History of Economic Thought

Question 1

Briefly explain the dialectical materialist theory of history. Compare Marx’s ideas with those of Hegel and Feuerbach

Answer 1

Marx’s dialectical materialist theory of history is based on the struggle of Men and the satisfaction of their needs.

Hegel believed in God and, therefore, a history both before and after Man that did not necessarily revolve around Man alone

Marx, on the other hand, agreed with Feuerbach who said that God is simply a projection of human desires, needs, and attributes; Man created God rather than the other way around. Therefore, Man is the ultimate power and highest importance; history begins with and revolves around him

However, the struggle of Man portion of Marx’s theory of history can be attributed to Hegel who, like Marx, believed that history does not follow a smooth progression nor is it a series of accidents, but instead a constant struggle between ideas (where every idea is opposed, every thesis has an antithesis).

Question 2

If value is created by labor, what determines the value of labor?” Explain the Marxian answer to this riddle. According to Marx, in what sense is labor “exploited?”

Answer 2

The sum total of workers’ contributions is equivalent to the price and value of the product

Therefore, workers are exploited because they do not receive (in total) the entire revenue from the product. Instead, the owner takes a profit from that which is owed to the workers.

Question 3

Explain and critically evaluate Marx’s theory of the falling rate of profit

Answer 3

• One producer finds and innovative way to make profits.
• Other producers try to keep up by substituting away from labor to capital
• Unfortunately for them, capital cannot be exploited because the capitalist who owns the capital will only sell it for what it is worth
• Thus the profits that the innovator initially received will begin to fall.
• If producers try to avoid this trap by continuing to exploit labor, they will not be able to keep up with the other, more efficient, producers in the market.

Question 4

According to Adam Smith and Karl Marx, what is the meaning of a “subsistence” wage? Did Marx’s analysis of this issue change over time? What was the significance of this concept to Marx’s analysis of capitalism?

Answer 4

According to Adam Smith and Karl Marx (initially), a subsistence wage is the amount of money necessary for a worker to survive day to day.

Later, however, Marx declared subsistence a relative term dependent on contemporary lifestyles. Therefore, the new “subsistence” means having only what the average manufacturing worker has and not what the richest people have.

The significance of subsistence wages to Marx were that they indicated all that is wrong with capitalism- the workers don’t get what they deserve and owners get what they don’t deserve.

Question 5

What, according to Marx’s critics, is the Great Contradiction in the labor theory of value? How did Marx handle this criticism?

Answer 5

The great contradiction is that Marx said all value comes from labor, but in reality market prices differ from labor values. Marx’s response to the contradiction/criticism was in his third volume when he enacted the theory of the competition of capitals, which establishes a uniform rate of profit for all firms engaged in production.

When he added the average product derived from different costs of production in different industries, he found that the individual deviations of market prices from true (labor) values tended to cancel out in the aggregate. So it wasn’t actually a contradiction.

Question 6

What did Marx and Engels tell us about the “future” socialist society, and what did they leave out of their description? How did Marx’s views differ from those of the anarchist and democratic socialists?

Answer 6

Marx and Engels believed that capitalism would begin to fail by itself, causing companies to lay off many of their employees. These employees would form a proletariat “army” (nonviolent, at least at first) that would take over the companies as well as the government. He suggested that the proletariat should then put specific laws in place (unlike anarchy which is marked by the absence of laws) for the common ownership of property, a graduated income tax, abolition of inheritance, centralization of banks, transportation, and other companies, and free education.

These desires are similar to those of democratic socialism except that democratic socialists believe that the equal distribution of income/wealth is possible and strive for that goal, while Marx recognized that there would never be truly “fair” distribution of income/wealth. Marx and Engels left out any specifics on the way the proletariat should organize or attempt to pass these measures.

Question 7

Explain the basic assumptions and conclusions of von Thunen’s location theory.

Answer 7

Assumptions:
Farmers produce crops with the highest market value
Homogenous landscape (equally fertile land with same access to water)
Isolation of the system (no trade connections with outside states)
Theorized that:
More perishable products would be grown closer to market
Products with higher economic productivity per land area would be grown closer to market.
Products that are more difficult to transport will be grown closer to market

As one gets closer to the city (market), the price of land increases
Farmers balance transportation costs, land, and profits to produce the most cost effective product for market.

Question 8

What is the “equimarginal principle” of utility maximization? How can it be used to explain the negative slope of a demand curve?

