Demand
In every market, there are both buyers
and sellers. The buyers' willingness to buy a particular good (at various
prices) is referred to as the buyers' demand for that good. The sellers'
willingness to supply a particular good (at various prices) is referred to as
the sellers' supply of that good.
The buyers' demand is represented by a
demand schedule, which lists the quantities of a good that buyers are willing
to purchase at different prices. An example of a demand schedule for a certain
good X is given in Table 1 . Note that as the price of good X increases, the
quantity demanded of good X decreases.
TABLE 1
Demand Schedule for Good X
Price of good X
Quantity demanded
This kind of behavior on the part of
buyers is in accordance with the law of demand. According to the law of demand,
an inverse relationship exists between the price of a good and the quantity
demanded of that good. As the price of a good goes up, buyers demand less of
that good. This inverse relationship is more readily seen using the graphical
device known as the demand curve, which is nothing more than a graph of the
demand schedule. A demand curve for the demand schedule given in Table
1 is presented in Figure 1 .
Figure 1
Demand curve for good X
The vertical axis in Figure
1 depicts the price per unit of good X
measured in dollars, while the horizontal axis depicts the quantity demanded of
good X measured in units of good X. In addition to the demand schedule and the
demand curve, the buyers' demand for a good can also be expressed a third
way—algebraically, using a demand equation. The demand equation relates the
price of the good, denoted by P, to the quantity of the good demanded, denoted
by Q. For example, the demand equation for good X corresponding to the demand
schedule in Table 1 and the demand curve in Figure 1 is
From the demand equation, you can
determine the intercept value where the quantity demanded is zero, as well as
the slope of the demand curve. In the example above, the intercept value is 10
and the slope of the demand curve is −2. In order to satisfy the law of demand,
the slope of the demand equation must be negative so that there is an inverse
relationship between the price and quantity demanded.
Change in the quantity demanded. A
change in the quantity demanded is a movement along the demand curve due to a
change in the price of the good being demanded. As an example, suppose that in
Figure 1 the current market price charged for good X is $4 so that the current
quantity demanded of good X is 3 units. If the price of good X increases to $6,
the quantity demanded of good X moves along the demand curve to the left,
resulting in new quantity demanded of 2 units of good X. The change in the
quantity demanded due to the $2 increase in the price of good X is 1 less unit
of good X. Similarly, a decrease in the price of good X from $4 to $2 would
induce a movement along the demand curve to the right, and the change in the
quantity demanded would be 1 more unit of good X.
Change in demand. A change in demand is
represented by a shift of the demand curve. As a result of this shift, the
quantity demanded at all prices will have changed. Figures 2 (a) and 2 (b)
present just two of the many possible ways in which the demand curve for good X
might shift. In both figures, the original demand curve is the same as in Figure
1 and is denoted by DA. In Figure 2 (a), demand curve DA has shifted to the
left to the new demand curve DB. The leftward shift means that at all possible
prices, the demand for good X will be less than before. For example, before the
shift, a price of $4 corresponded to a quantity demanded of 3 units of good X.
After the shift left, at the same price of $4, the quantity demanded is less,
at 1 unit of good X. In Figure 2 (b), demand curve DA has shifted to the right
to the new demand curve DC. The rightward shift means that at all possible
prices, the demand for good X will be greater than before. For example, before
the shift, a price of $6 implied a quantity demanded of 2 units of good X.
After the shift, at the same price of $6, the quantity demanded is greater, at
4 units of good X.
Figure 2
A change in demand: Leftward and
rightward shifts of the demand curve for good X
Reasons for a change in demand. It is
important to keep straight the difference between a change in quantity
demanded, or a movement along the demand curve, and a change in demand, or
shift in the demand curve. There is only one reason for a change in the quantity
demanded of good X: a change in the price of good X; however, there are several
reasons for a change in demand for good X, including:
1.
Changes in the price of related goods:
The demand for good X may be changed by increases or decreases in the prices of
other, related goods. These related goods are usually divided into two
categories called substitutes and complements. A substitute for good X is any
good Y that satisfies most of the same needs as good X. For example, if good X
is butter, a substitute good Y might be margarine. When two goods X and Y are
substitutes, then as the price of the substitute good Y rises, the demand for
good X increases and the demand curve for good X shifts to the right, as in
Figure
1.
2 (b). Conversely, as the price of the
substitute good Y falls, the demand for good X decreases and the demand curve
for good X shifts to the left, as in Figure 2 (a). A complement to good X is
any good that is consumed in some proportion to good X. For example, if good X
is a pair of shoelaces, then a complement good Y might be a pair of shoes. When
two goods X and Y are complements, then as the price of the complementary good
Y rises, the demand for good X decreases and the demand curve for good X shifts
to the left, as in Figure 2 (a). Conversely, as the price of the complementary
good Y falls, the demand for good X increases and the demand curve for good X
shifts to the right, as in Figure 2 (b).
2.
Changes in income: The demand for good
X may also be affected by changes in the incomes of buyers. Typically, as
incomes rise, the demand for a good will usually increase at all prices and the
demand curve will shift to the right, as in Figure 2 (b). Similarly, when
incomes fall, the demand for a good will decrease at all prices and the demand
curve will shift to the left, as in Figure 2 (a). Goods for which changes in
demand vary directly with changes in income are called normal goods. There are
some goods, however, for which an increase in income leads to a decrease in
demand and a decrease in income leads to an increase in demand. Goods for which
changes in demand vary inversely with changes in income are called inferior
goods. For example, consider the two goods meat and potatoes. As incomes
increase, people demand relatively more meat and relatively fewer potatoes,
implying that meat may be regarded as a normal good, and potatoes may be
considered an inferior good.
3.
