Circular Flow—Invisible Hand—Law of Markets

1. Circular Flow—Invisible Hand—Law of Markets Cantillon—Circular Flow Quesnay—Tableau Economique Smith—Invisible Hand Jean-Baptiste Say—Law of Markets • Centrality of entrepreneur • Oversupply in one market  shortage in another Malthus—Gluts  deficient effective demand Sismondi—production outstrips demand  gluts • Factor immobility inhibits price clearing • Regulate … constrain unfettered capitalism Marx—Crises: Disproportion/Realization/Liquidation Mill—Say’s Law holds if money is viewed as a commodity Walras—General Equilibrium Keynes—deficient effective demand Arrow-Debreu—Conditions of market clearing

2. Synthesis and Refinement of Classical Economics:Nassau Senior/John Stuart Mill Major/Dominant Texts A. Smith, The Wealth of Nations, 1776 David Ricardo, Principles of Political Economy & Taxation, 1817 Nassau Senior, Outline of the Science of Political Economy, 1836 John Stuart Mill, Principles of Political Economy, 1848 Alfred Marshall, Principles of Economics, 1898 Paul Samuelson, Economics, 1948 Popular Principles of Economics Texts Campbell McConnellGregory Mankiw George Leland Bach Wm. McEachern James Gwartney Paul Krugman & Robin Wells Wm. Baumol and Alan Blinder Ben Bernanke & Robert Frank Roger Arnold Michael Parkin Bradley Shiller Wm. Boyes and Michael Melvin Glenn Hubbard and Patrick O’Brien

3. Synthesis and Refinement of Classical Economics:Nassau Senior/John Stuart Mill Nassau Senior, Outline of the Science of Political Economy, 1836 Wealth = scarce goods & services that have utility (supply) (demand) Bridge from Classical economics to Neo-classical economics? Not quite. Four postulates: • People want as muchwealth as possible at as littlesacrifice as possible  Services have value/Demand affects value • Population limited by “moral or physical evil” or fear of lacking subsistence • Means of subsistence increase faster than population owing to accumulation of capital … the Malthusian devil is tamed • Productivity may be increased by accumulating capital (= “abstinence”) • Abstinence (on margin) as factor of production  Profit/Interest • Profit as well as wages enter value: Labor theory of value • Productivity of “waiting”…roundabout production • Increasing returns in manufacturing • Diminishing returns in agriculture

4. The Circle of James Mill (1773 -1836) Jeremy Bentham(1748-1832) – utilitarianism “Greatest good for the greatest number” Calculus of pleasure and pain Daniel Bernoulli … St. Petersburg Paradox (1738) Diminishing marginal utility of income Everyone’s happiness counts equally  Robin Hood principle Roles for State Employer of last resort Redistribute wealth … but maintain incentives Panopticon: an ideal prison Thomas Robert Malthus David Ricardo John Stuart Mill (1806 – 1873) Prodigy/philosopher/East India Co. administrator Learned Greek @ age 3/Read Plato @ 8 … the Illiad for fun Studied Ricardo & Smith @ 13/Edited father’s & Bentham’s works @ 19 Stayed with Say on trip to France/Nervous breakdown @ ~20 Philosophical Radical: civil liberties; women’s rights… MP, opinion-maker: “Saint of rationalism”

5. John Stuart Mill’s Concerns: Human Development • Emancipate women! • Contraceptive rights • Property rights/Voting rights If the principle of equality and liberty is true, we ought to act as if we believe it and not ordain that to be born a girl instead of a boy…shall decide a person’s position throughout life. • Finance colonization • Educate/Participate ...the uncultivated cannot be judges of cultivation • Limit inheritance • Competing Producer Cooperatives ...each man a capitalist, manager, and employee • Public utilities “Justice” • Malthusian Specter • Division of Labor Drudgery/Ignorance • Inequality • Monopoly Naïve

6. Letter on the Negro Question, 1850 and The Condition of Ireland, 1846 A response to Thomas (“dismal science”) Carlyle’s complaint that emancipated slaves in the West Indies weren’t working very hard • The proprietors hadn’t worked at all [Mill’s consistent complaint...the idle rich] • Mill rejects Carlyle’s racism, that “you [Negroes]will have to be servants to those that are born wiser than you, that are born lords of you—servants to the whites...” • Carlyle wasn’t more favorably inclined to the Irish, who had just suffered famine • Mill’s allusion to Ireland: The labour market admits of three possible conditions, and not, as this would imply, of only two. Either, first, the labourers can live almost without working, which is said to be the case in Demerara; or, secondly, which is the common case, they can live by working, but must work in order to live; or, thirdly, they cannot by working get a sufficient living, which is the case in Ireland. • That [make-work] system must be promptly put an end to. We must stop telling the Irish that it is our business to find food for them. We must tell them...that it is their business. They have a right, not to support at the public cost, but to aid and furtherance in finding support for themselves. Millions of acres are lying waste, requiring little more than labor to render them productive, and to avoid giving these acres to the destitute, we are giving them, instead, many millions of pounds sterling. Mill’s philosophy of progress stated in the Letter: To reduce very greatly the quantity of work required to carry on existence, is as needful as to distribute it more equally...The progress of science, and the increasing ascendancy of justice and good sense, tend to this result.