Answer 8

different courses of action should be pursued upto the point where all the courses give equal marginal benefit per unit of cost. It claims that a rational decision-maker would certainly allocate or hire resources in a fashion that the ratio of marginal returns and marginal costs of various uses of a provided resource or of various resources in a given use is the same.

Question 9

Explain the assumptions, reasoning, and conclusions reached in Jevons’s theory of labor supply.

Answer 9

He defined labor as “any painful exertion of mind and body undergone partially or wholly with a view of future good.” Assumed workers were on a piece work system and that they could alter the amount of work performed. He focused on three quantities:

1. Net pain from work,
2. Amount of production, and
3. amount of utility gained.

A worker’s wage depended on the worker’s output/production. The reward for working is regarded as the product of the rate of production and the degree of utility. He assumed that the act of beginning work is onerous and produces net pain, but as one works it becomes more pleasurable, until painfulness outweighs pleasure.

The worker will stop producing when the net pain is equivalent to the degree of utility of the wages produced.

Question 10

What was Marshall’s attitude concerning the use of mathematics in economics?

Answer 10

Personally, Marshall loves math. He grew up reading it under the covers when his dad thought he was studying religion. However, he finds that it muddles economic arguments. Thus, he believed that math should be used as shorthand to try to work out novel and important ideas. However, once the idea is developed, it should be put in clear English with helpful images and the math should be burned.

Question 11

Did Marshall believe that previous economists had played a progressive role in society?

Answer 11

Yes, Marshall believed that previous economists had been instrumental in opposing antisocial monopolies, supporting pro-union legislation, and working to reform welfare. Despite the fact that many people believed they did nothing to improve economic conditions when society was struggling, Marshall believed economists were just being cautious and judicious in order not to make bad economic decisions.

Question 12

Discuss the use of time in Alfred Marshall’s analysis. What is the difference between the short run and the long run? Is it possible for an increase in demand to cause a decrease in the equilibrium price of a product in the long run?

Answer 12

In the short run, capital and production capacity cannot be altered, in the long run, they can. Yes, it is possible because in the long run, supply will also increase and new technology may reduce company costs, allowing for a reduced price.

Question 13

According to the terminology established by Alfred Marshall, explain what is meant by “internal economies” and “external economies.”

Answer 13

These are two ways to reduce costs through economies of scale:
-Internal economies arise from division of labor, buying supplies in bulk and using specialized large machinery smaller companies can’t afford
-External economies occur when the industry locates in a particular area which reduces the cost of finding labor and may reduce supply costs as subsidiaries develop there as well
Internal - firm-specific advances that only benefit the one firm
External - non firm-specific advances that benefit the entire industry

Question 14

Did Marshall believe that people employed in agriculture and industry are inherently more productive than people employed in the service sector? What was his reasoning?

Answer 14

There are good producing sector and service sector. Men cannot create material things, they just rearrange them. Good producing (agriculture and industry) sectors take ingredients and rearrange them into final goods and service sectors (merchants) make them more accessible. The value of each sector is based on the utility they generate.

Question 15

According to Marshall, how is elasticity of demand related to social class?

Answer 15

Elasticity is the responsiveness to price. If a price is “high,” elasticity will be higher or people will be more likely not to purchase the good after a small increase in price. If a price is “low,” elasticity will be lower or people will be less likely to not purchase the good after a small increase in price.

However, high and low prices are relative terms- a high price to a poor person may be low to a rich person. If this is true, the rich person will not have a high elasticity to the “high” price of a good while the poor person will.

When the price is very high relatively to any class, they will buy little of it, which may prevent them from buying the product even after the price has fallen. Elasticity of demand (responsiveness) is high for high and medium prices. Elasticity declines as price falls and fades away if the price drops to a satisfied level. Spices and cheap medicines are so low priced that even the poor can afford them, which means no fall in price would increase the demand for the product. Same for necessities, people react little to price changes. Higher priced/higher quality items depend on sensibility.

Question 16

“Alfred Marshall developed a compromise between the objective and subjective theories of value.” Explain and comment

Answer 16

Alfred Marshall says that the price a person pays for things can never exceed and seldom comes up to that which he would be willing to pay rather than go without it: so that the satisfaction which he gets from its purchase generally exceeds that which he gives up in paying its price; and thus he derives a surplus of satisfaction.

The price never exceeding what the person is willing to pay is objective, we can observe that the person is willing to pay the price if he/she purchases the good and that they are not willing to pay the price if they do not purchase the good. The satisfaction surplus is subjective; satisfaction from the good differs from person to person and we cannot observe it.

