A historical journey through the schools of economic thought, starting with the thinkers of Ancient Greece and reaching the end of the 19th century.
The contributions of the Greeks and scholastics
To begin with, we must understand the environment in which these ideas were developed, it was very different from today, societies were characterized by being mainly agricultural, where product exchanges were presented but on a very low scale since family production was for self-consumption, this period covers from 800 BC to the year 1,500 AD, during these 2,300 years the advances were few and it was characterized by non-systematic studies of the economy.
The economy of that time was not subject to mercantile dependence for production or consumption, since the characteristic of the self-sufficiency of families made markets inconsequential; on the other hand, authority was the main guideline for the allocation of resources. resources, and indeed early thinkers lacked a clear vision of the meaning of scarcity. Thus began the first steps toward the analysis of the economy.
The first thinkers focused on the distribution mechanisms of that time and their reflection on the quality and fairness of people’s lives. We can recognize two themes that occupied the pioneers the longest:
- These thinkers were concerned about the correct level of research for the appropriate analysis of society, that is, they did not agree with the separation of the study topics concerning the activities that were developed, or it could be that they did not even understand the possibility. of the separation of said topics such as the economy in the case at hand was part of philosophy itself.
- The emphasis of the lectures was directed to the deepest philosophical issues, such as fairness, justice, and equity, all with a critical look at prices and exchange activities.
The Greeks were the first to try to discover the intimacies of the functioning of the economy, represented by philosophers such as Hesiod, Xenophon, Plato, and Aristotle, it was thanks to the first that this great career began since Hesiod found it very obvious that the scarcity did not correspond to the interaction of people’s desires and the existence of resources, but rather he assumed that this was a curse unleashed on humanity thanks to the irresponsible opening of Pandora’s chest. This gives us an understanding of how little awareness these writers had of the market, how many other Greek philosophers were of peasant origin and lifestyle, and therefore was interested in problems of efficiency, understood as the performance that can be achieved from the inputs so that the greatest amount of output will result. And since they were self-consumption family companies, they were not interested in aggregates such as the efficiency of the company.
Xenophon, for his part, takes up the very concept of economy in his book Oeconomicus, which deals with the efficient administration at the level of the producer and/or the family, but applies it to more complex stages such as the military and public administration, likewise, he comes to accept that efficiency improves with the degree of division of labor that exists in the activity.
Before Aristotle made his appearance, thinkers such as Democritus and Plato had spoken about private property and its importance in society. The first praised the advantages of this since it tended to development and facilitated progress, for his part Plato considered that within his ideal society, the military and philosophers should be excluded from private possession since this entailed problems that distracted their attention from main occupations; instead, he envisioned the communal property as the solution for these groups.
Finally, we come to the Aristotelian thought, he advocated the non-limitation of private property which could be misinterpreted as a clash of inconsistency with his doctrine that the pursuit of economic gain was unnatural. To better understand the arguments we must return to the moral discussion of the use of money in exchange instead of direct barter between producers; This discourse started from the differentiation between the need and the desire of the agents; that is to say, it was understood that the needs were moderate, not the unlimited desires in such a way that the natural thing was to produce goods to cover needs but not desires. However, this interesting proposal ran into a difficult obstacle, in the market it is not easy to distinguish the interests at the time of the exchange or transaction. To elucidate the conflict Aristotle arrived at a solution. The barter reflected the coverage of needs without incurring economic gain, but if it was done with money then it could be understood that its objective was pecuniary gain.
On the other hand, he considered that scarcity was a problem that could be solved if the utopia of reducing consumption was reached thanks to the change in human attitude.
Around the year 1300 thought had taken some steps forward with the important contributions of the so-called Scholastics who, led by Saint Thomas Aquinas, had assimilated the feudal foundation in their writings. This period covers the fall of Rome to the appearance of the Mercantilist school around the year 1600.
The feudal economy was characterized mainly by its subsistence agricultural features where tradition, customs, and authority were the rectors of social and economic activities there was a fourfold division of groups: deer, landlords, royalty, and the clergy.
In this order of ideas, the ownership of the land was given to the church and the king, so he assigned it to the lords who owed an obligation to the crown for its use; Clearly, the contractual relationship was not as we would present it today, but goods, services, and obligations were inherited from father to son by tradition.
Likewise, the relationship between serfs and the feudal lord was characterized by an exchange where the lord allowed the serf the use of the land in exchange for a tribute (in kind or metal) and it was assumed that the serf would be under the protection of the noble.
This made each fief behave as an independent economic and political unit except for its devotional relationship to the crown.
For its part, the church was the largest landowner and, thanks to the training of the clergy, this was the best-managed land. The divine right to property fell on the king, which automatically generated a clash between authority and the rights of servants and nobles. It is here where the church and its doctrine play a vital role in maintaining balance since it was evangelized teaching that revealing itself against that authority endangered the salvation of the soul and that entry into the kingdom of God was given only to those who conformed. Logically, this alienation caused the assets, capital, and labor to not be considered in the market. But there was to come the end of feudalism at the hands of technical progress which reduced the need for labor and human strength.
The Scholastics were monks who dedicated themselves to writing regulations for economic behavior that was consistent with religious doctrines. As we already mentioned, the main scholastic was Santo Tomas de Aquino who, like the others, focused his efforts on the discussion of private property and the discussion of concepts of fair price and usury; Here the great influence of Aristotelian thought must be mentioned, but more than anything it is interesting to see how a race to reconcile the doctrines of religion with the increasingly accelerated advances and socioeconomic transformations of the time begins.
Aquinas finds himself with the great task of adjusting the biblical texts to the teaching of Aristotle since these condemn private property, wealth, and, of course, economic gain since the communal property was the lifestyle of Jesus and his apostles, which supported the idea of natural law; It was then when Santo Tomas argued that private property is not contrary to natural law, combining under the assumptions that all property is of a communal nature and well faced the dilemma saying that private property was an addition like clothing to the naked and that therefore he leaned towards the good of man.
He disapproved of the regulation of property by the state and accepted that there could be an unequal division of the distribution but on the other hand, he advocated the deep religious commitment of the church, which required a lot of dedication, for which the ideal for the clergy it was to follow Plato’s ideas regarding communal property.
Regarding the price of goods, ethical aspects such as justice and equity were the axes of the discussion more than the monetary aspects that we are evaluating today.
Like Aristotle, Santo Tomas assumed the difference between need and desire as a starting point. However, he tried to soften the concepts that were held about money, since he said that when the exchange is carried out in the market to satisfy needs, this was not a reason to involve ethical elements. But when it was produced expressly for the market in anticipation of profit, it was only virtuous if the motives for it were charitable and the prices at which it was made were fair. However, the fair price according to him was characterized by being the one that covered the costs of the work but it can also be interpreted as the equivalent in terms of utility or terms of the total cost of production.
This conception is closely linked to the defense of the existing social status since the interests of the feudal hierarchy could not accept that through the market there was a rise of the serfs, that is, that this evaluation of the fair price maintained the set of economic forces. and social as they were, since it did not allow the accumulation of capital resulting from profit thanks to economic activity, however, this vision cannot be considered a theory of prices.
This position of the Scholastics brought with it numerous clashes between the church and the merchants, especially when the issue was usury, as a consequence of the Scholastic consideration that any interest as a utilitarian charge was detrimental, just as Aristotle would have raised it by assuming that the Profit per loan was not natural because according to him, money is in itself unproductive (sterile), of course, after some time and varied interests, the concept softened at least for the margins that indicated purely commercial purposes.
We can assert that the moralism of Santo Tomas could at some point hinder the pace of growth and of economic thought itself, however, he displayed an interesting quality for abstractly presenting the issues.
In the period from 1500 to 1780, there is a clear positive trend in economic activity, and social changes are also reflected in the markets; it passes from the fiefdom to the nation-state.
Mercantilism (1500 – 1750)
It arose in England and France, where the authors were merchants who wrote about their interests and their relationship with economic policy. It is the time in which each man was his economist, and that gave rise to a great difference in the topics exposed by each one; that is to say, that the universality in the criteria and topics was very limited. However, wealth and power were the goals common to all of them, and therefore they wrote about the most opportune economic policy to achieve them.
The assumptions that were handled were very rudimentary; they assumed the wealth in the world was fixed, which was the same as saying that in the economic relationship, a gain was not possible without incurring a loss on the part of the other actor (this concept comes from the Scholastic School). At the national level, foreign trade is the key to power and wealth, through an always positive trade balance. On the other hand, the mercantilist line assumes that the purpose of economic activity is production and that the nation’s wealth is different from the sum of individual wealth. They said that increasing production would increase the level of exports, but maintain a low level of domestic consumption, so they advocated low wages as a competitive advantage. To reinforce this last idea,
Entering more into the mercantilist theme par excellence, the trade balance, they were very precise when pointing out that exports had to be encouraged and imports discouraged, for which state intervention was necessary, both in import substitution and in the stimulation of production, the creation of tariffs for foreign manufactures and the importation of raw materials at a good price.
