History of Economic Thought I, Lecture Note

CHAPTER-1 1. INTRODUCTION
In every society it is necessary that there be a process to organize and coordinate choices
regarding the production, distribution and consumption of goods and services. The
need for this process arises because:
• Our resources or inputs are finite at any moment in time,
• Our technical knowledge constrains our ability to utilize these resources to produce goods
and services,
• Individuals, organizations, social institutions, businesses and
Governments may constrain output,
• In Western societies, wants or desires of individuals or groups are shaped by cultural or
physical forces and often exceeds the availability of economic goods and services.
Ideally, these relatively scarce resources should be allocated to their ―highest valued use.‖
A solitary individual who knows her/his preferences will typically use resources to satisfy
those preferences to the greatest extent possible within constraints. This requires
information, knowledge and choices about which goods and services should be produced
and how to best produce them. When individuals live in social groups it becomes necessary
to distribute the goods among the individuals as well as choosing which goods and services
to produce. In the jargon of the economist, it is necessary to decide
• What should be produced?
• What is the best way to produce it?
• Which individuals should get which goods and services?

The method that a society devises to answer these questions shapes the nature of society
and influences the answers to the questions. There are many possible approaches to
organizing economic activities of individuals living in social systems. Whatever method is
chosen, it is necessary to coordinate or integrate the behavior of individual members of the
society. The history of economic thought is a study of the more important attempts to
analyze, describe and explain the relationships in actual or idealized economic systems.

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Knowledge of alternative explanations of economic processes provides a basis for
evaluating the performance of industrial economies. It also provides a basis for critically
evaluating economic theories and models that purport to describe modern industrial
economies.

1.1. WHAT IS HISTORY OF ECONOMIC THOUGHT?

What is economic science? What about economic thought? And what is history of
economic thought?
Economic science is a result of accumulation of human knowledge and it includes
doctrines and generalizations which deal with economic phenomena in social life.
Economic thought generally covers the set of theories, doctrines, laws and generalizations
applied to the study and solution of economic phenomena and problems.
Definition: A history of Economic thought is a query in to the origin and growth of
economic ideas.
It deals with the origin and development of economic ideas and their interrelations.
It is a historical account of the development of economic doctrines as also of their impact
on economic institutions and activities.
The history of economic thought concerns thinkers and theories in the field of political
economy and economics from the ancient world right up to the present day.
A study of economic thought covers study of development of economic science in static
and stagnant economy as well as in a dynamic economy. A group of economists, whose
work reflects a common intellectual orientation, are called as a 'School of Economics.'
Prof. Haney (1949) defined study of economic thought as, 'A critical account of the
development of economic ideas, searching into their origins, interrelations and
manifestations.' Prof .Schumpter holds that ―economic thought is the sum total of all
the opinions and desires concerning economic subjects especially public policies of
different times and places‖. He further states that the history of economic thought traces
the historical change of attitudes.

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According to Prof. Bell, ―It is the study of the heritage left by the writers on economic
subjects‖.
The history of economic thought deals with different thinkers and theories in the field of
political economy and economics from the middle ages right up to the present. Changes in
economic thought have always accompanied changes in the economy, just as changes in
economic thought have propelled change in economic policy.
Economic thought has evolved through feudalism in the Middle Ages, through mercantilist
theory in the renaissance, through modern political economy during the ‗industrial
revolution,‘ to the fractured economic schools of thought that dragged humanity into the
twentieth century and a new globalized era of the twenty first.

1.2. HISTORY OF ECONOMICS VS HISTORY OF ECONOMIC THOUGHT

Like economic history, the history of economic thought (HET) investigates economic issues
in long-run perspective. But History of Economic Thought should not be confused with
History of Economics and Economic History. Although, they are all studies of the
constituents of History and Economics, they are separate branches of study having different
subject matters and varying in emphasis on different aspects of the subject matter.
 Economic History: is an objective study of the development of economic life of a
particular society. It examines the evolution of the economy and economic
institutions, using methods and techniques of from the fields of economics, history,
geography, sociology, psychology, and political science. Examples, Great
Depression of 1930s, 1997 Asian Financial Crisis, etc.
Economic History studies the origin and growth of commerce, manufacture, trade,
banking, transportation and other economic phenomena and institutions. It deals with the
ideas men have concerning economic facts and forces.
 History of Economics: is the history of the intellectual efforts that men have made
in order to understand economic phenomena. It is a systematic record of the
development of the science of economics.

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 History of economic thought: on the other hand, deals with the origin and
development of economic ideas. It provides a historical account of how people
viewed and understand economic phenomena.
In short, Economic History treats of facts. History of Economics and History of Economic
Thought treat of the theory of these facts. It will thus be observed that History of
Economic Thought has a much wider scope.

1.3. NATURE OF ECONOMIC THOUGHT

What is characteristic feature of economic thought?
The following are some of the characteristic features of economic thought:
I. Economic thought is not a fixed set of theories or tools and techniques of
analysis:
An economy is a dynamic phenomenon and, therefore, economic science is a dynamic one.
With social changes new economic questions present themselves. The result is that
economic science is always undergoing a change. Over successive time intervals, specific
sets of economic ideas, theories, doctrines tools and techniques acquire recognition and
acceptance implying thereby that in different contexts we have different systems of
economic thought. The study of the history of economic thought, therefore automatically
becomes a study of these various systems of economic thought. History of economic
thought is not basically a history of ideas but that of economic proper. It is a body of
economic ideas and generalizations which can be seen to belong to each other.
Economic ideas collectively become economic thought.
II. Economic thought is closely related to economic environment:
The role and growth of each significant theory, the set of theories and policy prescriptions
provided by each school and even the significant contribution by individual economists
must be viewed in the context of the prevalent economic environment. Therefore,

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economic doctrine or economic thought reflects the condition of the society it relates.
Economic thought is the product of time.
III. Ideas on economic subjects and problems have been expressed at all times and
in all ages. The development of the systematic body of economic doctrine in the
history of human thought may be recent but reflection and to a certain extent
speculation on economic phenomenal must be as old as human thought itself. In
ancient times economic doctrines were reflected from customs, laws and institutions
and lacks scientific precision and coherence.
IV. Anybody of economic doctrine/theory has limited validity:
Political thought throughout has been in large measure an attempt to explain how and what
theory contemporary society is operating. Economic doctrines /principles / theories are
under continuous improvement and advances. But it should be remembered that no
absurdity in the history of economic thought was in its time quite as absurd/unreasonable
as it appears know ( they are not absurd when they are viewed at the time they are
formulated).
Hence, economic thoughts should be evaluated under the context of the socio-economic
status when they were developed. We should also note that advancement of theories
/doctrines don‘t necessarily mean castration of old ones. Old doctrines never die; they only
fade away with a strong power of recuperation /reappearance in an appropriate
environment.

1.4. SIGNIFICANCE OF HISTORY OF ECONOMIC THOUGHT

‗Why study economic theory? Why study its history?‘ why do we study history of ideas?
Many answers come to mind. “A primary reason for studying the history of economic
thought is to become a better economist.”

Two major reasons, other than the personal advantages that might be gained, justify the
study of economic theory. First, such study allows us to gain an understanding of how an
economy works; that is, what makes it hang together and function? Second, economic

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theory helps society reach the economic goals that it has selected for itself. Society can
progress faster in achieving economic goals through knowledge of economics. Economic
theory makes economic analysis easy and understandable. Economic analysis, on the other
hand, helps us devise systems through which the common good can be individually and
socially defined and through which people can pursue their own interests while
simultaneously enhancing the wellbeing of others.

The following are some of the importance of studying history of economic thought:

1. The study of economic thought will help us to understand the origin of economics.
Such a study enhances one's understanding of contemporary economic thought.

Mark Blaug (1980) said that ―contemporary theory wears the scars of yesterday's
problems now resolved, yesterday's blunders now corrected, and cannot be fully
understood except as a legacy handed down from the past.‖

2. The study of the subject helps us to avoid the mistakes committed by earlier
economic thinkers; the vast amounts of analysis and evidence that economists have
generated over the decades can provide a closer check on irresponsible generalizations.
This should enable us to make fewer errors than in the past when making personal
decisions and when formulating national and local economic policies. Yet, numerous
unsolved problems and unanswered questions remain in economics. Our understanding of
past successes, errors, and dead ends will be useful in solving these problems and answering
these questions.
3. The study of history of economic thought will enable us to know the person
responsible for the formulation of certain important principles.

4. Through the study of economic thought one can realize that economics is different
from economists.

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5. The study of history of economic thought provides a broad basis for comparison of
different ideas. It will enable a person to have a well-balanced and reasonable judgment.

6. Finally, and above all, the study of the history of economic thought provides
perspective and understanding of our past, of changing ideas and problems, and of our
direction of movement.

It helps us appreciate that no group has a monopoly on the truth and that many groups and
individuals have contributed to the richness and diversity of our intellectual, cultural, and
material inheritance. A study of the evolution of economic thought and the changing social
background associated with it can light up changes in other areas of concern to us, such as
politics, art, literature, music, philosophy, and science.

CHAPTER TWO: Methodological Issues of

Economics
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2.1. Methodological Controversies in Economics and

Evolution of Various Methodologies

Methodology of economics is the study of methods, especially the scientific method, in

relation to economics, including principles underlying economic reasoning. It is about
―What do economists know and how do they know that they know it?‖ Such questions
belong broadly to epistemology, the study of human knowledge; in the philosophy of
science they are included in the subject ―methodology‖ because methodology significantly
influences what economists do, it is better to briefly consider the evolution of
methodological thinking and its influence on economic thought. Before you can begin to
study economic issues, you must decide what you will study and what approach you will
take you must make methodological decisions.
The study of methodology is addictive; it lulls you into thinking about what you are doing
rather than doing it.
Before introducing the Methodology of economics (how do economists know that they
know it) it would be necessary to specify what economists know. The answer to what
economists know has remained as an important point of distinction in methodological
differences among economists. There are generally three distinctly defined areas of
economics about what economists know. These are; the art of economics, positive
economics and normative economics.

2.1.1. Economics as an Art and as a Science

a) Economics is a science: Science is a systematized body of knowledge that traces the
relationship between cause and effect. Another attribute of science is that its phenomena
should be amenable to measurement. Applying these characteristics, we find that
economics is a branch of knowledge where the various facts relevant to it have been
systematically collected, classified and analyzed. Economics investigates the possibility of
deducing generalizations regarding the economic motives of human beings. The motives

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of individuals and business firms can be very easily measured in terms of money. Thus,
economics is a science.
Economics - A Social Science: In order to understand the social aspect of economics, we
should bear in mind that laborers are working on materials drawn from all over the world
and producing commodities to be sold all over the world in order to exchange goods from
all parts of the world to satisfy their wants. There is, thus, a close inter-dependence of
millions of people living in distant lands unknown to one another. In this way, the process
of satisfying wants is not only an individual process, but also a social process. In economics,
one has, thus, to study social behavior i.e., behavior of men in-groups.
Economics as a science adopts two methods for the discovery of its laws and principles, viz.,
(a) deductive method and (b) inductive method.
i) Deductive method: Here, we descend from the general to particular, i.e., we start
from certain principles that are self-evident or based on strict observations.
Then, we carry them down as a process of pure reasoning to the consequences that they
implicitly contain. For instance, traders earn profit in their businesses is a general
statement which is accepted even without verifying it with the traders. The deductive
method is useful in analyzing complex economic phenomenon where cause and effect are
inextricably mixed up. However, the deductive method is useful only if certain assumptions
are valid. (Traders earn profit, if the demand for the commodity is more).
ii) Inductive method: This method mounts up from particular to general, i.e., we
begin with the observation of particular facts and then proceed with the help of reasoning
founded on experience so as to formulate laws and theorems on the basis of observed facts.
E.g. Data on consumption of poor, middle and rich income groups of people are collected,
classified, analyzed and important conclusions are drawn out from the results.
In deductive method, we start from certain principles that are either indisputable or based
on strict observations and draw inferences about individual cases. In inductive method, a
particular case is examined to establish a general or universal fact. Both deductive and
inductive methods are useful in economic analysis.

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B) Economics is also an art. An art is a system of rules for the attainment of a given end.
A science teaches us to know; an art teaches us to do. Applying this definition, we find that
economics offers us practical guidance in the solution of economic problems. Science and
art are complementary to each other and economics is both a science and an art.
The art of economics concerns questions of policy. It relates the science of economics to
normative economics and asks questions such as: If these are one‘s normative goals, and if
this is the way the economy works, then how can one best achieve these goals? The
methodology of the art of economics is more complex because it concerns policy and must
address interrelationships among politics, social forces, and economic forces. In it one must
add back all the dimensions of a problem that one abstracted from in positive economics.

Positive vs Normative Economics

Positive and normative economic thought are two specific branches of economic
reasoning. Although they are associated with one another, positive and normative
economic thought have different focuses when analyzing economic scenarios.
Positive economics is objective and fact based, while normative economics is
subjective and value based. Positive economics is utilized as a practical tool for
achieving normative objectives. The methodological basis for a positive/normative
distinction has its roots in the fact-value distinction in philosophy, the principal
proponents of such distinctions being David Hume and G. E. Moore.

