer/more capital
intensive processes of production → relative scarcity consumer goods/prices ↑ → extra
production capital goods.
- When expansion of credit breaks down → banks increase market rate → longer processes
of production no longer profitable.
- Dumping capital goods/turning away from longer processes of production → loss of
output/employment.
Start of expansion: when banks expand credit above level of savings, which leads to a lower
market interest rate. Consequently, investments become more attractive, which increases the
demand for investment goods.
Prices of consumer goods ↑ → market interest rate ↑ → reallocation of resources → eventually a
depression.
Friedrich Hayek
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The London School of Economics challenged Cambridge (Keynes) with Hayek as front man,
however, LSE (Hayek) lost the battle. Later on, he became a professor in Chicago, one of the
main figures of the Chicago School. He was in favor of free markets, because of the complexity
of the economy, which could not be replaced by government intervention. He believed in the
market as a self-correcting mechanism.
Friedrich Hayek explained how an artificially low interest rate induces malinvestments.
Time profile of decisions:
- Households: preferred distribution between present and future consumption.
- Producers: planning of distribution of production for present and future consumption.
Credit expansion → supply of capital ↑ → market interest rate ↓ → investments become more
attractive → investments in higher stages of production → shifting output of consumer goods
towards a more distant future (longer time profile). However, future demand is not present, due to
the shorter time profile of households.
Given low interest rate, consumers tend to shorten time profile.
Result: investment profile ≠ public planned savings, creating a crisis.
With consumption and investments both increasing, an expansion starts, creating competition for
resources between longer/shorter production processes. A crisis develops as soon as investments
cannot be profitably completed and terminated.
This is a monetary explanation of fluctuations. Hayek was close to neoclassicism, in the sense
that he assumed a normal process of restoring the equilibrium. Keynes objected to this
assumption.
John Maynard Keynes

Frame of mind: Keynes considered capitalism to be a (useful) stage in society, it allowed for the
growth from poverty to abundance. However, it was based on the ‘love of money’, an illness, as
Keynes described it. Capitalists value the money itself higher than the products they buy with it.
Once capitalism has brought prosperity, the love of money should be restricted. Money became
an end in itself, contradicting the ‘good life’. Markets tend to feed the love of money, therefore
they shouldn’t be left free.
Central role for animal spirits: psychological condition of decisions taken by economic agents,
this leads to instability. Government should stability these animal spirits.
Rejection of Say’s law: urge to consume (demand) drives economy, not supply. Aggregate
demand is crucial for Keynesian economics.
Consumption: determined by subjective (psychological) and objective (interest, distribution,
expectations) factors. Propensity to consume is determined by subjective factors.
Investments: decision based on expected return (unstable and erratic) and costs (interest rate).
This is all about expectations, which often depend on irrational sentiments, which leads to
fluctuations.
General Theory (1936)

Treatise on Money (1930): process of growth and decline caused by discrepancies between
savings (households) and investments (producers).
Repair mechanism: savings and investments are interconnected through the interest rate.
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This mechanism failed because it is simply untrue that during a depression there is an unused pile
of savings ready for investments. On the contrary: income declines, low savings. With low levels
of output and employment, there may be a stable equilibrium in which S = I holds. However, this
would be low levels of savings and investments. Savings don’t have an effect on the interest rate,
due to their low level, there is no correcting mechanism. This stable equilibrium may go on for a
long time.
Economics: logic of choice in conditions of uncertainty, not scarcity. Difference between

probability (can be calculated) and fundamental uncertainty (dominant). This brings about
instability.
Aggregated demand may fall short relative to supply → supply (Y) adjusts downwards to bring
back equilibrium at a level below full employment.
Keynes also criticized the classical labor model of supply and demand, where unemployment can
be reduced by lowering the real wage until supply equals demand. This aggravates the entire
situation.
Expectations in a world of uncertainty and instability.