7. John Stuart Mill, Principles of Political Economy, 1848 Ricardo with Wiggle Room Synthesis of Classical Economics...Abstract Truths (Ricardo’s influence) • Economic man  self-interest as motive force • Invisible hand  harmony through competition • Minimal government …but still a role • Discern economic laws Say’s Law: Saving is spending No Crises in Mill’s Principles Law of Population Iron Law of Wages Law of Diminishing Returns in agriculture (“most significant proposition”) Law of Comparative Advantage Mill: Competition  Efficient Production …butPolitical Redistribution can enhance utility • Natural science production But Institutions  personal distribution • Wiggle room in “wage-fund”  union bargaining not futile • Assure equality of bargaining power • Anticipation of Welfare State

8. Principles in Mill’s Principles Text …happily, there is nothing in the laws of value which remains for the present or any future writer to clear up; the theory of the subject is complete. • Operation of Supply and Demand • Value (price) adjusts to clear the market • Short-run / long-run distinction…PLong-Run= Cost • “Productive labor”  Capital/Saving employs “productive labor”Say • Economies of scale  monopoly • Role for public utilities • Free trade  losers as well as winners • Division of gains from trade … reciprocal demand • Tariffs and terms-of-trade  strategic trade theory • Defense of infant industry protection • Socialism  indolence • Competition  efficiency … but thenredistribute • Technology can benefit all positive steady state • Agricultural technology must overtake diminishing returns • Role for government guidance  knowledge/progress...public goods • Human drives + Institutions Economic Outcomes • Institutions are subject to political intervention

9. Mill and the Stationary StateRecall Ricardo: Value, Distribution, and Growth • Mill: Welcome the stationary state • Acquisition is distasteful • Growth  Overcrowding • Work Less! • Reproduce Less! • Redistribute!!! • Live Better...Cooperate • Pursue the arts/philosophy Marginal Product (corn) Rent w* Profit squeezed to zero  Growth ceases Wage Bill K* K1 Capital-Labor Input

10. More from Mill’s Principles • Analytics...Beyond Ricardo’s “Corn Economy” • Non-competing groups (limited mobility) and wages • Joint products and theory of value • Opportunity cost of land  cost of production entering value • Economics of the firm – economies of scale • Supply and demand with numerical examples • Say’s Law elucidated (got to treat money as commodity) • Applications • Provision of public goods • Peasant proprietorship championed  sand into fertile soil • Co-operative socialism (producer co-ops) • Flat income tax • Exemption for low income • Progressive rates penalize enterprise • Poor relief: guaranteed minimum income—negative income tax • Wage fund as limit on wage share ... But labor unions can be effective Laissez-faire...with exceptions/Active but limited, decentralized government

11. Harriet Taylor’s contribution. • ...when two persons have their thoughts and speculations completely in common it is of little consequence in respect of the question of originality, which of them holds the pen." • . Conventional wisdom: Harriet Taylor was Mill’s “co-author” • But • Mill regularly credited others with originating “his” ideas • This includes Helen Taylor, Harriet Taylor’s daughter, who was no great intellect • Mill developed (most of) the ideas he gives Mrs. Taylor credit for before she could possibly have presented them to him • She (perhaps) did encourage him to articulate and give prominence to certain radical ideas • The emancipation of women • Favorable treatment of “socialism” • Injustice of competitive system: hardest work done by the least paid • ...unite the greatest individual liberty ...with common ownership of the raw material of the globe

12. Mill’s Idealism: A Sample from Mill’s Autobiography … [W]e (Mill & Taylor) dreaded the ignorance, selfishness and brutality of the mass; but our ideal of ultimate improvement went far beyond Democracy and would class us [as] Socialists…[W]e looked forward to a time when society will no longer be divided into the idle and the industrious; when the rule that they who do not work shall not eat will be applied not to paupers only, but impartially to all; when the division of the produce of labor , instead of depending …on the accident of birth, will be made…on an acknowledged principle of justice; and when it will no longer … be impossible for human beings to exert themselves strenuously in procuring benefits which are not to be exclusively their own, but to be shared with the society they belong to. …We saw clearly that to render any such social transformation possible or desirable, an equivalent change of character must take place both in the uncultivated herd who now compose the laboring masses, and in the immense majority of their employers…Education, habit, and the cultivation of the sentiments will make a common man dig or weave for his country, as readily as fight for his country. It is only by slow degrees…that men in general can be brought up to this point…The deep-rooted selfishness which forms the general character of the existing society, is so deeply rooted, only because the whole course of existing institutions tends to foster it. John Stuart Mill, Autobiography, 1873