To measure wealth, they used the amount of precious metals, so their accumulation became the objective and, since a favorable balance injected metals into the nation, it was necessary to support it.
The point of discussion at the time was whether the trade balance had to be favorable with all nations or there could be exceptions, for which it was said that if the type of imports were inputs there was no problem; in fact, the export of gold was a rejected action unless it was to import raw materials for export products.
As for money, they were not very deep in their analysis of what has to do with its consequences in an economy. The flow of metal from America to Europe reduced special phenomena that were better addressed by the so-called Late Mercantilists, who noted the relationship with the price level, the quantity of money, and the velocity of circulation, such as Jean Bodin and Locke, respectively. Hume evaluated the Trade Balance, the quantity of money, and the general level of prices within his study called “Flow species – price”, which points out the impossibility of maintaining a positive trade balance for a long time, since increasing the quantity of money and silver (species) prices rise with a mirror reaction; In this way, exports decrease and imports increase as a result of the lower price abroad until finally, a self-correction occurs. Due to these facts, it is considered that in the period between 1660 and 1776, literary advances are very important within the chair for a better understanding of the effect of money on prices and the economy.
An important point of mercantile thought is that they consider monetary factors as the determinants of growth and economic activity, beyond real factors and, therefore, they considered that a monetary supply brought changes in the level of product.
The main motivation of the mercantilists may be their desire to find high levels of income, given their reality as merchants who take advantage of the government and its decisions to increase their capital, but, more than that, their contribution to economic analysis lies in their ability to do it separately from the social sciences and philosophy, in the style of the physical sciences, adopting the cause-effect framework; however, the transition is not complete and moralistic traits are still found in their analyses.
For them, by knowing the laws of causality, they would control the economy, but intervention should not complicate basic economic truths, such as setting prices, which can create imbalances that lead to shortages and imbalances in demand.
The man was equal to the homo economicus and they established that his purpose was to seek his profit, therefore, they assumed it with selfish traits.
Late mercantilists saw errors in the assumptions of their predecessors such as the following:
- Currency is not the measure of wealth
- Not all countries can have a positive trade balance
- No country can sustain a favorable trade balance in the long run
- Trade can be mutually beneficial for nations
- The advantages for countries with specialization and greater specialization of work are greater
- State intervention must be reduced (according to levels raised by the mercantilists).
Unfortunately, the Mercantilist School was not able to show the total functioning of the market economy (price formation, allocation of scarce resources, etc.).
Another mercantilist hypothesis was that of the conflict between private interest and the public good, in which the state had to intervene as a channel. This belief is broken with the arrival of classicism.
mercantilism. The assumptions that were handled were very rudimentary; they assumed the wealth in the world was fixed, which was the same as saying that in the economic relationship, a gain was not possible without incurring a loss on the part of the other actor (this concept comes from the Scholastic School). At the national level, foreign trade is the key to power and wealth, through an always positive trade balance.
The Physiocratic School arises in France and develops exclusively there. These thinkers realized the relationships between sectors of the economy and, on the other hand, studied the functioning of markets that were not regulated by the state. Another of its characteristics is the short time during which physiocratic thought develops: approximately 30 years (from 1750 to 1780).
Headed by François Quesnay, the physiocrats believed in a natural law that governed economic functioning, independent of the will of the human being. However, that order could be studied and used by man, for his benefit.
They raised the importance of building theoretical models by separating or isolating an economic variable that is valuable for analysis and study.
Like the mercantilists, the interest of the physiocrats was largely focused on defining a macroeconomic development strategy that included coherent policies; However, physiocracy arises as an intellectual reaction to the common interventionist conception of mercantile thought, and to further deepen the differences, they studied the real forces that lead to development, that is, they studied the creation of physical value and concluded that the origin of wealth was agriculture (ultimately, nature itself was the source of wealth).
For this, they established that production should be greater than what was needed to pay the factors (real costs) to society; that is, a surplus value was generated which was called the Net Product, which can also be defined as the result of the productivity of nature. Following this approach, they claimed that factors could only create enough to pay production costs, but that the land was different because it was the land that produced a surplus.
The physiocrats assumed that given their observation of the markets, manufacturing was a sterile activity since great progress was not seen in this sector. This was due to the size of the industry at that time, which constitutes a flaw in his analysis, which also derives from the greater interest in physical productivity and not in value productivity.
Returning to land, rent was the measure of the net product of society, since it was the price for the use of that wealth-creating resource.
The most important analytical contribution of this school was introduced by Quesnay in his “Tableau Économique”, where three sectors are shown: Farmers, Landowners, and Craftsmen/servants, in a quite intelligent intellectual creation. Thus, it was about scrutinizing the issue of the flow of monetary income between the sectors of an economy, showing the creation and periodic circulation of the so-called Net Product through the system.
On the other hand, they assume that individuals seek to maximize profit and that prices are built in the market, the result of the same economic activity (which led to the conception that free competition generates better prices).
Regarding its policies, the tax issue was easy to resolve, since the tax burden should fall on the land.
Another important element is that there was awareness of the role of prices in integration, that is, that personal efforts were somehow connected thanks to the price system of the economy). This also obeyed a superior natural order that made the economic system conceived as a self-regulating mechanism. From here arises the central idea of Laissez-Faire(leaving things to their free will) as a function of the government, since the obstacles to growth were the result of (mercantilist) regulations on international trade and the internal market. The physiocratic observation takes on a more practical character when we remember his assumptions about the export of grain, which, by not being able to go to the foreign market, was kept at a low price, which weakened the momentum of agricultural growth. According to them, laissez-faire would bring large-scale agricultural growth.
To summarize, both the mercantilist and the physiocratic schools were interested in growth policy, but for the former, it was exchanged in international trade, while for the others it was laissez-faire and its effect on agriculture, the only actor capable of creating the net product
Physiocracy. Headed by François Quesnay, the physiocrats believed in a natural law that governed economic operation, independent of the will of the human being. However, that order could be studied and used by man, for his benefit.
It is time to get to know the so-called Classical Economy, which emerged in the second half of the 18th century along with industrialization, especially in Great Britain. By then, the physiocrat theses were no longer considered adequate to assume a deep and conscious analysis given the new realities of capitalist society; Liberalism then emerges as a new doctrine that responds to the demanding expectations resulting from the profound socioeconomic transformation. At the head of this new line is the Scotsman Adam Smith, who is considered the forger and architect of liberal economic theory.
Adam Smith (1723-1790)
Let’s start by indicating that Smith was not exclusively an economist but rather an academic, which made his observations superior to those of the previous speakers since they were mostly businessmen.
As a professor in Glasgow, he taught the courses that we would now know as Social Sciences and Humanities, taking an interest in the moral philosophy that greatly influenced his work. His contribution is framed in his great ability to point out the different socioeconomic connections and interrelationships and in his intelligent synthesis of previous writings and contributions.
He was influenced by Francis Hutcheson and David Hume, which is why he reached conclusions opposite to those of Bernard Mandeville regarding state intervention in the economy, even though his starting point was the same, the selfish nature of the human being.
His main work is An Inquiry Into The Nature And Causes Of The The Wealth Of Nations (1776) which is enriched with political, sociological, and historical material; however, it follows mercantilist lines in terms of the scope of economics as a discipline. His main interest was in economic development and stimulus policies.
Smith’s defense of Laissez Faire rests on a conceptual basis that does not obey solely and exclusively an abstract methodology but rather includes the observation of the environment and the empirical results obtained from it, in addition, it is necessary to situate their opinions and appreciations within the momentum. that was lived in England around 1750 in other words, Smith defended the Laissez Faire not because he thought that the markets were perfect nor because the non-intervention of the markets would bring an optimal performance of the allocations, but because the experience linked to his theoretical concepts they had shown him that the outcome of the market was often superior to the outcome of government intervention.
Smith’s reasoning for Laissez Faire as an economic policy is based on the assumption that human beings are selfish and that they seek to maximize their interest to promote social welfare. But how is this process? In his work, Smith argues that since it is not altruistic moral motives that drive the capitalist but the desire to make profits, he produces the items that people want, which will lead to competition among capitalists but with a production cost that covers factors; If there are levels of profit higher than normal, a greater number of producers will be mobilized towards the segment, which will reduce the price. On the other hand, the consumer will give his approval through signs in the market that reflect his wishes;
Smith distinguishes between market or short-term prices and natural or long-term prices. In his analysis of competitive markets, he makes the following assumptions: a large number of sellers and a large number of owners who are aware of market information, as well as free movement between industries and in the sector where the market price is higher at the natural price and the yields are higher and there would be a mobilization of resources towards it until the natural price prevails and consumers get what they want at the lowest possible cost with the maximum rate of growth.