If animal spirits are low, there is no spontaneous recovery of full employment by the economy.
The government should intervene by investments and/or fiscal/monetary policy → creating a
‘multiplied’ effect on output, income, and employment.
After the General Theory:

- Debate on what Keynes precisely meant.
- Mathematical explorations.
- Hicks/Hansen: development of a model in which neoclassicism and Keynesian
perspectives are combined: IS-LM: neoclassical synthesis.
Milton Friedman (1912-2006)

Influenced by:
- Mitchell: importance of empirical research. Need for testing economic theory but by the
correspondence between predictions and facts.
- Marshall: theory as an engine of analysis for addressing real problems.
- Knight: suspicious of state intervention.
Free market ideology and focus on optimizing behavior, mathematical orientation → Chicago
School.
Importance of money and monetary policy

- Quantity Theory of Money: MV = PT
- V is relatively stable → money supply affects the level of economic activity (T) only in
the short run.
- In the long run, money supply only affects prices, there are no real effects.
- Therefore pumping money into the economy only leads to inflation. Government
shouldn’t intervene.
- Rejection of the Phillips curve: natural rate of unemployment.
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1. Government cannot control unemployment and interventions only create inflation.

2. To prevent inflation, golden rule is to ensure that growth of money supply = growth rate
of the real economy.
Overview
Eras
Industrial Revolution (1760 – 1830)
The Industrial Revolution is one of the most significant changes in recent human history. The
transition included people moving from countryside to larger cities, going from hand production
to the use of machines, increased use of steam power and going from wood and other bio-fuels to
the use of coal. For the first time in recent history the living standard of the masses of ordinary
people began experienced a sustainable growth. The classical school was largely influenced by
the industrial revolution and thus influenced economics.
The Marginal Revolution (1865 – 1880)

There are four main reasons for this period being called the Marginal Revolution. First, during
the late nineteenth century much of the focus in economics turned from the classical long-term
development, which is the theory of population, welfare and growth, towards shorter terms. The
use of capital and labor in production, the choices of the consumer and utility became important
subjects. As hinted by the phrasing «the Marginal Revolution», the theory of decisions made at
the margin was much studied and strongly influenced future economics. This goes especially for
the theory of marginal utility. Second, the use of mathematics became more and more common,
though Jevons did not particularly contribute to this development. Walras was the major
contributor on this field. As mentioned earlier, von Thünen, Cournot and some others began this
way of looking at economics some years before Jevons’ time, but the majority did not. However,
in the 1870’s, largely due to the major advances in natural science, the general view in economics
took a more mathematical approach. More than the pioneers mentioned earlier, Jevons, Menger
and Walras incorporated these new theories into a system. And perhaps more importantly, more
than earlier these thoughts gained acceptance among the scientific environment. Although both
Walras and Menger wrote important works in the field of marginal utility and the use
mathematics in economics, Jevons developed his theories rather individually. Finally, the
generation of economist including Jevons was, as mentioned earlier, among the first to have a
formal education in economics. Thus the scientific field gradually turned towards being a
profession, which is rather different from earlier economists.
The Great Depression (10/29/1929 – 1940)

The Great Depression was a severe worldwide economic depression in the decade preceding
World War II. The timing of the Great Depression varied across nations, but in most countries it
started in 1930 and lasted until the late 1930s or middle 1940s. It was the longest, most
widespread, and deepest depression of the 20th century. The depression originated in the U.S.,
after the fall in stock prices that began around September 4, 1929, and became worldwide news
with the stock market crash of October 29, 1929 (known as Black Tuesday). The Great
Depression had devastating effects in countries rich and poor. Personal income, tax revenue,
profits and prices dropped, while international trade plunged by more than 50%. Unemployment
in the U.S. rose to 25%, and in some countries rose as high as 33%.
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Schools
Physiocrats (1710 – 1765)
Physiocracy is an economic theory developed by the Physiocrats, a group of economists who
believed that the wealth of nations was derived solely from the value of “land agriculture” or
“land development.” Their theories originated in France and were most popular during the second
half of the 18th century. Physiocracy is perhaps the first well-developed theory of economics.
- Quesnay
- Cantillon
- Tourgot.
Classicism (1735 – 1860)

Classical economics is widely regarded as the first modern school of economic thought. Its major
developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John
Stuart Mill. Classical economists claimed that free markets regulate themselves, when free of any
intervention. Adam Smith referred to a so-called invisible hand, which will move markets
towards their natural equilibrium, without requiring any outside intervention. Pre-runner:
- Adam Smith
- Ricardo
- Malthus
- Mill, James
- Mill, John Stuart
- Say.
Pre-Marginalists (1800 – 1850)

The pre-marginalist did, as the marginalists, focus upon maximization and individual behavior,
either on the production or the demand side of the economy. However, contrary to the
marginalist, they did not achieve much publication and fame in the scientific environment.
- Von Thünen
- Dupuit
- Cournot.
Marginalism (1850 – 1900)