A. Positive Economics

Positive economics a branch of economics based on factual analysis and cause and effect
that avoids value judgments, opinions or moral and ethical statements. It (as opposed to
normative economics) concerns the description and explanation of economic phenomena
as well as their casual relationships.

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It focuses on facts and cause-and-effect behavioral relationships and includes the
development and testing of economics theories. An earlier term used for positive
economics was value-free economics.

The methodology of positive economics is formal and abstract; it tries to separate economic
forces from political and social forces.

Still, positive economics is commonly deemed necessary for the ranking of economic
policies or outcomes as to acceptability, which is normative economics. Positive economics
is sometimes defined as the economics of "what is".

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Positive economics as science concerns analysis of economic behavior. Positive economics
as such avoids economic value judgments. It concerns the forces that govern economic
activity. It asks such questions as: ―What is”, ‘How does the economy work‘? ‗What are
the forces that determine the distribution of income‘?

For example, a positive economic theory might describe how money supply growth affects
inflation, "The unemployment rate in France is higher than that in the United States." The
sole purpose of these inquiries is to obtain understanding for the sake of understanding,
but it does not provide any instruction on what policy ought to be followed. More examples
are:

• If the government raises the tax on beer, this will lead to a fall in profits of the brewers.

• The rising price of crude oil on world markets will lead to an increase in cycling to work.

• A reduction in income tax will improve the incentives of the unemployed to find work.

• A rise in average temperatures will increase the demand for sun screen products.

• Higher interest rates will reduce house prices.

• Cut-price alcohol has increased the demand for alcohol among teenagers.

• All African nations will qualify for the World Cup next time.

B. Normative Economics

Normative economics (as opposed to positive economics) is a part of economics that

expresses value or normative judgments about economic fairness.

It focuses on what the outcome of the economy or goals of public policy ought to
be. Many normative judgments are conditional in that they are given up if facts or
knowledge of facts change. Normative economic statements are opinion based, so
they cannot be proved or disproved. It is one that seeks to establish or relate to a
standard (norm) according to some principle or belief:

Example;

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• The price of milk should be $6 a gallon to give dairy farmers a higher living standard and to
save the family farm. This is a normative statement, because it reflects value judgments. This
specific statement makes the judgment that farmers deserve a higher living standard and that
family farms ought to be saved.

• The GDP of this country should be $10,000 per capita for 2018.

• What should be the inflation rate for this country?

• Higher inflation is bad.

• Mobile phones should be banned in all classes.

• All African nations should qualify for the World Cup next time.

• Government should provide basic healthcare to all citizens.

Normative economic statements are preferred by political leaders who purpose

solutions to economic problems or who wish to influence economic theory.

Positive and normative economics are often synthesized in the style of practical
idealism. In this discipline, sometimes called the "art of economics," positive
economics is utilized as a practical tool for achieving normative objectives.

2.1.2. The Importance of Empirical Verification

How we go about answering the questions ―What do we know?‖ and ―How do

we know that what we know is right?‖ depends on the answer to the question ―Is
there an ultimate truth that scientists are in the process of revealing (an absolutist
view), or is there no underlying truth (a relativist position)?‖ If there is ultimate
truth, how do we find it? If there is none, are some propositions more truthful than
others? Methodologists past and present have failed to reach consensus on these
problems but have generated an enormous amount of material on the subject.
Believing that an ultimate truth exists leaves one with the problem of deciding
when one has discovered it.

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The means by which the growing scientific world strove to discover the truth
involved trained empirical observation as exemplified in the scientific method.
This entailed the integration of reason with empirical observation. Although this
subject is far too complicated for us to elaborate, verification is discussed in detail
in the writings of Kant, Hume, Descartes, and other seventeenth- and eighteenth-
century philosophers. We will simply define three terms that have played an
important role in the discussion, inductive, deductive, and abductive. The first two
terms are well known. Inductive reasoning is empirical, proceeding from sensory
perceptions to general concepts; deductive reasoning (logic) applies certain clear
and distinct general ideas to particular instances. Because most philosophers
believe that knowledge derives from a mix of these, the debate usually centers on
the nature of the optimal mix.

―Abductive‖ is the name pragmatic philosopher Charles Peirce gave to a

particular mix of the inductive and deductive approaches. The abductive concept
is important for economics and other studies of complex systems. Abductive
reasoning uses both deduction and induction to tell a reasonable story of what
happened. It combines history, institutions, and empirical study to gain insight;
however, it does not claim to provide a definitive theory, because, when we are
dealing with a complex system, definitive theories are beyond our grasp.

Methodological issues have played major roles in the development of economic thinking,
but they quickly become complicated.

The Evolution of Methodological Thought

Let us now consider the evolution of methodological thinking and how it influenced
economics.

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2.1.3. The Rise of Logical Positivism

The methodology of science moved into the twentieth century with the
development of logical positivism, which provided the scientific method with
philosophical foundations. It established a working methodology expressing the
empirical and nonempirical aspects.

Logical positivism is a school of philosophy which arose in Austria and Germany

during 1920s, primarily concerned with the logical analysis of scientific knowledge.
Linked with deductive reasoning a logical positivist desires to let the facts speak
for themselves.

It originated with a group known as the Vienna Circle, which attempted to

formalize the methods of scientists by describing the methods scientists actually
followed. The logical positivists argued that scientists develop a deductive
structure (a logical theory) that leads to empirically testable propositions.
A deductive theory is accepted as true, however, only after it has been empirically
tested and verified. The role of the scientist, they said, is to develop these logical
theories and then to test them.

Although there was debate among the logical positivists as to what constituted
truth, all concurred that it would be discovered through empirical observation.
Logical positivism reigned in the philosophy of science only from the 1920s through
the 1930s, but its influence in economics continued much longer.

It was logical positivism that formalized the distinction between normative and
positive economics, first made by Nassau Senior in 1836 and later by J. S. Mill and
John Neville Keynes. This distinction is still retained in most introductory
textbooks, which describe economics as a positive science whose goal is to devise
theories that can be empirically validated. Normative discussions were purged
from economics as unscientific. According to logical positivism, there is no any

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method of discovering a hypothesis prior to its test by deducing empirical
consequences, and therefore a scientist can propose any hypothesis he prefers; only
logical relationships between the hypothesis and the given empirical evidence are
relevant.

2.1.4. Falsificationism
Logical positivism represented a culmination of the belief that the purpose of
science is to establish ―truth.‖ The methodology of science has since progressively
removed itself from that view. The first departure resulted from a concern about
the ―verification‖ aspect of logical positivist theory. This concern is best expressed
in the writings of Karl Popper, who argued in the 1930s that empirical tests do not
establish the truth of a theory, only its falsity—which is why Popper‘s approach is

sometimes called falsificationism. Karl Popper as founder of falsificationism

in his critical rationalism, a kind of historic fallibilism, stated that there is nothing
we can be 100% sure about; there is ALWAYS the chance of being wrong.

According to Popper, it is never possible to ―verify‖ a theory, since one cannot

perform all possible tests of the theory. For example, assume that a theory predicts
that when the money supply increases, prices will increase by an equal percentage.
Then assume that in an appropriate experiment the predicted result does in fact
occur. According to Popper, this indicates only that the theory has not yet been
proved false. The theory may or may not be true, since the next experiment may
produce a result that is not consistent with the theory‘s prediction.

Popper asserts, therefore, that the goal of science should be to develop theories
with empirically testable hypotheses and then to try to falsify them, discarding
those that prove false. The progression of science, according to Popper, depends
upon the continuing falsification of theories. The reigning theory will be the one

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that explains the widest range of empirical observations and that has not yet been
falsified.

2.1.5. Paradigms
It would be nice if methodological problems could be resolved as neatly as Popper‘s
approach suggests, but methodological debates are anything but neat.

More recent developments have moved methodology progressively away from

such neat distinctions. The modern rejection of Popper‘s theory is not without
grounds: falsificationism has several serious problems.

First, empirical predictions of some theories cannot be tested because the technology
to test them does not exist. What should one do with such theories?

Second, it is difficult to determine when a theory has or has not been falsified. For
example, if an empirical test does not produce the expected results, the researcher
can and often does attribute the failure to shortcomings in the testing procedure
or to some exogenous factor. Therefore, one negative empirical test often will not
invalidate the theory.

A third problem arises from the mindset of researchers, who may fail to test the
implications of an established theory, assuming them to be true. Such a mindset
can block the path to acceptance of new and possibly more tenable theories.

Partly in response to these problems, Thomas Kuhn, in The Structure of Scientific

Revolutions (1962), moved methodology away from falsificationism by introducing
the concept of the paradigm into the debate.
A paradigm, as Kuhn uses the word, is a given approach and body of knowledge
built into researchers‘ analyses that conforms to the accepted textbook
presentation of mainstream scientific thought at any given time.

Kuhn argued that most scientific work is normal science, in which researchers try
to solve puzzles posed within the framework of the existing paradigm. This work

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often leads to the discovery of anomalies that the paradigm fails to account for, but
the existence of such anomalies is not sufficient to overthrow the reigning
paradigm—only an alternative paradigm that is better able to deal with the
anomalies can do so. Once such a superior paradigm is developed, a scientific
revolution becomes possible. In revolutionary science, first the existing paradigm
is rejected by part of the scientific community, and then the old and the new
paradigms begin to compete and communication between researchers in the
opposing camps becomes difficult. Ultimately, if the revolution is successful, new
questions will be posed within the new framework and a new normal science will
develop.

Whereas in Popper‘s view ―truth‖ (or the closest we can get to truth) will win out, in
Kuhn‘s view a superior theory might exist but not be adopted because of the inertia favoring
the existing paradigm. Hence the reigning theory is not necessarily the best.

Those who disagreed with mainstream theory quickly adopted Kuhn‘s analysis,
because it suggested that the paradigm they preferred might prove to be superior
to, and thus able to supplant, the mainstream view. Moreover, Kuhn‘s work
suggested that changes occur by revolutions; it offered hope that change, when it
came, would come quickly. Although Kuhn focused on the natural sciences, he had
a significant influence on the social sciences, such as economics. Methodological
discussions throughout the 1970s and 1980s were peppered with the term
paradigm.

2.1.6. Recent Developments in Methodology of Economics

In one way, the developments we have just outlined move progressively away from
logical positivism, but in another way they are refinements of it that recognize the
limitations of empirical testing.
A much more radical departure from previous methodology can be found in Paul

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Feyerabend‘s Against Method: An Outline of an Anarchistic Theory of Knowledge
(1975). Feyerabend argues that the acceptance of any method limits creativity in
problem solving and that the best science is therefore to be confined to no
method—in other words, anything goes.

Though his radical argument at first seems crazy, he has provided some new
perspectives on knowledge that throw light on the rhetorical and sociological
approaches that have influenced recent developments in the methodology of
economics.

Although earlier approaches acknowledged the difficulty of discovering truth, they did
not question the Platonic vision of truth as absolute.

The rhetorical and sociological approaches do just that. Since they refuse to assume
the existence of an ultimate and inviolable truth, they search out other reasons to
explain why people believe what they believe.

The rhetorical approach to methodology emphasizes the persuasiveness of

language, contending that a theory may be accepted not because it is inherently
true but because its advocates succeed in convincing others of its value by means
of their superior rhetoric.

The sociological approach examines the social and institutional constraints

influencing the acceptability of a theory. Funding jobs and control of the journals
may have as much influence on which theory is accepted as the theory‘s ability to
accurately explain phenomena. Those who adhere to the sociological approach
contend that most researchers are interested less in whether the theories they
advance are correct than in whether they are publishable. What these two theories
most notably share is skepticism about one‘s ability to discover truth, or even
whether truth exists at all. According to these approaches, a theory has not

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necessarily evolved because it is the closest to the truth; it may have evolved for a
variety of reasons, of which truth—if it exists—is only one.

2.2. Methodological Conclusions

Methodological arguments in economics have generally lagged far behind those in
epistemology and the philosophy of science. According to most economics
textbooks, the reigning methodology in economics is still logical positivism, which
was long ago declared dead in other fields, as well as in the methodologically
oriented economics journals. But occasionally the economics profession goes
through a methodological spasm, looking inward and asking, ―Is this what we
should be doing?‖ It never fully answers this question but goes on as before, though
equipped with slightly updated methodological views. Even though methodology
is seldom discussed, ultimately it is methodology that accounts for many of the
differences among economists. Formalists are more likely to use a logical positivist
or falsificationist methodology and believe in an absolutist approach; non-
formalists are more likely to use a sociological or rhetorical approach and believe
in a relativist approach.

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CHAPTER THREE: ANCIENT IDEAS OF ECONOMIC THOUGHT

3. INTRODUCTION

The origin of economic thought is lost in the past. In its simplest form it must have always
existed wherever human beings sought to gain a living. Economic ideas of any definiteness
find their earliest expressions, however, in rules of conduct or moral codes formulated by
priests or lawgivers. These moral codes, like the Mosaic Law, for example, in dealing with
man‘s place in the world, with life and death, and the end of existence, necessarily touched
upon economic matters. Thus, our economic heritages as obtained from these simple
communities are rudimentary ideas about economic relationships within themselves. Also,
most of these ancient economic ideas are transmitted to us as an embodiment of religious
teachings, codes of law, and moral exhortations. The following are among ancient ideas of
economic thought.

3.1. THE HEBREWS

The Hebrew was a nation of ancient civilization whose history dates back to 2500 BC.

