Aristotle's Politics (c.a. 350 BC) was mainly concerned to analyse different forms of a state (monarchy, aristocracy, constitutional government, tyranny, oligarchy, democracy) as a critique of Plato's advocacy of a ruling class of "philosopher-kings". In particular for economists, Plato had drawn a blueprint of society on the basis of common ownership of resources. Aristotle viewed this model as an oligarchical anathema.
In Politics Book I, Aristotle discusses the general nature of households and market exchanges. For him there is a certain "art of acquisition" or "wealth-getting". Money itself has the sole purpose of being a medium of exchange, which means on its own "it is worthless... not useful as a means to any of the necessities of life".[15] Nevertheless, points out Aristotle, because the "instrument" of money is the same many people are obsessed with the simple accumulation of money. "Wealth-getting" for one's household is "necessary and honourable", while exchange on the retail trade for simple accumulation is "justly censured, for it is dishonourable".[16] Aristotle disapproved highly of usury and also cast scorn on making money through monopoly.[17]
Middle Ages
Main articles: Thomas Aquinas, Scholasticism, Duns Scotus, Ibn Khaldun, and Islamic economic jurisprudence
Thomas Aquinas (1225-1274) was an Italian theologian and writer on economic issues. He taught in both Cologne and Paris, and was part of a group of Catholic scholars known as the Schoolmen, who moved their enquiries beyond theology to philosophical and scientific debates. In the treatise Summa Theologica Aquinas dealt with the concept of a just price, which he considered necessary for the reproduction of the social order. Bearing many similarities with the modern concept of long run equilibrium a just price was supposed to be one just sufficient to cover the costs of production, including the maintenance of a worker and his family. He argued it was immoral for sellers to raise their prices simply because buyers were in pressing need for a product.
Aquinas discusses a number of topics in the format of questions and replies, substantial tracts dealing with Aristotle's theory. Questions 77 and 78 concern economic issues, mainly relate to what a just price is, and to the fairness of a seller dispensing faulty goods. Aquinas argued against any form of cheating and recommended compensation always be paid in lieu of good service. Whilst human laws might not impose sanctions for unfair dealing, divine law did, in his opinion. One of Aquinas' main critics[18] was Duns Scotus (1265-1308) in his work Sententiae (1295). Originally from Duns Scotland, he taught in Oxford, Cologne and Paris. Scotus thought it possible to be more precise than Aquinas in calculating a just price, emphasising the costs of labour and expenses - though he recognised that the latter might be inflated by exaggeration, because buyer and seller usually have different ideas of what a just price comprises. If people did not benefit from a transaction, in Scotus' view, they would not trade. Scotus defended merchants as performing a necessary and useful social role, transporting goods and making them available to the public.
Mercantilists and nationalism
Main article: Mercantilism
From the localism of the Middle Ages, the waning feudal lords, new national economic frameworks began to be strengthened. From 1492 and explorations like Christopher Columbus' voyages, new opportunities for trade with the New World and Asia were opening. New powerful monarchies wanted a powerful state in order to boost their status. Mercantilism was a political movement and an economic theory that advocated the use of the state's military power to ensure local markets and supply sources were protected. Mercantile theorists thought international trade could not benefit all countries at the same time. Because money and gold were the only source of riches, there was a limited quantity of resources to be shared between countries. Therefore, tariffs could be used to encourage exports (meaning more money comes into the country) and discourage imports (sending wealth abroad). In other words a positive balance of trade ought to be maintained, with a surplus of exports. The term mercantilism was not in fact coined until the late 1763 by Victor de Riqueti, marquis de Mirabeau and popularised by Adam Smith, who vigorously opposed its ideas.
Thomas Mun
Main article: Thomas Mun
English businessman Thomas Mun (1571-1641) represents early mercantile policy in his book England's Treasure by Foraign Trade . Although it was not published until 1663 it was widely circulated as a manuscript before then. He was a member of the East India Company and also wrote about his experiences there in A Discourse of Trade from England unto the East Indies (1621). According to Mun, trade was the only way to increase England’s treasure (i.e., national wealth) and in pursuit of this end he suggested several courses of action. Important were frugal consumption in order to increase the amount of goods available for export, increased utilisation of land and other domestic natural resources to reduce import requirements, lowering of export duties on goods produced domestically from foreign materials, and the export of goods with inelastic demand because more money could be made from higher prices.