The marginalists includes Jevons, Menger and Walras, who were the most important contributors
to the Marginal Revolution. They worked on the decisions made by individuals in the economy
and developed the demand and supply curves. The three began the process of making economics
a profession.
- Jevons
- Walras
- Menger.
Neoclassicism (1850 – 1970)

Irving Fisher introduced the term neoclassical economy in 1900, but it was later used to include
the works of also earlier writers. The term is an umbrella term for several different schools
including marginalism. However, excluding institutional economics and Marxism. As expressed
by E. Roy Weintraub, neoclassical economics rests on three assumptions, although certain
branches of neoclassical theory may have different approaches:
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- People have rational preferences among outcomes that can be identified and associated
with a value.
- Individuals maximize utility and firms maximize profits.
- People act independently on the basis of full and relevant information.
- Jevons
- Menger
- Walras
- Von Weiser
- Von Böhm-Bawerk
- Marshall
- Wicksell
- Fisher
- Slutsky
- Pareto
- Hicks
Austrian School (1865 – 1920)

The Austrian School of economics is a school of economic thought which bases its study of
economic phenomena on the interpretation and analysis of the purposeful actions of individuals.
It derives its name from its origin in late-19th and early-20th century Vienna with the work of
Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others.
- Menger
- Von Böhm-Bawerk
- Von Wieser
American Institutionalism (1918 – 1950)

The ‘institutional approach’ to economics goes back to a conference paper in 1918 by Walton
Hamilton titled ‘The Institutional Approach to Economic Theory’. The paper was a call for the
profession at large to adopt the ‘institutional approach’ and a conception of economic theory that
was:
(i) Capable of giving unity to economic investigations of many different areas.
(ii) Relevant to the problem of social control.
(iii) Relate to institutions as both the ‘changeable elements of economic life and the
agencies through which they are to be directed’.
(iv) Concerned with ‘processes’ in the form of institutional change and development.
(v) Based on an acceptable theory of human behavior, in harmony with the ‘conclusions
of modern social psychology’.
At its inception, then, institutionalism could be seen as a very promising program – modern,
scientific, pointing to a critical investigation and analysis of the existing economic system and its
performance. Institutionalism was critical of marginal utility theory as a basis for a theory of
consumption and emphasized the social nature of the formation of consumption values.
Institutional economics after 1945

Institutionalism had a strong position in American economics in the interwar period, but declined
in prestige after WWII from mainstream of American economics to a heterodox tradition on the
margins of the discipline.
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Keynesianism (1945 – 1980)

Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-
war period from the writings of John Maynard Keynes. A group of economists (notably John
Hicks, Franco Modigliani, and Paul Samuelson), attempted to interpret and formalize Keynes’
writings, and to synthesize it with the neo-classical models of economics. Their work has become
known as the neo-classical synthesis, and created the models that formed the core ideas of neo-
Keynesian economics. These ideas dominated mainstream economics in the post-war period, and
formed the mainstream of macroeconomic thought in the 1950s, 60s and 70s.
Pre-runner:
- John Maynard Keynes
- Hicks
- Modigliani
- Samuelson.
New Classicism (1970 – Present)