The main source of their history and ideas is the writings of the Hebrew prophets. Their
ideas are contained in the 'Rules of conduct'. The main theme of their education and the
chief concern of government was the observance of these laws and commands. The 'Old
Testament' is the most important and original source of information regarding their
economic thought.

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The economic ideas of the Hebrew prophets as expressed in their commands and laws can
be summarized as follows:

1. Usury or Interest: Although the prophets did not use the term „interest‟ they
prohibited usury or anything that is lent up on ‗usury‘. If the thing accepted in return was
more in value than what was given to the borrower, it was considered to be an act of usury.

2. Commerce and Just Price: There was hardly any place for middle men. The export
of food was prohibited and at times of scarcity and famine, hoarding of food grains was not
permitted.
All these provisions aimed at safeguarding the interest of the poor.
Thus, the Hebrews developed the basic concepts of ‗just price‘ in its rudimentary form.

3. Agriculture and Industry: Hebrews gave preference to agriculture. A Hebrew

maxim runs as follows, “Although trading gives greater profit, there may be loss in a
moment. Therefore never hesitate to buy land”. This shows that how agriculture had
become the supreme occupation. At that time the purpose of lawgivers was to fix the people
in agricultural life which was a settled one. There was a tendency on the other hand to
disregard trade and the mercantile community. Perhaps it is for this reason that Hebrews
did not enter into commerce and manufacture to any great extent. Hebrews held
agriculture and tilling of land in high esteem while they looked down up on trade. The
saying goes that ―he that tilled the soil shall have plenty of bread.‖ They did not
encourage manufacturing of goods and commerce to any considerable extent. It is, thus,
clear that their laws were conducive to the growth of agriculture while they discouraged
industry and trade.

4. Labor and Wages: The Hebrews regarded all kinds of labor dignified, but the pride
of place was given to the agricultural labor. There was no labour problem as we have these
days. Wage workers were common. They did not lay down rules for regulating the

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relationship between the employer and employee. The chief regulations were concerning
mercy and justice to them. Payments were made in kind.

5. Seventh and Jubilee Years: There was a very peculiar institution of Seventh and
Jubilee year among the Hebrews. The Hebrew prophets evolved a particular method of
regulating and restricting the alienation of land by instituting the seventh and the Jubilee
years.

i. The Seventh Year: was one in which land lay fallow, i.e. after tilling it for six
continuous years, the land was not to be cultivated for one year. They even attached some
religious sanctity to this measure but it was mainly designed to conserve the fertility of the
soil. The slaves serving for six years were freed in the seventh year. In this year all debts
should be cancelled.

ii. The Jubilee Year: meant the 50th year. According to this provision, the land
transferred to some ones to revert to its first owner in the fiftieth year. Thus, sale of land
really amounts no more than lease. In those days land was the main form of wealth.
They tried to prevent concentration of wealth and also the acquisition of land of small
holders by owners of large estates.

By the institution of Seventh and Jubilee year the Hebrews desired to prevent inequality in
wealth.

6. Value and Exchange: The value of a commodity depends up on its

usefulness and/or intensity of wants. The greater the intensity of wants for a
commodity, the more will be paid for it.

7. Interest and Money: The Hebrews seemed to have understood the

functions of money. Money was used mainly in the form of bullion. There was no
question of stamped money. While money serves as a medium of exchange it
cannot be regarded as productive.

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8. Sabbath: The Sabbath was the cornerstone of Hebrew Economic thought.
It was their weekly day of rest, relaxation and good living. It was enjoyed by the
masters of the house and his family as well as the slaves and the servants.
According to Spiegel, ―the institution of the weekend was a social invention that
has no parallel in the civilization of Greek, Rome or other ancient culture‖.

9. Property: Land was the main form of property. Wealth was measured in
lands, slaves, talents, silver, and other precious metals. The owner of a plot of land
was the owner of all resources above and below the surface of land.

According to the Law of Inheritance the first claim on property went to the eldest
son. If there was no son it went to the daughter and in the absence of a daughter
it might go to the close relatives like brothers, uncles etc.

10. Trade: In those days only surplus corn was sold in the market. The Hebrew
wives were Craft – Women who used to spin wool and flax. Commerce flourished
in the reign of King Solomon. He made successful voyages to distant lands,
including India.

11. Taxes: Taxes did not exist in the Hebrew economy. Labour service was
utilised for the construction of bridges, roads and other public utility services.
Customs and toll tax were also collected. The toll tax was known as a tribute
realized from every male for the maintenance of temples.

3.2. GREEKS

Which country of our planet is considered as the source of knowledge? And what is the
contribution of this nation to the development of economic thought?

Greeks are the pioneers in many branches of knowledge. In this regard it is not surprising
if they are the beginners of economic theory. Economic literature recognized that it is in

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the Greek writers that theorizing on economic matters first explicitly emerged. But they
did not contribute much to the growth of economic ideas. There was no demarcation
between politics, economics and ethics. Economics was viewed as a minor subsection of
ethics and politics and economic ideas were found in isolated fragments and mangled
remains. The Greek philosopher who really laid the foundation of economics as a science
was Aristotle. According to Eric Roll, ―Plato was the first of a long line of reformers
and his student Aristotle was the first analytical economist”.

Among the Greek writers who made some contributions to economic theory were Plato,
Aristotle and Xenophon. Let us see the contribution of these scholars to the development
of economic thought.

A. Plato (427-347 BC)

Plato was a Greek philosopher. He was born in Athens in an aristocratic family. He was a
pupil of Socrates. He taught mathematics and philosophy in the first great school of
philosophers – the

Academy, founded by him. His famous writings, ‗The Republic‟ and „The Laws‟ are the
most important sources of his economic thought. Though essentially an aristocrat, Plato
did not support his class. Moreover, he disliked Athenian democracy, because he abhorred
the excesses of commercialism with its entailing corruption, misery and general
degradation. He looked down, as did his fellow aristocrats, upon both manual labor and
the pursuit of wealth, but exalted the warrior, the statesman and those responsible for
agriculture.

His views are expressed in the form of dialogues. His main political and economic ideas
are found in the Republic written about 400 B.C. and Laws. His economic teachings are
incidental to the theories of politics and ethics.
In the Republic Plato proposed the establishment of an ideal city state, which would
inaugurate a new social order: communism. In such an ideal state there should be two

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classes: the rulers and the ruled. The former would be divided into guardians and
auxiliaries; the latter would consist of peasants and artisans or craftsmen who ought to be
excluded from political rights.

The exclusion from political rights of the ruled masses was based on Plato‘s belief that no
member of these masses, devoted as they were to menial work and the manual occupation
of production and exchange of wealth, could have the ability to manage the high duties of
citizenship and the capacity to run a government.

Both the guardians and the auxiliaries were not to possess any property nor have an income
beyond that which would be necessary for their maintenance.

Plato believed that the proposed system would produce ideal rulers - capable and honest
rulers. Plato argued that these rulers, through a well-devised educational system were free
from the degrading pursuit of wealth.

In the Laws, which, was written by Plato when he was older, he considered that the fall of
the ideal state would invariably be related to the accumulation of wealth and to the
inequalities and cleavages created thereby.

The elimination of private property from the ruling class is thus the cornerstone of Plato‘s
system.

The essence of Plato‘s thought is shortly summarized as follows:

1. State: Plato traced the origin of state to economic consideration. According to Plato,
―A state arises out of the need of mankind, no one is self-sufficing but all of us have
many wants‖. The state in order to supply the necessary commodities to satisfy human
wants gathered together.

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The members of the ruling class must be selected from among teen-agers and set apart
from early childhood, properly educated not only in philosophy but also in the arts of war,
since it would be their duty to protect the state from external attacks and internal disorders.
At the age of thirty, they would have to pass an examination and the successful candidates
would be the guardians or the philosopher-kings. Those who could not pass the
examinations would remain auxiliaries concerned with general administrative duties.

Plato distinguished five types of government:

1. Aristocracy – rule by the few and best.

2. Timocracy – rule by the soldiers.

3. Oligarchy – rule by wealthy men.

4. Tyranny – no one has discipline and society exists in chaos,

5. Democracy - rule by majority.

2. Division of Labor: At the first time, it is Plato who states the division of labor. He
attributed division of trade to the differences in nature and aptitude of human beings.

Each man specializes in a given field in which he shows special proclivity which amounts
to saying that specialization causes men to be no longer self-sufficient but inter-dependent
one on another. His idea of division of labor emanates (originates) from his belief that
‗there is diversity of nature among men and each should do what is natural to him.‘ It
means that everybody should do what is natural to him and leave the others.

3. Communism: It is Plato who state communism for the first time. Plato was not a
supporter of private property. In his earlier works, Plato espoused communism and has
proposed a state based on communism. Plato‘s ideas regarding communism are
extremely remarkable.

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Plato‘s communism is the most talked about and misunderstood part of his philosophy. But
later, he abandoned the idea to a more realistic approach to economic life.

Communism is a social and economic system in which the state owns and controls
the means of production on behalf of the people. It is aimed to create a society in
which everyone is paid & work according to their needs and abilities.
4. Size of Population: The problem of population was also analyzed by Plato. The size of
population in his state was assumed on the basis of the best results of division of labour.

He provided a careful regulation of population to maintain stability in the economy. The

right number of population suggested by Plato for a state was 5040. Only such a number
provided opportunity for everyone to be familiar with all the other persons and help the
economy to achieve self-sufficiency. It also helps to reap maximum productive efficiency.
If the number showed a decreasing tendency, the state should offer prizes to encourage the
growth of population. But if the number exceeds 5040 new colonies must be established.

5. Value: He considered value as inherent quality of the product. According to him a man
should not attempt to raise the price, but simply ask the value.

6. Money and Interest: Plato recognized the value of money as medium of exchange. He
did not favor the idea of allowing gold and silver to be used by the common men.
Instead he suggested the use of domestic coins for payment of wages and other
transactions. As regard to interest, he thought that neither interest should be given nor
the principal or a loan repaid.

7. Wealth: He opposed accumulation of wealth on ethical grounds. According to him,

‗Great riches and happiness are incompatible‘. To him great riches and happiness cannot
exist together because the rich people spend a part of their wealth without any justice.
Plato had suggested an ideal property arrangement. Only farmers and artisans were

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allowed to get property while the rulers and the administrators were not allowed to enjoy
the property rights.

8. Education: Plato stated that both boys and girls should receive the same kind of
education.
His idea on education is more important in the modern days.

B. Aristotle (384-322BC)

Aristotle was born at Stagaria and was a pupil of Plato. He went further than other thinkers
in antiquity in the direction of detaching a separate science of Economics.

Aristotle was the first analytical economist who laid the foundation of the science of
Economics. Although he did not write any separate treaties on economics, many of his
discussions were centered on economic problems.

The following are the theme of Aristotle‘s economic thoughts.

1. Idea of state: According to Aristotle the state originates out of the needs of
mankind. He explains the origin of the state in terms of household. The household is an
association formed to satisfy the wants of the family members. The village grows out of a
number of households and finally the state comes into existence.

Man is by nature a social animal, so the state is possible because all men live together in a
society. The aim of the state is promotion of good life. Thus, Aristotle attributes the origin
of the state to economic and political causes.

2. Private property: While Plato advocated public property Aristotle supported the
institution of private property. Aristotle argued that public property would not be looked
after as carefully as private property. According to him, a system of communism would not
work and that it violates natural human instincts. Private property is more productive than
public property. Hence, Aristotle said that property should be private. When there is

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private property they will make much progress because everyone will be attending to his
own business. It was his belief that people pay most attention to their own private property.

He argued that unity built on communism is in fact a delusion /illusion. The common purse
leads to quarrels arising out of trivial causes (because human beings take care for their own
property than they do for common property). In contrast to Plato, he was for private
property.

3. Slavery: Aristotle was the supporter of slave and he defended slavery. According to
him, ―the principle of rule and subjugation is inevitable and beneficial.‖

He meant that ‗Slaves are not only inevitable but also beneficial.‘

According to him, there were natural slaves and there were also legal slaves. By natural
slaves he meant that those that are regarded by the society as naturally inferior. His legal
slaves include those that are imprisoned or captives. But, he concentrates up on natural
slaves.

4. Finance: His discussion on finance was related to the acquisition of wealth (method
of wealth acquisition). Aristotle distinguished three kinds of finance: Natural (healthy)
finance, Unnatural finance, Intermediate finance.
i. Natural finance: refers to the acquisition of wealth through natural ways. According
to him, the wealth through natural finance is a genuine wealth and has a limit. This limit
is provided by the means of subsistence, by the needs of the household, and the state. His
natural finance includes activities like farming, husbandry and bee keeping.

ii. Unnatural finance: refers to the acquisition of wealth through those methods that
do not have natural existence. Unnatural finance doesn‘t belong to domestic economy but
natural finance belongs.

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According to Aristotle unnatural finance is merely money making. It belongs to trade and
this trade comprises commerce, usury and hired labor. Wealth acquired through unnatural
finance doesn‘t have a limit.

For Aristotle, usury is the worst form of finance. He said the function of money is merely for
the exchange and nothing more. For him, money is sterile, unproductive and barren (not
producing anything without success or useful result). Usury is condemned because it
doesn‘t have any natural finance.

iii. Intermediate finance: comprises something common to each of the others. This
finance is concerned with the product of the earth such as wood cutting, and mining
(extractive industries).

