History of Economic Doctrines

Lecture 10

 

The Close of the Classical System

 

NOTE: Distinction between “classical” economics and “neoclassical” economics is that neoclassical economics resulted from the introduction of calculus, primarily by French “engineers” [Dupuit and Cournot] in the 1830s or so, by the Austrians von Thünen, von Mangoldt, Menger, Wieser, and von Böhm-Bawerk, by Walras and Pareto at Lausanne [in Switzerland], by Jevons and Edgeworth in Cambridge, England, and by John Bates Clark in the United States.

John Stuart Mill

The “magnificent dynamics of the classical system” [a phrase drawn from William Baumol] was summarized by its last significant practitioner, John Stuart Mill (1806-1873), who was even more renowned as a philosopher than he was as the most prominent economist in the England of his era. Curiously, despite his reported mastery of advanced mathematics by age 10, Mill was the last important analytical economist to formally integrate little if any calculus into his economic analysis.

 

1.      Programmed kid: rigorous academic upbringing-- Greek and Latin at age 3. Emotionally fragile. Mill had a mental breakdown at the age of 20. Then Mill met his wife, who helped him cope with his depression and altered his views about things

2.      Utilitarian -- follower of Jeremy Bentham who was drawn to Auguste Comte’s logical positivism.

3.      Mill’s Principles of Political Economy: A “classical liberal:” free markets are usually efficient.

a.       Elaborated Ricardo’s theory of rent and Smith’s ideas on wages and labor.

b.       Asserted that theorizing must correspond to the real world.

c.       Solved the problem of pricing in joint production; e.g., beef and hides. [The sum of the prices must be equal to the average costs of production.]

d.      Pointed out that GDP is whatever people want it to be (the “shmoo” concept).

4.      Mill provided a theoretical underpinning for reliance on a gold standard for the money supply.

  1. Following in the tradition of Hume’s “specie-flow” mechanism, Mill asserted that the price level is positively related to the supply of money.
  2. Mill argued that the amount of labor required to mine extra gold is constant, so that any change in the demand for gold would result in a proportional change in its quantity.
  3. If gold = money, then the price of gold can be thought of as the reciprocal of the “cost of living” – the price of shmoo.
  4. Mill never explicitly used supply and demand curves, but in effect he hypothesized the supply of gold to be horizontal (perfectly elastic) so that the quantity of gold in circulation would be precisely proportional to the demand for it.

 

e.       In this model, an increase in the price of gold from Po to P* [a reduction in the price of “shmoo”] would temporarily follow an increase in demand for gold from D0 to D1, but in the long run an increase in quantity to Q1 drives the price of gold back down, and with it, restoration of the original price level, which rises when the price of gold falls.

  1. The graph above simply expresses the notion that if the price of everything else [shmoo] goes down, then the price of gold will go up, prompting more gold mining. On the other hand, if we have inflation, the price of gold will go down [relative to shmoo], and no more mining will take place.  Ultimately, such an automatic system will eventually lead the economy to the efficient point star on the graph.
  2. Under a Gold Standard, the government did not need to do anything special to the Money Supply.  All that is required is for government to ensure the quality of money and mint (coin) the gold dust and bullion the miners turn in to the Treasury.  The market would take care of the rest. This automatic adjustment is another strand of laissez faire typical of classical liberalism.

1.      Influenced heavily by his wife, Mill favored many social reforms, including equal rights for women.

2.      He opposed slavery (drawing Carlyle’s condemnation of economics as “the dismal science.”)

3.      Mill also attempted to separate production from the distribution of income and wealth. He asserted that, within limits, society can determine how income is distributed.

  1. Who determines who owns what? – Production doesn’t mean ownership.
  2. Society determines who owns -- (Follows reasoning of Grotius).
  3. Redistribute from prosperous to poor – problem = disincentives for both to work
  4. Education? -- Redistribution of land?
  5. Proposed reliance on inheritance tax and not income tax, reasoning (questionably) that no incentive to work will be lost – but substitution effects?

                                    i.       People might beat inheritance taxes by substituting gift of education (for example) for monetary gift?

                                  ii.       there is no perfect system to implement what Mill envisioned

4.      Mill’s On Liberty: A ringing endorsement of free markets, free speech, and civil liberties.

  1. Libertarian approach to freedom  à civil rights and liberties
  2. Do whatever you want as long as you don’t step on property rights.
  3. Free speech, religion, thought, expression…
  4. Logic as an organizing principle -- education through argument

Ironically, many modern conservatives now categorize Mill with modern liberals, primarily because of his views on redistribution, education, women’s rights, etc.

 

Social Policies: Crime and Punishment

BENTHAM, Chadwick, … à Becker

Issue: Is criminal behavior aberrant or merely self-interested?

 

Bentham: Primary concern was crime and punishment

1.       People commit crimes because of attempts to gain utility – to get their “jollies.”

2.       The punishment should fit the crime

3.       The punishment should equal the damage done to society.

 

Sir Edwin Chadwick agreed with Bentham’s view that criminals try to maximize their jollies. His analysis suggested that criminals weigh the probability of punishment significantly, and that criminals consider the probabilities:

1.       If detected and apprehended, of being indicted.

2.       Of error when a prosecutor frames the indictment.

3.       Of dismissal of a bill of indictment by a grand jury.

4.       That witnesses will vary in the quality of their testimony.

 

Gary Becker also agreed that criminals try to maximize their jollies.

1.       Becker is concerned with optimal law enforcement

2.       Becker’s model assumes that criminals weigh expected costs and benefits.

3.       Contrary to Bentham, Becker concluded that the punishment should be set so that punishment equals damage × [1/(probability of being apprehended and punished.)]

Aside: The Money Supply and the Price Level

Cambridge Equation: The amount of money demand=fixed K coefficient multiplied by Income (PQ).  The amount of spending determined the Money demand proportionally, and the amount of spending we plan is proportional to our income.  Thus, the price level was proportional to the amount of gold we have.  The price of Gold is reciprocal to the CPI so that Au=1/CPI. This “Cambridge equation” was described by Arthur Cecil Pigou in 1917, but was based on earlier discussions, probably with Alfred Marshall at Cambridge University in the late 1890s.

Irving Fisher: MV=PQ.  He held that: %Change in MS + %Change V= %Change in P + % Change Q. MS and V were held constant.  Therefore, if % Change in output increases by 3%, then the % Change in P will decrease by -3%.  Thus, if this was the U.S. gold standard, a decrease in the price level would increase our ability to buy. [More on this later.]

 

 

These web pages are significantly edited and elaborated versions of student notes based on lectures by Ralph Byrns, 2002-2005.