New classical macroeconomics, sometimes simply called new classical economics, or
monetarists, is a school of thought in macroeconomics that builds its analysis entirely on a
neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations based
on microeconomics, especially rational expectations. New classical macroeconomics strives to
provide neoclassical microeconomic foundations for macroeconomic analysis. This is in contrast
with its rival new Keynesian school that uses micro foundations such as price stickiness and
imperfect competition to generate macroeconomic models similar to earlier, Keynesian ones. One
of the most famous new classical models is the real business cycle model, developed by Edward
C. Prescott and Finn E. Kydland.
Economists
Petty, William (1623 – 1687)
Contributions to classical political economy in methods, concepts and analysis. Argued for
optimal taxation. A notion of surplus.
Quesnay, Francois (1694 – 1774)
“Tableau Economique” – circular flow of economy – and founder of Physiocrats. Agriculture
only sector that produced net surplus.
Cantillon, Richard (1697 – 1734) His only work rediscovered by Jevons. Influenced by Petty.
Land/Labor theory of value. Demand/Supply determining market prices. Major influence on
Quesnay.
Smith, Adam (1723 – 1790) Adam Smith is without doubt one of the most important economist
throughout history. Although most of the content in “The Wealth of Nations” were already
discussed by earlier economist Smith put together theoretical elements in a convincing manner
and appeared to be dealing with the real world instead of theoretical aspects. He wrote on the
productive organization, the causes of economic growth, value and distribution. His most famous
theory is that of the invisible hand.
Tourgot, Anne (1727 – 1781)
Realized decreasing returns in agriculture. Analysis of productive use of capital in all sectors.
Forerunner to Adam Smith. Laissez-faire.
Bentham, Jeremy (1748 – 1832)
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Bentham was the founder of the utilitarian ethics and not an economist, but has none the less
been extremely important for the development of economics.
Mill, James (1763 – 1836)
James Mill was along with Ricardo one of the founders of the classical school. However, his
contributions has been rather overshadowed by his son, John Stuart Mill, and by his colleague
Ricardo.
Malthus, Thomas (1766 – 1834)
Argued against economist which believed in limitless improvement of society. Malthus placed
the longer-term stability of the economy above short-term expediency and thought that the
dangers of population growth would preclude endless progress towards a utopian society.
Say, Jean-Bapiste (1767 – 1832)
Say was a French economist who became most famous for the “Say Law”, stating that “supply
creates its own demand”. He had classical liberal views, and argued for free trade.
Ricardo, David (1772 – 1823)
Ricardo demonstrated the possibilities of using the abstract method of reasoning to formulate
economic theories. Ricardo’s theorizing attracted a band of a scholars, corroborating, amending
and extending his theories. His most important topics can be summarized to:
- The Theory of Rent
- The Labor Theory of Value
- The Distribution Problem
- The Currency Question
- Comparative Advantage
- Ricardian Equivalence.
Von Thünen, Johann Hermann (1783 – 1850)
Von Thünen was an important contributor to the ideas of profit maximization and marginal
productivity. One important insight was the idea of diminishing returns, i.e. how marginal
productivity varies with factor inputs. The importance of going from one factor to two factors
should not be underrated, this was the major contribution by von Thünen. The works and ideas of
von Thünen was, however, not very noted in his own time and did not get much attention before
the rediscovery by Jevons.
Cournot, Antoine Augustin (1801 – 1877) Cournot had unique insights in applying
mathematics in economics and social sciences and contributed in the theory of prices, monopoly
and perfect competition. Cournot’s ‘demand function’ is not a demand schedule in the modern
sense, it summarizes the empirical relationship between price and quantity sold, rather than the
conceptual relationship between price and the quantity sought by buyers. Cournot’s function is
not derived from theories of individual behavior, he notes that the “accessory ideas of utility,
scarcity, and suitability to the needs and enjoyments of mankind…are variable and by nature
indeterminate, and consequently ill-suited for the foundation of a scientific theory” (Cournot,
1838: p.10). Also Cournot’s works was mostly recognized with the marginal breakthrough in the
1870’s.
Dupuit, Arsène Jules Étienne (1804 – 1866)
Dupuit made the first successful connection between marginal utility and demand, though only
on an individual level and did not make any comments upon the aggregate. His remarkable effort
at developing a cost-benefit analysis of public works led him to draw the demand curve in price-
quantity space. Unlike Cournot, Dupuit did not rest his demand curve on empirical intuition but
rather identified the demand curve as the marginal utility curve itself.
Mill, John Stuart (1806 – 1873)
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Mill’s work on economics were much influenced by his utilitarian views. His early economic
philosophy was one of free markets. However, he accepted interventions in the economy, such as
a tax on alcohol, if there were sufficient utilitarian grounds. He also supported the Malthusian
theory of population. By population he meant the number of the working class only. He was
therefore concerned about the growth in number of laborers who worked for hire. He believed
that population control was essential for improving the condition of the working class so that they
might enjoy the fruits of the technological progress and capital accumulation. He propagated
birth control as against moral restraint.
Gossen, Hermann Heinrich (1815 – 1858)
Gossen independently presented, in 1854, a theory where demand was derived from the process
of utility-maximizing by the consumer. However, Gossen’s work did not gain much publicity and
thus were not discovered by Jevons until after publishing «The Theory of Political Economy» in
1871. Gossen’s second law is the crucial one and often referred to nowadays just as ‘Gossen’s
Law’. The idea that, at the margin, the consumer substitutes between goods to obtain the same
marginal utility across goods, yields the downward-sloping demand curve for each of the goods.
When the price of a good rises, the marginal utility in terms of money (MU i/pi) declines and thus
(by Gossen’s first law), less of that good will be bought.
Marx, Karl (1818 – 1883)