Changes in preferences: As peoples'
preferences for goods and services change over time, the demand curve for these
goods and services will also shift. For example, as the price of gasoline has
risen, automobile buyers have demanded more fuel-efficient, “economy” cars and
fewer gas-guzzling, “luxury” cars. This change in preferences could be
illustrated by a shift to the right in the demand curve for economy cars and a
shift to the left in the demand curve for luxury cars.
4.
Changes in expectations: Demand curves
may also be shifted by changes in expectations. For example, if buyers expect
that they will have a job for many years to come, they will be more willing to
purchase goods such as cars and homes that require payments over a long period
of time, and therefore, the demand curves for these goods will shift to the
right. If buyers fear losing their jobs, perhaps because of a recessionary
economic climate, they will demand fewer goods requiring long-term payments and
will therefore cause the demand curves for these goods to shift to the left.
The Worldly Philosophers is a useful
book — not only to college students, but to any person wishing an understanding
of economics. Basically the book offers three benefits:
1.A simple but comprehensive
explanation of the ideas of the Great Economists. It gives the reader an
insight into the lives of these economists and the history of economics. Robert
L. Heilbroner places their concepts in a proper context, thereby explaining how
their philosophies evolve along with historical events. Throughout the book,
the author weaves into the narrative the freshness of language, wit, and
originality which makes for interesting reading. He discusses economic concepts
in plain, understandable language.
2.A valuable introduction to any course
in economics. Students will find a basic explanation of capitalism, socialism,
communism, prosperity, depression, and the practical workings of an economy. In
marked contrast to the dry, technical, and theoretical treatment of economics
by most textbooks, The Worldly Philosophers offers a vibrant, practical explanation
of the world of economics — past, present, and future. A student will find it
extremely profitable to study the book along with these notes prior to
enrolling in a course or taking an exam in economic principles and problems.
3.An overview of the political, social,
and ethical concepts of economic thought. For the person pursuing an education
on the history of the lives, times, and ideas of the great economic thinkers of
the Western world, this book contains a capsulized version of the major tenets.
The Worldly Philosophers is an
engaging, readable text. As such, it presents readers with a comprehensive
explanation of the development of modern economic philosophy. This guide is
designed to supplement the book in order to instruct students in unfamiliar
basic concepts, such as mercantilism, as well as in periods of historical
development in the social sciences, notably the scientific revolution,
Renaissance, commercial revolution, and the Great Depression.
The text of this guide offers many insights
into the realm of basic economics. A particular challenge is the bridging of
gaps as the author leaps from idea to idea. The organization of this guide
simplifies materials through chapter summary, analysis on background
information, further explanations of relevant points in each chapter, and,
finally, an overview and evaluation of the book as a whole. Overall, the guide
seeks to sharpen the reader's comprehension of economics as a science.
The subject of The Worldly Philosophers,
the great economists, covers those theorists whose words and thoughts
concerning the creation and distribution of wealth have had a major impact on
society. Indeed, these men have swayed and shaped the world. The title of the
book comes from their common interest: the human drive for worldly wealth. From
this compulsion is derived the concept of worldly philosophers. Surprisingly,
these economists did not appear on the scene of world events until long after
the advent of history, philosophy, science, politics, art, and statecraft. They
began in the latter part of the eighteenth century with the work of Adam Smith.
Analysis
Even though these economists are not
yet named, they are described by such intriguing characterizations as madman,
skeptic, and tramp. Among the identifications, which become apparent in
subsequent chapters, are these:
•a philosopher — Adam Smith
•a parson — Thomas R. Malthus
•a stockbroker — David Ricardo
•a nobleman — Saint-Simon
•a madman — Charles Fourier
•a revolutionary — Karl Marx
•an aesthete — John Maynard Keynes
•a tramp — Henry George
•a skeptic — Thorstein Veblen
From the beginning of civilization,
human beings have faced the challenge of survival, which depends upon two
factors — work and cooperation with others. Since individuals are notably
self-centered, the possibility that humans will not remain faithful to work has
threatened society's existence. If there are not enough miners to work the
mines or if most miners should decide to follow another line of work; if
farmers should decide to fish instead of plow and reap; or if an insufficient
number of students studied medicine or engineering, the economy would break
down. In summary, if the interdependence of human workers should fail at any
vital point in the economy, the world would suffer. During the early portion of
civilized life, only two methods safeguarded against such an outcome —
tradition and command.
Tradition
The passage of tasks, or jobs, from
generation to generation through custom — a carpenter's child becomes a
carpenter or a farmer's offspring take charge of the family farm. This reliance
on tradition for the selection of a life's work was especially true of the
Middle Ages and is still true in many underdeveloped areas of the world.
Command, or Central Authoritarian Rule
The enforcement of economic survival by
absolute rule or dictatorship. An example of this principle is the building of
the pyramids in ancient Egypt and the carrying out of the Soviet Union's
Five-Year Plans in the post-World War II era.
Throughout most of history, one or the
other of these two methods has solved the problem of survival. Because the
methods are simple and need no economic explanation, there has been no need for
economists. Since the Economic Revolution, however, the evolution of a third
method — the market system — has presented a more challenging economic puzzle.
The Market System
A system where buyers and sellers,
motivated by self-gain, freely conduct business with the goal of making
profits. Another name for this arrangement is capitalism. Prompted by neither
the "pull of tradition or the whip of authority," free markets are
motivated by a single factor — the human urge to acquire goods.
The market system is not the simple
exchange of goods which existed in primitive society, nor the commercial fairs
of the Middle Ages. Nor is it a farm produce market or a stock exchange. The market
system supports and maintains an entire society. Unplanned and slow to evolve,
it was brought about through the most far-reaching revolution of the Western
world — the Economic Revolution.
Many factors combined to cause the
revolution, such as the breakup of the manorial system, the decline of guilds,
the acceptance of the concepts of land, labor, and capital, the effects of the
Renaissance, scientific advancement, European voyages of discovery and
exploration, the emergence of modern nation-states, and the Protestant
Reformation, which sanctioned the concept of profit.