5. Interest: According to Aristotle interest taking was the most unnatural of all the
methods of getting wealth. Money served only as a medium of exchange, it cannot be
regarded as productive. As one piece of money could not produce another, interest was
unjust.

Money had no business to increase from hand to hand. In those days money was borrowed
by the poor persons for consumption purposes and therefore interest taking was considered
unjust.

6. Monopoly: Aristotle defined monopoly as a position in a market of a single seller.

He condemned it as unjust.

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C. Xenophon (434-355BC)

Xenophon was the third in the chain of the great writers. Xenophon become a pupil of
Socrates but preferred a military life to the quiet life of scholarly pursuit. In spite of his
active military life, he could find time for composing literary works.

The main points raised by him that may be regarded as economic thought are summarized
as follows:

1. Wealth: Xenophon held that wealth like any other commodity had value for those
who make adequate use of it. According to Xenophon, wealth is interpreted in relation to
needs. To him, a man of simple tastes and little substance is wealthy in comparison with
the man of greater processions on who excessive claims rest.

The implication of Xenophon‘s argument is that even if a man possesses much wealth when
compared to the society, if his needs are greater than his money, he is no more rich.

2. Agriculture: Xenophon wrote in praise of Agriculture. He considered agriculture to

be the simplest art to learn, the source of all things and the quickest to yield returns.

Emphasizing the importance of agriculture, he declared that ―When husbandry flourishes,

all the other arts are in good shape, but whenever the land is compelled to lay waste, the
other parts of landsmen and mariners perish.‖

This is to say that the base of an economy is agriculture.

3. Factors of Production: According to Xenophon, there were only two factors of

production, labor and land. He said that agriculture supplies good things in plenty, but ‗it
suffers them not to be won without work hard‘.

4. Law of Returns: Xenophon showed an understanding of the operation of the law

of returns. He held that agriculture was an industry subject to diminishing returns while
silver mining yielded increasing returns.

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Regarding the diminishing return of agriculture, he said that the landowners could tell you
how many team and how many labors are required for their estate. If anyone employs hands
in excess of requirements, it is reckoned as a loss. Regarding the increasing return of silver
mine, he said that the greater the number of people employed, the more prolific becomes the
ore.

Although he is not the first man to explain the law of diminishing returns, he approaches
or seems to it in a fumbling way.

5. Joint Stock: In order to overcome the risks inherent in opening new silver mines,
he suggested something approaching to a joint stock method of operation.

He thought that joint stock companies are safer than the individual enterprises. In his
opinion there should be a happy combination of public and private enterprises running
with mutual cooperation and goodwill.

6. Public Finance: He saw foreign residents as a source of revenue. He said in peace

time, wealth (revenue) is accumulated and in war time it is lost.

7. Division of Labor: Xenophon showed a definite advance over Plato‘s idea that
division of labor arose from differences in the innate abilities of men. One can even discover
the roots of the modern theory of division of labor in Xenophon.

This will be evident from the following lines in his works:

And it is of course, impossible for a man of many trades to be proficient in all of them. One
man, for instance, makes shoes for men and the other for women; and there are places even
where one man earns a living by only stitching shoes, another by cutting them out, another
by sewing the uppers together, while there is another who performs none of these operations
but only assembles the parts.

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It follows, therefore, as a matter of course, that he who devotes himself to a very specialized
line of work is bound to do it in the best possible manner.

3.3. ROMANS

The contribution of Romans to the development of economic thought is very little.

Whatever contributions Rome made to theories is an echo of Greece.
That is why the Roman writers were not considered as the original thinkers. But
they are practical men. For instance, while the Greeks produced a philosophy
which strengthened the moral and economic fiber of societies, the Romans shaped
legal and political institutions with great finesse. Hence, Romans are known not
for their theory but for their practice. They had some but still the contributions of
these writers were very small and most of it is the repetition of what is said by
Greeks.
The contribution of Rome to the discussion of economic topics falls under three groups.
These are:
- The philosophers: Cicero, Seneca and Pliny
- The agricultural writers: Cato, Varro and Columella.
- The jurists: there are a host of people whose ideas have economic significance

a) Philosophers
Cicero (106-43 BC)
- Cicero attached great importance to agriculture as an occupation but conceded
the value of wholesale trade.
- He strongly condemned usury and money lending. Usury was condemned not on
any ethical or economic grounds but because it incurred ill-will.

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Seneca (c4BC- c65AD)

- Seneca views money as root/source of all evils. He despised money lending
and advocated simplicity of life. For him, envy and greed are the source of all
injustice. - He argued that some things have greater value than their price and hence
utility should be the criterion for determining exchange value.
- He recommended geographical division of labor on the ground that various
quarters of the earth are endowed differently with natural resources.

Pliny (23–79 CE)

Pliny is also a rich source of agriculture and horticulture. Grapes and wine are
discussed in rich detail with reference to 91 varieties of grapes, 50 kinds of local
wines; 38 foreign wines, and 18 sweet wines.

b) Agricultural Writers
The agricultural writers (Cato, Varro and Columella) had the highest regard for
agriculture. But they were concerned about all the technique of agriculture and
less with the economics of agriculture.
Marcus Porcius Cato (234–149 BCE): Cato the earliest of the Latin writers is
known as Cato the Censor based on his position as a Roman Magistrate. Cato had
written more on the technical aspects of agriculture. Cato was a prolific author and
is regarded as the father of Latin prose. However, the only complete works of his to
survive are a loose collection of agricultural instructions and advise, in essence a
farmer‘s notebook, about the care of farm estates
Marcus Terentius Varro (116–27 BCE): Varro advised crop growing and livestock
breeding. Agriculture was viewed not as an industry run for profit, but as a problem
of domestic economy. Although he has not used the term ‗demand,‘ Varro has

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recognized its importance in the determination of the amount of goods to be
produced.

Lucius Junius Moderatus Columella (1st century CE): The works of Columella
are considered to be the most comprehensive and systematic of all Roman
agricultural treatises of Roman.

c) The Jurists
The Roman jurists were the most original Roman thinkers and chiefly concerned
with the framing of laws and evolving doctrines to regulate the commercial
mechanism of Rome. In this regard, they produced a law which is popularly known
as the Roman law.
In relation to the Roman law; we can talk about two points.
Roman jurists recognized very well the importance of money as medium of exchange.
They treated money like a commodity whose value was more or less changeable and
essential to its function. In general they were opposed to interest taking, especially to
usury. But no legislation could undo this evil.
To summarize, it can be concluded that the Romans added little to the stream of
economic theory. But it might be admitted that their importance as a medium for
such thought is great.
Overall, then, economic enquiry during antiquity did not grow fast as compared to its
development in the recent era.

3.4. MEDIEVAL ECONOMICS AND FEUDALISM

The period between 470AD to 1453AD, covering about ten centuries is generally known as
the medieval period or the Middle Ages.
The Middle Ages came to a close towards when Europe witnessed the advent of the
Reformation and the discovery of the New World. The end of the Middle Ages also marks
the beginning of Modern Times.

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The downfall of the Roman Empire and the disintegration of its vast territorial possessions
were followed by the emergence of the Feudal System throughout Western Europe.
Medieval society, where the dominant form of economic organization is feudalism, has its
essence in the class division between the Lords and the Serfs which is a derivation from the
structure of latter-day Rome.
The feudal society of Medieval Europe was one in which all authority was derived from God
by the church, which was headed by the Pope. The king of a land or region delegated power,
responsibility, and land grants to his royal subordinates (nobles, barons, lords, etc.).

SCHOLASTICISM
Scholasticism (The Schoolmen) refers to the school of economic thought that developed
in Europe during the medieval period (500-1500). Scholastic thinkers are known for their
moral and philosophical approach to the study of exchange, value, and ownership within
the context of the time period. Until the arrival of Mercantilism in the 14th century the
Scholastics (or Schoolmen as they are commonly referred to today) were at the forefront of
the foundations of establishing economic theory within the framework of philosophy.

Probably the most influential economic thinker of the Scholastic period was a Sicilian-born
Roman Catholic by the name of Thomas Aquinas.
The authoritative version of the medieval economic ideas is found in the works of St.
Thomas Aquinas and Nicole Oresme. But the most known one of scholastic period is St.
Thomas Aquinas.

St. Thomas Aquinas

Saint Thomas Aquinas (1225–1274) was an Italian Catholic Priest and one of the most
important medieval philosophers and theologians. He was immensely influenced by
scholasticism and Aristotle. Although he wrote many works of philosophy and theology
throughout his life, his most influential work is the Summa Theologica.

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St. Thomas‘s views on all economic matters were highly influenced by Aristotle &
Christianity. The influence of Christianity: An important implication of Christianity is
the principle that men are equal in the sight of God; (that is, all men are children of a
common father, and hence brothers with immortal soul and of equal value in eternity.)
Christianity‘s belief that this world is the preparation to another world led St. Thomas to
state that ―even a slave may enter the kingdom of Heaven”.
The views of St. Thomas were, therefore, the admixture of the teachings of the Bible and
the philosophy of Aristotle.
His views in particular and the scholastic writers in general, can be briefly stated as follows:
1. Role of the state: According to St. Thomas Aquinas, the State was for the
maintenance of population, provision of the poor, establishment of safe and free roads, and
regulation of currency. The regulation of currency was thought necessary because a slight
change in its quantity might affect its price (which was later/in the modern era developed
as the quantity theory of money).
2. Exchange and Value: To Aquinas the issue of exchange was of significant
importance in barter situations. It was his belief that the measure of exchange between
heterogeneous goods indicated that some value must be placed on each good and that an
ethical dilemma would arise. The only just exchange would be that of two identical goods
for the same quantity, but this would be redundant; therefore, some value would have to
be established for the goods in order for the exchange to be just to both buyer and seller
(or in his case traders, being that little to no market existed for surplus commodities). This
posed, for him, the ethical aspect of prices, raising issues of equity and justice‖.
3. Prohibition of usury: Of course this concept was explicitly started in the Aristotle‘s
period but has also borrowed ideas from the teachings of Christianity. The bible teaches
that a Christian should lend hoping for nothing again.
When the question first emerged, usury was forbidden only to clerics or clergy; and later
prohibition was made general.

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In the hands of St. Thomas Aquinas usury involves an offence against justice. His argument
rests on the distinction between those items for which use and consumption cannot be
separated and those for which they can be separated.
 Wine & Bread: use and consumption are identical.
 Car & House: Use and Consumption are different.
 Money: use and consumption cannot be separated. In money borrowed, ownership
is transferred. It is paid for the holder.
In the case of money, he argued, use and consumption are inseparable. St. Thomas further
argues that a loan of money is in fact bound to be a sale (a change of ownership); you can‘t
sale the use of money.
As it is inadmissible to sell bread to a man and simultaneously charge him for the use of it, so
it is inadmissible to sell money and charge also for its use. The proper price is the return of
the same money; the additional charge for its use is of the nature of swindle/fraud.
4. Good and Justice: Central to the theories of the Scholastics is the notion that man
is directed through his interactions with his society by free will, and autonomy. This moral
philosophy has been introduced into economics by Aquinas, Adam Smith, J.S. Mill, and
Karl Marx to name a few. ―It is a matter of common experience that our conduct is
motivated by different aims: riches, honor, material pleasure, social positions, etc.‖
5. Private property: He holds that ―possession is natural to man‖. Private property
is not contrary to the natural law; rather it is added to natural law by a further creation of
human reason.
St. Aquinas distinguished the two kinds of rights which men may have in
things: i. The right to acquire and administer property – private ii. The
right to use – communal
6. Just price: The Scholastics preached the concept of 'just price'. The two cardinal
economic doctrines of the middle ages are found in the notion of just price and the
prohibition of usury. A just price is the price equivalent to that the producer needs to live

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according to his rank; that is a price that suitably supports the producer according to his
rank.
The idea of just price emanates from the understanding that we are brothers and should
behave as brothers, respecting each other‗s right and positions of life; hence each should
receive that to which he is entitled. No one, under any circumstances, should take
advantage of his neighbors.

3.5. MERCANTILISM

3.5.1. Introduction

Mercantilism is economic nationalism for the purpose of building a wealthy and powerful
state.
Adam Smith coined the term ―mercantile system‖ to describe the system of political
economy that sought to enrich the country by restraining imports and encouraging exports.
This system dominated Western European economic thought from the 16th to the late 18th
centuries.

The goal of Mercantilist policies was, supposedly, to achieve a ―favorable‖ balance of trade
that would bring gold and silver into the country and also to maintain domestic
employment. The mercantile system served the interests of merchants and producers such
as the British East India Company, whose activities were protected or encouraged by the
state.

The most important economic rationale for mercantilism in the 16th century was the
consolidation of the regional power centres of the feudal era by large. Other contributing
factors were the establishment of colonies outside Europe; the growth of European
commerce and industry relative to agriculture; the increase in the volume and breadth of
trade; and the increase in the use of metallic monetary systems, particularly gold and silver,
relative to barter transactions.