Philipp von Hörnigk
Main article: Philipp von Hörnigk
Philipp von Hörnigk (1640-1712, sometimes spelt Hornick or Horneck) was born in Frankfurt am Main and became an Austrian civil servant writing in a time when his country was constantly threatened by Ottoman invasion. In Österreich Über Alles, Wenn Sie Nur Will (1684, Austria Over All, If She Only Will) he laid out one of the clearest statements of mercantile policy. He listed nine principal rules of national economy.
"To inspect the country's soil with the greatest care, and not to leave the agricultural possibilities of a single corner or clod of earth unconsidered... All commodities found in a country, which cannot be used in their natural state, should be worked up within the country... Attention should be given to the population, that it may be as large as the country can support... gold and silver once in the country are under no circumstances to be taken out for any purpose... The inhabitants should make every effort to get along with their domestic products... [Foreign commodities] should be obtained not for gold or silver, but in exchange for other domestic wares... and should be imported in unfinished form, and worked up within the country... Opportunities should be sought night and day for selling the country's superfluous goods to these foreigners in manufactured form... No importation should be allowed under any circumstances of which there is a sufficient supply of suitable quality at home."
Jean Baptiste Colbert
Main article: Jean Baptiste Colbert
Jean Baptiste Colbert (1619-1683) was Minister of Finance under King Louis XIV of France. He set up national guilds to regulate major industries. Silk, linen, tapestry, furniture manufacture and wine were examples of the crafts in which France specialised, all of which came to require membership of a guild to operate in. These remained until the French revolution. According to Colbert, "It is simply, and solely, the abundance of money within a state [which] makes the difference in its grandeur and power."
British enlightenment
Britain had gone through some of its most troubling times through the 17th century, enduring not only political and religious division in the English Civil War, King Charles I's execution and the Cromwellian dictatorship, but also the plagues and fires. The monarchy was restored under Charles II, who had catholic sympathies, but his successor King James II was swiftly ousted. Invited in his place were Protestant William of Orange and Mary, who assented to the Bill of Rights 1689 ensuring that the Parliament was dominant in what became known as the Glorious revolution. The upheaval had seen a number of huge scientific advances, including Robert Boyle's discovery of the gas pressure constant (1660) and Sir Isaac Newton's publication of Philosophiae Naturalis Principia Mathematica (1687), which described the three laws of motion and his law of universal gravitation. All these factors spurred the advancement of economic thought. For instance, Richard Cantillon (1680-1734) consciously imitated Newton's forces of inertia and gravity in the natural world with human reason and market competition in the economic world.[20] In his Essay on the Nature of Commerce in General, he argued rational self interest in a system of freely adjusting markets would lead to order and mutually compatible prices. Unlike the mercantilist thinkers however, wealth was found not in trade but in human labour. The first person to tie these ideas into a political framework was John Locke.
John Locke
Main article: John Locke
John Locke (1632-1704) was born near Bristol and educated in London and Oxford. He is considered one of the most significant philosophers of his era mainly for his critique of Thomas Hobbes' defence of absolutism and the development of social contract theory in Leviathan (1651). Locke believed that people contracted into society which was bound to protect their rights of property.[21] He defined property broadly to include people's lives and liberties, as well as their wealth. When people combined their labour with their surroundings, then that created property rights. In his words from his Second Treatise on Civil Government (1689),
God hath given the world to men in common... Yet every man has a property in his own person. The labour of his body and the work of his hands we may say are properly his. Whatsoever, then, he removes out of the state that nature hath provided and left it in, he hath mixed his labour with, and joined to it something that is his own, and thereby makes it his property.[22]
Locke was arguing that not only should the government cease interference with people's property (or their "lives, liberties and estates") but also that it should positively work to ensure their protection. His views on price and money were laid out in a letter to a Member of Parliament in 1691 entitled Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of Money (1691). Here Locke argued that the "price of any commodity rises or falls, by the proportion of the number of buyers and sellers," a rule which "holds universally in all things that are to be bought and sold."[23]
Dudley North
Main article: Dudley North (economist)
Dudley North (1641-1691) was a wealthy merchant and landowner. He worked as an official for the Treasury and was opposed to most mercantile policy. In his Discourses upon trade (1691), which he published anonymously, he argued that the assumption of needing a favourable trade balance was wrong. Trade, he argued, benefits both sides, it promotes specialisation, the division of labour and produces an increase in wealth for everyone. Regulation of trade interfered with these benefits by reducing the flow of wealth.