Now, let us observe that the defense of Laissez Faire presupposes the existence of perfect markets and hence Smith’s attack on monopolies; this means that the intervention is not negative per se. The invisible hand intervenes to unite public and private interests only within competitive frameworks that direct selfish interests toward the social good.
Regarding capital, he pointed out that the wealth that nations have depends on its accumulation since this is how the level of division of labor and the proportion of the population that is needed in productive work is determined. Likewise, then the accumulation of capital leads to economic development; On the other hand, he pointed out that the optimal allocation of capital between industries is the result of the selfish interest of the individual together with the level of accumulation, but then where is that capital generated from?
In a privately owned economy, the source of capital is in the savings of the actors, but they are not all accumulators of capital, so according to Smith, the worker could not accumulate capital since the salary only covers consumption needs, on the other hand, I observe that the landowners did not meet the requirements either, since even when they had a high level of capital, it was spent unproductively on tastes and luxuries; I conclude then that the members of the industrial class were those who struggled to obtain profits and that through savings and investment, they accumulated capital; In this way, he pointed out that the distribution of income needed to favor the capitalists since without that there would be no economic growth because otherwise, all the product would supposedly go into consumption.
Regarding the meaning of wealth for Smith, this was a flow of goods and services measured annually and in principle, the work is indicated as the source of wealth of a nation; Another important point is that the purpose of economic activity was consumption, unlike the mercantilist thesis in which production was pointed out as the end of economic activity, which openly breaks with the previous economic theses, and also points out that the measurement It should not be done in absolute terms of how much the country’s total income was, but a per capita measurement is necessary; Likewise, he maintained that labor productivity and the amount of productively employed labor were the pillars on which the income of a nation depended.
Labor productivity depends on the degree of specialization and division of labor and this in turn depends on what Smith called the Extension of the Market and again on the Accumulation of Capital in turn the Extension of the Market also depends on a great extent on the accumulation of capital that exists in the nation. About work, I try to distinguish between productive and unproductive work, the first being the one that is used for the production of a good that can be carried out, while the second is the one that is dedicated to services.
It is the accumulation of capital that determines the wealth of nations despite his first observation that it would be work
The exposition of the Theory of Value Smith is quite confusing and has given rise to the fact that historians of political economy have interpreted his vision in different ways, which in turn has led to various discussions. However, we can somehow distinguish between various nuances that can help clarify what Smith thought.
In the first place, we must distinguish between the two types of economy in which I try to apply his ideas; namely a primitive and an advanced economic society; In the first, the application of the Labor Cost Theory was more direct, which says that the price depends on the necessary time that is invested in the work to produce a good and the Theory of Labor That a Good Can Have; that is to say that the price depends on the amount of work that good can demand; in both cases, for this primitive type of economy the relative prices turn out to be the same for the advanced economy where land and capital are scarce the Theory of Production Costs applies where the price is the sum of labor, land and costs capital.
As for his Theory of Distribution, it was not very extensive; However, it became clear that the prices and the quantities of the factors that the family or individuals put on the market determine the distribution, but for the majority of families, work turns out to be the only factor that they possess and the price of this is the salary that multiplied by the time worked will set the income; On the other hand, these families may have properties and savings, so the income and capital available are added to the salary to determine the income.
The salary and his determination earned Smith several theories that even when contradictory did not seem to bother the author. He raised subsistence as a theory of wages as well as productivity, he accepted the possibility of negotiation and made that of the residual claimant appear, and finally, the doctrine of wage funds, which is particularly the most transcendental for the classics; This last part of the assumption that there is a fixed fund of resources destined to the payment of wages in an economy, that is, wage rate = wage fund/labor force, and suggested that an increase in the wage rate would cause an increase in the population and of the supply of labor with which wages would fall to their previous level.
On the other hand, Smith accepted that the profits were the fair payment to the capitalist for his social function, which was to satisfy the needs and provide materials and machinery for production, thus he also considered that the profit was not only made up of interest returns but also that contained a return for the risk that was run.
Regarding income, as with the previous factors, it was contradictory but could propose at least four theories of origin a) monopolies, b) endowment of nature, c) rights of landowners, and d) differential advantages, concluding that prices are what determine rent.
The capitalists’ rate of profit was a concern that Smith raised in his writings when he considered that it would decrease over time for three reasons, firstly, he considered that an increase in accumulation would bring higher wages, which would decrease the rate of profit He also believed that there could be an increase in output and competition, but this conflicts with his assumption of over productivity. Third, he was a bit naive in considering a limited range of investment possibilities.
For Smith, well-being was a factor that should be measurable over time, however, his analysis was confusing since it simultaneously took the factors that determine the general level of prices; however, when taken separately, it can show its qualities.
Smith starts from a company with only one good, which facilitates the analysis, but when there are two or more goods that intervene in the market, everything is complicated since a point of reference must be found; After several attempts, Smith concluded that the best measure of well-being is the leisure of the workers or, more technically speaking, the disutility of work since if we can produce the same amount of goods with less work, we will have a better situation, however. Smith did not take into account the social costs or the quality of life and in parallel affirmed that abundance in any case is better than scarcity, that is, he was not aware of the sacrifices that could mean for nature and the environment.
Theory of Value. We must distinguish between the two types of economics to which I try to apply his ideas; namely a primitive and an advanced economic society.
David Ricardo (1772 – 1823)
Now we will deal with the Englishman of Jewish origin David Ricardo who is the most illustrious member of the classical school after Smith. This classical thinker was first a successful stockbroker who later became an economist. His capital work is Principles of Political Economy and Taxation (1817)
This classical thinker was first a successful stockbroker who later became an economist. His capital work is On the Principles of Political Economy and Taxation (1817), which soon replaced Smith’s “wealth of nations” as the fundamental text on economic issues, and his contributions to economic theory are in methodology, theory of value. and the clear income theory that international trade and public finance were also addressed by him.
Ricardo was characterized by being a pure theoretician who separated his theoretical construction moving away from the events of his time. Despite his deductive and abstract method, Ricardo was highly oriented toward political practice he maintained that theory was an important prerequisite for a correct and efficient analysis of the real world and for making political decisions.
In his time, the economic problems of England were the rising prices of grains together with the phenomenon of high incomes, apart from the problems between agriculture and industry resulting from structural changes.
The style of the Ricardian method achieved non-contextual policy recommendations and this was the path that the Orthodox current took for its development.
However, David Ricardo affirmed that determining the laws that regulate the distribution of income among the actors of the economy (workers, capitalists, landowners) should be the purpose of the economy, that is, to indicate what participation labor, capital, and land in the national product. However, it was changed in the functional distribution of income over time that focused his attention, so he began by proposing a theory that could explain profit, interest, rent, and wages.
Let’s start by indicating the tools and assumptions on which he worked his theories:
- It assumes that changes in relative prices over time depend on the change in the cost of labor measured in hours.
- Within his model, money is neutral and does not influence relative prices.
- It assumes that the labor-capital ratio is invariable, that is, that there are fixed coefficients of production for labor and capital.
- Returns are assumed to be diminishing in agriculture and constant in manufacturing.
- Assumed full employment in the economy,
- there is perfect competition
- Fully defined actors with rational and calculating characteristics (landlords, workers, and capitalists)
- Ricardo handled in his argument the Malthusian thesis on the population that says that this tends to increase at a higher rate than the food supply.
- The doctrine of salary funds.
With his theory of rent, Ricardo tries to explain the changes in the amounts of the total product that will be delivered to the landlord and what portion of that product will remain in the hands of the capitalist in the long run. For this, he uses the concept of increasing returns which, together with the assumption of the scarcity of fertile land, are the causes of the existence of rent.
The concept of rent for Ricardo was that of a payment received by the landowner, which equalized the rates of profit for lands with different levels of fertility. In other words, if land A was the most fertile and land B was not so fertile, rent would be paid for the former which would make the productivity of the two kinds of land equal for the capitalist. This analysis can be done using the intensive margin that reflects the principle of increasing marginal returns, that is, that in the same type of land, the second unit of labor and invested capital would yield less than the first, or using the extensive margin, which reflects the passage from one quality of land to another of inferior quality.
Now, another way of expressing the economic fact of rent is by saying that the marginal costs of production increase as the land is cultivated more intensively, that is, that the marginal cost is the increase in the cost amount needed to produce a larger quantity of the final product.
Ricardo extends the analysis by saying that prices depend on the marginal cost of the last unit produced by the least efficient producer, finally, he concludes that prices are what set income and not prices.
Ricardo’s theory of value differed from most that tried to explain the forces that determine relative prices in a given period, instead concentrating on explaining the economic forces that cause changes in relative prices over time. On the other hand, although he tried, he could not find a good whose value was invariable in time through which to find the cause of the change in relative prices, that is, that the value depends according to him on the amount of work necessary to produce it. production and not the wages paid for work, which was Smith’s thesis. Apart from this, he observes that use value is essential for the existence of exchange value even though it does not express its measure.