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During the mercantilist period, military conflict between nation-states was both more
frequent and more extensive than at any other time in history. In exchange for paying levies
and taxes to support the armies of the nation-states, the mercantile classes induced
governments to enact policies that would protect their business interests against foreign
competition.
Thus, mercantilist writers were essentially practical businessmen, merchants and
administrators in various European countries like England, France, Italy, Germany,
Scotland, and Spain etc.

The ideas and policies which dominated the economic scene of England 'and a part of
Europe between the close of the 16th century and the middle of the 18th century can
rightly be called as mercantilism. Mercantilist writers put emphasis on foreign trade as a
means of accumulating treasure and building a strong nation.

3.5.2. Factors responsible for the rise of Mercantilism

The growth of Mercantilism was the result of combination of factors like cultural, religious,
political and economic factors. In the beginning of the 16th century Europe witnessed
great religious and intellectual awakening due to Reformation and Protestantism. These
two movements associated with the names of Erasmus and Martin Luther respectively
which gave a great stimulus to the ideas of individualism and personal freedom and went a
long way in developing the concepts of property and contract rights which in turn led to
the growth of commerce and free exchange.

Renaissance played even more significant role and highlighted the element of humanism.
It challenged the medieval theologian concept that happiness in heaven should be
preferred over worldly happiness, and asserted that happiness on this earth was to be
preferred over the promised pleasures of the other world.

The important factors are given in detail below:

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(1) Economic Factor: Towards the end of the 15th century, economic changes
were taking place in European countries. The important economic change was the
decline of feudalism and its gradual replacement by Commercial Capitalism. The
market economy was slowly emerging, replacing the feudalistic self-sufficient local
economy.
Agriculture was being replaced by trade and commerce.
Monetary transactions were rapidly expanding. The feudal society was rapidly
breaking up and commercial system was gradually evolving. This paved the way
for the rise of a commercial system using money.
(2) Political Factors: The major political change was the transition from
feudalism to nationalism.

Building up a strong nation state was in the forefront. In many European countries
feudalism was superseded by the formation of nation states.
These countries required a strong Government. The merchants and trading
community were looking forward for a strong centre to protect them from rivals
and to nourish their trading interests.
(3) Religious Factors: The ideas of Reformation and Protestantism spread
individualism and personal freedom. The Reformation movement revolted against
the supremacy of Roman Catholic Church and the authority of the Pope. These
religious changes helped a lot in developing property rights and contract rights
which were essential for the growth of commerce.
(4) Cultural Factors: Medieval theology laid emphasis on heavenly happiness.
It preached the people to detach from material wealth. Against this two important
cultural changes arose in the society. They are renaissance and humanism. These
cultural changes gave emphasis to creative human activities, acquisition of wealth,
and trade and commerce. This new ideology was able to uphold the spirit of the
traders and merchants to accumulate wealth.

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(5) Discoveries and Inventions: Various discoveries and inventions played
an important role in the promotion of trade and commerce and helped the
development of mercantilist thought. Eg. invention of Mariner's compass,
Columbus Discovery of America, Discovery of Gold and silver mines in the new
world, the invention of printing press, new sea route to India etc. helped a lot for
the expansion of foreign trade and development of foreign markets.
All the above factors helped the growth of mercantilism which was a new adventure
in the direction of the commercial merchant capitalism in the European countries.

3.5.3. The analytical contributions of mercantilists to the economic theory

(1) Concept of Nationalism: The mercantilist emphasized on national strength

and prosperity. The building up of a nation state was put in the forefront. State
intervention was an essential part of mercantilist doctrine. Economically expansion of
commerce and trade and politically success in war were their natural goals.
This can be achieved only by a strong Nation built upon the spirit of nationality. Thus
the mercantilists demanded a state to be strong enough to protect the trading
interests.
(2) Importance of Treasure: To the mercantilists the most important concern
was the strength of the country. To the mercantilists the strength of his country
depends upon the stock of wealth which the nation possesses. By wealth they mean
the stock of precious metals. According to the mercantilists the great and ultimate
effect of trade is not wealth at large but particularly abundance of silver, gold and
jewels, which are not perishable. Hence the mercantilist attached great importance to
treasure and bullion as the most useful and generally accepted form of wealth. The
important slogans raised at the time were “gold more gold, wealth more wealth”.

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(3) Foreign Trade and Balance of Trade: The mercantilist considered treasure
(Gold, Silver, precious metals) as wealth par excellence.
The mercantilist considered foreign trade as the only source for acquiring gold
and silver. In respect of its exports a country must receive payments in the form of
silver or gold. In order to increase the supply of Bullion in a country, it is necessary
that there be a ―favourable balance of trade‖ represented by excess of export, over
import. So it is easy to conclude that all exports in the nature of goods are good
and desirable whereas all imports are evil and damnable.
(4) Industrial and Commercial Regulations: The mercantilists followed a
number of policies in order to maximize the net gain from foreign trade.
The main strategy is to increase the production of exportable commodities in the
domestic economy and to reduce the import of articles from foreign countries. In
order to maximize output in the domestic economy, the mercantilist suggested the
following methods/procedures.
(a) Land resources may be fully utilized and fallow lands may be brought under
cultivation.
(b) Employment opportunities should be increased, so that unemployed human
resources can be utilized for increasing production of goods meant for export. (c) Better
method and technique of production should be introduced in the production process.
(d) In order to increase production and employment, 'the mercantilists advocated a
system of low wage level.
(e) Colonies can be utilized as source of raw materials to the mother country. Along
with this a series of trade regulations and policies were framed by the mercantilists.
These policies were aimed at export promotion and import restriction. The
important among them were:
(a) Restraints on the importation of foreign goods especially manufactured goods
(b) Encouragement to the export of manufactured products
(c) Restriction on the export of raw materials

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(d) Restriction on the industries which interfere with other industries or trades of greater
national importance.
(e) Ban on the export of bullion
(f) Establishment of banks and the promotion of use of credit instruments.
(5) Role of Government
In order to execute all their schemes and programs, the mercantilists looked to a
benevolently paternal government which can interfere everywhere. There was
nothing the government ought not to do, if its activities help to promote the
general wellbeing. The control and regulation of the government are essential for
the attainment of favourable balance of trade. Almost all kind of protectionist
arguments are available in the mercantilist writing.
The mercantilist protection argument can be summed up as follows;
(a) Protection may be granted to strategic industries. These industries which are strategic
for the nation both in terms of their export contribution and also in terms of their
contribution to economic development can be earmarked by the government of the
country.
(b) Protection may also be granted to the weak but promising industries which were at
the- infant stage of growth.
(c) Protection may also be granted to the defense industries
(d) Protection may be given for industries which help for the attainment of selfsufficiency
and self-reliance for the country.
(e) Protection may also be given to industries which are engaged in producing import
substitutable and export promoting goods.
(6) Ideas on Money: In mercantilist writing an important role was assigned to
money. Money was desired to be used as a medium of exchange. Just as an
individual saves out of his income, a country must spend less than its income, if it
wants to increase its wealth. To the mercantilist wealth of a nation lay in its

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productive capacity. Mercantilists disfavored the idea of accumulating money as
treasure. Thus, mercantilist maintained the doctrine that money stimulates trade.

3.5.4. Particular Economic Theories

(1) Value: Value was inherent in commodities and depends upon human needs. Value
was regarded as a market phenomenon, which depends upon exchange. Mercantilists
distinguished between two types of value. That is intrinsic value and extrinsic value.
Intrinsic value is the power of the commodity to satisfy human wants. By extrinsic value,
the mercantilists mean only the cost of production. William Petty clearly mentioned that
value depends upon expenses of production. According to him market value was the
extrinsic value of commodity which fluctuated according to a rise or fall in the supply and
demand.

(2) Production: According to mercantilists, production was a process of application of

human labour to resources and hence they advocated an increase of labour and resources.
Mercantilists regarded agriculture as insignificant. They believed that foreign trade alone
was the, roost productive. They made a distinction between productive and unproductive
labour. The labour of a merchant, a manufacturer and a farmer was considered productive.
Labour of professional persons like doctors, stock brokers and shop keepers was considered
unproductive.

(3) Taxation: The views of mercantilist on taxation were quite interesting.

Mercantilists favoured a multiple tax system based on the basic principle of each should
pay according to the benefits received from the state. They held that man should be taxed
according to the expenditure incurred by him, in his opinion; a tax on expenditure is the
most equitable.
Generally speaking the mercantilists favoured law customs, excise duties, a tax on interest
etc. Their chief cannon of taxation was that of equity.

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(4) Population: Mercantilist favoured increasing population for maintaining military
strength. It was also advocated for increase in productive capacity of the economy. They
believed that cheap and abundant supply of labour would help in keeping the cost of
production at lower levels. They encouraged family life and parenthood.

(5) Interest: There was no uniformity of opinion regarding the interest concept.
Thomas Mun, Locke and North favoured interest taking in money lending. According to
them money lending provided the necessary capital to the poor merchants. Further it also
led to gainful employment of the saving of widows, orphans and others. But the
mercantilists were opposed to high rate of interest.

3.5.5. Important Mercantilist Writers

Sir William Petty (1623-1685)

Petty is regarded as the founder of political economy. He is remembered for his

contribution in the field of statistical methods and economic theory. He was the first to
develop a fact finding approach on economic enquiry. As a statistician Petty confined
himself only to the employment of quantitative data and used simple average as the
statistical technology. His most famous work was the Treatise of taxes and contributions
(1662).

Thomas Mun (1571-1641)

He was born in England in 1571. He was a merchant by profession. His famous book is
England's Treasure of Foreign Trade. Mun was responsible for shaping the trade policies
of England during his time. He advocated the fundamental rule of International Trade. To
him the rule of international trade should be ―to sell more to strangers yearly than we
consume of them in volume.‖

He was an ardent believer of nationalism and a strong govt. This according to him would
be realized only by accumulation of treasure.

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He suggested imposition of heavy import duties on goods meant for domestic consumption
and moderate duties on export. He also recognized the importance of taxation.

David Hume (1711 -1776)

Hume was a close personal friend of Adam Smith. Hume could be called a liberal
mercantilist; he had one foot in mercantilism, but with the other stepped forward into
classical political economy. In international trade theory Hume‘s contribution has become
known as the price specie-flow mechanism. Hume pointed out that it would be
impossible for an economy to maintain a favorable balance of trade continuously, as many
mercantilists advocated. If one country has a favorable balance of trade, some other country
or countries must be having an unfavorable balance.

Richard Cantillon (1680 -1734)

Cantillon was part mercantilist (mostly in his views on foreign trade), part physiocrat (in
his emphasis on the primary role of agriculture in the economy), and part physiocrat-
classical (in his vision of the interrelatedness of the various sectors of the economy).
Cantillon defined wealth as everything that gives satisfaction and labour and capital as the
true source of wealth. Capital was regarded as a dependent factor produced jointly by land
and revenue. In his discussion on value, Cantillion defined normal price of a commodity as
'a measure of the quantity and quality of land and labour entering into its production.
Cantillon's most significant contribution was in the field of money. He analysed the
relationship between money supply and price level.

3.5.6. Criticism of Mercantilism

Mercantilism was severely criticized. Towards the end of 17th century, the mercantilist
theories and practices were strongly opposed by many writers who championed the cause
of individual liberty and agricultural productions. Severe criticisms were leveled by the

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physiocrats and Adam Smith. The following criticisms were leveled against mercantilism
by the opponents:

1. The mercantilists exaggerated the importance of Commerce to the extent of depressing

agriculture and other branches of human industry.

2. Undue importance was attached to gold and silver.

3. They were under erroneous belief that a favorable balance of trade alone would bring
prosperity to the country.

4. Their idea about value, utility capital and interest were vague and imperfect.

5. They are narrow minded nationalists and not cosmopolitans. They could not conceive
the ideas of mutually advantageous trade.

Mercantilism leads to TIT FOR TAT POLICIES – high tariffs on imports leads to retaliation
(take revenge for a wrong action).

The growth of globalization and free trade during the post-war period showed possibilities
from opening markets and respecting other countries as equal players. Economies of scale
from specialization possible under free trade.

However we cannot dismiss their ideas as useless or impractical. The idea of nationalism,
selfsufficiency and economic strength were the outcome of their policies. The mercantilist
policy proved successful in France, England, Holland and Germany who were competing
for colonial supremacy.

3.6. PHYSIOCRACY
The Physiocrats were a group of economists who believed that the wealth of nations was
derived solely from agriculture or land development. Their theories originated in France
and were most popular during the second half of the 18th century.

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Physiocracy was perhaps the first well developed theory of economics. Physiocrat is derived
from the Greek for ―Government of Nature‖.
The principles of Physiocracy were first put forward by Richard Cantillon, an Irish banker
living in France, in his 1756 publication Essai sur la nature du commerce en géneral
(Essay on the Nature of Commerce in General).
The ideas were later developed by François Quesnay into a more systematic body of thought
held by a united group of thinkers.
The Physiocrats saw the true wealth of a nation as determined by the surplus of
agricultural production over and above that needed to support agriculture (by feeding
farm labourers and so forth). Other forms of economic activity, such as manufacturing, and
other non- agricultural activities were seen as 'sterile' in that their income derives
ultimately not from their own work, but from the surplus production of the agricultural
sector.
The Physiocrats strongly opposed mercantilism, which emphasized trade of goods between
countries, as they pictured the peasant society as the economic foundation of a nation's
wealth.