The market system emerged only after
bitter opposition to change by the people who tried to maintain their role in
the status quo. Nevertheless, as the profit motive became respectable, the
market system took shape, bringing with it the economists who satisfactorily
explained the complexities of the system. In 1776, Adam Smith wrote his amazing
masterpiece, Inquiry into the Nature and Causes of the Wealth of Nations, a
work which helped society understand how changes in economics were leading
toward a new plateau in human history.
Analysis
Tradition, or the subsistence economy,
bases itself on family, clan, or tribe. By this system, each unit produces all
that it needs, and it consumes all that it produces. In many rural areas of
Africa, Asia, and Latin America, the question of who will work and what work
will be assigned to whom is settled by custom.
The planned economy under central
authoritarian rule differs from tradition in that the means of production and
the authority to make economic decisions belong to the state. Examples existed
in ancient Egypt and Babylonia, where massive work projects were organized at
the whim of the ruling class. In more recent times, the communist nations which
were formed after the Russian Revolution in 1917 have attempted the same
large-scale operations as an outgrowth of a centralized authority. In neither
instance did individuals actualize their own ideas or goals.
In the market system, or market
economy, economic decisions are decentralized: Each member of the labor force
chooses which job to follow; each household selects what to buy with its
income; and each business decides what to produce, what production methods to
use, and where to sell the resulting product. Modern examples exist in the
United States, Western Europe, Japan, and Great Britain. This capitalism, which
is also called a free or private enterprise system, is named for its use of
capital, or investment funds.
None of the three methods, or systems,
exists in pure form. Systems practiced today in the United States, Great
Britain, Japan, or the Soviet Union are better described as mixed economies,
which contain elements of both the market economy and the planned economy. For
example, within free enterprise there are obvious government-sanctioned
monopolies, such as electric power companies, railroads, and communications
systems.
In order to develop what is meant by
the Economic Revolution and its roles in the remaining chapters of the book, a
few definitions will prove helpful:
Economics: The study of the ways in
which human beings make a living; the study of human wants and their
satisfaction; the science of wealth.
Economic System: The rules, laws,
customs, and principles which govern the operation of an economy. Each economic
system has its own peculiar problems and therefore produces its own solutions.
Economic Activity: All action concerned
with the creation and distribution of goods and services.
Consumption: The process by which goods
and services are utilized in satisfying human needs and wants.
Production: The process of creating
goods or services to be consumed.
Distribution
a. Physical: The process of
transporting these goods and services to the people who need or want to consume
them.
b. Personal: The division of income
among persons.
c. Functional: The categorization of
income according to type — wages, rent, interest, and profit.
Basic Agents of Production of the
Market System
Land: Natural resources.
Labor: Human effort.
Capital: The physical necessities for
production — buildings, machinery, tools, equipment, and supplies.
Economists call these basic agents
"factors of production." They include a fourth factor — management,
which plans, coordinates, and directs production, although some economists
label this factor a specialized high-level form of labor.
The market system involves a high
degree of economic activity, revolving around the production of goods and
services. It is significant that the basic agents of production — land, labor,
and capital — did not exist as abstract ideas until the Economic Revolution. Of
course, there was land used for agriculture, and labor in the form of human
workers doing physical tasks, and capital that provided funds for buying tools
and maintaining the land. However, society as a whole did not consider these
terms as impersonal ideas in the modern sense of "Let's start a business —
we need land for the location of the factory, we need a labor force to do the
work, and we must have the capital to finance our efforts."
During the Middle Ages, land existed in
the form of estates, manors, and principalities, but it was not "for
sale" in the modern sense. Instead, the ownership of land provided the
prestige and status around which social life revolved. There were serfs,
apprentices, and journeymen who worked, but there was no labor market — that
is, people who were looking for jobs. The serfs were bound to the land of their
masters, the lords. The apprentices and journeymen served the master and were
rigidly controlled by guild regulations. Capital funds in the sense of private
wealth existed, but not with any idea of investing, expanding, or taking risks.
The goal of medieval landholders was to stabilize and protect the nation by
financing wars and conquests and by underwriting the household expenses of
kings. A good example is the Fugger banking family of Bavaria, which failed to
pursue the amassing of wealth begun by their patriarch, Anton Fugger. Under the
medieval system, advertising was unheard of; the basis of price was the just
price. People lived as their ancestors had lived — off the output of the family
land.
Without land, labor, and capital there
was no production in the modern economic sense and therefore no market system.
Society in the Middle Ages was run by custom and tradition. This system changed
after the Economic Revolution, which represented a radical departure in
commercial practices and concepts. The following factors were responsible for
the Economic Revolution, which ushered in the market system:
The Renaissance (1350-1600) — when the
weakening of restrictive religion produced a more skeptical, inquiring
attitude.
The Scientific Revolution (1500-1700) —
the discovery of scientific principles which laid the foundations for the
Industrial Revolution.
Emergence of Nation-States (15th-l7th
centuries) — a process that gave rise to royal patronage for favored
industries, maritime trade, and the standardization of laws, measurements, and
currencies.
The Age of Exploration and Discovery
(l5th-l7th centuries) — an era which saw the rise of wealth in gold, silver,
and raw resources from colonies in the New World.
The Protestant Reformation (1500-1648)
— an era which encouraged enterprise, the investment of capital, and the
respectability of interest and profit.
The greatest single change necessary
for the adoption of the market system, or capitalism, was a radical change in
the attitude of society toward profit, or self-gain. Without the profit motive,
there would be no capitalism, or market system.
Certainly, the concepts of money and
profit are old, with the first coined money dating back to Lydia, around 600
B.C., and with such Greek philosophers as Xenophon, Plato, and Aristotle, who
were well aware of wealth, money, and profit. However, rather than emphasize
any economic considerations, the ancient philosophers denounced economics in
favor of basic questions about truth, good, evil, God, and life.
