Test Two Study Cards Flashcards
How does the Wealth of Nations refute mercantilist wealth?
Wealth doesn’t equal amount of gold and silver. Wealth=#of consumable goods.
What is the sole end purpose of all production?
Consumption
According to Smith, whose wealth counts?
Everyone's consumption counts: cannot negate a class of individuals. Cannot ignore the poor. If there is a large impoverished class, then the nation is not rich. Smith refutes the rise of utility of poverty theory. (radical)
What did Smith believe about the equality of man?
All men are created equal: “by nature a philosopher is not…half so different from a street porter.” (WN)
We have different preferences, but that benefits society.
When we imagine ourselves in each other’s shoes, all men must be equal.
Why is natural liberty so important to society?
Encourages spontaneous order in which society becomes better off.
What is the assumption about capitalists?
That free market means that we just support the rich/elite businessmen.
Capitalists encourage business competition so that society can benefit as a whole
Why was Smith anti-business?
Because he thought businessmen always looked for monopolies and privileges. He instead favored pro-markets, pro-competition.
What did Smith say about regulation?
“When the regulation, therefore, is in favor of the workmen, it is always just and equitable; but it is sometimes otherwise when in favor of the masters.”
What are payments in kind?
Agreeing to be paid in money, but getting paid in corn instead. Smith emphasized the enforcements of law on contracts.
Did Smith’s main concern lie with the poor or the rich?
The poor
What was Smith’s legacy?
He created a moral philosophy of liberty and a legacy of concern, not for the privileged, but for the everyman (very different idea than that found in mercantilism)
What did Smith believe about wealth generation?
He believed in not just rearranding the pieces between two countries, but working together to mutually benefit. Very different from mercantilism. Discouraged reallocation of resources.
Who created the idea of comparative advantage?
David Ricardo
What is comparative advantage?
The total output of a group of individuals, an entire economy, or a group of nations will be the greatest when the out[ut of each good is produced by the person (or the firm) with the lowest opportunity cost of production for that good.
Gains through specialization.
Looking at a static picture (taking a snapshot of the economy)
What is the opportunity cost of production?
How much it costs to make the next good. Usually priced according to what the manufacturer must give up in order to make that good.
What is an absolute advantage?
Even if you are better at making everything, and I’m worse at everything, we can still gain from specialization and exchange.
As long as relative production costs of two goods differ between the 2 people, gains from trade will be possible.
What are relative production costs?
The fraction of the good it costs to make the other product.
Shows how much you are giving up to make a certain good.
Why do we not make the things we most love?
Not economically beneficial: it’s a bit odd and counterintuitive to not make the things that you most desire.
If I want more of something, I should do something else to get money and then buy the good from someone else.
Who thought of the gains of division of labor?
Adam Smith
What is division of labor?
The division of a complex production process into a number of simpler tasks, each one of which is undertaken by a different individual.
Observed throughout time, and is not static.
Even if we were all exactly the same (drones), we could still benefit from division of labor.(does not work in comparative advantage)
What is the lesson learned from the pin factory?
There are great increases in production through specialization in certain aspects of the process of production and division of labor.
What are the 3 dynamic gains from specialization?
- Economies of scale 2. Learning by doing 3. Technology gains from familiarity.
what are economies of scale?
Cost advantages that a business obtains due to expansion. A farmer can provide everything for himself and have crappy tools to work with, or he can specialize in one job and invest his capital into better technology. From this, he may trade.
What is learning by doing?
When you make a product, after a while, you get better at making it. Practice makes perfect. The extra productivity that comes from doing one thing over and over.
What are technology gains?
If you continually work on a process, you will be much more likely to find ways to improve it. If you specialize in one activity, you won’t be constantly be switching tasks. Sometimes corporate leaders refer to lower workers to get feedback on how to improve their technological process.
How can you incorporate comparative advantage with the division of labor?
First, one must apply the division of labor to increase production rates so that you have more to trade through comparative advantage.
Completely contrasts mercantilism.
Supports mutually beneficial exchanges.
When did Frederic Bastiat live?
1801-1850
What was Bastiat know for?
His writing
Was a politicisn, journalist, wrote witty essays and fables
Demolished protectionism and govt. subsidies thorugh his writing
Advocated the free market.
How long did Bastiat write economic essays for?
Only the last 6 years of his life.
Despite this short time, he still made an increadible impact on the world of economics.
What were his ad absurdum arguments?
He took the other side’s arguments and extended them to their ridiculous parallel conclusions.
Through this, he broke down the basics of arguments to show what they meant and how upsurd the logic was.
What was Bastiat’s book, Economic Harmonies about?