3.6.1. Factors Responsible for the Rise of Physiocracy

Physiocracy was a revolt against mercantilism in France. This was due to the deteriorating
economic and social conditions at that time which were chiefly due to mercantilist policies.
The various factors responsible for the growth of physiocracy in France are enumerated
below.
1. Tyranny and Extravagant Court Life
France was experiencing an absolute monarchy but without its potential benevolence. The
life of the political administrators, from the king downwards, was very luxurious and
corrupt.
Public expenditure was very extravagant and wasteful.

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2. Regressive Taxation
In France, during the reigns of Louis 14, taxation was unduly heavy, unjust and inequitable.
The nobility and clergy owned about two-thirds of the country's land, but they were hardly
paying any taxes while the poor peasants were being crushed under all sorts of levies in
addition to the extortionist land rents. The manner of tax collection was also highly
deplorable. Obviously the farmers were hardly left with any surplus which they could use
for improvement of land or for improving their own consumption standards. The peasants
also had to bear the burden of providing services to the feudal lords. 3. Reaction against
Mercantilist Policies
Mercantilist policies gave undue emphasis to trade. In England an agricultural revolution
was taking place due to large scale farming. The works of several English writers were
translated into French. This provided an opportunity to the French thinkers' to understand
the progress of Great Britain, which depended to a great extent upon agricultural activities.
The people were in search for an alternative system which could substitute mercantilism.
This system was provided by physiocracy.
4. Neglect of Agriculture:
Agriculture in France was in a state of stagnation compared with its increasing usefulness
and profitability in England. Industrial development was taking place in France at the cost
of agriculture. Investments were diverted from agriculture to manufacture.
The value of agricultural produce fell on account of restricted markets. Lower prices of
agricultural products prevented capital accumulation in agriculture.

5. Emergence of a Group of Ambitious Agriculturists

In France a group of ambitious agriculturists and landlords started seriously thinking of the
development of agriculture in France. They did not tolerate the suppression of French
agriculture by king.

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6. Subjective Factors
There were great subjective factors at work for change and progress discarding mercantile
policies. During the period of Louis XIV, the people could not criticize his policies.
After his death the people of France got sufficient liberty to express their opinion. This was
the beginning of breaking away from the established policies, politics and religion.
7. Existence of Socio-economic Inequality
France witnessed an extreme form of inequality between different classes of people and
between different sectors of the economy. There were both privileged and unprivileged
classes. The common people were underprivileged who wanted an escape from this
unwanted situation.
8. Influence of the Writers
Thinkers concerned with the ills of the society were trying to figure out and convey
suggestions for the reformation of the system. There were analytical discussions and
explorations regarding the ill effects of the existing system and the type of the ideal system
which should replace. They were all agreed that the ideal system is physiocracy.

3.6.2. Economic Doctrines of Physiocrats

The Economic Doctrines of the physiocrats in detail are discussed as follows.
(1) Natural order or Natural philosophy
Natural order is the symbol of physiocratic system. Dupontde- Nemours defined
physiocracy as ―the science of natural order‖.

According to physiocrats, natural order was an ideal order of things created by god for the
maximization of human happiness. The man made social orders were artificial in nature.
So the physiocrats wanted the people to do away with artificial manmade rules.
Physiocrats believed that people suffer from social evils because the social order did not
confirm to the natural order. In their opinion, the present organization of state should be
suitably modified to bring the life, behaviour and ideas of the people within the orbit of the
natural order.

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(2) The Net Product
To the physiocrats the only productive wealth was agriculture. To them the other
occupations, other than agriculture were unproductive and sterile. By the gift of nature
(fertility) agriculture produces more than what the farmers consume. This surplus
production in the agriculture sector is called as “Net product”.
It means that agriculture not only satisfied the needs of those engaged in it, but also of
others engaged in trade, manufacture, and other professions. In Industry merely raw
materials are transferred into finished products. In commerce and trade a mere transfer of
wealth is taking place. In agriculture alone a surplus is generated. So labour which was
applied anywhere except to land was sterile because man is not a creator.
(3) The circulation of wealth
Based upon the concept of Net Product, the physiocrats advanced the theory of circulation
of wealth. That is distribution of net product. Physiocrats were the first to attempt to
analyse the problem of distribution. The credit for putting the idea in a systematic manner
goes to Francis Quesnay. He skillfully and graphically analyzed the concept of circulation
of wealth, drawing 'analogies from the circulation of blood in the' body. Being a doctor; he
was able to describe it very eloquently.
(4) Individualism and Laissez Faire
The Physiocrats, especially Turgot, believed that self-interest was the motivating reason for
each segment of the economy to play its role. Each individual will work harder for the
benefit of himself. The system works best when there is a complementary relationship
between one person‘s needs and another person‘s desires, and trade restrictions place an
unnatural barrier to achieving one‘s goals.

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(5) Private Property
None of the theories concerning the value of land could work without strong legal support
of ownership private property. Combined with the strong sense of individualism, private
property becomes a critical component of the workings of the Tableau.
(6) Diminishing Returns
Turgot was one of the first to recognize that ―successive applications of the variable input
will cause the product to grow, first at an increasing rate, later at a diminishing rate until it
reaches maximum‖. This was recognition that the productivity gains required to increase
national wealth had an ultimate limit, and, therefore, wealth was not infinite.
(7) Investment Capital
They recognized that capital was needed by farmers to start the production process. Capital
was also needed to sustain the laborers while they produced their product.
Turgot recognizes that there is opportunity cost and risk involved in using capital for
something other than land ownership, and he promotes interest as serving a ―strategic
function in the economy.‖
(8) Taxation
Physiocrats put forward a simple system of taxation. They advocated a single tax system,
namely the land tax, which should be paid by the proprietary class directly to the govt. The
theory of taxation was closely linked with the concept of net product. Some taxes were
required for meeting the expense of the state 'for the maintenance of security, spread of
education and establishment of public works. The only source which could be tapped was
the net product and the only class who could pay tax were the landed proprietors. So they
advocated a single tax on land. This single tax was direct and hence cannot be evaded. It
was simple to assess.
(9) Value
Physiocrats had taken little interest in the theory of value. But they did not regard value
inherent in commodities; they also differentiated value in use and value in exchange. But
they treated price and value as one and the same thing. Value according to physiocrats was

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not fixed but changed from time to time depending upon demand: Anyhow, the theory of
value was not much important part of the physiocratic school.

(10) Trade
As commodities of equal value were exchanged, trade and commerce were considered as
unproductive. According to them trade did not produce any real wealth. Hence all
commodity transition was sheer waste of time and energy.

Thus, they hold that “All that is bought is sold and all that is sold is bought” They
wanted to counteract the evils of commerce by advocating complete freedom in the field
of commerce.
(11) Functions of the state
The physiocrats were not anarchist. They suggested a state with minimum of civil laws
which place no hurdles in the way of the realization of the natural order. The functions of
the physiocratic sovereign were; to preserve natural order, to defend private property, to
spread universal education, to undertake a program of public work.

3.6.3. François Quesnay's Tableau Économique

The founder and leader of physiocracy was Dr. François Quesnay (1694–1774). Quesnay
served as the consulting physician to King Louis XV at Versailles. Late in life he developed
an interest in economics, publishing his first book on the subject in his 60s. Quesnay‘s
system of political economy was summed up in Tableau économique (1758). Quesnay
wanted Louis XIV, the king from 1715 to 1774, to deregulate trade and to slash taxes so that
France could start to emulate wealthier Britain. He was, indeed, one of the originators of
the 19th century doctrine of the harmony of class interests and of the related doctrine that
maximum social satisfaction occurs under free competition.

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The foundation of the Physiocrats‘ economic theories was first described in François
Quesnay's Tableau Économique, which was published in 1759.
The model of Quesnay consisted of three economic movers:
Proprietary class consisted of only landowners.
Productive class consisted of all agricultural laborers.
Sterile class is made up of artisans and merchants.

3.6.4. Criticism of Physiocrasy

The chief weakness in the physiocratic teaching lay in its theory of value. While agriculture
brings forth the raw material of production, commerce and manufactures are equally
productive of wealth.
The important criticisms leveled against physiocracy are as follows:
1. The physiocrats failed to consider the labouring Class as a productive class. Moreover
their contention that manufacturing class is sterile is also subject to severe criticism.
2. The physiocrats do not have a clear cut concept of value. They have confused value with
utility. They held the view that value depend on utility.
3. Their conception of landlord as partly productive class is more based upon political
motive. .
4. Physiocrats placed too much emphasis on agriculture and have neglected the non-
agricultural sector.
Anyhow physiocracy occupied an important place in the history of economic thoughts.
They are notable in the history of Economic thought because of their constructive and
positive contribution for the development of the science of Economics.

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CHAPTER FOUR
THE CLASSICAL SCHOOL
4.1. Over view of the classical school
Classical economics refers to work done by a group of economists in the eighteenth and
nineteenth centuries. They developed theories about the way markets and market
economies work. The study was primarily concerned with the dynamics of economic
growth. It stressed economic freedom and promoted ideas such as laissez-faire and free
competition. Economic thought until the late 1800‘s.
Adam Smith‘s Wealth of Nations, published in 1776 can be used as the formal beginning of
Classical Economics but it actually evolved over a period of time and was influenced by
Mercantilist doctrines, Physiocracy, the enlightenment, classical liberalism and the early
stages of the industrial revolution.
Classical economics as the predominant school of mainstream economics ends with the
‗Marginalist Revolution‘ and the rise of Neoclassical Economics in the late 19th century. In

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the 1870‘s William Stanley Jevons‘ and Carl Menger‘s concept of marginal utility and Leon
Walras‘ general equilibrium theory provided the foundations. Vilfredo Pareto and Alfred
Marshall provided the tools for neoclassical economics. Neoclassical economics is an
extension of
Classical economics but, the focus of the questions changed as well as the tools of analysis.‘
The belief in the efficacy of a ‗free market‘ is central to both classical and neoclassical
ideology.

4.2. Factors Giving Rise to Classicism

There were two main factors for the emergence of classical school of thought. These
are;

i. The Scientific Revolution: in the last quarter of 17thc, Isaac Newton (1642-1727)
greatly advanced Kepler‘s earlier scientific laws of planetary motion and Galileo‘s
mathematical laws of the movement of bodies on earth. This revolution in science,
associated particularly to Newton, popularized the already existing idea that the universe
is governed by natural laws. This had its own impact on the ideas of the classical school.
According to the classicists, the lingering feudal institutions and the restrictive controls of
mercantilism were no longer necessary.
For them Newtonian science furnished a nature fully as effective as the earlier will of God.
If the Divine had created a mechanism that worked harmoniously and automatically
without interference, then Laissez-faire was the highest form of wisdom in social affairs.
Natural laws would guide the economic system and the action of people.
ii. The Industrial Revolution: In the same quarter, industrial revolution was just
beginning, but it intensified over the period in which the latter classical economists wrote.
Both the industrial revolution and classical political economy developed first in England.
In 17th c, England trailed Holland in commerce but lagged behind France in manufacturing.
But, by the middle of 18th c, England gained supremacy in both commerce and industry.
England stood to benefit from international trade. As English entrepreneurs became

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stronger, they no longer had to rely on government subsidies, monopoly privileges, and
tariff protections.
As a result, many mercantilist practices were breaking down under the upsurge of business
activities that were spreading in every direction. This growth of industry led to increased
emphasis on the industrial aspect of economic life on current thinking.

4.3. Major Tenets of Classical School of Thought

Classical doctrine is frequently called economic liberalism. Its bases are personal liberty,
private property, individual initiative, private enterprise, and minimal government
interference.

The major features of this body of thought can be summarized as follows.

1. Minimal government involvement: The first principle of the classical school was
that “the best government governs the least”. The forces of the free, competitive market
would guide production, exchange, and distribution. The economy was held to be self-
adjusting and tending toward full employment without government intervention.
Government activity should be confined to enforcing property rights, providing for the
national defense, and providing public education.

2. Self-interested economic behavior: The classical economists assumed that self-

interested behavior is basic to human nature. Producers and merchants provided goods
and services out of a desire to make profits; workers offered their labor services to obtain
wages, and consumers purchased products as a way to satisfy their wants.
3. Harmony of interests: With the important exception of Ricardo, the classicists
emphasized the natural harmony of interest in a market economy. By pursuing their own
individual interests, people served the best interests of society.

4. Importance of all economic resources and activities: The classicists pointed out
that all economic resources (such as land, labor, capital, and entrepreneurial ability) as well
as all economic activities (such as agriculture, commerce, production, and international

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 History of Economic Thought I, Lecture Note
exchange) contribute to a nation's wealth. The mercantilists had said that wealth was
derived from commerce; the physiocrats had viewed land and agriculture as the source of
all wealth.

5. Economic laws: The classical school made tremendous contributions to economics

by focusing its analysis upon explicit economic theories or "laws." Examples include the
law of comparative advantage, the Malthusian theory of population, the law of markets
(Say's law), and the Ricardian theory of rent. The classicists believed that the laws of
economics are universal and immutable.

4.4. Major Representatives/ Founders of the Classical School

There were dozens of great philosophers that contributed to the development of the
classical school. But a remarkable contribution is made by the following three great
thinkers of the time.