Later, the Church and its philosophers,
especially St. Augustine and St. Thomas Aquinas, were completely absorbed with
the question of immortality. These religious thinkers emphasized salvation as
the all-important concern of society and criticized the acquisition of earthly
material goods or riches. And so it was that the New Testament phrase "For
the love of money is the root of all evil" (I Timothy 6:10) blocked the
development of the market system, which emphasized self-gain and profit rather
than spirituality.
Gradually, however, the factors listed
above helped shape the market system. The Renaissance encouraged a new
individualism in economic affairs and contributed to the breakdown of the guild
system and to the rise of enterprise. Protestantism became a strong force in
the alteration of concepts. Calvinism especially encouraged enterprise. Some Calvinists
saw prosperity as a sign of God's grace, and poverty as evidence of damnation.
Thus the Protestant Reformation obliterated the old concept of the just price
and the ban against charging interest on loans. Consequently, the loaning of
money and the investment of capital became respectable, and Western society as
a whole adopted the profit motive, an idea explained by Adam Smith, the father
of modern economics.
Glossary
Economics The study of the ways in
which people make a living; the study of human wants and their satisfaction;
the science of production, distribution, and consumption of goods and services.
Economic System The rules, laws,
customs, and principles which govern the operation of an economy. Each economic
system has its own peculiar problems and therefore produces its own solutions.
Economic Activity All action concerned
with the creation of goods and services to be in some way consumed.
Consumption The process by which goods
and services are utilized in satisfying human needs and wants.
Production The process of creating the
goods or services to be consumed.
Physical Distribution The process of
getting goods and services into the hands of consumers.
Personal Distribution The division of
income among individuals.
Functional Distribution The division of
income according to different types . . . wages rent, interest, profit.
Basic Agents (Factors) of Production
Land, labor, capital, and management
Land Natural resources.
Labor Human effort.
Capital The physical necessities for
production — buildings, machinery, tools, equipment, and supplies. This term
commonly refers to the money used to purchase these necessities.
Management The planning, coordination,
and direction of production.
The Economic Revolution The development
of historical factors which culminated in the adoption of the market system
(capitalism).
The Renaissance (1350-1600) — the era
which saw the decay of a restrictive religious spirit in favor of a spirit of
skepticism and inquiry.
The Scientific Revolution (1500-1700) —
the period of scientific experimentation and discovery which laid the
foundation for the Industrial Revolution.
The Emergence of Nation-States
(l5th-l7th centuries) — a period giving rise to royal patronage for favored industries,
maritime trade, common laws, standard measures, and common currencies.
The Age of Exploration and Discovery
(l5th-l7th centuries) — an era which provided natural wealth from the colonies
in the form of gold, silver, and other raw resources.
The Protestant Reformation (l500-1648)
— a time period encouraging enterprise and the investment of capital; a
philosophical outgrowth which made interest and profit respectable.
Adam Smith (1723-90), a quiet, nervous,
scholarly Scottish bachelor, taught first at Oxford University and then at the
University of Glasgow. He gained fame as a moral philosopher, and during his
lifetime, his book The Theory of Moral Sentiments earned the critics' appraisal
as his best work. Consequently, he was already well known before publishing his
enduring masterpiece, An Inquiry into the Nature and Causes of the Wealth of
Nations.
During a three-year tour of Europe as
traveling tutor of the stepson of Charles Townshend, Smith met the leading
thinkers of the Age of Enlightenment, including Benjamin Franklin and Dr.
Samuel Johnson. He was particularly impressed with Francois Quesnay, principal
spokesman for the French physiocrats, who believed that wealth arises from
production. While traveling, Smith worked on his Wealth of Nations and
completed the book in 1776, ten years after his return to Scotland.
The Wealth of Nations, which resembles
an encyclopedia, is far more than a mere textbook on economics. One critic
calls it "a history and criticism of all European civilization."
Among a host of topics, it discusses the origin and use of money,
apprenticeship, statistics, waste, the military, foreign trade, landlords, the
clergy, royalty, farming, and "the late disturbances in the American
colonies."
The book's 900 pages are demanding
reading, for Smith often belabors a point without drawing a conclusion. It is
not actually original in the sense that its basic ideas are unique to Smith.
The author refers to more than 100 authors in developing his arguments,
including Locke and Hume. He borrows heavily from the physiocrats, particularly
Quesnay, from whom he takes the doctrine of laissez faire, or "leave it
alone." However, the book is a masterpiece because it presents a
comprehensive picture of economics — a revolutionary doctrine which views the
economy as though it were a living organism.
Briefly, these are Adam Smith's
economic laws:
1. How can society depend on
capitalism, which is an unregulated market system? Smith replies with two laws
of the market. The desire for wealth permeates all human activity. Therefore,
self-interest, or profit, motivates people to perform necessary tasks for which
society is willing to pay. As Smith writes, "It is not from the
benevolence of the butcher, the brewer, or the baker that we expect our dinner,
but from our regard to their self-interest." Thus, the first law of the
market is self-interest, or the profit motive.
2. But how can the individual's selfish
desires benefit society? What stops greed from overwhelming the public,
resulting in ruthless exploitation by profiteers? Smith answers that the
individual, in the process of providing for personal interests, unintentionally
contributes to the economic wellbeing of society. Therefore, the second law of
the market is competition. The individual who overcharges for products soon
learns that competitors will take away business by offering more reasonable
prices. If wages are too small, workers will hire out to another employer who
will pay more for their services. Thus, selfish motives are tempered by
interaction, resulting in social harmony.
According to Smith, under the market
system each worker freely chooses a trade. Through such a multitude of choices,
society reaps the benefit of having all its necessary tasks filled. The
individual, motivated by self-interest, selects a particular task. Competition
for these tasks prevents the individual from over-charging society. Thus, the
two laws of the market — self-interest and competition — react upon each other
and form a balance, guaranteeing the survival of society.
