Adam Smith (1723–1790)

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Adam Smith 1723 1790 Udayan RoyECO 54 History of Economic Thought Adam Smith 1723 1790 The Ordinary Business of Life by Roger Backhouse pages 121 .
The Worldly Philosophers by Robert Heilbroner Chapter III TheWonderful World of Adam Smith New Ideas from Dead Economists by Todd Buchholz Chapter II The Second Coming of Adam Smith Chief contributions.
Built a coherent and logical theory of how the economy works The elements of Smith s theory were mostly already available in thewritings of earlier writers However in those earlier writings good ideas coexisted alongsidenumerous other bad ideas.
Somebody had to figure out which theories were useful and which wereuseless and combine the useful theories into a consistent and persuasiveoverall theory that could be used reliably to think about society This is what Smith did For this he is called the father of economics Two main works.
The Theory of Moral Sentiments 1759 An Inquiry Into the Nature and Causes of the Wealth of Nations Theory of Moral Sentiments Theory of Moral Sentiments This book was an argument against the views of writers such as Hobbes and.
Rousseau who argued that the pursuit of self interest an important humaninstinct inevitably leads to a cruel and nightmarish society Smith argued that we are able to imagine what others are going through we are able to empathize with the sufferings of others We feel pain when we see the pain of others .
We can act to relieve the pain of others in order to reduce our owndiscomfort if nothing else So it is perfectly consistent to believe that human beings pursue self interest and are generous towards others Passions bias moral rules.
Sometimes our passions cause us to do bad things We have an instinctive tendency to defend ourselves even when we knowthat we did something bad This leads to a bias that prevents us from seeing that we did something This problem is partially corrected by the wide acceptance of moral rules.
in a society When the moral rules are clear cut a misdeed may so clearly violate amoral rule that it might be impossible even for the perpetrator to deny themisdeed bias notwithstanding At times even moral rules may not be enough to keep society.
In that case laws and the enforcement of those laws would benecessary to keep society together However unlike Hobbes and Rousseau Smith did not believethat in the absence of a structure of laws society wouldinevitably descend to chaos .
Peace Prosperity Moreover apart from the human ability to empathize with thesorrows of others the sheer practicality of peace the factthat we realize that peace is necessary for prosperity may beenough to encourage good behavior .
The Wealth of Nations Wealth of Nations The causes of economic progress and the creation of wealthwas Adam Smith s main topic of interest David Ricardo by contrast focused on how wealth is shared among.
different groups in society According to Smith the wealth of a nation derives from thelevel of the technology in use The level of technology and its rate of improvement depend onthe division of labor .
Greater division of labor leads to higher productivity Smith discussed three reasons why a greater division of labormay increase productivity Practice makes perfect Less waste of time between tasks.
More automation Division of labor extent of the market economic progress The division of labor is determined by the extent of the market This creates the possibility of an ever expanding economy For example if the extent of the market increases perhaps because of an expansion.
of trade within the country or with another country there will be greater division oflabor which will lead to improvements in the level of technology which will lead togreater national income which will lead to another increase in the extent of themarket which will lead to another increase in the division of labor which will lead toanother increase in the level of technology and so on and on .
However Adam Smith felt that a scenario in which this growth graduallypeters out with each round of increases being smaller than those of thepreceding round was more likely Division of labor and capital Division of labor is enabled by capital.
In a backward agricultural economy people produce on a regularbasis the simple things they need When workers specialize in the production of more complex goods production may take time The worker can be sustained during the lengthy production period.
only when capitalists can make loans In this way the accumulation of additional capital enablesadditional division of labor Luxury spending not crucial Earlier writers had argued that the growth of an economy depended heavily.
on the luxury spending by the rich the poor consumed just the barenecessities and therefore more would not be produced unless the rich wouldbuy the extra output Smith argued that this idea was false If the rich saved any money they would lend it to businessmen to earn interest .
The businessmen would borrow the money and spend it on capital equipment Therefore all income would be spent and all production would be purchased There was no need to encourage luxury spending In fact the more the rich saved the greater would be the level of investment bybusinesses and the faster would be the rate of growth .
Capitalists hold the key Given the importance of division of labor and the workers need for loanswhen division of labor necessarily lengthens the production process capitalaccumulation is crucial to economic progress But which class of people can be relied upon to save and accumulate capital .
Not the workers they barely earn enough to pay for necessities Not the landlords they are dissolute and prone to ostentation Only the capitalist strivers who earn profits would save and accumulate capital The state could raise the rate of growth by redistributing income fromlandlords to capitalists.
Free Trade Smith was in favor of free trade He derived his support for free trade among nations by basing it on the obviousdesirability of trade among individuals It is the maxim of every prudent master of a family never to attempt to make at home.
what it will cost him more to make than to buy According to Smith free trade expands the extent of the market and thereby allows greater division of labor Free trade also increases productivity by allowing countries to specialize in whatthey do well .