1850
Discusses how natural it is for people within society to be in harmony with each other.
How did Bastiat impact the everyman?
He demolished the everyman’s misconceptions of economics
What was the broken window fallacy?
It points to the importance of notiving what is seen and what is unseen. An action has multiple effects
Immediate consequenses and subsequent consequences
Disproves the false belief that accidents such as a broken window will create and keep job alive
This is a trap that many economists fall into when a natural disaster occurs.
What was Bastiat’s petition of the candle makers?
Proved how protectionist policy doesn’t make sense
“If you shut off as much as possible all access to natural life, and there create a need for artificial light, what industry in France will not ultimately be encouraged?”
Said that competition creates tariffs
Tariffs are good for the producer, but bad for the consumer
The sun=the foreign market that floods our market with cheap goods
What was Bastiat’s negative Railroad?
When two countries sell goods between each other, a railroad is built to help exchange.
When we start having more exchanges with the other country, then the producer from one country calls for a tariff. This tariff is the same as destroying the railroad that connects the countries because it adds to the cost between the two exchanges.
What is the significance of Bastiat’s The Law?
Said the proper role of government is to defend the “God-given right to life, liberty and property” and to “prevent injustice from reigning.”
Focused on the enforcement of justice.
What do libertarians emphasize?
Believed to only emphasize wealth. However, they also emphasize peace, morals, and happiness.
the happiest places are the places in which the government interferes the least.
What are two causes that pervert the law?
Stupid greed and false philanthropy
What is stupid greed?
Slavery, tariffs, legalized plunder (govt. has a legitmate use of force.) in general: law has become an instrument of injustice.
What is false philanthropy?
Non-voluntary charity detaches individuals from societal needs: arrogance of what is best for all.
Just because people think something is the best way for the country does not mean that the government must implement it.
What is the conclusion of Bastiat’s The Law?
“Try liberty; for liberty is an acknowledgement of faith in God and His works.”
When did J.D. Say live?
1767-1832
What is J.D. Say’s background?
French Adam Smith Economist and businessman Classically liberal Macroeconomic theory: Say's Law Popularized Smith's idea: read WN
What was the difference between Say’s property rights vs. violation of property rights
Liberty vs. Coercion distinction
“The property a man has in his own industry, is violated, whenever he is forbidden the free exercise of his faculties or talents, except insomuch as they would interfere with the rights of third parties.”
If people are not using their property ina coercive manner, then we should allow them to use their property in their own way.
Trying to have coercion within the system usually causes more harm than good.
What did Basitat believe about facts and experiences?
Although he believed in the “rigorous deduction of undeniable general facts”, he also believed that we should check oujr facts with experience. Conclusions should match with reality/observation.Our observations can sometimes deceive us.
Bastiat believed it important to test our theories so many times so that they “rest upon immovable foundations.”
Why did Bastiat fear math?
He didn’t want to oversimplify or overmodel ideas by cramming it into a formula
He saw his good friend, David Ricardo the mathematician do this often.
What was Bastiat’s subjectiv e nature of supply and demand?
Man acts through his individual preferences. A qualitative (subjective) approach to economics, but not having a defined, mathematical nature.
Why did Bastiat denote “value in use”?
Because it was irrelevant in an exchange economy (water diamond paradox: Doesn’t matter if water is the most useful item). Value based on supply and demand
How did Say’s background of a businessman affect his view towards economics?
He saw how the entrepreneur played a role in the economy
Asked what demanders wanted, and wanted an efficient allocation of resources.
the entrepreneur must use some “combination of moral qualities” such as “judgment, perserverance, and knowledge of the world” to “estimate…the importance of a specific product.”
What did Say say about the importance of entrepreneurship?
That is it "necessay for the setting in motion of every class of industry whatever; that is to say, the application of acquired knowledge to the creation of a product for human consumption." Those who guess well within the market get to continue to guess: those who succeed will continue to get rewarded with an allocation of resources aimed toward them Responsibility of resources
What did Say believe about risk?
He knew the entrepreneur’s role in pushing the economy forward meant taking a degree of risk
Using judgment to try to use goods in the best way. Sometimes this leads to failure, but sometimes it can lead to a great reward for that risk.
What does the entrepreneur unite together?
All means of production
Land, labor and capital
The entrepreneur may pay to rent the land, wages to the labor, and interest on the capital, but can keep the rest of the profit.
The amount you make doesn’t have to equate with how much you work.: can be smart about it and take a risk.
Investing in a Taco Bell franchise on a college campus.
What is the role of the entrepreneur?