An important observation within Ricardo’s theory of value is that scarce goods that cannot be freely reproduced in competitive markets were excluded, that is, paintings, coins, wines, etc. that are unusual, in any case, the theory Ricardo’s value in value of work cost had four major problems that it had to solve before establishing itself as such.
Distinguish a measure of the amount of work, for which he measured the amount of work through the amount of time involved in the production of a good, that is, only by the hours.
Taking into account the different skill levels of the work, that is to say, it falls into Smith’s circular error, however, since it is an analysis of changes over time, this obstacle is overcome; Furthermore, Ricardo was able to solve it by including in his analysis the assumption that if workers’ wages do not change in the long term, the relative price is not given by them.
If goods are produced with both work and capital, how does the latter influence the price of the final good? This problem was solved by considering capital as accumulated work.
The problem of income as an economic good. As already stated, income within the Ricardian analysis is determined by price and not the other way around.
The role of profit in price. According to Ricardo, profit is not transcendent in his theory of value since it does not intervene with his proposal that changes in relative prices over time are a function of changes in the relative amounts of work incorporated in final goods.
We now turn to Ricardo’s theory of distribution; for him, the product was divided into three parts: income, profit, and wages, which went to each of the actors: landowners, capitalists, and workers respectively, and since marginal productivity is decreasing then, to a greater number of work units and invested capital will lower the rate of profit since the portion for the landlord would increase and the worker has his fixed salary according to the assumptions of the subsistence wage, in such a way that the profit could reach zero. In the case of manufacturing, the evaluation is the same, with which, a point is reached where, without profit or accumulation, the entire system enters a gloomy stationary state.
On the issue of foreign trade, he spoke with his doctrine of comparative advantage, which says that if a country has an absolute advantage in the production of a good over another country and this, in turn, is in the same condition concerning the first with a good differently both can benefit if they specialize in the good that costs less to produce. The first country may have an absolute advantage in both goods; however, if the second country has an absolute advantage in its market for one good over another, specialization may be advantageous. Thus, it was proved that the determining element of the level of profits that a country receives thanks to international trade does not depend on the absolute advantage but on the comparative advantage.
Ricardo’s defense of Say’s Law undermined all the observations of critics of the system who saw flaws in the model. In any case, we cannot deny Ricardo’s brilliant presence within the panorama of political economy and his transcendence in economic thought.
John Stuart Mill (1806-1873)
We study John Stuart Mill, the last great representative of classical economic thought; who was characterized, like Smith, for having a fairly broad conception of the world. With this installment, we finish the review of the classical orthodox school since by then the weaknesses of the models that were proposed were too obvious.
His main work was entitled Principles of political economy with of their applications to social philosophy ( Principles of political economy with some of its applications to social philosophy ), this reflects his concerns in the vast world of philosophy and society; which made him a thinker who sought to somehow improve the situation of individuals in society. His work, published in 1848, assumed that the complete classical theories were correct and that there were no major problems to be solved.
Mill conceived of economics as a science that used an a priori method; that is to say that after indicating assumptions the conclusions are deduced. This method should prove its effectiveness, however, there is not always agreement in Mill’s words, which is why some disturbing causes are pointed out that could not be taken into account in his analysis. But far from considering these causes, they were used as an excuse to justify the divergences between the model and reality.
Regarding his contributions, he pointed out that his only and most important contribution was the differentiation between the laws of production and distribution; that is to say, regarding the first ones, he said that these are natural where human intervention cannot change said laws, about the laws of distribution Mill affirms that they are the product of social arrangements and in themselves, it is the institutions that build them. and do the distribution. On this point, he differed from the vast majority of classical thinkers who built a system that was used in politics to close the roads to the oppressed masses, since according to this there was no way to improve worker compensation despite the goodwill that was expressed. had.
An extremely important element in Mill’s thought is his clear tendency towards eclecticism, which in turn makes him difficult to classify but not to understand. As for the Laissez Faire Mill, it is located in an intermediate position that combines his conviction of the classical theory with his interest in social welfare; he knew that in the absence of government interventionism, maximum freedom was not necessarily given and that there were restrictions and injustices that only legislation could eliminate. Behind these statements, there is an acceptance that relations between societies are not entirely harmonious.
Private property for Mill is a right that should not be considered absolute, so society can bring its criteria when there is a conflict with the public good. The elements of the discussion of private property respond to Mill’s eclecticism. Regarding the economic policy model, Mill accepts some elements of the socialist chair but not all. Mill begins by stating that when observing the situation of the capitalist model, he preferred a socialist model of development, but then he retracts considering that compared to the socialist model he prefers the capitalist in its splendor.
Continuing with Ricardian economics, he accepted the fury of the stationary state but his philosophical amplitude led him to make that gloomy end a desirable state in his eyes as society became a kinder and less materialistic entity, preoccupied with the social and not economic welfare of the agents.
Let’s go back to the laws of distribution; Regarding this, Mill points out that apart from the competition, the customs reflected in the institutions that had prevailed throughout history were responsible for the distribution of income and not only the first, as classical economics generally assumes.
His theory of value presented it in terms of production costs in which monetary costs fundamentally represent the real costs of the disutilities of labor and the abstinence of capitalists’ consumption.
He did not look for the invariable measure like Ricardo but was concerned with the study of relative prices. For a good to have exchange value, it must be useful or difficult to obtain, and only in some very unusual cases does the use value determine the exchange value he considered this class of goods inconsequential since very few have a curve of perfect and inelastic supply.
Manufactured goods have a perfectly elastic curve and you concluded that the cost of production is what determines the price. Regarding agricultural products, he considered that the price depends on the production costs prevailing in the most unfavorable circumstances, what was clear to him is that the final equilibrium is achieved when the quantity demanded is equal to the quantity supplied but his terminology obscures the concepts of supply and demand.
International trade was also the subject of his study and his main consideration is how the profits obtained internationally are distributed among countries. It went beyond Ricardo who could only give an average solution. John Stuart Mill concluded that the terms of trade depend on the demand that exists in both countries for imported products, on the other hand, he introduced the concept of transportation costs and analyzed the influence of tax rates on trade.
He made a brilliant defense of Say’s Law and developed a psychological theory of business cycles.
To finish we must know the reactions of Mill on the salary fund, at first he accepted the conventional doctrine, but supported the formation of unions since he considered the disadvantages of the disorganized worker against employers when negotiating a salary. Then he retracted and affirmed that the number of funds destined for the payment of salaries was determined; by a fixed labor force and wage rate.
The workers would not be able to exhaust that given amount, so the wage rate is not fixed in stone and there are a large number of possible wages.
The professionalization of the economy, the increasingly clear contradiction between theory and practice, and literature of a humanistic nature were the foci from which the attacks on classical doctrine were elaborated, concluding with the “fall” of the hegemony of this school.
Theory of value. His theory of value was presented in terms of production costs, in which monetary costs fundamentally represent the real costs of the disutilities of labor and the abstinence of capitalists’ consumption.
Karl Marx (1818-1883)
We must consider one of the most important philosophers in the history of economic thought, Mr. Karl Marx, who influenced a large part of the global socio-economic order in the 20th century with his model.
To describe Marx, we must do justice to the fact that even though he is mainly related to the economics profession, he was much more than an economist, standing out as a sociologist, philosopher, and above all a revolutionary, the latter title, which makes us understand the because of his inclination to promote the changes in society that he considered necessary, instead of being satisfied with the interpretation and analysis of reality. For this, he proposed that a revolution of profound scope should be carried out on the bases of the established order instead of isolated demonstrations of nonconformity that in the end were not of great importance.
His main work was Das Kapital (Capital I, II, and III), but he is also well remembered for The Communist Manifesto (The Communist Manifesto) which he wrote together with Engels. In his work, it is obvious that the main interest is to clearly show the so-called laws of the dynamics of capitalism, that is to say, I propose a dynamic approach to the stage of changes within the capitalist economy.
The previous characteristics are already quite different from those that the classical representatives had manifested, but they are not the only ones; in fact, the essence of Marxist thought is an interesting combination of French utopian thought, elements of orthodox classical theory, and Hegel’s philosophy of dialectic.
To sum up; Marx followed the basic guidelines of the Hegelian philosophy of thesis, antithesis, and synthesis, to explain the development of history, which according to this current did not behave cyclically, but rather advanced in a straight line, with the difference that for Marx The changes occurred in matter and not in the world of ideas, since for him it was in matter where the seeds of discord were found in the process. This is why this method is known as Dialectical Materialism.
As already said, he considered that history was in a process of progress and therefore did not agree with the acceptance that capitalism was a social state with ideal characteristics and that this was the last stage of development. To argue this idea, he maintained that within capitalist society there were two facets into which it could be divided.