Marx held that labor power could be considered a commodity, like any other commodity for sale,
whose price could be explained in the same way as other commodities. Marx’s labor theory of
value differed from Ricardo’s by determining the absolute value of goods and services. Use value
vs. exchange value of commodities. Exchange value determined by the “socially necessary labor
time” embodied in the commodity. Marx was one of the first to point out that business cycle
fluctuations was a normal occurrence in capitalist economies. The class struggle leads inevitable
to the overthrow of the capitalist system and the dictatorship of the proletariat.
Walras, Leon (1834 – 1910)

Walras was one of the three economist related to the Marginal Revolution, and he was by far the
one who evolved the use of mathematics in economy the most. He formulated the “marginal
theory of value”, independently of Jevons and Menger, and pioneered the development of a
general equilibrium theory.
Jevons, William S. (1835 – 1882)
Jevons was one of the three economists related to the Marginal Revolution. His contribution
centered mainly about utility. He argued that utility was the reason for value and that economists
should maximize happiness, i.e. utility. He defined the final degree of utility as the additional
utility gain for the last additional commodity. From this he argued that utility is decreasing in
amount of commodity, that optimal allocation is reached when the final degrees of utility of
different uses are equal. He did not however add a demand curve. All his theories are worked out
independently of other economists.
Menger, Carl (1840 – 1921)
Menger was the third economist related to the Marginal Revolution. Also he developed a theory
of marginal utility, independently of other economists writing on the topic. He also explained
how both sides would gain from trade.
Marshall, Alfred (1842 – 1924)
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Alfred Marshall succeeded Ricardo and J.S. Mill as the great name of British economics. He
dominated the scene through eight editions of “Principles of Economics” from 1890 to 1920. The
700-page book was like a Bible for British economists and used in universities in other countries
as well. Marshall is regarded as founder of the Cambridge School of Economics. He used the
ideas of predecessors from Ricardo to Jevons and added a number of useful tools, concepts and
graphs.
Edgeworth, Francis Ysidro (1845 – 1926)
Edgeworth was the leading economist in Britain next to Marshall. His innovative brilliance made
him influential long after Marshall was virtually forgotten. Edgeworth applied utilitarianism as
the appropriate principle of distributive justice through a contractarian approach. He also argued
for maximum utility as the single principle in social sciences. Edgeworth used Lagrange
multipliers and even calculus of variations, techniques few economists were familiar with. The
book was difficult to read, because of both content and style. It was in this book that Edgeworth
introduced the generalized utility function, U(x, y, z, …), and drew the first indifference curves.
Utility curves entered in almost everything Edgeworth did in economics. He was the first to apply
formal mathematical techniques to individual decision making in economics. Jevons had studied
the equilibrium when all agents took prices as given, Edgeworth was concerned with
understanding how an equilibrium could be reached among few or many agents through
contracting. Such contracting led generally to multiple possible outcomes. Edgeworth’s
achievement was to show the conditions under which competition between buyers and sellers,
through a barter process, lead to the same point as when all agents act as price takers.
Edgeworth’s attitude to taxation was similar to that of the major classical economists (and unlike
Wicksell), in rejecting a benefit approach on the argument that taxation is not an economic
bargain governed by competition, it is about determining the distribution of taxes for common
purposes.
Pareto, Vilfredo (1848 – 1923)

Pareto’s name is associated with general equilibrium, welfare economics and ordinal utility. He
was a forerunner of the axiomatic approach culminating with the Arrow–Debreu model. The
impact of Pareto’s work was not immediate and to begin with confined to Italy and France.
Pareto was preoccupied by the idea of the economy as a complete system and by the interaction
between the various parts of the economy, in line with Walras’ thinking and far from the partial
equilibrium analysis of Marshall. One of Pareto’s major contributions was to establish that an
ordinal notion of utility is sufficient for the construction of equilibrium theory. Few have studied
general equilibrium theory without learning about the Edgeworth box. Despite the name, this
graphical representation first appeared in Pareto’s Manuale, where it was used to motivate the
attempted proofs of the welfare theorems in the general case. Pareto provided the standard
equilibrium conditions for the consumer side of economy, with the marginal rate of substitution
equal to the price ratio. Of all Pareto’s contributions it is ‘Pareto optimality’ that has made the
greatest impact. Yet, it was not Pareto who first gave a definition of this concept, as Edgeworth in
1881 had defined a situation in which the utility of each individual is maximized given the
utilities of all others. Pareto had the insight that this notion of efficiency was independent of all
institutional arrangements and distributional considerations. Pareto went on to establish the first
theorem of welfare economics, i.e. a competitive equilibrium is a Pareto optimum and a tentative
version of the second theorem, that any Pareto optimum can be obtained as a competitive
equilibrium from an appropriate distribution of initial resources.
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Von Wieser, Friedrich (1851 – 1926)