In addition, the laws of the market not
only insure that prices are competitive, but they also determine the quantities
of goods produced. As Smith explains, when the public demands more gloves than
shoes, there will be a brisk business in gloves, but little demand for shoes.
Consequently, the price of gloves will rise as demand exceeds supply and pushes
prices up. The price of shoes will go down because the supply exceeds the
demand.
At this point, self-interest becomes a
factor. Since there are higher profits in the glove business and a greater need
for gloves, new producers begin manufacturing gloves. Workers move from shoe
factories to glove factories. The result is that glove production rises and
shoe production falls. Before long, the market achieves a balance. As the
supply of gloves grows to meet demand, glove prices decrease. As the supply of
shoes falls below demand, shoe prices rise. This price increase stimulates shoe
production. Therefore, the opposing forces of self-interest and competition
balance the market.
Finally, the laws of the market also
regulate incomes of producers. When profits in one type of business become
unusually large, new producers are attracted to the business — until
competition reduces the surplus of profit. In the same way, labor's wages are
regulated — workers are attracted to higher paying industry until the labor
supply lowers the pay scale to that of comparable jobs. By the same token, the
reverse is true — when profits or wages are too low, producers or workers will
leave that field for more lucrative areas.
But the key to the operation of the
laws of the market is that the market is "its own guardian." It is
self-regulating if left alone (laissez faire) so that competition can operate
freely without government control and without monopolies.
Does capitalism, or the market system,
actually operate in this way? It did during Smith's time, for the business
world was a world of atomistic, or elemental, competition. Yet, there was
evidence that a large number of people did not profit from the system. Still,
even though more than an eighth of England's population in 1720 was poor, Smith
insisted that society could not flourish if "the greater part of the
numbers are poor and miserable." In his radical view, society was
definitely improving. By comparison, the capitalistic world of today differs
greatly with its giant corporations and massive labor unions. However, the twin
laws of self-interest and competition still form the basis of the market
system.
Adam Smith was optimistic in his vision
of the future. To him, the society of the market system was dynamic and
progressive. During his lifetime, division and specialization of labor greatly
increased productivity. He expressed enthusiasm after his visit to a pin
factory which employed only ten people.
Each worker specialized in a single
operation; the total daily output was over 48,000 pins. If each worker were to
handle all steps involved in the manufacture of pins, the total output per
worker would fall to twenty pins per day for a total production of 200 pins.
According to Smith, a simple factory worker, in comparison with an African
king, lives a more luxurious life as a result of the work of specialized labor.
In his vision of society's economic
progress, Smith saw two additional fundamental laws which propelled the market
system in an ascending spiral of productivity and away from the "avarice
of private greed." These laws he called the law of accumulation and the
law of population.
3. The law of accumulation refers to
the accumulation of profits, which are put back into production. By
accumulating profits, capitalists can purchase additional machinery, which will
stimulate further division and specialization of labor, thereby boosting
productivity. However, additional machinery means more workers to work them.
Eventually this increased demand for workers leads to higher and higher wages
until profits vanish. At this point, further accumulations are impossible.
4. The solution to this obstacle is
Smith's law of population. Labor, like any other commodity, is subject to
demand. As the law of accumulation increases wages for workers, the numbers of
the working class will increase. As the population of workers increases, its
size becomes a counterforce, pushing wages down. As a result of lower wages,
profits for the capitalist will rise again, and accumulation will continue.
Thus, these two evolutionary laws form
an endless chain for society through which progress is inevitable. Even though
the Law of Population depresses wages toward a subsistence level, it never
arrives there. Conditions steadily improve, resulting in further accumulation
for further investment. What is the end result? Not a utopia, but the economy,
if left alone, will ultimately reach its "promised reward" — a world
where poverty and wealth balance each other.
Analysis
To comprehend fully why Smith's Wealth
of Nations was a revolutionary book, one must know something of the economy and
living conditions in England in 1776. The nation was entering the second of
three stages of capitalism.
1.The first stage, known as commercial
capitalism, occurred between 1450 and 1750. It was brought about by the five
factors which produced the Economic Revolution and was affected by geographic
discoveries, colonization, and increase in overseas trade. The early
capitalists were protected by government control, subsidies, and monopolies and
made their profits from transporting goods.
2.The second stage began about 1750 and
was made possible by new sources of energy, primarily the steam engine. This
invention enabled the factory system to develop through the use of machines for
manufacturing and resulted in the rapid growth of wealth. This stage, known as
industrial capitalism, which reached its height during the 1850s, resulted as
capitalists profited from manufacturing.
3.The third stage of capitalism began
in the last quarter of the nineteenth century. Because of the control and
direction of industry by financiers, this stage is known as financial
capitalism, with profits coming from investing.
Wealth of Nations appeared in England
just as the Industrial Revolution was beginning, a fact unknown to Adam Smith
and the capitalistic class of his day. In England, the government controlled
practically every sector of the economy, including prices, wages, hours of
work, production, and foreign trade. The House of Lords represented the noble
families, or landed aristocracy, which controlled the vote as well as public
office. Only 3 percent of the population affected the election of members to
the less static House of Commons.
For the poor, conditions were
abominable. Men, women, and children, stripped to the waist and stooped over in
semi-darkness, worked in dank mineshafts. The masses struggled brutally for a
meager existence. When wool became a profitable commodity, land owners enclosed
new pastures to raise sheep. The process of enclosure, which began in the
sixteenth century, reached its height in the nineteenth century, with thousands
of tenant farmers thrown off the land in order to make room for the more
profitable sheep. Over 1.5 million of England's twelve to thirteen million
population suffered poverty. Yet the grasping aristocracy, who considered the
poor a necessary segment of a stable society, opposed any suggestion of a more
equitable distribution of wealth.