The Forces Of Production: These are represented in the techniques and knowledge that are applied to carry out the productive processes, which are dynamic.
Production Relations: These contain a static element since they are represented in the so-called rules of the game or rather, in social and property relations.
The Status Quo of society is reinforced by what he called the Superstructure, which are cultural and artistic forms, as well as other manifestations that are accepted by society but whose main task is to maintain Production Relations.
So we have already identified the thesis, the Relations of Production, which is opposed by the evolution of technology and knowledge represented in the Forces of Production, which is the antithesis. The incompatibility between institutions and technology manifests itself in a class struggle that will end in a social revolution and the establishment of a new order in which the forces and relations of production agree on what he calls the synthesis, which will generate a new thesis and antithesis as the forces begin to distance themselves from the relations of production.
On the other hand, following the utopian premises, he points to private property as alienating the human being and points out that it is because of the existence of markets that people are removed from the path of happiness, likewise, he pointed out that it would be the same men that in the end they would free themselves from the markets and put an end to the alienation that private property exercises over humanity. Somehow this explains Marx’s reluctance towards religion, which he accused of being “the opium of the people” since he considered it within the Superstructure, moreover, he pointed out that with the intervention of religion what was achieved was the delay in the changes, in fact, the religion according to him, distracted the attention of the faithful to the events that were the product of the expired Relations of Production.
In the study that Marx makes of history, he analyzes feudal society and its evolution towards capitalist society, but faithful to his criticisms, he points out that the latter contains the seeds of its own destruction and that it will be replaced by socialism is characterized by the expropriation of the means of production that will be transferred to the proletariat, but at this stage, it will still be necessary to encourage and reward people so that they work, just as in capitalism it will later evolve to communism where the classes have disappeared and the agents no longer they need monetary motivation to develop their activities; In other words, the point has been reached where the agents contribute according to their work capacity but in return, they consume according to their needs. Note that these statements presuppose an intrinsic goodness of the human being which is corrupted by the markets; When these disappear, man is left with goodness freed from him, likewise, he goes so far as to affirm that a moment will come in which differences of all kinds will be rejected or abandoned and each person will be considered a comrade.
Let’s go more fully to review Marx’s contributions to Economic Thought. Of course, we must not forget that his work is profoundly influenced by philosophy and sociology.
In his method, Marx considers that the whole determines the parts; that is, he began his study with the complete structures of society and the economy to later consider the development of the parts.
For him, capitalism was a system formed mainly by two social classes, the capitalists who owned the means of production and the proletarians who sold their labor power, hence the wage relationship between them was so important. In this way, one of the main characteristics of capitalism was that the workers were deprived of ownership of the means of production. To understand the mechanisms that generate income from the ownership of the means of production, he decided to evaluate the determinants of prices and the payment that labor receives for the generation of this value.
In a capitalist society, goods are produced for their exchange value. When these reach the market, two forms of relationships are traded: quantitative and qualitative. In the same way, the salary represents these two relations between the proletarian and the capitalist.
His theory of value was fundamentally based on Ricardo’s and even when he was able to make a clear statement, he could not be more than Ricardo and he ran into the same problems that Ricardo had. In this way, we can say that Marx raised a Theory of the Value of Labor Power, where the amount of labor time necessary to produce goods was what determined relative prices.
For Marx, the value of a commodity could be divided into three parts: the Constant Capital (raw materials, depreciation, etc.), the Variable Capital (wages and salaries), and the surplus value, which is the subtraction of the constant and variable capital expenditures of the gross profit of the capitalist.
Following the analysis, the disbursements in Constant capital offer the capitalist an equal profit, while the variable capital offers a higher level of remuneration concerning the disbursements. In this way, it presents work as the only generator of value.
For Marx, the capitalist buys the inputs at competitive prices and sells his products at competitive prices, but in any case, there is an extra value that is the surplus value, this is because the capitalist buys merchandise that through the production processes creates more value than it you are paying for it. In other words, if the worker can produce what is necessary to provide the real salary for work in the half-day, the capitalist will make him complete his day, thus generating surplus value, and since the capitalist is the owner of the means of production can put the worker in the situation of working full time or being fired.
The capitalist is always seeking to increase the rate of surplus value. In conclusion, the rate of profit varies directly with the rate of surplus value, which is the surplus value concerning payments to variable capital. On the other hand, there is an inverse relationship with the organic composition of capital, which is the degree of capital intensity used by the industry.
The capitalist is always seeking to increase the rate of surplus value. In conclusion, the rate of profit varies directly with the rate of surplus value, which is the surplus value concerning payments to variable capital. On the other hand, there is an inverse relationship with the organic composition of capital, which is the degree of capital intensity used by the industry.
Marx had certain premises that are considered laws for capitalism; an army of unemployed, a falling rate of profit, economic crisis, the concentration of industry, and misery of the proletarian class. If we remember well we find that Marx was an applicator of orthodox tools and his proposals are similar to the classical course but sometimes with completely contrary conclusions.
These proposals can be listed as follows:
- A labor cost theory explains relative prices, the setbacks of which are known as transformation problems.
- money neutrality
- Constant returns in manufacturing and decreasing returns in agriculture.
- perfectly competitive markets.
- Rationality and cold calculation of the economic man.
- A Modified Wage Fund Doctrine.
Hence his critical force of capitalism came to suggest that capitalists in pursuing profit sow the seeds of their destruction.
As for the reserve army, it is good to note that it plays the role of the rejected Malthusian theory of population in the Marxist model and consists of a surplus supply of labor in the market that controls wages and maintains a positive value of surplus value and earnings. This army is fed by technological unemployment, increases in the organic composition of companies’ capital, and the arrival of new members to the labor supply.
Regarding the decreasing rate of profits, let us remember that profit varies directly with surplus value and inversely with the organic composition of capital, so if the rate of surplus value remains the same, any increase in the organic composition will cause the rate to fall. of gain. Marx pointed out that competition between the labor and commodity markets leads to an increase in the composition which leads to a fall in profit rates.
Unfortunately, Marx did not delve further into cyclical studies of economic crises, but it is at least clear that he rejects Say’s Law which said that despite minor fluctuations the economy would tend to function at full employment. He argued that in a simple economy, people produce goods for the use value that consuming them directly grants them or that they obtain from other merchandise through barter, while a monetary economy produces merchandise that can be exchanged for money and money at its disposal. time for goods.
But in capitalism what it pursues are profits with which the market is reached with money to buy the factors and then the product is exchanged again for money and according to the surplus value obtained the success of the capitalist will be measured, that is to say, due to orientation towards exchange value and profit overproduction is a very likely possibility within the capitalist model.
Changes in the rate of profit will result in changes in investment spending, which according to him is the main cause of the fluctuations.
It also casts doubt on the system’s ability to reallocate resources uniformly and suggests that imbalances in submarkets could spread to the entire economy. This disproportionality would also bring a decline in economic activity.
In summary, Marx considers the capitalist economic system as unstable with periodic fluctuations that are due to internal contradictions.
Let us now turn to the concepts of concentration and centralization of capital.
Concentration is the process during which, in the course of the accumulation of surplus value, large capitals grow faster than small ones, so that the large capitalist has the advantage over the small one in production.
Centralization refers to the absorption of other capital, that is, through competition processes the strongest wins and takes over the small business. This shows us the interest in the economic problems of the economy that concerned Marx.
To finish, Marx pointed out as one of the greatest contradictions of capitalism the growing misery of the proletariat, however the arguments he put forward have been refuted by experiences such as:
That the real income of the masses of society decreases as a function of the development of capitalism.
That the participation of the proletariat in the national income declines in the long term.
However, this theory can be interpreted from the side of extra-economic aspects, however, what results here is that there is no clarity on the way these factors are measured.
In summary. Marx feared that the accumulation of capital, economies of scale, the growth of credit markets, and the dominance of the corporate form would lead to an economic monopoly of the resources and means of production.
The neoclassical Jevons, Mengler, and Walras
The emergence of the Neoclassical school has its origins in the 1870s when three professors separately published their works, in which they state that the value or price of a commodity depends on the marginal utility it provides when consumed.
These thinkers were:
- WS Jevons with his 1871 Theory of Political Economy.
- Carl Menger with his book Principles of Political Economy also from 1871.
- Leon Walras with his work Elements of Pure Political Economy from 1874.
In parallel, we can mention Alfred Marshall who published his ideas in “Principles of Economics” in 1890.
Despite everything, the acceptance of marginalist ideas was not accepted until after a long journey. The ideas of utility had already been presented before the previous authors; starting with Aristotle with its use value, then Bentham applied the concept in philosophy, and finally, others had already had the idea that by consuming increasing quantities of a good the marginal utility received from it was decreasing, but it was from the end of the 19th century that its application to economic issues was clearer and more forceful.