This is the Law of Absolute Advantage David Ricardo refined this idea into the Law of Comparative Advantage Theory of value Smith used different theories of value at different points in theWealth of Nations.
His discussion is at times contradictory Theory of value labor For primitive economies sustained by hunting and fishing Smithadopted the Labor Theory of Value This was adopted by Classical economists such as Smith Malthus and Ricardo .
If among a nation of hunters for example it usually costs twice the labor tokill a beaver which it does to kill a deer one beaver should naturally exchangefor or be worth two deer This theory was meant to apply to economies that did not use capital goodsand all land used in production was free.
But even in such a case there is no standard unit of labor The hardship andingenuity involved can vary from task to task Theory of value unit cost When analyzing the industrialized economy of the Great Britain of his time Smith thought of the natural price or long run price of a product as the cost of all resources used in production.
Cost includes wages payment for labor rent for land and profit for the capital of theentrepreneur Note price unit cost does not mean profits zero it only means supernormal profits zero Profit is what the entrepreneur gets for risk taking As workers need to be paid even if the output is not ready for sale the entrepreneur is essentially.
a money lender to the workers Therefore profit also includes what we call interest today From today s point of view the classical theory of value which denies the influence of demand andidentifies production cost as the only influence on prices has some validity in the long run but isnot useful for short run analysis Prices signal opportunity.
In Smith s view of the workings of the market system anyshort run deviation of the market price from the long run pricewould trigger the forces of competition by which Smithmeant profit seeking entry and loss avoiding exit whichwould eventually take the market price to its long run level .
Wages Iron Law of Wages Smith used different theories of the wage rate at different times One was a form of the Iron Law of Wages This theory held that wages are by and large equal to the subsistence level of wages If wages exceed the level that is just enough to keep the worker and his dependents.
alive there will be an increase in population that will drive wages down to thesubsistence level If wages fall below what the workers need to stay alive population will fall and wageswill rise to the subsistence level This meant that any increase in total output went not to the workers but to.
capitalists who would save and invest in machinery that would make possiblefurther division of labor and technological progress Wages bargaining The wage rate depends on the bargaining power of workers and businesses Employers can collude with greater ease because employees are numerous.
In Great Britain at Smith s time employers collusion was allowed but unionswere not There were laws against raising wages but none against lowering Employers have more wealth to survive a strike workers have few savings totide them over It is clear that Smith had a very complex view of the nature of a market.
In that original state of things which precedes both the appropriation ofland and the accumulation of stock i e capital the whole produce oflabour belongs to the labourer He has neither landlord nor master toshare with him But in an industrial society the worker needs equipment which he can t.
afford to buy and he needs wages to survive during the possibly lengthyproduction period The capitalist provides these out of his own savings and extracts paymentfor these services This is Smith s explanation for the emergence of profits.
Smith had multiple theories of rent some of them contradictory Smith thought of rent as a residual that is leftover after wages andprofits had been paid out of total output Wages would be reduced to the subsistence level as we saw Competition would gradually reduce the rate of profit to a low level.
that would also be uniform across all industries Therefore only those who earn rent income would benefit from Falling rate of profit Economic progress depends on profits But Smith believed that the rate of profits would fall over time .
because of competition among capitalists This implied a slowing rate of growth over time The Invisible Hand Smith s argument that the pursuit of self interest can lead to asocially efficient outcome is the crowning glory of the Wealth.
of Nations Even though Cantillon had set out these ideas before Smith a lot ofthe credit has traditionally been and continues to be given to The Invisible Hand E very individual generally indeed neither intends to.
promote the public interest nor knows how much he ispromoting it he intends only his own gain and he is in this as in many other cases led by an invisible hand to promote anend which was no part of his intention The Invisible Hand.
Nor is it always the worse for the society that it was no partof it By pursuing his own interest he frequently promotes thatof the society more effectually than when he really intends topromote it I have never known much good done by those whoaffected to trade for the public good It is an affectation .
indeed not very common among merchants and very fewwords need be employed in dissuading them from it The Invisible Hand Consumer sovereignty and business competition are the keycomponents of Smith s argument that the pursuit of individual self.
interest leads to an excellent social outcome Consumer sovereignty ensures that consumer needs determinewhat gets produced Business competition ensures that prices are driven down to unit Thus without any government control the most beneficial goods.
get produced and at the lowest possible price The Invisible Hand What economists call the First Welfare Theorem which emphasizes the role ofFor example, if the extent of the market increases—perhaps because of an expansion of trade within the country or with another country—there will be greater division of labor, which will lead to improvements in the level of technology, which will lead to greater national income, which will lead to another increase in the extent of the ...

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