“Shifts economic resources out of an area of lower and into an area of higher productivity
What did Bastiat realize about rent-seeking?
That the entrepreneur could look to add wealth by providing what others wanted in markets or could look to get his own fain by using political power (rent seeking, mercantilism, seeking privilege.)
foreshadowed the capture theory of regulation (using real resources in order to impact political policies to provide payoffs for yourselves.)
Favors the producers and hurts the consumers.The loss of the consumer exceeds the gains of the monopolist producer.
What did say foreshadow?
The capture theory of regulation: using real resources in order to impact political policies to provide payoffs for producers. The loss of the consumer exceeds the gains of the monopolist.
How did the classicals view macroeconomics?
Favored the macroeconomic ideas. They created them from microeconomic principles because they saw no distinction betwen micro and macro concepts.
What is the main concept of macroeconomics?
Studying how economies grow, not just one market. Larger scale. How to create wealth as a nation. Say’s law: output and employment are directly linked.
What are the characteristics of classical macroeconomics?
- All markets clear: Spontaneous order on a larger scale
- Wages are flexible: no stickiness of wages: wages are prices of the labor market.
- No involuntary unemployment: wage rate wil lclear the market people willing to supply labor at a lower price (wages are flexible and will clear)
- Quantity theory of money: long run, market clearing economy.
What was the main macroeconomic concern of classical economists?
Growth
Smith studied how nature causes the Wealth of Nations
Ricardo believed that society progressed toward a stationary state. moving toward equilibrium. Also concerned with rent theory.
Malthus: population concerns specific to labor market, but concerned with growth of the enture economy. Asked what level of population is sustainable?
What specifically did Adam Smith say about growth?
Recognized the natural price in the long run that was the fixed level of prices in a market.
The labor market has an LRSC: long run wages will come down to their natural price.
How do you grow the economy?
Make more stuff and raise the natural price above the LRSC level.
Increasing demand in the labor market wil lmake suppliers want people to make more stuff.
Simply raising wages will not create economic growth
Higher wages are a reflection of the situation of movement forward in an economy.
What was the feeling on growth limitations??
the economy may have a cap, a limit on a certain level of growth.
Concerned that the growth will reach an ultimate limit.
We ahave a certain demand and our ability has or has almost reached that level.
People always assume that we are at the pinnacle of economic potential
what was Say’s reaction to growth limitations?
Said that a central key to classical macro. rests on Say’s law which claims that no such limits exists.
Believed that overproduction was impossible.
Produing beyond people’s demand was impossible. Insufficient demand was impossible.
However, you can’t just make “stuff.” Production is meant for consumption: must be useful.
Why can’t we have a glut of goods?
We may have it in the short run, but not in the long run or across all goods as a whole within the economy.
If people aren’t selling their stiff, then they cannot consume (b/c they don’t have money.) they would find another market to sell their skills.
Within the limiting factor approach, what must be considered about demand and supply?
We have unlimited wants and desires within our preferences.
More is preferred to less.
Supply: there are limited resources.
Therefore, we cannot just demand our way into prosperity.
What does Say’s law say about the growth of prosperity?
Focused on production in order to consume.
Consumption will not hold us back.
Meant a dependent society on others.
How does consumption take care of itself?
- How do I get what I want?
- Produce things others value
- This gives me a little certificate that says i have provided for my fellow man “this much”
- I use that amount to get as much consumption as I can.
Does it matter whether it is a barter or money economy?
No.
Say originally examined a barter situation where by definition supping one good requires the demand of another.
Supplying something that others value.
Adding money and nothing changes: it’s just a convenient medium of exchange.
“For what, in point of fact, do you want money? Is it not for the purchase of raw materials or stock for your trade, or of victuals for your support? Wherefore, it is products that you want, and not money.”
You want the money to get other products to consume.
What did Thomas Sowell say about Say’s :aw on investment?
Investment is only an internal transfer, not a net reduction of aggregate demand.
The same amount that could have been spent by the thrift consumer will be spent by capitalists and/or the workers in the investment goods spector.
Keynes beleived that if people saved, they did not invest.
Classicals believed that investment meant money still being spent. it is not a loss to the economy. Money is reinvested by another person.
What did thomas Sowell say about Say’s law on a higher rate of savings?
A hihger rate of savings will cause a higher rate of subsequent growth in aggregate output.
Savings lead to capiral. The more capital, the better off we can produce.
What did Sowell say about Say’s law on disequilibrium?
Disequilibrium in the economy can exist only because the internal proportions of output differ from the sonsumer’s preferred mix, not because output is excessive in the aggregate.
How does disproportioned production occur, according to Say?