David Hume
Main article: David Hume
David Hume (1711-1776) agreed with North's philosophy and denounced mercantile assumptions. His contributions were set down in Political Discourses (1752), later consolidated in his Essays, Moral, Political, Literary (1777). Added to the fact that it was undesirable to strive for a favourable balance of trade it is, said Hume, in any case impossible. Hume held that any surplus of exports that might be achieved would be paid for by imports of gold and silver. This would increase the money supply, causing prices to rise. That in turn would cause a decline in exports until the balance with imports is restored.
Physiocrats and the circular flow
Main article: Physiocrats
Similarly disenchanted with regulation on trademarks inspired by mercantilism, a Frenchman name Vincent de Gournay (1712-1759) is reputed to have asked why it was so hard to laissez faire, laissez passer (free trade, free enterprise). He was one of the early physiocrats, a word from Greek meaning "government of nature", who held that agriculture was the source of wealth. As historian David B. Danbom wrote, the Physiocrats "damned cities for their artificiality and praised more natural styles of living. They celebrated farmers."[24] Over the end of the seventeenth and beginning of the eighteenth century big advances in natural science and anatomy were being made, including the discovery of blood circulation through the human body. This concept was mirrored in the physiocrats' economic theory, with the notion of a circular flow of income throughout the economy.
François Quesnay (1694-1774) was the court physician to King Louis XV of France. He believed that trade and industry were not sources of wealth, and instead in his book, Tableau économique (1758, Economic Table) argued that agricultural surpluses, by flowing through the economy in the form of rent, wages and purchases were the real economic movers. Firstly, said Quesnay, regulation impedes the flow of income throughout all social classes and therefore economic development. Secondly, taxes on the productive classes, such as farmers, should be reduced in favour of rises for unproductive classes, such as landowners, since their luxurious way of life distorts the income flow.
Jacques Turgot (1727-1781) was born in Paris and from an old Norman family. His best known work, Réflexions sur la formation et la distribution des richesses (1766, Reflections on the Formation and Distribution of Wealth) developed Quesnay's theory that land is the only source of wealth. Turgot viewed society in terms of three classes: the productive agricultural class, the salaried artisan class (classe stipendice) and the landowning class (classe disponible). He argued that only the net product of land should be taxed and advocated the complete freedom of commerce and industry. In August 1774, Turgot was appointed to be Minister of Finance and in the space of two years introduced many anti-mercantile and anti-feudal measures supported by the King. A statement of his guiding principles, given to the King were "no bankruptcy, no tax increases, no borrowing." Turgot's ultimate wish was to have a single tax on land and abolish all other indirect taxes, but measures he introduced before that were met with overwhelming opposition from landed interests. Two edicts in particular, one suppressing corvées (charges from farmers to aristocrats) and another renouncing privileges given to guilds inflamed influential opinion. He was forced from office in 1776.
Adam Smith and The Wealth of Nations
See also: Industrial revolution
Adam Smith (1723-1790) is popularly seen as the father of modern political economy. His publication of the An Inquiry Into the Nature and Causes of the Wealth of Nations in 1776 happened to coincide not only with the American Revolution, shortly before the Europe wide upheavals of the French Revolution, but also the dawn of a new industrial revolution that allowed more wealth to be created on a larger scale than ever before. Smith was a Scottish moral philosopher, whose first book was The Theory of Moral Sentiments (1759), in which he argued that ethical systems develop through individual relationships, and that right and wrong are sensed through others' reactions to one's behavior. This gained Smith more popularity than his next work, The Wealth of Nations, which the general public initially ignored.[25] Yet Smith's political economic magnum opus was successful in circles that mattered. In The Wealth of Nations Smith makes a case that the free market, while appearing chaotic and unrestrained, is actually guided to produce the right amount and variety of goods by an "invisible hand". Smith argued for a "system of natural liberty" where individual effort was the producer of social good. He argued that an individual who pursues self-interest does more to promote the good of society than does an individual who intends to benefit society. Self-interested competition in the free market, he argued, would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services.
An often-quoted passage from The Wealth of Nations is:
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.[26]
Smith believed that the division of labour was the driver of economic efficiency.