Mercantilism, the dominant economic
concept of the day, upheld the view of government and business that real wealth
consisted of gold and silver. Since the reign of Henry VIII, mercantilists
sought a strong, self-sufficient economy, protected by a strong central
government. Their program called for the following:
1.accumulation of gold and silver
2.a favorable balance of trade through
an excess of exports
3.the self-sufficiency of the nation
through the utilization of raw materials from either England or her colonies
4.colonies to provide raw materials, as
well as a market for England's manufactured goods
5.low wages and long hours for workers
6.high tariffs to protect home industry
and to discourage imports
7.a strong merchant marine
Adam Smith's Wealth of Nations launched
a specific attack on the doctrine of mercantilism. In his celebrated Book IV,
he called for free trade and the abolition of economic restraints and
monopolies. Forget "balance of trade," he argued. "Wealth does
not consist in money, or in gold and silver, but in what money purchases, and
is valuable only for purchasing." As opposed to the emphasis on
agriculture by the physiocrats, Smith emphasized manufacture. For Smith, the real
wealth of nations consists of the goods which they can produce and trade. This
condition can be accomplished only by allowing production and commerce to
develop freely, without controls.
The replacement of mercantilism with
the doctrine of laissez faire did not come immediately with the publication of
Smith's views. It was not until the nineteenth century that the Wealth of
Nations made its full impact. Then Great Britain discarded mercantilism
completely to become the world's wealthiest nation. Unfortunately, the rising
industrial capitalists managed to disregard certain stinging accusations in
Smith's philosophy, such as "People of the same trade seldom meet together
but the conversation ends in a conspiracy against the public, or in some
diversion to raise prices . . ."
Adam Smith, in fact, was neither
pro-capital nor pro-labor. At the University of Glasgow, he was influenced by
the concept of "the greatest happiness of the greatest number."
Consequently, he avoided taking sides with any class, concerning himself with
the promotion of wealth for all of England's classes.
A principle which his contemporary
capitalists chose to ignore was Smith's concept of labor value. His observation
that labor is the only real standard of value has been contradicted by most
economists, but widely adopted by socialist writers. Some ninety years later,
Karl Marx seized and expanded upon this idea, building it into his exaggerated
theory of "surplus value."
What British capitalists stressed was
Smith's gospel of laissez faire. Ignoring the philosopher's warnings about the
dangers of monopoly, they justified resistance to government attempts at social
legislation. During this era, child labor was common in poorly ventilated and
unsanitary factories; manufacturers shackled children to machines. To quell
child labor laws, factory owners quoted Wealth of Nations in defense of
deregulation.
Accordingly, Adam Smith's proposals for
protective measures for workers, farmers, consumers, and society as a whole;
the abolition of slavery; and the control of monopolies were ignored.
Capitalists championed the Wealth of Nations as a vindication of corrupt
business practices. In this way, Adam Smith, the soft-spoken scholar, became
the patron saint of free enterprise in the capitalistic world. In later times,
Adam Smith, by thoroughly describing and explaining the market system, became
the father of modern economics.
He founded the school of Classical
Economists, whose chief spokesmen were David Ricardo and Thomas Malthus.
Glossary
Age of Enlightenment A period (roughly
1700-89) when political, economic, and social thought was dominated by an
optimistic faith in reason and in the progress of the human race.
Mercantilism The doctrine which
dominated European economic policies from 1500 until the advent of laissez
faire through a program which stressed that the real wealth of a nation
resulted from its stores of gold and silver, which could be acquired by an
excess of exports to imports, self-sufficiency of the nation, and exploitation
of colonies.
Physiocrats A group of thinkers during
the Age of Enlightenment who opposed mercantilism, believing instead that the
true source of wealth derives from land and agriculture; they advocated the
doctrine of laissez faire.
Francois Quesnay (1694-1774) French
economist who founded the school of Physiocrats and greatly influenced Adam
Smith.
Laissez Faire Literally, "let [it]
function" — the economic doctrine founded by Quesnay and the Physiocrats
and expounded by Adam Smith, stressing no governmental interference in the
operations of the market economy.
Industrial Revolution The transition
from the stable agricultural and commercial society of the Western world to the
modern industrialized society; the second stage of capitalism.
Enclosure Movement The practice of
fencing off lands formerly subject to common rights in order to provide pasture
land for sheep. This movement caused a shift of the poor in England from farms
to cities.
Patron Saint of Free Enterprise Adam Smith.
Father of Modern Economics Adam Smith.
Classical Economists The economists who
preached the doctrine of laissez faire and stressed that the production,
consumption, and distribution of goods and wealth are determined exclusively by
economics laws and principles.
Adam Smith's vision of the world
demonstrated glowing optimism when he founded the school of Classical
Economists. Ironically, the chief spokesmen for that school — David Ricardo and
Thomas Malthus — while accepting the principles which Smith laid down, differed
sharply from him in their pessimistic views of an ominous future. Ricardo and
Malthus violently disagreed with each other's economic views on practically
every point except one — the dangers of overpopulation. When one published a
book or article developing a particular economic thesis, the other attacked it.
Yet, despite differences of philosophy, the two economists were congenial and
held a high personal regard for each other.
Of Dutch extraction, David Ricardo was
a successful Jewish stockbroker who, by the age of 26, became financially
independent. He won widespread respect, and his social position ranked high,
including membership in Parliament where he earned the title, "the man who
educated Commons." His Principles of Political Economy (1817) helped shift
the economic picture from Smith's optimism to a widespread pessimism. A
practical man in financial matters, Ricardo was essentially a theorist who
created a dry, mechanistic picture of society.
In contrast, the Reverend Thomas
Malthus had none of Ricardo's good fortune or social success. He never enjoyed
more than a modest income and was continually criticized for his ideas. In
fact, his biographer called him "the best abused man of his age."
Spending most of his life in academic research, Malthus was not at all
practical in financial matters, yet was most practical in his economic views.