Say did not deny the existence of depressions, unemployment, or unsold goods. This leads to disproportioned production.
Ricardo said, “Men err in their productions…there is not a deficiency of demand: we fail because we invest in or make the wrong things.
In an aggregate supply-aggregate demand graph, what are the titles on the horizontal and vertical lines?
Vertical: Price level
Horizontal: GDP, or goods and services
In an aggregate supply-aggregate demand graph, what does the LRAS represent and what does it look like?
LRAS is a vertical line
Represents the most that we can make/sustain: the maximum output level.
Anything to the left means the market is producing less than our potential max. output.
Anything to the right means the market is producing more than our potential max. output.
What do we expect to see if the market is to the left of the LRAS?
We would expect real interest rates to fall b/c weak demand for investment
We would also expect real resource prices to fall b/c of weak demand and high unemployment.
Unemployment is greater than the natural rate.
What do we expect to see if the market is to the right of the LRAS?
Real interest rates will rise b/c of strong demand of investment.
Real resource prices rise because of strong demand and low unemployment.
Unemployment greater than natural rate.
What will move the market back to the natural rate?
Spontaneous order or the self-correcting mechanism
How does the market move the rate back from the right to the natural rate?
High demand of intereset rates will cause less people to invest, and drive back aggregate demand.
Higher resource prices will cause suppliers to buy less and move the SRAS to the left.
Higher resource prices reduce SRAS
Higher real interest rates reduce AD
How does the market move the rate back from the left to the natural rate?
We have a sputtering economy, high employment.
Interest rates will drop, which will increase the quantity of investment, and will shift AD to the right.
Lower resource prices will decrease production costs, which will cause suppliers to buy and produce more, which will move SRAS to the right.
People are willing to supply more because everything is cheaper.
A move toward direct output toward its full-employment potential
What can the aggregate supply-aggregate demand be applied to?
Resource markets and labor markets and the loanable funds market.
What happens if we are beyond full employment?
This means that output is beyond its potential, and higher interest rates and resource prices will restore the economy’s full employment rate of output.
How did the classicals view the quantity theory of money?
They believed that money is neutral in the long run.
If the loanable funds market (lowering and raising the interest rates) does not do its job clearing the market, then Say’s law and overall macro clearing may be an issue.
Classicals had faith in this market.
Believed that money isn’t wealth (backlash against the mercantilists)
goes back to Smith’s WN who refuted the mercantilists with liberty-oriented arguments
What was the Quantity theory?
MV=PY y=output level (predetermined fixed at full employment P=price level V=Velocity (circulation rate of money) M=money supply (quantity of money) V and Y are considered constants P (price level) will depend on M. If we increase one, we increase the other. This is more Keynesian interpretation
What was the debate over velocity?
Some said that velocirt, circulation rate of money) said that it was constant and some said it was not. It is relatively stable only over long periods of time.
Why was there a move away from monetary theory having a long-run impact on the economy?
Money has no real impact: “is only for the purpose of employing that money again immediately.” -Say
“Money can serve no other purpose besides purchasing goods-Smith,WN)
Money is only the go-between in exchanges. Acts like a veil
Money served only to obscure the character of the proceeding without essentially changing it.”
What were the exceptions to money not being neutral?
Could be because it is caused by shifts beween short and long run analysis
Also parallels shifts between arguments against mercantilism and monetary theory.
Describe industrial economics.
British income and population grew alongside each other from 1700-1871
Free market policies are more common
Mercantilism, feudalism, top-down control became less popular
Income increased 18-fold
Population increased 4-fold
Both of these factors affect the classical economists’ thought
What were the 3 industrial thoughts?
- Utility theory: Benthan tries to make his classically liberal standard a bit clearer. Argues for liberal policies that will maximize the outcome for all
- Population theory: Malthus: the population is exploding!
- Ricardo: more scientific or exacting models of the arguments of a market economy.
Who thought of utilitarianism?
Jeremy Bentham
Other than utilitarianism, what did Bentham think of?
Advocated individual and economic freedom (called for abolition of slavery)
Extremely free market: criticized Smith for not being free market enough
Wanted people to achieve the highest amount of happiness, which usually correlated with freedom.
Opposed the idea of natural law and natural rights, calling them “nonsense upon stilts” (opposed Locke): Believed more of David Hume, who believed we do things because they have good consequences.
What was the basic premise of utilitarianism?
The greatest good for the greatest number of people.
The general interest is the sum of individual interests.
Attempted to assign an outcome/level of happiness/utility for each action for each individual.
Objectively measure levels of utility
What did Bentham believe if pleasure and pain could be objectively measured?