Classical political economy
Main article: Classical economics
The classical economists were referred to as a group for the first time by Karl Marx[27], who admired their scientific rigor.[citation needed] One unifying part of their theories was the labour theory of value, contrasting to value deriving from a general equilibrium of supply and demand. These economists had seen the first economic and social transformation brought by the Industrial Revolution: rural depopulation, precariousness, poverty, apparition of a working class. They wondered about the population growth, because the demographic transition had begun in Great Britain at that time. They also asked many fundamental questions, about the source of value, the causes of economic growth and the role of money in the economy. They supported a free-market economy, arguing it was a natural system based upon freedom and property. However, these economists were divided and did not make up a unified current of thought.
Jeremy Bentham
Jeremy Bentham believed in "the greatest good for the greatest number".
Jeremy Bentham (1748-1832) was perhaps the most radical thinker of his time, and developed the concept of utilitarianism. Bentham was an atheist, a prison reformer, animal rights activist, believer in universal suffrage, free speech, free trade and health insurance at a time when few dared to argue for any. He was schooled rigorously from an early age, finishing university and being called to the bar at 18. His first book, Fragment of Government (1776) published anonymously was a trenchant critique of William Blackstone's Commentaries of the laws of England. This gained wide success until it was found that the young Bentham, and not a revered Professor had penned it. In The Principles of Morals and Legislation (1791) Bentham set out his theory of utility.[28]
The aim of legal policy must be to decrease misery and suffering so far as possible while producing the greatest happiness for the greatest number.[29] Bentham even designed a comprehensive methodology for the calculation of aggregate happiness in society that a particular law produced, a felicific calculus.[30] Society, argued Bentham, is nothing more than the total of individuals,[31] so that if one aims to produce net social good then one need only to ensure that more pleasure is experienced across the board than pain, regardless of numbers. For example, a law is proposed to make every bus in the city wheel chair accessible, but slower moving as a result than its predecessors because of the new design. Millions of bus users will therefore experience a small amount of displeasure (or "pain") in increased traffic and journey times, but a minority of people using wheel chairs will experience a huge amount of pleasure at being able to catch public transport, which outweighs the aggregate displeasure of other users. Interpersonal comparisons of utility were allowed by Bentham, the idea that one person's vast pleasure can count more than many others' pain. Much criticism later showed how this could be twisted, for instance, would the felicific calculus allow a vastly happy dictator to outweigh the dredging misery of his exploited populus? Despite Bentham's methodology there were severe obstacles in measuring people's happiness.
Jean-Baptiste Say
Main article: Jean-Baptiste Say
Jean-Baptiste Say (1767-1832) was a Frenchman, born in Lyon who helped to popularise Adam Smith's work in France.[32] His book, A Treatise on Political Economy (1803) contained a brief passage, which later became orthodoxy in political economics until the Great Depression and known as Say's Law of markets. Say argued that there could never be a general deficiency of demand or a general glut of commodities in the whole economy. People produce things, said Say, to fulfill their own wants, rather than those of others. Production is therefore not a question of supply, but an indication of producers demanding goods. Say agreed that a part of the income is saved by the households, but in the long term, savings are invested. Investment and consumption are the two elements of demand, so that production is demand, so it is impossible for production to outrun demand, or for there to be a "general glut" of supply. Say also argued that money was neutral, because its sole role is to facilitate exchanges: therefore, people demand money only to buy commodities. Say said that "money is a veil". To sum up these two ideas, Say said "products are exchanged for products". At most, there will be different economic sectors whose demands are not fulfilled. But over time supplies will shift, businesses will retool for different production and the market will correct itself. An example of a "general glut" could be unemployment, in other words, too great a supply of workers, and too few jobs. Say's Law advocates would suggest that this necessarily means there is an excess demand for other products that will correct itself. This remained a foundation of economic theory until the 1930s. Say's Law was first put forward by James Mill (1773-1836) in English, and was advocated by David Ricardo, Henry Thornton[33] and John Stuart Mill. However two political economists, Thomas Malthus and Sismondi, were unconvinced.