A. Adam Smith (1723-1790)

Adam Smith, the kindly, brilliant founder of the classical school, was born in the sea port
and manufacturing town of Kirkcaldy, Scotland. Smith attended Glasgow College at
fourteen years of age; he later studied moral and political science and languages at Balliol
College, Oxford. He then returned to his mother's home to continue independent study for
two years. After that Smith moved to Edinburgh, where he gave lectures on rhetoric and
literature. He was elected professor of logic at Glasgow College in 1751, and in the following
year he was given the chair of moral philosophy, which he held for nearly twelve years. In
1759 he published The Theory of Moral Sentiments, after which his lectures concentrated
less on ethical doctrines and more on Jurisprudence and political economy.
In 1776 Smith published An Inquiry into the Nature and Causes of the Wealth of Nations. Its
fame was immediate, and it established Smith's reputation forever.

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Economic Ideas of Adam Smith

Division of Labor: The first chapter of Wealth of Nations is titled ‗Of the Division of Labor‘
The first sentence reads as follows: ‗The greatest improvement in the productive powers
of labor, and the greater part of the skill, dexterity, and judgment with which it is anywhere
directed or applied, seem to have been the effects of the division of labor.‘

The division of labor, said Smith, increases the quantity of output produced for three
reasons.
First, each worker develops increased dexterity in performing a single task repeatedly.
Second, time is saved if the worker need not go from one kind of work to another.
Third, machinery can be invented to increase productivity once tasks have been simplified
and made routine through the division of labor.

Invisible Hand: Smith pointed out that participants in the economy tend to pursue their
own personal interests. The person of business pursues profit: ‘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 interest.’

The key to understand Smith's invisible hand is the concept of competition. The action of
each producer or merchant who is attempting to earn profit is restrained by the other
producers or merchants who are likewise attempting to make money. Competition drives
down the prices of goods and in so doing reduces the profit received by each seller. In
situations in which there is initially only a single seller, extraordinary profit attracts new
competitors who increase supply and erase the excessive profit. In an analogous way,
employers compete with one another for the best workers, workers compete with each
other for the best jobs, and consumers compete with one another for the right to consume
products. Stated in contemporary economic terms, the result is that resources get allocated
to their highest valued uses; economic efficiency prevails. Furthermore, because
businesspersons save and invest-again out of their self-interest, capital accumulates and

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the economy grows. The pursuit of self-interest, restrained by competition, thus tends to
produce Smith's social good (maximum output and economic growth).

Role of Government: the interference by government into the economy is not needed and
undesirable. According to Smith, governments are wasteful, corrupt, inefficient, and the
grantors of monopoly privileges to the detriment of the society as a whole. Smith extended
his belief in the harmony of interest and laissez-faire to international trade:

It is tempting to label Smith as an advocate of laissez-faire; we have seen his dislike for
government involvement in the economy. But unlike some of the more extreme advocates
of that view, Smith did see a significant, albeit limited, role for the state. Specifically, he
saw three major functions of government:
(1) To protect society from foreign attack,
(2) To establish the administration of Justice, and
(3) To erect and maintain the public works and institutions that private entrepreneurs
cannot undertake profitably.

Taxation: To finance the aforementioned government activities, Smith recommended

taxation.

His four maxims for good taxes are as follows:

i. Taxes should be proportional to the revenue enjoyed under the protection of
the state. This was a drastic departure from the regressive taxes prevalent at the
time.
ii. Taxes should be predictable and uniform as to the time of payment, the manner
of payment, and the amount to be paid. iii. Taxes should be levied at the time and
in the manner most convenient to the contributor.
Iv. Taxes should be collected at minimum cost to the government.
International Trade: Smith pointed out how foreign trade can promote greater division
of labor by overcoming the narrowness of the home market. Exports also remove surplus

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products for which there is no demand at home and bring back products for which there is
domestic demand. Smith also condemned bounties (subsidies) on export.
In a direct attack on mercantilism, Smith argued that government should not interfere in
international trade. Nations like individuals and private firms, should specialize in
producing goods for which they have an advantage and trade for goods for which other
nations have an advantage.
For Adam Smith, trade between two countries will occur only if each country has an
absolute cost advantage over the other in at least one commodity.
Value: In a statement in which he poses the "water-diamond paradox," Smith observed
that there are two kinds of value: the one may be called "value in use," the other, "value in
exchange." He said:
The things which have the greatest value in use have frequently little or no value in exchange;
those which have the greatest value in exchange have frequently little or no use value. Nothing
is more useful than water: but it will purchase scarce anything; scarce anything can be had in
exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great
quantity of other goods may frequently be had in exchange for it.
Profit: According to Smith, because every investment is exposed to the risk of loss, the
lowest rate of profit must be high enough to compensate for such losses and still leave a
surplus for the entrepreneur. The gross profit includes compensation for any loss and the
surplus. Net or clear profit is the surplus alone or the net revenue of the business.
Rent: In some parts of his book, Smith adhered that prices of agricultural produce
determine the rent that the landlord can charge. Rent, said Smith, "is the price paid for the
use of land." It is the highest price the tenant can afford to pay after deducting wages, the
wear and tear of capital, average profits, and other expenses of production.
Rent, therefore, is a surplus or a residual. High prices of produce yield high rents and low
prices yield low rents.

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Distribution of Employment: Smith spoke of one additional factor that might give rise
to increased productivity and growth. That was ‗a more proper distribution of
employment.‘ Here Smith made a distinction between productive labor, and unproductive
labor.

Productive Labor is that labor invested in a tangible commodity that has market value.
The productive workers are ‗artisans, manufacturers and merchants’ etc.
Unproductive labor is that invested in offering services; it does not result in tangible goods
available in the market place. The unproductive laborers include kings, soldiers,
churchmen, lawyers, doctors, writers, players, musicians, opera singers, dancers, and so
forth.
For him, material goods can be accumulated and, therefore, are a potential means of
increasing wealth. Even consumer goods produced today can be used to support workers
in the future, thereby enabling them to work and produce goods. But services are of the
moment only; they vanish in the simultaneous acts of production and consumption, and
they cannot be accumulated. From this point of view they are unproductive, although they
indeed are useful.

Laissez-faire: Laissez-faire is the term coined by Adam Smith to describe an economic

system in which there is minimal intervention from governments and regulations. (The
term means ‗leave it alone‘ in French).

Advocates of laissez-faire assert that transactions between private parties should be free
from regulations, taxes, tariffs, and monopolies, and that the role of government should be
limited to policing against fraud and enforcing contracts. Adam Smith, argued that
individuals who pursue their own desires are able to best contribute to society as a whole,
and this view was widely accepted and dominant economic thinking in Western world in
the 19th century.

Laissez-faire waned in popularity in the 20th century, when it proved inadequate to deal
with social problems caused by industrialization

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2. Thomas Robert Malthus

The Malthusian Population Doctrine

Malthus is best known for his hugely influential theories on population growth. Malthus
was the first economist to propose a systematic theory of population. He articulated his
views regarding population in his famous book, Essay on the Principle of Population
(1798), for which he collected empirical data to support his thesis.

The principal thesis of Malthus, that population tends to increase faster than the food
supply, was not original with him: it can be found in the writings of others, including Adam
Smith and
Benjamin Franklin. It was Malthus‘s presentation of the population problem, however, that
significantly influenced existing and subsequent economic thinking.
Assumptions
Malthus took into account two main assumptions:
i. Food is an essential component for human
existence. ii. Humans have the basic urge to multiply.
Malthus‘ theory was based on the assumption that the power of population to multiply is
much greater than the power of the earth to provide subsistence for man.
In his own words ‗passion between the sexes is an inevitable phenomenon‘, hence, when
unchecked, population would grow at such a high rate that it would outstrip food supply.
According to him, disease, food shortage and death due to starvation, were nature‘s way to
control population. He proposed that human beings adopt measures like infanticide,
abortion, delay in marriage and strict following of celibacy to check population growth.

Malthus presented his famous law of population as follows:

Population increases by geometric progression (1, 2, 4, 16, 32, 64, 128, 256, etc.).
Food supply, at most, can only increase arithmetically (1, 2, 3, 4, 5, 6, 7, 8, etc.). Therefore,
since food is an essential component to human life, population growth in any area or on

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 History of Economic Thought I, Lecture Note
the planet, if unchecked, would lead to starvation. On the basis of a hypothetical world
population of one billion in the early nineteenth century and an adequate means of
subsistence at that time, Malthus suggested that there was a potential for a population
increase to 256 billion within 200 years but that the means of subsistence were only capable
of being increased enough for nine billion to be fed at the level prevailing at the beginning
of the period.
Therefore, it may be safely asserted that, Malthus said, population, when unchecked,
increases in a geometrical progression of such a nature as to double itself every twenty-five
years.

Malthus identified two types of checks to population growth: those he called "preventive
checks" and those he called "positive checks."

Preventive Checks: these are those that reduce the birth rate. The preventive check of
which Malthus approved was termed moral restraint. People who could not afford
children should either postpone marriage or never marry. This included abortion,
prostitution, postponement of marriage, birth control and celibacy are few measures
that were advised to be strictly followed in order to help solve the problem.

Positive Checks: these are those that increase the death rate. These were famine, misery,
plague, and war. Malthus elevated these to the position of natural phenomena or laws;
they were unfortunate evils required to limit the population. These positive checks
represented punishments for people who had not practiced moral restraint.
If the positive checks could somehow be overcome, people would face starvation because a
rapidly growing population would press upon a food supply that at best would grow slowly.

According to Malthus, then, poverty and misery are the natural punishment for the failure
by the ‗lower classes‘ to restrain their reproduction. From this view followed a highly
significant policy conclusion: There must be no government relief for the poor. To give

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them aid would cause more children to survive, thereby ultimately worsening the problem
of hunger.

His Theory of Market Gluts

In his principle of principle of political economy, Malthus developed his theory general over
production. Here Malthus explained that there would be a possibility of inadequate
effective demand to maintain full employment. As a result, there will be a general glut of
commodities in the market. This has been known as „Malthus theory of Glut‟s.

For Malthus effective demand is that which establishes a price high enough not only to
cover costs but also yield a profit at the current rate. Production is sustained only if it is
profitable and that profitability depends on effective demand. Overproduction is, therefore,
the result of effective demand. The workers, he said, are unable to purchase all the
commodities in the market; capitalist, on the other hand, prefer to save rather than to
spend. So who will purchase the extra output?

As a solution to this problem, Malthus favored unproductive consumption by landlords.

For times of acute economic distress, Malthus recommended government spending on

public works. He had also the view that war offered another stimulus that could eliminate
gluts.

3. David Ricardo

David Ricardo was born on 19 April 1772 in London. He was the third son of a Dutch Jew
who had made a fortune on the London Stock Exchange. When he was 14, Ricardo joined
his father‘s business and showed a good grasp of economic affairs. In 1793 he married a
Quaker called Priscilla Anne Wilkinson; Ricardo then converted to Christianity, becoming
a Unitarian. This caused a breach with his father and meant that Ricardo had to establish
his own business.

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He continued as a member of the stock exchange, where his ability won him the support
of an eminent banking house. He did so well that in a few years he acquired a fortune. This
enabled him to pursue his interests in literature and science, particularly in mathematics,
chemistry, and geology.
Ricardo accepted Malthus‘ ideas on population growth. In 1815 another controversy arose
over the Corn Laws, when the government passed new legislation that was intended to raise
the duties on imported wheat. In 1815 Ricardo responded to the Corn Laws by publishing
his Essay on the Influence of a Low Price of Corn on the Profits of Stock, in which he argued
that raising the duties on imported grain had the effect of increasing the price of corn and
hence increasing the incomes of landowners and the aristocracy at the expense of the
working classes and the rising industrial class. He said that the abolition of the Corn Laws
would help to distribute the national income towards the more productive groups in
society.
In 1817, Ricardo published Principles of Political Economy and Taxation in which he analysed
the distribution of money among the landlords, workers, and owners of capital. He found
the relative domestic values of commodities were dominated by the quantities of labour
required in their production; rent being eliminated from the costs of production. He
concluded that profits vary inversely with wages, which move with the cost of necessaries,
and that rent tends to increase as population grows, rising as the costs of cultivation rise.
He was concerned about the population growing too rapidly, in case it depressed wages to
the subsistence level, reduce profits and checked capital formation. Illness forced Ricardo
to retire from Parliament in 1823 and he died on 11 September at the age of 51.

David Ricardo‟s Works

In 1809 Ricardo began to write down his own ideas in economics for newspaper articles. He
outlined the Classical system more clearly and consistently than anyone before had done.
His ideas became known as the ‗Classical‘ or ‗Ricardian‘ School. Ricardo was reckoned as
the

‗Theorists Theorist’.

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Theory of value
Modern discussion of the validity of the economic system of David Ricardo has centred
about the theory of value. The labour theory of value states that the relative price of two
goods is determined by the ratio of the quantities of labour required in their production.