Then legislation could be judged on welfare grounds: what legislation gives the community the most happiness?
Pleasure and pain are the “twin masters of the human condition”
Why did Bentham believe that government intervention could be justified?
If the number of people whose happiness was enhanced by government action exceeded the number of those whose happiness was diminished by the action.
If a passed law will create more happiness for more people, the that law should be passed.
What is Bentham’s Felicific Calculus?
An attempt to measure economic welfare in the scientific sense.
The summing up of collective pleasure and pain.
the key to economic welfare was to find a way to measure pleasure and pain.
What was Bentham’s ambition in life?
To create a pannamion: a complete utilitarian code of law.
Wanted to put a system of law that will maximize utility for all.
Other than propose many legal and social reforms, what else did Bentham do?
Also expounded an underlying moral principle on which they should be based
Tried to build a scientific approach to political economy: more exact, not using general terms. Somewhat provable using the measurements. Then it’s harder to argue against his “proven” policies.
Moved away from concrete details and toward scientific, provable stats.
What were the felivific calculus’ severe limitations?
- Involved making illegitimate interpersonal utility comparisons (subjective preferences of happiness cannot be compared)
- Arbitrary weighting of different qualitative pleasures
- Identifying the sum of individual pleasures as being equal to the general interest (one’s gain could differ from the sum of everyone’s gains)
- the absence of behaviorial motives other than pleasure and pain (sometimes pain can outweigh pleasure)
What was Malthus’ background?
Wrote An Essay on the Principle of Population (initially published anonymously) in 1798
Believed the dangers of population growth would preclude endless progress towards a utopian society (reaction against extreme optimism of Godwin and condorcet (French rev.)
highly influential, and controversial, in economic, political, social, and scientific thought.
What did Malthus think about the perfectability of mankind?
That it needed to be tempered with reality and logic.
Tried to use mathematical properties of population growth and the growth of economic production to understand the fate of society.
What was Malthus’ theory?
An unchecked population would grow at a geometiric rate: 4,8,16,32
Food would grow at an arithmetic rate: 4,6,8,10.
Believed that population growth would outstrip food supply
Graph of the Malthusian trap.
What did Malthus conclude from his calculations?
The biological caactiy of man to produce will, if left unchecked, outstrip the physical means of subsistence
Made human perfectibility impossible.
What did Malthus notice about history’s poor class?
Thought population growth generally expanded in times and in regions of plenty until the size of the population relative to the primary resources caused distress.
What did Malthus say would happen if we crush sexual passion?
That it would inevitably create a mere subsistence level of existence among the working class.
What were Malthus’ checks on population?
- Positive checks: those that increase the death rate: limits of food supply, war, disease, etc.
- Preventative checks: those that decrease the birth rate: moral restraint, cultural decisions to have less children, contraception.
What did Malthus’ study do?
Provided a useful framework for raising emperical questions about population changes
What was wrong about Malthus’ theory?
- Wrong about food production
- Held technology as fixed
- With an evergrowing population, we still have not hit the Malthusian trap
- Shows how sometimes scientific things can go wrong or get skewed.
What was the background on David Ricardo?
1772-1823
Considrered by many as the founder of economics as a rigorous science involving mathematical precision
A British political economist, member of parliament, and stock trader
Credited with systematizing economics.
What did Ricardo set out to do?
Systematize the Wealth of Nations
Focused more on allocation of goods than growth.
his study relied on long-run steadt state equilibrium: did buold a system that was consistent, coherent, and logical (but sometimes wrong)
What was Ricardo’s equation?
Total output=rent+profit+wages
Wages=set by subsistence (assumed that all labor was homogenous) Price=cost of production on the least fertile currently in cultivation
Rent=payment for the use of the original and indestructible powers of the soil: the least fertile land in use gets zero rent: theory of land rent developed for a closed economy
Profit=residual (whatever is left)
Overtime profits get squeezed down: eventually to zero, no incentive to invest once we reach a steady state.
This model was his attempt to figure out the world through its categorization: more scientific, model-oriented approach
What was the Ricardian Vice?
The divorcing of theory and history
Pure deductive reasoning
Used mathematical models
He didn’t look to see if the model made sense in the real world: usually fcused on closed systems
How did Ricardo’s and Smith’s markets differ?
Ricardo’s market gew to a certain extent, but then did not extend.
Smith believed in the division of labor, specialization, economies of scale, all of which could expand the economy.
What was Skousen’s quote about Ricardo?
“Ricardo carried his theorizing to extreme levels whereby he made all kinds of limiting and dubious assumptions in order to get the results he was looking for-in this case, his assertion that prices are determined by labor costs.”