Thomas Malthus
Main article: Thomas Malthus
Thomas Malthus (1766-1834) was a Tory minister in the United Kingdom Parliament who, contrasting to Bentham, believed in strict government abstention from social ills.[34] Malthus devoted the last chapter of his book Principles of Political Economy (1820) to rebutting Say's law, and argued that the economy could stagnate with a lack of "effectual demand".[35] In other words, wages if less than the total costs of production cannot purchase the total output of industry and that this would cause prices to fall. Price falls decrease incentives to invest, and the spiral could continue indefinitely. Malthus is more notorious however for his earlier work, An Essay on the Principle of Population. This argued that intervention was impossible because of two factors. "Food is necessary to the existence of man," wrote Malthus. "The passion between the sexes is necessary and will remain nearly in its present state," he added, meaning that the "power of the population is infinitely greater than the power in the Earth to produce subsistence for man."[36] Nevertheless growth in population is checked by "misery and vice". Any increase in wages for the masses would cause only a temporary growth in population, which given the constraints in the supply of the Earth's produce would lead to misery, vice and a corresponding readjustment to the original population.[37] However more labour could mean more economic growth, either one of which was able to be produced by an accumulation of capital.
David Ricardo
Main article: David Ricardo
David Ricardo (1772-1823) was born in London. By the age of 26, he had become a wealthy stock market trader and bought himself a constituency seat in Ireland to gain a platform in the British parliament's House of Commons.[38] Ricardo's best known work is his Principles of Political Economy and Taxation, which contains his critique of barriers to international trade and a description of the manner the income is distributed in the population. Ricardo made a distinction between the workers, who received a wage fixed to a level at which they can survive, the landowners, who earn a rent, and capitalists, who own capital and receive a profit, a residual part of the income.[39] If population grows, it becomes necessary to cultivate additional land, whose fertility is lower than that of already cultivated fields, because of the law of decreasing productivity. Therefore, the cost of the production of the wheat increases, as well as the price of the wheat: The rents increase also, the wages, indexed to inflation (because they must allow workers to survive) too. Profits decrease, until the capitalists can no longer invest. The economy, Ricardo concluded, is bound to tend towards a steady state.
To postpone the steady state, Ricardo advocates to promote international trade to import wheat at a low price to fight landowners. The Corn Laws of the UK had been passed in 1815, setting a fluctuating system of tariffs to stabilise the price of wheat in the domestic market. Ricardo argued that raising tariffs, despite being intended to benefit the incomes of farmers, would merely produce a rise in the prices of rents that went into the pockets of landowners.[40] Furthermore, extra labour would be employed leading to an increase in the cost of wages across the board, and therefore reducing exports and profits coming from overseas business. Economics for Ricardo was all about the relationship between the three "factors of production": land, labour and capital. Ricardo demonstrated mathematically that the gains from trade could outweigh the perceived advantages of protectionist policy. The idea of comparative advantage suggests that even if one country is inferior at producing all of its goods than another, it may still benefit from opening its borders since the inflow of goods produced more cheaply than at home, produces a gain for domestic consumers.[41] According then to Ricardo, this concept would lead to a shift in prices, so that eventually England would be producing goods in which its comparative advantages were the highest.
John Stuart Mill
John Stuart Mill (1806-1873) was the dominant figure of political economic thought of his time, as well as being a Member of Parliament for the seat of Westminster, and a leading political philosopher. Mill was a child prodigy, reading Ancient Greek from the age of 3, and being vigorously schooled by his father James Mill.[42] Jeremy Bentham was a close mentor and family friend, and Mill was heavily influenced by David Ricardo. Mill's textbook, first published in 1848 and titled Principles of Political Economy was essentially a summary of the economic wisdom of the mid nineteenth century.[43] It was used as the standard texts by most universities well into the beginning of the twentieth century. On the question of economic growth Mill tried to find a middle ground between Adam Smith's view of ever expanding opportunities for trade and technological innovation and Thomas Malthus' view of the inherent limits of population. In his fourth book Mill set out a number of possible future outcomes, rather than predicting one in particular. The first followed the Malthusian line that population grew quicker than supplies, leading to falling wages and rising profits.[44] The second, per Smith, said if capital accumulated faster than population grew then real wages would rise. Third, echoing David Ricardo, should capital accumulate and population increase at the same rate, yet technology stay stable, there would be no change in real wages because supply and demand for labour would be the same. However growing populations would require more land use, increasing food production costs and therefore decreasing profits. The fourth alternative was that technology advanced faster than population and capital stock increased.[45] The result would be a prospering economy. Mill felt the third scenario most likely, and he assumed technology advanced would have to end at some point.[46] But on the prospect of continuing economic growth, Mill was more ambivalent.