These three authors applied the marginal utility analysis to the theory of demand, conceiving the idea of marginal utility. All three agreed that the allocation of resources was the main issue in economics. This was a strong point of departure from the previous theory since the new ideas reflected a Microeconomic analysis, however, they differed in their methods. Jevons opted for empirical evidence, while Mengler was closer to abstract deductive logic, finally, Walras applied mathematics.
First, they discovered that the classical theory of value failed to explain commodity prices satisfactorily as there were exceptions that could not be adequately assumed.
They affirmed that the high production costs would not necessarily result in high final prices since the value depends on the consumption and the utility is generated in the future and not in the past, that is to say, that the price of a good when it reaches the market will depend on the utility that the buyer expects to receive for his consumption, that is to say, of the demand.
In this order of ideas, what was discussed was whether the factors created the value of the final goods, or if, on the contrary, it was the final goods that gave the value to the intermediate goods. For the Marginalists explained that the value of the factors was determined by the marginal utility of the final good that was manufactured with those factors but that these in turn did not confer any value to the final goods.
It was obvious that the error of the previous models was that the price does not depend on the total utility nor the average utility but on the marginal utility.
With this, it is much easier to explain paradoxes such as Smith’s water and diamonds.
The Neoclassicals did not discard all the classical material, for example, they adopted the idea of the rationality of agents so that families make their consumption decisions concerning the marginal utility they expect to receive.
Two questions arise: What is utility? How is utility measured? Paradoxically, these writers had not assumed them directly, in fact, none of them used the expression Marginal Utility. They limited themselves to taking their existence for granted and delegating to personal taste the decision to differentiate between the utilities of goods, implying that they considered utility as a non-measurable Psychological phenomenon, but that it was in consumer goods. However, for intermediate and exchange goods the concept of Acquired Utility was given.
After these concessions, they accepted the concept of Diminished Marginal Utility, which is nothing more than the idea that as a good is consumed its marginal utility decreases; however, this statement accepts that marginal utility can be measured. And contrary to their assertions, the three assumed in their examples the cardinal measurability of utility.
For their representations, Walras and Jevons used continuous utility functions, since with small variations in quantity and utility, equality in the consumption baskets continues, but not with discontinuous curves where it would be maximized but there would be no equality.
Mengler and Walras did not bother to explain whether interpersonal comparisons of utility could be made; For his part, Jevons claimed that this was impossible, however, he did it. But they did agree that a person could weigh the utility of two commodities.
Regarding the utility functions that these thinkers developed, we must say that they agreed despite the difference in the exposition methodology. According to them, the utility that a person received from the consumption of a good x depended solely on the amount of that good that has been consumed and not on the amounts of other goods y & z that have also been consumed, regardless of whether they are substitutes or complementary. That is why the total utility function is considered an additive function.
On the other hand, Jevons, Mengler, and Walras tried to point out the conditions under which the utility of individuals would be maximized together with a theory of exchange, and in the case of Jevons and Walras, they investigated the relationship between utility and demand.
Walras mathematically derived the equations that govern maximization while the other two, using more rudimentary techniques, exposed the concept according to which a consumer maximizes his utility if he spends his income in such a way that the last unit spent on good yields the same marginal utility. then if it had sufficed in any other good. This postulate is known as Gossen’s second law.
Remember that the utility of the individual is the cause of the demand, so there must be a relationship between the utility functions and the demand curves. Only Walras was able to solve this problem by showing that the engine that drives demand is marginal utility, but eventually, all three tried to find the relationships between marginal utility, utility maximization, and the exchange of goods. This time it was again Walras who took the first honors.
Let us not overlook the differences in the conception of price causality, since Jevons and Mangler maintained that the price of intermediate goods was given by the marginal utility of the final merchandise. The difference with Walras is that he assumed the analysis through a general equilibrium model, which gave him a great advantage in understanding causality that led him to understand that the relationships were much more complex.
Regarding the theory of value, they proposed that given an offer, demand determines the price, but they did not complement it with the opposite version, even though through their examples it can be understood that both supply and demand play a fundamental role. But Jevons later retracts that value depends entirely on utility and showed that with a fixed supply of two commodities and two agents, the prices and quantities exchanged depend on the marginal utilities that both commodities have for each one. of individuals. In the case of the variable offer, he elaborates on the following line of causality.
- Supply is determined by the cost of production.
- Supply in turn determines utility.
- This utility determines the value of the merchandise.
If this is the case, we can eliminate the second link, which would distort the analysis. Jevons and Mengler did not understand that cost, supply, demand, and price are interdependent and do not form a simple cause-and-effect chain as they proposed. This error is the same as the classics. Fortunately, Walrras and Marshall were able to better understand these assumptions.
All three developed the concept of marginal utility but Walras and Jevons applied the analysis to the theory of the firm, however, only Walras went further and formulated his general equilibrium analysis. But none reach factor markets nor did they develop the notion or applications of marginal productivity. This means that by having placed so much emphasis on the demand side, they made the same mistake as the classics with the supply side.
An important note is a great influence that Mengler exercised at the University of Vienna, with which his followers have been called the Austrian School, who continued the tradition of Mengler-style analysis. Unfortunately, his initiative to study knowledge as a development factor was not subsequently exploited.
The following methodological developments have mainly followed the lines of Jevons through econometric models and those of Walras who uses abstract reasoning through mathematics.
The thinkers. WS Jevons with his work Theory of Political Economy from 1871. Carl Menger with his book Principles of Economics also from 1871. Leon Walras with his work Elements of Pure Economics from 1974.
The application of marginal analysis
We will quickly explore the developments that complemented the application of marginal analysis to demand. We will see how this same methodological tool was applied to production and from there to other stages of economic knowledge. In the first place, we will talk about the so-called second generation of marginalists who contributed to the theory of production, costs, prices, the theory of income distribution, and the factors of production.
Extended marginal analysis
In the first place, we will talk about the so-called second generation of marginalists who contributed to the theory of production, costs, prices, the theory of income distribution, and the factors of production.
Frederich von Weiser and Eugen von Bohm-Bawerk, JB Clark, Knut Wicksell, PH Wicksted, and FY Edgeworth among others, were the ones who developed the concepts of the theory of distribution based on marginal productivity.
The principle of diminishing returns explains the shapes of firms’ short-run supply curves as well as firms’ demand curves for factors of production. If we hold a factor of production constant and add a variable factor to it, the resulting product will often first increase at an increasing rate, then decrease, and finally fall.
In traditional exercises, it is clear to see the relationship (concerning the amount of input) between the average product – which is the total product divided by the amount of work -, and the marginal product – which is defined as the variation in the total product concerning to the variation of the input- and the total product. The marginal product has its maximum when the total product curve shows its maximum inclination, the average product has its maximum when it intersects the marginal product, which is when the total product begins to show a downward slope, and finally, the total product reaches its maximum when the marginal product is zero.
The demand curve for the factors of production can be derived from marginal product curves, so if a firm faces a perfectly elastic demand curve for its output and a perfectly elastic supply curve for its input, the firm will purchase the variable input until the moment in which the last unit of input purchased contributes to the total performance of the company the same amount that represents its total cost.
Input price = (marginal product) (output price).
The left-hand side of the relationship is also known as the value of the marginal product, where the optimal quantity is when the price of the input is equal to the value of the marginal product. When dealing with several inputs, the optimality condition is when the last peso spent on the purchase of each input yields the same marginal fiscal product. The demand for an input is defined as the quantities that the company would hire at different prices. If we lowered the price of an input, the company would make greater use of it, until the last peso spent on said input would provide the same marginal physical product that the weight spent on other inputs.
By the above, there is a proposition that the payments to the factors of production will be equal to the total product, that is, by paying each factor its marginal product, the total product would be exhausted. Clarck and Wicksteed exposed this concern, however, they could not solve the exhaustion of the product, however, Leonhard Euler had previously given the mathematical parameters to be fulfilled by the production functions.
When factor payments have exhausted total output, the production function should show that a proportional increase in all inputs will increase total output in the same proportion. In other words, they are homogeneous of degree one or linearly homogeneous, hence the expression of constant returns to scale, which is how production or costs behave in response to proportional increases in all inputs, in this case, the increase is of the same proportion and the average costs do not change; Oppositely, if the proportional increases in the input are not matched by an increase in the output of the same magnitude, then we speak of diminishing returns to scale (homogeneous functions of degree <1), in conclusion, if no profits are obtained (given the competitive markets),
Otherwise, a homogeneous production function of degree >1 will result in decreasing average costs and increasing returns to scale. If the marginal physical products of the inputs are greater than their total average products, and if the inputs receive payments that are equal to their marginal products, the payments on the inputs will exceed total output and disutility may result. The opposite is for homogeneous functions of degree <1 which will give decreasing utilities to scale or increasing average costs. In this case, the marginal costs are greater than the average costs, and the marginal physical product of one of the factors will be less than the average product of said input.