His labour theory of value has the following assumptions:

 Both sectors have the same wage rate and the same profit rate;
 The capital employed in production is made up of wages only; The
period of production has the same length for both goods.
Ricardo himself realized that the second and third assumptions were quite unrealistic and
hence admitted two exceptions to his labour theory of value:
1. Production periods may differ;
2. The two production processes may employ instruments and equipment as capital and
not just wages, and in very different proportions.
Ricardo wrote that for a commodity to have exchange value, it must have use value. Utility
(subjective want satisfying power) is not the measure of exchangeable value, although it is
essential to it.
Possessing utility, or use value, commodities derive their exchange value from two sources:
(1) Their scarcity and
(2) The quantity of labor required to obtain them.
The value of non-reproducible commodities, such as rare works of art, classic books, and
old coins, is determined by their scarcity alone. For these items, supply is fixed, and,
therefore, demand will be the primary factor in determining exchange value. But most
commodities are reproducible, and Ricardo assumed that they are produced without
restraint under conditions of competition. It was these goods to which Ricardo applied his
labor theory of value.
Recall that Smith stated a labor theory of value for a primitive society and developed a
"labor commanded" theory for advanced economies. According to Ricardo, the exchange

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value of a commodity depends on the labor time necessary to produce it. The labor time
includes not only the work done in making the commodity itself but also the work
embodied in the raw materials and capital goods used up in the process of production.

Comparative Advantage

The tremendous subtlety of Ricardo‘s mind is evident in his doctrine of comparative

advantage as applied to international trade. With this argument he strengthened the case
for free trade by extending Adam Smith‘s analysis of the gains to be achieved by the free
movement of goods across international boundaries.
If nation A could produce a good at a lower cost than nation B, and nation B could produce
another good at a lower cost than nation A, both nations would gain by practicing territorial
specialization and trading. In the terminology of international trade theory, if one nation
has an absolute advantage in the production of one commodity and another nation has an
absolute advantage in the production of another commodity, each can gain by specializing
in the commodity that costs it the least to produce.

Ricardian distribution theory

The importance of David Ricardo‘s model is that it was one of the first models used in
Economics, aimed at explaining how income is distributed in society.
Starting assumptions:
there is only one industry, agriculture; only one good, grain;
there are three kinds of people:
i. Capitalists: they start the economic growth process by saving and investing. In return,
they receive profits, which is what is left once wages and rents have been subtracted from
the gross revenue.
Capital can be divided into fixed capital (machines) and working capital (wage
fund,). ii. Workers: they represent the labour force, in return for wages.
iii. Landlords: they allow production to take place in their lands in return for rent.

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 law of diminishing returns: affects labour (variable factor of production) and land
(fixed factor).
 principle of marginal product: marginal product of labour, which, along with the
average product of land, is decreasing.
 principle of economic surplus: profits are determined as a surplus of production.
Wages: Labor, said Ricardo, like all other things that are bought and sold, has its natural
price and its market price. The natural price of labor is that price that, given the habits and
customs of the people, enables workers to subsist and to perpetuate themselves without a
change in their numbers. The natural price of labor depends on the price of the necessities
of life required by the laborers and their families. The market price of labor depends on
supply & demand and fluctuates around the natural price.

In the long run, both the natural price of labor and nominal wages tend to rise, said Ricardo,
because of the increased difficulty and cost of producing food for growing number of
people.
Ricardo‘s idea that in the long run the worker gets only a minimum wage came to be known
as ‗the iron law of wages‘. When the market price of labor rises above the natural price,
a worker can rear a large and healthy family. As population increases, wages fall to their
natural price or even below. When the market price of labor is below the natural price,
misery reduces the working population and wages rise. Therefore, the long-run tendency
is for workers to receive the subsistence minimum.
Profits: Ricardo felt that the rates of profit in different fields of enterprise within a country
tend to equalize. If the rate of profit is higher in industry than in the farming of marginal
land, capital will flow from agriculture to industry, and a better grade of land will become
the new marginal land. If agriculture is more profitable than industry, capital will flow
towards agriculture, and the next worse grade of land will become the marginal land
cultivated.

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Recall that Ricardo emphasized that profits and wages vary inversely; one increases at the
expense of the other. If wages fall, prices will not fall. If they do, gold will flow into the
country, and prices will rise again. Therefore, a fall in wages will result in a rise in profits.
Ricardo thought that the rate of profit would fall because of the increasing difficulty of
growing food for an expanding population. Theory of Diminishing Return and Rent
Ricardo‘s law of diminishing returns and theory of rent developed in response to the debate
over the Corn Laws. Recall that the concept of diminishing return in agriculture dates back
to Turgot, the physiocrat. But it was Ricardo who developed the notion most clear and
complete. In using this concept to develop his theory of rent, Ricardo became the first
economist to formulate a marginal principle in economic analysis.
Rent, said Ricardo, is the proportion of the produce of the earth which is paid to the
landlord for the use of the original and indestructible powers of the soil. It includes the
return on the long run capital investments that are amalgamated with the land and increase
its productivity.
Ricardo‘s theory of rent assumes the operation of two principles: the differential principle
and the marginal principle. The first explains the differential nature of rent while the later
gives the measure of rent.
1. The Differential principle: implies that an equal amount of labor and capital may
produce different amounts of output. In agriculture, equal quantities of capital and labor
produce different quantities of output in two ways:
 Under extensive cultivation, the output differs when equal quantities of labor and
capital are employed on lands with different qualities. More fertile land yields more
output and hence more rent and vice versa.
 Under intensive cultivation, the output differs when equal quantities of labor and
capital are employed successively on the same land due to the law of diminishing
return.
2. The Marginal principle: this implies that the price of the product is determined by
the cost of production of the marginal producer. Marginal producer is the one who

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produces under the most unfavorable circumstances. When we apply the marginal
principle to agriculture, equal quantities of capital and labor produce different rent in two
ways:
under extensive cultivation, the price of output will cover cost of production on the
marginal land.
under intensive cultivation, the price of output will cover the cost of the marginal doze of
inputs required.
The implication of the above analysis is that the marginal land and the marginal doze of
capital and labor do not generate any rent because revenues just cover their cost of
production. All the intra-marginal land and intra-marginal units of capital and labor gets
rent because they operate under more favorable cost conditions than those at the margins
of production.

4. Jean Baptist Say

Jean-Baptiste Say (1767 – 1832) was a French economist and businessman. He had classically
liberal views and argued in favour of competition, free trade, and lifting restraints on
business.

He is best known due to Say‘s Law, which is named after him and at times credited to him.

Say‘s first literary attempt was a pamphlet on the liberty of the press, published in 1789. In
1804, having shown his unwillingness to sacrifice his convictions for the purpose of
furthering the designs of Napoleon, he was removed from the office of tribune. He devoted
his leisure to the improvement of his economic treatise, which had for some time been out
of print, but which the censorship did not permit him to republish.

Say‟s methodology
Say‘s approach to economics is, in philosophical terms, that of a realist and an essentialist.
He combined a healthy skepticism regarding the usefulness of statistical investigations
with an emphasis on observing the facts of reality. He sees economics as a genuine science

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 History of Economic Thought I, Lecture Note
capable of establishing ‗absolute truths,‘ but insists that it ‗has only become a science since
it has been confined to the results of inductive investigation.‘ In fact, Say declares that
political economy
‗forms a part of experimental science‘ and is, thus, rather similar to chemistry and natural
philosophy.
For Say, as for most modern Austrians, economics is not a shadowy realm to be penetrated
only by the expert, but a subject of enormous practical importance accessible to all.

Say‟s law of market

Say‘s law is commonly summarized as „supply creates its own demand.‟ This law, also
referred to as Say‟s „theory of markets‟ or „law of markets,‟ indicates that the act of
producing aggregate output generates a sufficient amount of aggregate income to purchase
all of the output produced. This principle indicated that excess production or insufficient
demand for production was unlikely to occur, at least for any extended period. When
combined with flexible prices and saving investment equality, Say‘s law further implied that
an economy would achieve and maintain full employment of resources. This law was
singled out by John Maynard Keynes in his critique of classical economics, but remains
relevant in current macroeconomic analysis, reflected in the circular flow model.
Say‘s law that ‗supply creates its own demand‘ is one of the fundamental principles of
classical economics. This principle though is attributed to J. B. Say, was simultaneously
advocated by several economists of the day. The law is often misinterpreted to mean any
firm that produces a good is guaranteed profitable sales. It more correctly means that the
act of production generates enough income for an equivalent amount of demand for other
production. When applied to the macro economy, Say‘s law indicates that economic
downturns cannot be caused by the lack of demand, that is, overproduction. The aggregate
production of output generates just enough income to equate aggregate demand with
aggregate supply.

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Say identifies two means by which the corrective process operates. Principally, he argues
that, though individuals do save part of the income derived from production, as long as
those savings are reinvested in ‗productive employment,‘ in the aggregate there need be no
decreases in production, income, or consumption. This process of reinvestment is fuelled
by differences in the profits earned by entrepreneurs. Those goods that are relatively more
scarce, and thus rising in price, attract additional investment, while those that are relatively
less scarce, and thus falling in price, discourage investment. And even if one hoards money
or buries it, ‗the ultimate object is always to employ it in a purchase of some kind,‘ so there
still cannot be deficient demand as long as real economic values are being produced. In
order for consumers to exist, there must first be producers.
Throughout his discussion of production and consumption, Say consistently maintains that
money is merely a neutral conduit through which aggregate supply is translated into
aggregate demand, or ‗money is the agent of the transfer of values’. There seems to be no
recognition of the transmission mechanism by which changes in the supply of money alter
the relative prices of goods and, thereby, redirect the entire interrelated structure of
production.
On the other hand, Say eloquently expresses a clear understanding that it is wholly
beneficial for a society to experience generally falling prices whenever such declining prices
are the result of productivity gains. Not only does this circumstance indicate, contrary to
popular belief, ‗that a country is rich and plentiful,‘ but also that ‗products formerly within
reach of the rich alone have been made accessible to almost every class of society.‘
Moreover, Say correctly perceives that: (a) the prices of goods reflect their utility to the
buyer,
(b) the prices of the factors of production are derived or ‘imputed’ from the prices of the
goods produced, and
(c) costs of production represent an interface between the utility of the good and the
productivity of the factors of production.

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 History of Economic Thought I, Lecture Note

5. John Stuart Mill

John Stuart Mill was born in London on May 20, 1806 and died May 8, 1873 in Avignon,
France.
He was a philosopher, economist and political theorist. He was the first parliamentary
deputy to support a woman‘s right to vote and was a co-founder of the first women‟s
suffrage organization.
In 1848, Mill published Principles of Political Economy, which soon became the most
important text of his time. The book examines the conditions of production, namely labour
and nature. Following Ricardo and Malthus, he emphasized the possibility of change and
social improvement and examines environmental protection needs. Furthermore, Mill
argued in favour of worker-owned cooperatives, which clearly reflect his views.
Written and developed in close collaboration with his wife, Harriet Taylor, Mill examines
the nature of power and argues for an absolute freedom of thought and speech.

For Mill it is only through such ‗freedom‘ that human progress can be attained and
preserved.

As he states: ‗The subject of this Essay is not the so-called Liberty of the Will, but Civil, or
Social Liberty: the nature and limits of the power which can be legitimately exercised by
society over the individual.‘ The only part of the conduct of any one, for which he is
amenable to society, is that which concerns others. In the part which merely concerns him,
his independence is, of right, absolute. Over himself, over his own body and mind, the

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 History of Economic Thought I, Lecture Note
individual is sovereign.‘ One of his main trajectories is that in the course of democratization
there is always the danger of tyranny of the majority. This is a danger one cannot be
protected from, even though the majority might be wrong. In general, for Mill such liberty
is only applicable and possible for people who are able to decide for themselves, therefore
such notion excludes children and those he calls

‗Barbarians.‘
John Stuart Mill developed a utilitarian ethical theory in Utilitarianism (1861). The
foundation of all utilitarian ethical principles is the ‘greatest happiness principle’. The
ultimate goal of utilitarianism, Mill argues, is to achieve such happiness for the majority of
people: ‗To do as one would be done by, and to love one‘s neighbor as oneself, constitute
the ideal perfection of utilitarian morality.‘
John Stuart Mill‘s works have never shied away from controversy. Mill‘s Examination of Sir
William Hamilton‘s Philosophy (1865) is said to contain the first secular appearance of
Phenomenalism.
It was only after this work that this doctrine became the standard among scientific
philosophers during this time. Co-written with his wife, The Subjection of Women (1869),
was quite radical for its time, and caused yet another controversy. The essay argued in favor
of equality of the sexes employing utilitarian arguments. Mill was convinced that the
inequality of women would impede human progress in general.
For Mill the only way to find out whether there are actually differences between men and
women, he argues, is by experiment.
Mill chose to publish this essay relatively late in his life, possibly to avoid controversy. For
similar reasons he did not want to have his Three Essays on Religion published during his
lifetime (they only appeared in 1874), though these were not as radical as his followers had
hoped. Convinced that they would impede progress, Mill here argues against an all-
powerful god and traditional religious views in general. Instead, he proposes a ‗religion of
humanity,‘ wherein humanity itself is reverenced.

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During his lifetime, Mill was quite prolific and produced a great number of works in various
fields such as economics, social philosophy, logic, but also religion and ethics. Among his
most important ones are Essays on Some Unsettled Questions of Political Economy (1844),
Thoughts on Parliamentary Reform (1859), Considerations on Representative Government
(1861), Auguste Comte and Positivism (1865), England and Ireland (1869). His fragmented
Autobiography was posthumously published in the same year of his death; he died on May
8, 1873 in Avignon, France.

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