"I confess I am not charmed with the ideal of life held out by those who think that the normal state of human beings is that of struggling to get on; that the trampling, crushing, elbowing, and treading on each other's heels, which form the existing type of social life, are the most desirable lot of human kind, or anything but the disagreeable symptoms of one of the phases of industrial progress.[47]
Mill is also credited with being the first person to speak of supply and demand as a relationship rather than mere quantities of goods on markets,[48] the concept of opportunity cost and the rejection of the wage fund doctrine.[49]
Marxist economics
Main article: Marxian economics
Karl Marx provided a fundamental critique of classical economics, based on the labour theory of value.
Just as the term "mercantilism" had been coined and popularised by its critics, like Adam Smith, so was the term "capitalism" or Kapitalismus used by its dissidents, primarily Karl Marx. Karl Marx (1818-1883) was, and in many ways still remains the pre-eminent socialist economist. His combination of political theory represented in the Communist Manifesto and the dialectic theory of history inspired by Friedrich Hegel provided a revolutionary critique of capitalism as he saw it in the nineteenth century. The socialist movement that he joined had emerged in response to the conditions of people in the new industrial era and the classical economics which accompanied it. He wrote his magnum opus Das Kapital at the British Museum's library.
Context
Robert Owen (1771-1858) was one industrialist who determined to improve the conditions of his workers. He bought textile mills in New Lanark, Scotland where he forbade children under ten to work, set the workday from 6 a.m. to 7 p.m. and provided evening schools for children when they finished. Such meagre measures were still substantial improvements and his business remained solvent through higher productivity, though his pay rates were lower than the national average.[50] He published his vision in The New View of Society (1816) during the passage of the Factory Acts, but his attempt from 1824 to begin a new utopian community in New Harmony, Indiana ended in failure. One of Marx's own influences was the French philosopher Pierre Proudhon. While deeply critical of capitalism, he also objected to those contemporary socialists who idolized association. In his book The Philosophy of Poverty Proudhon made a political economic attack on the classical subsistence theory of wages.(1846)[51] In his book What is Property? (1840) he argue that property is theft, a different view than the classical Mill, who had written that "partial taxation is a mild form of robbery".[52] However, towards the end of his life, Proudhon modified some of his earlier views. In the posthumously published Theory of Property, he argued that "property is the only power that can act as a counterweight to the State."[53] Friedrich Engels, a published radical author, released a book titled The Condition of the Working Class in England in 1844[54] describing people's positions as "the most unconcealed pinnacle of social misery in our day." After Marx died, it was Engels that completed the second volume of Das Kapital from Marx's notes.
After Marx
Main articles: Karl Kautsky, Rosa Luxembourg, Beatrice Webb, John A. Hobson, R. H. Tawney, and Paul Sweezy
The first volume of Das Kapital was the only one Marx alone published. The second and third volumes were done with the help of Friedrich Engels and Karl Kautsky, who had become a friend of Engels, saw through the publication of volume four.
Marx had begun a tradition of economists who concentrated equally on political affairs. Also in Germany, Rosa Luxembourg was a member of the SPD, who later turned towards the Communist Party because of their stance against the First World War. Beatrice Webb in England was a socialist, who helped found both the London School of Economics (LSE) and the Fabian Society.
Neoclassical thought
See also: Leon Walras, Alexander del Mar, John Bates Clark, Irving Fisher, William Ashley (economic historian), Enrico Barone, and Maffeo Pantaleoni
In the 1860s, a revolution took place in economics. The new ideas were that of the Marginalist school. Writing simultaneously and independently, a Frenchman (Leon Walras), an Austrian (Carl Menger) and an Englishman (Stanley Jevons) were developing the theory, which had some antecedents. Instead of the price of a good or service reflecting the labor that has produced it, it reflects the marginal usefulness (utility) of the last purchase. This meant that in equilibrium, people's preferences determined prices, including, indirectly the price of labor.