Wieser’s two main contributions are the theory of “imputation”, establishing that factor prices are
determined by output prices (reversing the Classicals) and the theory of “alternative cost” or
“opportunity cost” as the foundation of value theory. These became fundamental “subjectivist”
pillars in neoclassical theory. Wieser can be credited with turning neoclassical economics firmly
towards the study of scarcity and resource allocation – a fixed quantity of resources and unlimited
wants – all based on the principle of marginal utility.
Von Böhm-Bawerk, Eugen (1851 – 1914)
Böhm-Bawerk is particularly well known for his ‘three reasons’ for interest, which may be
viewed as BB’s personal contribution to the Austrian economics.
Wicksell, Knut (1851 – 1926)
Wicksell’s influence on modern economic thought has been profound and far-reaching. It is
noticeable not least in the discussion of saving and investment that preceded the Keynesian
breakthrough, in Hayek’s overinvestment theory of the business cycle emphasizing the notions of
capital shortage and forced saving, in Schumpeter’s theory of economic development, in Frisch’s
dynamic theory of the business cycles, and overwhelmingly in Swedish economic thought.
Wicksell’s use of mathematics, although often somewhat hidden by literary form of presentation,
set an important precedent. Wicksell developed the marginal productivity theory of distribution,
integrating it with the theory of capital and interest. His claim to fame today rests much on his
contribution to monetary theory, based on the notion of monetary equilibrium and the distinction
between the actual rate of interest and the “natural” one. Wicksell’s third contribution is his
celebrated feedback policy rule, under which the central bank stabilizes the price level by
adjusting its interest rate in response to price level deviations from target, stopping only when
prices converge to target. A precursor of the modern Taylor rule, Wicksell’s rule is the prototype
of all feedback policy rules discussed in the monetary literature today.
Veblen, Thorstein (1857 – 1929)

Veblen was primarily an economist who wrote extensively on methodological issues. Veblen
believed that technological developments would eventually lead toward a socialistic organization
of economic affairs, but his views regarding socialism and the nature of the evolutionary process
of economics differed sharply from those of Marx. While Marx saw socialism as the ultimate
goal for civilization and the working-class as the group that would establish it, Veblen saw
socialism more as an intermediate phase in an ongoing evolutionary process in society that would
be brought about by the natural decay of the business enterprise system and by the inventiveness
of engineers.
Fisher, Irving (1867 – 1947)

Irving Fisher is (according to James Tobin) the greatest economist America has produced. He
made seminal and durable contributions on a wide range of economic science. Strongly
promoting mathematical economics (with Cournot as his great hero). Much of standard
neoclassical theory today is Fisherian in origin, spirit and substance. Most modern models of
capital and interest are essentially variations on Fisher’s theme, the conjunction of intertemporal
choices and opportunities. Fisher’s theory of money and prices is the foundation for much of
contemporary monetary economics. Fisher was deeply involved with quantitative empirical
research, index numbers and their properties (on which he was a world authority), and other early
econometric approaches. Fisher’s ideas have frequently been rediscovered by others, e.g.
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distributed lag regression, life cycle saving theory, the ‘Phillips curve’, ‘consumption tax’ rather
than ‘income tax’, the modern quantity theory of money, real vs. nominal interest rates, and many
other standard tools in economists’ kits. Fisher was not fully appreciated by his contemporaries,
partly because he was far ahead of others, partly due to the reputation he lost.
Slutsky, Evgeny E. (1880 – 1948
Slutsky was a mathematician, statistician and economist, known in economics mainly for the
1915 article, which was unnoticed until the mid-1930s but influenced the further development of
consumer theory. Building on earlier work by Pareto, Slutsky showed that the effect of a price
change on the quantity demanded can be divided into two effects, which we are familiar with as
the Slutsky equation.
Keynes, John Maynard (1883 – 1946)