For this last case, the competitive company will have marginal costs equal to the price and will generate profits. In other words, when all the factors receive the value of their marginal product, the input payments will be less than the total production, with which the total income will be higher than the total costs.
For Wicksell a company could present the three types of returns (increasing, constant, and decreasing), this Swedish economist developed the concept of a long-term average cost curve. For him, even if the production function of a company yields increasing, constant, or decreasing returns, the forces of the competitive market would make the company work in the long-term equilibrium at the point where its production function yields constant returns, which is the same point where it is of degree = 1 and where the minimum average costs occur.
Frederich von Weiser and Eugen von Bohm-Bawerk, JB Clark, Knut Wicksell, PH Wicksted, and FY Edgeworth among others, were the ones who developed the concepts of the theory of distribution based on marginal productivity.
The second generation of marginalists
We will continue reviewing the contributions of the so-called second generation of marginalists, but this time the points of the dissertation will be the theory of employment, the theory of profits, and interest.
Other applications of marginal analysis theory
Let us start with the application of marginalism to employment theory. Under the assumptions of partial equilibrium, if the price of labor increases, then less labor will be hired until the value of the marginal product of labor is equal to the highest price of labor, then this decision by the companies will cause it to increase. the marginal physical product of labor will therefore increase the value of the marginal product of labor. This means that the price of the work will depend on its demand.
If we consider labor as a commodity, then the surplus will be controlled through prices, which in this case are flexible wages. According to the supply and demand analysis, unemployment will decrease as wages decrease and thus the imbalance will disappear. However, frictional unemployment of 3% was considered.
Many policy considerations arose from this orthodox conclusion which ultimately preaches that unemployment and depressions can be eliminated by allowing the market to act on wages by lowering them. In other words, unemployment depends on a temporary imbalance in the market and the factors that prevent wages from falling. This position is criticized by Keynes, who reveals that the approach ignores aggregate demand.
Now let’s move on to the issue of profit and interest from the perspective of the second generation.
In the first place, the marginal analysis was effective to explain and even justify the return on capital, JB Clark explained that the return on capital is justified because the capital is productive, that is to say, that the return is not a robbery but something completely transparent, that is, Factors are rewarded for their contribution to the social product. This includes both land and work.
The new generation knew how to distinguish between the concepts of profit and interest, however, they accepted that more complex developments were needed to understand their true implications.
For the theory of profit, they were able to distinguish that the classical concept (payment for the use of capital + payment for administration + payment for risks = profit) was wrong. Instead – as Clark put it – the management fee is not a profit but a salary, the payment for the use of the capital is interest, and the profit is the remainder after factor payments. In competitive markets with a homogeneous production function of degree 1, this profit is zero.
The gain can be better assumed as a product of the disequilibrium, which in turn is the product of mobilization to a new long-term equilibrium position.
These shocks can be demand or supply shocks, so the gain is associated with the dynamic elements of the economy. Outside of perfect competition, the forces that drive profit may be to the degree of market monopoly or monopsony.
On the side of the theory of capital and interest, it is good to clarify that it is still controversial knowledge since it implies time horizons and uncertainty, however, three sources claim to explain: monetary, non-monetary, and neo-Keynesian.
Monetary theories affirmed that increases in the volume of the money supply, apart from inflating prices and reducing the purchasing power of money, would decrease the interest rate. This was the thesis until the classical period when the ideas of royal forces claimed greater importance. The economists affirmed that the variations in the interest rate depend on the rate of return of the investment expenses, that is to say, that in the long term, the productive capital is the real factor of influence.
For the neoclassical (also non-monetarists) the problem of interest is summarized in that if capital is produced by land and labor, the yield of this is equal to the value of the factors, then where does the interest come from? Three possible answers arise. First, that there are not two but three factors and interest is the payment of the third, second, that the statement that in long-term equilibrium revenues are equal to costs is wrong, the third is a criticism of the static methodology and perfect of fringe theory.
The developments of Eugen Von Bohm-Bawerk and Irving Fisher somehow resolve the contradiction of the problem of interest by saying that in a long-term competitive equilibrium interest arises because the agents of the economy prefer present goods to an equal quantity of said goods but in the future, this means that the payment made to the factors will be less than the price of the final good that occurs in the future. So we can inscribe this discussion within the analysis of supply and demand.
The neo-Keynesian approaches brought together the monetarist and non-monetarist visions, but that is a subject that we will deal with later.
The new generation. He knew how to distinguish between the concepts of profit and interest, however, they accepted that more complex developments were needed to understand their true implications.
León Walras: the general equilibrium
In the Walrasian model we can represent the price of the quantity supplied and demanded in interrelated equations, that is to say, while we have the prices, the quantity of supply, and the quantity of demand as the three variables, we are only concerned with two unknowns, the price and the quantity Since in equilibrium the supply must equal the demand.
The processes of union of the analysis of the offer with the one of the demand have two different forms of coupling, the general equilibrium is one of them. In short, Walras’s contribution to economics is to a certain extent superior to that of Jevons and to that of Menger due to his greater sophistication.
The general equilibrium consists of an analysis of the phenomena of the economy where all the sectors that comprise it are considered simultaneously.
In such a way that all direct or indirect impacts are considered and, most importantly, the interrelationships of the markets.
Previously Smith and Quesnay had already explored the concept, later Cournot was able to formalize part of these microeconomic concepts but only Walras was able to give mathematical notation to the general equilibrium statement.
General equilibrium allows the mobility of economic variables in a greater number than in partial equilibrium. This mobility occurs while other variables that are not considered strictly economic remain constant (ceteris paribus), this characteristic makes it an excellent instrument for non-contextual argumentation.
In the Walrasian model we can represent the price of the quantity supplied and demanded in interrelated equations, that is to say, while we have the prices, the quantity of supply, and the quantity of demand as the three variables, we are only concerned with two unknowns, the price and the quantity Since in equilibrium the supply must equal the demand.
The assumptions of the equilibrium models are usually quite rigorous, for example, they assume perfect competitiveness, given prices, fixed technology, etc. In a two-agent case, households and firms, one also assumes full employment, invariable preferences, and intermediate markets are eliminated. Families sell factors of production to companies and these in turn sell final goods to families. Companies seek to maximize their profit and families’ utility. Equilibrium in the long term will occur when prices are equal to the average costs of production, this gives us an idea of how the different markets are interrelated and how a change in the price of one final good will push us to another. equilibrium where both actors maximize.
By adding the supply of goods by companies, and subtracting it from the aggregate demand for goods by families, the market should be cleared, in a similar way to the factor market. Within families, their income resulting from the sale of factors must be equal to their expenditure for demand for goods and the same for companies.
In this way, we have clarified the prices of goods and factors and the quantities of the same goods and factors in the market.
On the other hand, it is important to point out that since the model does not use money, then a numeraire is used, which consists of choosing a good as the unit of measurement of prices.
His general equilibrium model and its law are applied today in the determination of quantities or prices.
Now it is easier for us to understand the reason for the importance and the place that León Walras occupies in economic thought. His merit went beyond the application of marginal utility and came to the conception of the interrelationships of an economy with a mathematical notation. He did not see a unidirectionality in the conception of value like Jevons and Menger with which he discovered the connections of the complexity of the markets.
Despite the above, it had inaccuracies that diminished its exposure. The most obvious was that since his interest was in marginal utility, his focus was on the supply function, not the production function.
Other limitations that are mentioned are the fact that the general equilibrium model does not apply to reality does, not apposes virtuosity, and despite considering it a great creation, it is placed outside the domains of reality.
Walras himself did not empirically measure his model, however, he did make variations to include it in policy discussions, for example, he proposed models that resorted to contractual commitments and even developed the concept of an auctioneer who received information and then dictated prices. and allow trade.
His vision of politics led him to be described as a market socialist since he did not defend Laissez-Faire so firmly, he even found spaces where state action was preferable, such as in the creation of competitive markets, which according to him led to a maximum of satisfaction (utility maximization).
Alfred Marshall: The Thinker (1842-1924)
We will deal with the economic thought of Alfred Marshall who carried out the partial equilibrium model.
He is considered one of the fathers of modern orthodox economics, along with Leon Walras. During his youth, he achieved excellent university preparation in mathematics, but apart from this he was also distinguished by his strong humanitarian feelings, relative to improving the quality of life of people, he remained in Cambridge after graduating with his degree in mathematics, but soon He ventured into the reading of metaphysics, ethics, and economics, the latter being the one in which he showed the most interest, to the point of teaching economics at the same University of Cambridge.
Although Jevons had declared himself the champion of marginalist theory, Marshall experimented among his students and colleagues for more than 20 years before expounding his ideas in 1890, when he published his Principles of Economics.
Marshall was aware of the change over time in theories and ideas fueled by human concern, so he tried to combine his mathematical preparation with his background in history, to adapt more easily to these fluctuations.