This current of thought was not united, and there were three main schools working independently. The Lausanne school, whose two main representants were Walras and Vilfredo Pareto, developed the theories of general equilibrium and optimality. The main written work of this school was Walras' Elements of Pure Economics. The Cambridge school appeared with Jevons' Theory of Political Economy in 1871. This English school has developed the theories of the partial equilibrium and has insisted on markets' failures. The main representatives were Alfred Marshall, Stanley Jevons and Arthur Pigou. The Vienna school was made up of Austrian economists Menger, Eugen von Böhm-Bawerk and Friedrich von Wieser. They developed the theory of capital and has tried to explain the presence of economic crises. It appeared in 1871 with Menger's Principles of Economics.
Marginal utility
Carl Menger (1840-1921), an Austrian economist stated the basic principle of marginal utility in Grundsätze der Volkswirtschaftslehre[55] (1871, Principles of Economics). Consumers act rationally by seeking to maximise satisfaction of all their preferences. People allocate their spending so that the last unit of a commodity bought creates no more than a last unit bought of something else. Stanley Jevons (1835-1882) was his English counterpart, and worked as tutor and later professor at Owens College, Manchester and University College, London. He emphasised in the Theory of Political Economy (1871) that at the margin, the satisfaction of goods and services decreases. An example of the theory of diminishing returns is that for every orange one eats, the less pleasure one gets from the last orange (until one stops eating). Then Leon Walras (1834-1910), again working independently, generalised marginal theory across the economy in Elements of Pure Economics (1874). Small changes in people's preferences, for instance shifting from beef to mushrooms, would lead to a mushroom price rise, and beef price fall. This stimulates producers to shift production, increasing mushrooming investment, which would increase market supply and a new price equilibrium between the products - e.g. lowering the price of mushrooms to a level between the two first levels. For many products across the economy the same would go, if one assumes markets are competitive, people choose on self interest and no cost in shifting production.
Early attempts to explain away the periodical crises of which Marx had spoken were not initially as successful. After finding a statistical correlation of sunspots and business fluctuations and following the common belief at the time that sunspots had a direct effect on weather and hence agricultural output, Stanley Jevons wrote,
"when we know that there is a cause, the variation of the solar activity, which is just of the nature to affect the produce of agriculture, and which does vary in the same period, it becomes almost certain that the two series of phenomena— credit cycles and solar variations—are connected as effect and cause.[56]
Mathematical analysis
Vilfredo Pareto (1848-1923) was an Italian economist, best known for developing the concept of the circumstance under which nobody need be made worse off, and nobody better off through wealth redistribution. When this situation exists, the economy is said to be "Pareto efficient". Pareto devised mathematical representations for this optimal resource allocation, which when represented on a graph would yield a curve. Different points along the curve represent different allocations, but each would be optimally efficient. Rather than using the persuasive language of classical economists like Mill, the Pareto efficient curve could be represented with a precise mathematical formula:
.Alfred Marshall is also credited with an attempt to put economics on a more mathematical footing. He was the first Professor of Economics at the University of Cambridge and his work, Principles of Economics[57] coincided with the transition of the subject from "political economy" to his favoured term, "economics". He viewed maths as a way to simplify economic reasoning, though had reservations, revealed in a letter to his student Arthur Cecil Pigou.
"(1) Use mathematics as shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This I do often."[58]
Coming after the marginal revolution, Marshall concentrated on reconciling the classical labour theory of value, which had concentrated on the supply side of the market, with the new marginalist theory that concentrated on the consumer demand side. Marshall's graphical representation is the famous supply and demand graph, the "Marshallian cross". He insisted it is the intersection of both supply and demand that produce an equilibrium of price in a competitive market. Over the long run, argued Marshall, the costs of production and the price of goods and services tend towards the lowest point consistent with continued production. Arthur Cecil Pigou in Wealth and Welfare (1920), insisted on the existence of market failures. Markets are inefficient in case of economic externalities, and the State must interfere. However, Pigou retained free-market beliefs, and in 1933, in the face of the economic crisis, he explained in The Theory of Unemployment that the excessive intervention of the state in the labor market was the real cause of massive unemployment, because the governments had established a minimal wage, which prevented the wages from adjusting automatically. This was to be the focus of attack from Keynes.