John Maynard Keynes was a British economist whose ideas have fundamentally affected the
theory and practice of modern macroeconomics, and informed the economic policies of
governments. He built on and greatly refined earlier work on the causes of business cycles, and is
widely considered to be one of the founders of modern macroeconomics and the most influential
economist of the 20th century. His ideas are the basis for the school of thought known as
Keynesian economics, as well as its various offshoots. In many ways, subsequent developments
in 20th century economics can be viewed as either building on Keynes’ ideas or reacting against
them. In the 1930s, Keynes spearheaded a revolution in economic thinking, overturning the older
ideas of neoclassical economics that held that free markets would, in the short to medium term,
automatically provide full employment, as long as workers were flexible in their wage demands.
Keynes instead argued that aggregate demand determined the overall level of economic activity,
and that inadequate aggregate demand could lead to prolonged periods of high unemployment.
He advocated the use of fiscal and monetary measures to mitigate the adverse effects of economic
recessions and depressions. Following the outbreak of the Second World War, Keynes’s ideas
concerning economic policy were adopted by leading Western economies. Keynes died in 1946,
but during the 1950s and 1960s the success of Keynesian economics resulted in almost all
capitalist governments adopting its policy recommendations.
Hicks, John R. 1904 – 1989
Hicks may have been close to being in the last generation of economists who could take up
almost any theoretical problem. The most familiar of his many contributions in the field of
economics were his statement of consumer demand theory in microeconomics, and the IS/LM
model (1937), which summarized a Keynesian view of macroeconomics. His powerful and
original mind first made its mark on what is now called microeconomics and in welfare
economics. Hicks’ best-known work, Value and Capital (1939), goes beyond microeconomics to
offer economic dynamics and discussion of monetary theory which reaches into
macroeconomics. Value and Capital is a work very rich in ideas and a short account cannot do it
justice. It showed that the basic results of consumer theory could be obtained from ordinal utility;
it expounded what became known as the ‘Hicksian substitution effect’, obtained by varying
income as relative prices changed so as to maintain an index of utility constant.
Friedman, Milton (1912 – 2006)

He theorized there existed a “natural” rate of unemployment, and argued that governments could
increase employment above this rate (e.g., by increasing aggregate demand) only at the risk of
causing inflation to accelerate. He argued that the Phillips curve was not stable and predicted
what would come to be known as stagflation. Milton Friedman’s works include many
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monographs, books, scholarly articles, papers, magazine columns, television programs, videos,
and lectures, and cover a broad range of topics of microeconomics, macroeconomics, economic
history, and public policy issues.
Source: http://www.preceden.com/timelines/67774-history-of-economics
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Lecture notes, lecture 1-8 - Notes History of Economic

History of Economic Thought (Erasmus Universiteit Rotterdam)

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Notes History of Economic Thought

Period Classical period Neoclassical period Modern economics

Goal: to improve one’s condition.

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Smith’s ideas were in complete contrast with previous ideas.

Before 1776: Pre-classical period.

Who? Greek philosophers and Mercantilists Smith/classical

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Why was mercantilism inadequate?

Classical economics: Independence

Forerunners classical economics

Analysis of Wealth of Nations

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- Demand > Supply  Market price > natural price

Suppose demand > supply

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- Capital (accumulation): stock can be used in two ways

Obstruction and inequalities

Thomas Malthus (1766-1834)

Malthus’ population theory

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Checks to balance these unequal forces.

David Ricardo (1772-1823)

Ricardo’s rent theory

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According to physiocrats, agriculture is the only source of wealth.

Physiocrats on low wages

Societal development  Distribution of income  Growth and distribution of wealth

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Tendency of declining rate of profit

Ricardo was against the Corn Laws for two reasons:

General Glut controversy (Malthus)

Development and refinement of classic system:

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Jeremy Bentham (1748-1832). Utilitarianism: ethical arithmetics. Consequentialism: the

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- Approach to economics which rejects the abstract-deductive method of the classical

Three objections against classical approach:

Utopian socialist: Robert Owen

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- New Lanark Mills:

Legal, social, political structures

Forces of production constantly change due to changes in population, technology, education,

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- Law of declining rate of profit

Production depends on capital and labor

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Capitalists’ intention to increase S leads to a decrease in profits. Decreasing labor: decreasing

Laws of motion in capitalism

 Business crises and reserve army of the unemployed

Classic value theory: value paradox

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- Demand in relation to supply; ratio between quantities → price

Problems labor theory of value:

Classic value theory

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Consequences of rent development

Classical School Marginalist School