As we mentioned before, already in 1870 he had begun his work on the mathematical foundation of his theory, complementing it with graphic techniques, but only when he had all the material ready, which included a more rigorous mathematical development, with more elaborate graphs, and footnotes. and even appendices, he gave his work to the world to be discussed. However, his extremely balanced judgments led him on several occasions to issue vague and indecisive statements, falling into what seemed to be an inoperative relativism.
For Marshall “political economy, or economics, is the study of humanity in the ordinary occupations of life; examines that part of individual and social action which is most closely connected with the attainment and use of the material requisites of well-being.”
Although reference is made here to political economy and economics, it should be noted that while the one reflected the relationship between economics and politics, the second is closely connected with normative judgments, that is, it encompasses what the goals of political economy should be. society, however, Marshall’s work reflects that his forte was in the art of economics he is capable of relating positive science to normative goals; that is to say, he concentrated on the application of theory and applied theory.
As expected, he assumed a rather conciliatory position regarding the particular definition of the economy and stated that each economist could assume the concept as best suited to his inclinations, to optimize his performance.
Unlike the classics, Marshall was convinced that the economy had the main task of eliminating poverty to such an extent that he complained to Ricardo for not understanding that poverty generates more poverty, given that the lack of resources in families does not guarantee either health or the preparation to allow them to earn more.
When considering Marshall’s method, it must be borne in mind that his mathematical ability had enabled him to skillfully handle that tool in the field of economics and that he also understood that the construction of abstract models was a vital point within economic constructions; however he was able to point out that considering society stable was a classic error that the combination of abstract theory and historical analysis could correct; Perhaps, for this reason, he also did not pay much attention to the fact that if economists used this or that method, or even if they used several at the same time he accepted this diversity that provided different points of view on the functioning of the economy.
The Marshallian method was aware that the comforts of the laboratory and the facilities for experimentation were not available to economists, so since they cannot keep all the variables constant, they must experiment at a theoretical level, imposing assumptions; The central technique, in this case, is the so-called CETERIS PARIBUS, which means “other things being equal” and it turns out to be an excellent option since the loss of realism is controlled.
In itself, the Marshallian procedure limited the problem to partial equilibrium with most of the variables constant and then very carefully allowed its mobility “one thing at a time”.
This methodological technique was closely related to the conviction that short-term analyzes and conclusions of a particular cause may be incorrect when applied to the long term. More specifically, it is considered that supply over time reflects more marked changes than demand.
Marshall’s four conventional times are the market period, in which supply is fixed and perfectly inelastic. The short term in this is reached to change the production and supply but not the installed plant. The long term, and at this level all costs are variable. In the secular period, in this not only the technology varies but also the population composition.
Moving on to another topic, at the end of the 19th century a great controversy had formed around the theory of price or value in terms of the greater or lesser influence of supply and demand. While the classics emphasized supply, the neoclassical emphasized the demand side.
Marshall had reached a point where he tried to defend the truth, according to him, apart from the fact that his approaches were even earlier than those of Jevons, Menger, and Walras, for him the shorter the period, the more important the power of the lawsuit would be. to fix the price; On the contrary, the longer the time factor lasted, the more relevant the influence of the offer became. In itself, Marshall condemned to failure any single-causal attempt to explain price and value variations.
One of the most interesting criticisms generated by Marshall is that of the misuse by economists of marginal analysis as if this were the omnipotent determinant of the value of the whole when the truth is about understanding marginality as the field where the forces that govern the value of the whole and not to affirm that the marginal utility or the marginal cost determine the price, since these, thanks to the mutual interaction of the factors, are also determined at the margin.
The previous observation is closely related to the conception of one-way causation that Jevons and Menger had pointed out; that is, that demand, supply, and price interact with each other mutually in the marginal space to determine their respective values.
He was always very interested in Ricardian economics, so much so that he rejected the declaration of the demolition of Ricardo’s theory of value by Jevons and other Marginalists, with the overwhelming triumph of the theory of demand.
After appreciating the fundamentals that make Marshall one of the greatest thinkers in economic history, we will delve deeper into the details of Marshall’s partial equilibrium approaches, which will help us arrive at the analysis of the aggregate economy through modifications to make it less and less partial. We will delve a little into his concepts and his economic principles.
Let us first point out that Marshall’s most important contribution to the theory of demand was the clear formulation of the concept of price elasticity of demand, where price and quantity demanded are inversely related.
The degree of the relationship between the change in price and the change in quantity demanded is indicated by the coefficient of price elasticity, which is the negative significant relationship between the percentage change in quantity demanded over the percentage change in prices.
That is to say that if the price decreases by 1% and the quantity demanded increases by 1%, the total expense or income will remain unchanged and the coefficient will be 1. If the; price decreases and expenditure or income increases, the coefficient will be greater than 1 and it will then be said that the price is elastic, on the contrary, if the price decreases and the quantity demanded increases by a lower percentage then the coefficient will be less than 1 and then the price will be inelastic.
As for how he assumed utility, Marshall handled an additive function. And he supposed that individuals consumed for the utility obtained. So his function considered the utility of each good separately, therefore complementarity and substitution relationships were ignored.
To make his job easier, Marshall assumed that utility was measurable through price. But he also pointed out that the main concern of demand theory was to determine the shape of demand curves. He accepted diminishing marginal utility and formulated the equilibrium condition that would give maximum utility to an individual who consumed many commodities. This is that in equilibrium the consumer will spend so that the last monetary unit spent on any final good has the same marginal utility as if it were spent on any other good.
From the above, the concept of marginal utility of money is derived, the marginal utility of a single good is equal to its price multiplied by the marginal utility of money. In effect, Marshall assumed that the income effect due to small changes in the quantity of money was negligible and he could not distinguish it from the substitution effect since he did not have the necessary theoretical tools.
For this reason, Marshall ventured into welfare economics starting with the concept of consumer surplus where consumers measure the marginal utility of the last good consumed by price, but they also measure the intramarginal ones. The difference between what they pay and what they would be willing to pay is consumer surplus. An important element is that he assumed the aggregate of consumer surplus before the individual.
The Marshall surplus is a valid means of representing the gains in utility obtained from consuming the good, but under the assumptions that there is an additive utility function that ignores substitution and complementarity relationships and that the income effect is negligible, that is, that the marginal utility of money is constant.
Regarding taxes and welfare, he used his consumer surplus, concluding that for companies with constant costs, taxes and subsidies were undesirable, however, in the case of a company with decreasing costs, taxes and subsidies could contribute. to increase welfare and society would benefit from taxing these industries.
Unfortunately, since the bases are not solid, the practicality of the policy is questionable. However, the basic engine that was wanted to show was that the free markets were not completely efficient and that the intervention could bring them closer to the optimum.
In the theory of supply, it contributed correctly to the conceptualization of the times, the short term divided the costs into fixed and variable, with which I evaluate a series of circumstances of the company in which I point out its characteristics. In the long term, he differentiated between internal and external economies to explain the growth processes of companies.
Distribution was also touched on by his writings where he solved the problem of measuring marginal products by calculating what he called net product at the margin, so if an extra worker is needed his net product is the worker’s addition to total income minus the added cost of the tool you use.
With his concept of quasi-income, he not only helped to understand the functioning of the market system but also resolved part of the controversy between the classics and the neoclassical regarding the line of cause and effect of prices. While the classics argued that the payments of the factors of production except for land determined prices. The prices of the final goods depended on the costs of production at the margin because there is no income at the margin, wages, profit, and interest determined the prices. In other words, prices were determined on the supply side. For the marginalists instead, the payments of the factors of production are determined by the price.
For Marshall, whether a payment of the factor of production determines the price or it is determined by the price depends on the time that is considered and the perspective that is assumed. So for land, wages, profit, and interest play an important role in elasticities and points of view in determining who determines whom and under what circumstances.
As for the equilibrium, one can differentiate between stable and unstable equilibrium, but the most curious thing is that Marshall, unlike Walras, took the quantity as an independent variable and not the prices, with which he said that the adjustments would occur through the supply that was made. put on the market and that the price depended on it.
The concepts of stable and unstable depend on whether or not the equilibrium points under pressures that change this state return to the equilibrium position or, in a more special case, another equilibrium is created. But no matter how we take it, it is important to understand that the conclusions are the same when the demand curve is downward and the supply curve is upward. It is not the same when the supply curve is skewed downwards and to the right. The stability of the equilibrium will depend on the relative biases of the supply and demand curves and the behavioral assumptions used.
Marshall’s suggestions regarding employment and depression economic policy were inscribed in the thoughts of JS Mill, first suggesting that markets had to be controlled so that credit does not expand excessively in periods of business confidence, and second when a recession occurs, governments can help restore business confidence by insuring companies against risk.
Finally, it is important to note that Marshall inspired a great series of discussions around his writings, concepts, and proposals, making clearer the important role he played in the creation and consolidation of the orthodox line of contemporary economics.