The Austrian school
Main articles: Eugen von Böhm-Bawerk, Friedrich von Wieser, Joseph Schumpeter, Ludwig von Mises, Friedrich Hayek, and Austrian School
While the end of the nineteenth century and the beginning of the twentieth were dominated increasingly by mathematical analysis, the followers of Carl Menger, in the tradition of Eugen von Böhm-Bawerk, followed a different route, advocating the use of deductive logic instead. This group became known as the Austrian School, reflecting the Austrian origin of many of the early adherents. Thorstein Veblen in 1900, in his Preconceptions of Economic Science, contrasted neoclassical marginalists in the tradition of Alfred Marshall from the philosophies of the Austrian school.[59][60]
Joseph Alois Schumpeter (1883 – 1950) was an Austrian economist and political scientist mostly known for his works on business cycles and innovation. He insisted on the role of the entrepreneurs in an economy. In Business Cycles: A theoretical, historical and statistical analysis of the Capitalist process, Schumpeter made a synthesis of the theories about business cycles. He suggested that those cycles could explain the economic situations. According to Schumpeter, capitalism necessarily goes through long-term cycles, because it is entirely based upon on scientific inventions and innovations. A phase of expansion is made possible by innovations, because they bring productivity gains and encourage entrepreneurs to invest. However, when investors have no more opportunities to invest, the economy goes into recession, several firms collapse, closures and bankruptcy occur. This phase lasts until new innovations bring a creative destruction process, i.e. they destroy old products, reduce the employment, but they allow the economy to start a new phase of growth, based upon new products and new factors of production.[61]
Ludwig von Mises (1881 – 1973) was an Austrian economist who contributed the idea of Praxeology, "The science of human action". Praxeology views economics as a series of voluntary trades that increase the satisfaction of the involved parties. Mises also argued that socialism suffers from an unsolvable economic calculation problem, which according to him, could only be solved through free market price mechanisms.
Mises' outspoken criticisms of socialism had a large influence on the economic thinking of Friedrich von Hayek (1899-1992), who, while initially sympathetic to socialism, became one of the leading academic critics of collectivism in the 20th century.[62] In echoes of Smith's "system of natural liberty", Hayek argued that the market is a "spontaneous order" and actively disparaged the concept of "social justice".[63] Hayek believed that all forms of collectivism (even those theoretically based on voluntary cooperation) could only be maintained by a central authority. In his book, The Road to Serfdom (1944) and in subsequent works, Hayek claimed that socialism required central economic planning and that such planning in turn would lead towards totalitarianism. Hayek attributed the birth of civilization to private property in his book The Fatal Conceit (1988). According to him, price signals are the only means of enabling each economic decision maker to communicate tacit knowledge or dispersed knowledge to each other, in order to solve the economic calculation problem. Along with his contemporary Gunnar Myrdal, Hayek was awarded the Nobel Prize in 1974.
John Maynard Keynes, the Keynesian revolution
John Maynard Keynes (1883-1946) was born in Cambridge, educated at Eton and supervised by both A. C. Pigou and Alfred Marshall at Cambridge University. He began his career as a lecturer, before working in the British government during the Great War, and rose to be the British government's financial representative at the Versailles conference. His observations were laid out in his book The Economic Consequences of the Peace.[64] In his Theory of Money, Keynes said that savings and investment were independently determined. The amount saved had little to do with variations in interest rates which in turn had little to do with how much was invested. Keynes thought that changes in saving depended on the changes in the predisposition to consume which resulted from marginal, incremental changes to income. Therefore, investment was determined by the relationship between expected rates of return on investment and the rate of interest.
During the Great Depression, Keynes had published his most important work, The General Theory of Employment, Interest, and Money (1936). He argued that there exists a continuum of equilibria, the full employment equilibrium position being just one of them. One innovation in his core argument is to stop taking prices and wages as perfectly flexible, arguing instead for a certain degree of stickiness. Thanks to stickiness, it is established that the interaction of "aggregate demand" and "aggregate supply" may lead to stable unemployment equilibria. To combat unemployment Keynes advocated low interest rates and easy credit. However, Keynes also argued that low interest rates were not the only necessary condition to restore economic activity. If investers' expectations are pessimistic (they forecast that effective demand will not grow) they will not invest. So lasting unemployment was entirely possible, and there would be no automatic self correction without external intervention by government. Keynes advocated that state spending be financed by a budgetary deficit.
The book was an enormous success, and though it was criticised for false predictions by a number of people.[65] As a UK representative he helped formulate the plans for the International Monetary Fund, the World Bank and an International Trade Organisation[66] at the Bretton Woods conference, a package designed to stabilise world economy fluctuations and create a level trading field across the globe.
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