Question 17

Discuss the differences between the Keynesian and classical views of the labor market. In particular, explain Keynes’s distinction between “voluntary” and “involuntary” unemployment.

Answer 17

Voluntary unemployment is when workers choose not to work because the necessity level is higher than the wage rate. Involuntary unemployment is when people are willing to work at the current wage rate, but the surplus of labor keeps them from working.

Classical’s believe that unemployment in the economy is either voluntary or due to some external interference. Believe involuntary unemployment does not exist because adjustment in the wage rate will assure the unemployed will be hired again.

Keynes said that economies operate at less than 100% employment. People won’t work for less than they need to live, which means low wages equal unemployment.

Question 18

Explain the classical view of equilibrium in the product market. What was Keynes’s objection to this theory?

Answer 18

Classical’s believed that wages and prices are fully flexible.
Keynes believed that wages and prices are more rigid and equilibrium may not exist in the short term product and labor markets, which causes unemployment.

Question 19

Discuss the differences between the Keynesian and classical views of the money market. If the Federal Reserve increases the supply of money, how will the market pull itself back into equilibrium according to Keynes and the classical authors?

Answer 19

Classical’s believed that what wasn’t spent immediately would enter the money market as savings, which will be put back into the economy as investment when it is borrowed. Interest assures that no money is left idle in savings. The interest rate adjusts to reach equilibrium.

Keynes said that investors and savers have different plans, which may not assure that equilibrium exists in the money market. During a recession, investments do not equal savings because although the low interest rate,

1. Borrowers have poor sales prospects,
2. Banks are afraid of lending due to potential bankruptcy, 3. Savers want to wait for higher returns

Question 20

According to Keynes, his analysis removes “one of the chief social justifications of great inequality of wealth…” Explain and evaluate

Answer 20

The social justification of the inequality of wealth that Keynes debunks is that growth of capital (an important impetus to economic growth) depends on individual savings, especially savings of the rich. This belief leads many to fear a heavy progressive tax. However, Keynes believes that growth of capital is in fact achieved by a high propensity to consume rather than a low one. He also foresees that the redistribution of wealth through taxation and government spending programs would increase this propensity to consume, therefore increasing the growth of capital and improving the economy.

Question 21

According to Keynes, what are the economic responsibilities of the government? How did his view differ from the classics, and how were they similar?

Answer 21

According to Keynes, the State should guide propensity to consume through taxation, fixing the rate of interest, and its own investment in order to achieve close to full employment. The classical theory advocates for less governmental intervention in the economy, although even classical economists recognized that the State needed to regulate certain economic functions such as taxation and the rate of interest. The biggest difference is that classical economists did not look towards the government for generating investment.

Question 22

What are the continuing themes in Milton Friedman’s work? How are these illustrated by his proposals for monetary policy, welfare reform, exchange rate management, school finance, and drug regulation?

Answer 22

The biggest theme in Milton Friedman’s work was that the economy was stable on its own and should not be intervened with constantly by the government. He believed that the velocity of money (how quickly people spend their money) was stable, demand for money was constant, and consumption (while tied to income) was stable over the long run. His goal was to grow the stock of money slowly and steadily rather than trying to “fine tune” the economy.

For this reason, he advocated that permanent, long-term policies be put in place rather than temporary ones.

For instance, he believed in the idea of permanent tax plans and he suggested replacing the Federal Reserve with a robot that would raise rates along with a predetermined amount of growth in the economy rather than react immediately to economic events.

His view on welfare reform was also that it was way too intrusive, giving people a disincentive to work by providing for the unemployed. He suggested a “negative income tax” as an alternative (low income individuals would gain an extra percentage of their income rather than pay a percentage in taxes).

For exchange rates, Friedman suggested that they be allowed to float rather than being fixed by the government.

He also believed schools run by the government (public schools) were far less efficient than their private alternatives.

Finally, he believed that drugs, like alcohol, shouldn’t be regulated because it was a waste of government resources and an infringement on freedom. Instead, he thought people should make their own decisions and the government should only step in if harm to another person was likely.

Question 23

According to Friedman, what will happen if the Federal Reserve attempts to use monetary policy to keep the unemployment rate below the natural rate of unemployment?

Answer 23

Using monetary policy to inflate demand will drive up prices and the phillips curve shows that prices are inversely related to unemployment. Thus monetary policy can stimy unemployment for a time but in the end, the inflation that results will drive unemployment back up to its natural levels.