David Ricardo (1772-1823)
Summary
During the forty years following the
publication of Adam Smith's Wealth of Nations, rivalry between the rising
industrial capitalists and the conservative, complacently landed aristocracy
dominated the English scene, particularly over the matter of food prices. Since
capitalists had to pay at least a subsistence wage to workers, they were
vitally interested in lowering grain prices. To this end, they welcomed cheap,
imported wheat and corn. Landowners and landlords naturally resented imports
because they depressed prices and profits from their own grains.
The landlords' resentment was
translated into action in Parliament where they held the majority. The result
was the passage of the Corn Laws, which imposed duties on imported grains,
thereby effectively keeping low-priced grain out of England. The landlords'
political clout was so great that Parliament did not repeal the Corn Laws until
thirty years later.
Observing the advantageous position of
the landlord, the struggle of competing capitalists, and the economic plight of
the worker, David Ricardo envisioned an unpromising future for capitalism. To
Adam Smith, society appeared balanced and harmonious, but, to Ricardo, society
was a bitterly competitive contest. He viewed the worker as little more than an
automaton, whose only human expression was an indulgence in sex. Instead of
raising the family standard of living when wages rose, the worker produced more
children and thereby increased the labor supply, offsetting the tendency for
wages to rise as the supply met and exceeded the demand for workers. Thus, the
worker was doomed to gain no more than a subsistence level of wages.
As for capitalists, Ricardo saw them as
eternally seeking profits but engaged all the while in fierce competition with
other capitalists. This situation naturally reduced profits. Worse, the
capitalist was further squeezed by the landlord because profits depended
largely on the amount of wages which had to be paid, and the high price of
grain always resulted in high food prices, which led to higher wages. While
Ricardo considered the roles of the worker and the capitalist in the market
system to be legitimate, he saw the landlord as a villain.
Ricardo explained rent — the landlord's
income — as a very special kind of return which originated from the differences
in cost between productive land and less-productive land. In other words, the
yield was so much greater from productive land that its cost of production was
much less than that of less-productive land. This difference in costs was
represented in rent, for the selling price of the product — artificially high
due to great demand and lack of competition from imported grains — was the same
for both yields.
Rent in the nineteenth century was not
controlled or restricted by free competition because land did not change hands.
Thus, Ricardo viewed land as a monopoly. As the economy progressed and the
population increased, more farming was needed to meet the increased demand for
grain necessary to feed that population. This situation pushed the selling
price of grain up and increased the income of the landlord. Thus the
capitalist, who paid increased wages to the workers to enable them to live,
also suffered. Therefore, concluded Ricardo, of the three parties in this
bitter struggle — worker, capitalist, and landlord — only the landlord
profited.
As to the future, it held little
promise as the worker was doomed to a subsistence wage because of his growing
family, and the capitalist had his profits gobbled up by the landlord.
Ironically, Ricardo was himself a landlord. However, this fact did not prevent
him from attacking what he saw as an evil, and he continually sought the
abolition of the Corn Laws. As a result, David Ricardo became the champion of
the rising capitalists.
Analysis
A little over twenty years after the
death of David Ricardo, the Corn Laws were abolished (1846), and the industrial
capitalists eventually broke the power of landlords and replaced them.
Consequently, the dismal future which Ricardo had envisioned did not come to
pass. One of Ricardo's main contributions to economic theory was his concept
that rent rises from differences in the quality of land. This situation was a
direct refutation of the physiocrats' concept that rent rose from the bounty of
nature.
Of greater importance, however, was
Ricardo's theory of wages. While not called as such in the text, this theory
has been labeled the Iron Law of Wages — which states that wages must remain at
the subsistence level. This level, according to Ricardo, is labor's natural
price — the income which is necessary for the worker to exist. By applying the
doctrine of laissez faire, Ricardo argued that wages should be left to free
competition and should never be controlled by government interference.
Capitalists agreed with his theory.
Thomas R. Malthus (1766-1834)
Summary
Oddly enough, since his income was
modest and he owned no land, Thomas Malthus defended the landlord and attacked
Ricardo's views. Instead of viewing landlords as villains, Malthus praised them
as ingenious capitalists. Still, Malthus was pessimistic over the future of
capitalism, but for a different reason. He warned of general gluts, when the
process of saving might lead to a lessened demand for goods and thereby to an
excessive quantity of products without enough buyers. Although Ricardo refuted
this logic, Malthus did demonstrate his foresight in predicting depressions.
While motivated by compassion for the poor, Malthus earned criticism by
opposing relief and housing projects, objecting to these measures on the
grounds that charity is really cruelty in disguise. He reasoned that by keeping
the poor alive, they would continue to propagate, producing more poor.
It was not his articles on economics
nor his Principles of Political Economy (the same title as Ricardo's book)
which made Malthus famous. Rather, it was his anonymously published Essay on
the Principles of Population as It Affects the Future Improvement of Society
(1798), whose reception was so great that Malthus expanded the original edition
from a 50,000-word pamphlet to a 600-page book. The effect changed Adam Smith's
optimism to an outlook so bleak that Thomas Carlyle named economics "the
dismal science." Critics heaped scorn and derision on "Parson"
Malthus. Yet approval came from an unexpected quarter, for David Ricardo
substantiated Malthus' claims about the perils of rising population.
The inspiration for Malthus'
masterpiece came from his reading of Political Justice, an incorrigible piece
of optimism by William Godwin. Godwin's vision of the future was a utopia
containing neither war nor crime nor disease nor government — nothing but
complete happiness. Malthus expressed his dissension through his Essay on
Population.
Malthus' thesis — known as the
Malthusian Doctrine — states that population grows at a rate greater than the
means to feed it, and, if unchecked, the world's population will double every
twenty-five years.
Being the first economic statistician,
Malthus based this estimate on the population growth of the United States,
where a real census appeared before it did in England and revealed that the
U.S. population had doubled in twenty-five years. So, explained Malthus,
population will continue to increase geometrically, doubling itself from 1 to 2
to 4 to 8 to 16 to 32 times its original size until it reaches cataclysmic
proportions.
Meantime, the land, which cannot keep
pace with subsistence, is put into cultivation in units of one additional
section at a time. In other words, the means of subsistence can only increase
arithmetically from 1 to 2 to 3 to 4 to 5 to 6 and so forth. Clearly, Malthus
concluded, the result will be too many people with not enough food — that is,
if population growth continues unchecked.
How can population be checked?
1.First, by positive checks — war,
disease, infanticide, poverty, and famine. However, it's obvious that these
age-old inhibitors cannot halt the disastrous population spiral.
2.Second, there are the preventive
checks of sexual abstinence and vice — that is, prostitution and homosexuality.
What Malthus advocated as the only possible solution is abstinence or
"moral restraint." He called for late marriages because fertility
lessens in the later years and passions cool. Even though he was acquainted
with birth control, he disapproved of it on moral grounds. Being a minister,
Malthus could hardly advocate vice, so he stressed the advantages of restraint.
However, the Reverend, a realistic observer of human conduct, doubted the
ability of people to practice restraint. Consequently, he predicted that the
future of humankind will be starvation.
Are Malthus' facts correct? Yes, if
measured by the actual rate of population growth in much of the world,
particularly in India and China. Why, then, has his prediction not come to
pass? Basically, because of the widespread use of modern birth control methods,
especially in the Western world, and the tremendous increase in agricultural
technology, which provides more than enough food in advanced countries.
Analysis
While the majority of economists and
scientists consider the Malthusian Doctrine invalid, an increasing number of
demographers (scientists who study population statistics) warn that it is very
real indeed. Less than 20 percent of the world's people depend on preventive
checks. These people live in advanced areas of the world, especially Europe and
the United States. The countries where population explosions occur are less
technologically advanced areas in the Third World, notably India, China, and
Latin America. Ironically, the increased use of modern sanitation, hygiene, and
preventive medicine has increased the problem of overpopulation by reducing
high death rates, which once served as a positive check.
Malthus was not as incorrect in his
analysis as modern economists would have us believe, but the Malthusian
Doctrine is still a specter that haunts the minds of an increasing number of
modern theorists. In any case, the warnings of the chief spokesmen for the
school of Classical Economists swayed the minds of the nineteenth century, and
the wonderful world of Adam Smith became the gloomy world of Thomas Malthus and
David Ricardo, paving the way for the Utopian Socialists.
Glossary
Iron Law of Wages Labor's wages must
remain at the subsistence level, or natural price, because of the worker's
tendency to produce more children. (David Ricardo)
Malthusian Doctrine Thomas Malthus'
thesis that population, unless checked, grows at a greater rate than the means
of subsistence and will result in starvation.
Neo-Malthusianism A name originally
denoting birth control.
"Gloomy" describes not only
the future described by Malthus and Ricardo, but also the actual world of
England in the 1820s. On the Continent, the nation had triumphed in the long
struggle against Napoleon, but at home it wallowed in social evils brought on
by the factory system. By current standards, working conditions were terrible.
Children of ten years and younger labored in such industrial centers as
Manchester and Birmingham in poorly ventilated buildings that lacked basic
sanitary and safety measures. It was not unusual for children to be whipped —
not only for a slight mistake, but to stimulate efficiency.
Food, shelter, and treatment for
workers presented additional problems. In some places, children were tortured
and sexually abused and had to scramble with the pigs for food. A sixteen-hour
working day was common — from six in the morning to ten at night. Many children
spent their few hours of sleep on factory cots to save the long trudge home.
Machinery saved labor, but wreaked
havoc on workers. New machines were not covered or fenced off, and mangling
accidents were common. With no workmen's compensation or health insurance, an
injured employee was likely to be thrown into the streets. Mobs known as
"Luddites" rallied to wreck and burn mills as a means of expressing
their hatred of factories. The populace, alarmed by these disturbances, feared
an insurrection of the poor against the rich.
In the midst of this miasma appeared an
unusual capitalist — Robert Owen.
Robert Owen (1771-1858)
Summary
The early life of Robert Owen resembles
a Horatio Alger story. Born into a poor Welsh family, Owen's schooling ended at
age nine when he was apprenticed to a linen merchant. Nine years later, he
moved to Manchester, borrowed $100, and began manufacturing machinery for the
textile industry. Bold for a small capitalist, he became factory manager of a
large spinning mill, even though he knew nothing about the trade. By age
twenty, Owen advanced to part owner, becoming the boy wonder of the textile
industry. A few years later, with borrowed funds, he bought a group of textile
mills at New Lanark, Scotland, married the former owner's daughter, and made a
fortune.
Within five years, Robert Owen
revolutionized mill operation by eliminating the typical evils of the British
factory system and transforming New Lanark into a model workers' community,
which was visited by writers, reformers, and skeptics — even the Tsar of
Russia. By raising wages, reducing hours of work, improving factory sanitation,
rebuilding workers' homes, and providing schools for employees' children, he
reversed the standard concept of labor relations. Having improved conditions
through benevolence, Owen gained productivity and efficiency. With New Lanark
as a laboratory to test his hypothesis, he proved that a capitalist's concern
for workers is profitable.
What was his philosophy? Owen believed
that humanity is no better than its environment. Since people are shaped by
environment, improvement of that environment can produce a paradise on earth.
Owen shocked business and government leaders by stating that the development of
machine production, if organized entirely for profit, would inevitably lead to
poverty and degradation for workers. His solution was cooperation. Envisioning
Villages of Cooperation — planned communities where 800-1200 persons worked
together and lived in private apartments — Owen insisted that kitchens, reading
rooms, and sitting rooms be used in common. Young children would be boarded;
older children would tend the gardens. The community would carry on a variety
of occupations insuring self-sufficiency. At a distance from the commune would
be the factory unit.
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