Download Capitalist theory of value

Chapter 3
Adam Smith
• Big Ideas
– Free Market Capitalism
– Free Trade
Biography


Scotland 1723 – 1770
Studied





Glasgow
Oxford
Professor at Edinburgh
Tutor to Henry Scott
Physiocrats
*Adam Smith - PHYSIOCRATS



A philosophy that natural laws govern
human behaviour
artificial laws created by humans were
unnecessary and ineffective
Their doctrine of non interference known
as LAISSEZ-FAIRE
 leave to do
 leave it be
Times
• Industrial Revolution
• Mercantilism predominant
economic theory
– Goal: increase a nations
wealth by increasing holding of
gold and silver
– Achieved: increasing exports
limiting imports through Tariffs
and Taxes
– Result: decline in world trade
Big Ideas

Published in the book
the WEALTH OF
NATIONS
Big Idea 1- The Invisible Hand




Self correcting system governed by the
laws of supply and demand
People will act out of self interest
Invisible hand: adjust prices and output
to meet the needs of the market
Key Assumption: Competitive Market
place

Argued against monopolies
Big Idea 2 Trade


“What applies to the
individual applies to the
nation with respect to division
of labour”
All nations will benefit if each
nations specializes in what
they are best at


Absolute advantage
Governments should not
block trade
*Other ideas


Division of Labour – specialization of
labour leads to increase in production and
therefore greater profits and better
economic efficiency
If people do what they do best in order to
further their own self interest society will
prosper
*Other ideas

Law of Accumulation – industrialists
will increase profits and eventually
reinvest profits in capital goods to further
economic growth of society.
Socio Economic Spectrum



Far right of spectrum
Limited roll of government
Businesses should satisfy needs and
wants
Strengths and Weaknesses
Strengths
• Free market and
trade policies =
wealth creation
•
•
•
•
Weaknesses
Laissez faire policies
not perfect
Great depression
Credit Crunch
Poor distribution of
wealth
Application in Canada

Canada has elements of the Smith’s ideas



Trade
Free Market Capitalism
Much larger roll for public sector
Thomas Robert Malthus

Big Idea:


Population and food
production
THE DISMAL SCIENCE
Challenged Smith’s view of
ever increasing prosperity

Population and Food Production



Food – necessary to sustain human life
Sexual Instinct – constant
From these 2 premises he reasoned
that


Population would grow at a
Geometrical rate
Food can only grow at a arithmetical
rate( law of diminishing returns)
“Malthus Dilemma”


Humans will not be able to produce
enough food to meet needs – famine
He recongnized 2 forms of population
checks


Positive Check – increse of death rate ex.
War, famine disease
Preventive Check – reduce birth rate ex.
Moral restraint, late marriage

So why has the world not self destructed?
Was Malthus wrong?
Malthus was wrong… so far

He failed at predicting two developments


Green Revolution – technological
breakthroughs in agriculture that increased
production ex. Fertilizer, mechanization
Decrease in Industrialized Country Birth Rate



Woman’s roll in the work force
“The Pill”
Education
Owners of the factors of
production

Identified 3 main groups in society
1.
2.
3.

Working Class – wage labours
Industrialists – profits from factory
ownership
Aristocrats – landlords who received money
from landownership
He argued that group 3 could only
prosper from exploitation of other two
groups
David Ricardo (1772 – 1823)
• Big Idea
– Wages
– Trade
IRON LAW of WAGES



Believed that higher wages would
increase population in working class but
not standard of living because wage
would have to be distributed amongst
larger family
Therefore wage = surplus population
Provided incentive and logic for
industrialist to keep wages low
Free Trade



A firm believer in free trade he was the first to
compare Absolute and Comparative Advantage
Absolute Advantage – when 1 community
produces wool more effieciently and another
community produces wheat more efficiently –
trade between both communities will be of
absolute advantage (Adam Smith)
Comparative Advantage – the capacity of one
economy to produce a good with comparatively
fewer resources than another. ( e.g. having a
lower opportunity cost)

Rational for bigger countries to trade with smaller
countries
Example:










You are a skilled cabinetmaker as well as a gifted painter.
1 day = 1 cabinet
1 day = 1 painting
1 cabinet =$400
1 Painting = $350
Your Neighbour shares the same skill set
1.5 days = 1 cabinet
3 days = 1 painting
What type of advantage do you have over your neighbour?
Therefore it would make sense for you to out produce your neighbour
correct?



WRONG!!
Over a 6 day work week

YOU: 3 paintings and 3 cabinets $2,250

Neighbour: 1 painting and 1 cabinet $1,100

Total: 4 paintings and 5 cabinets = 9 production units = $3,350
HOWEVER!!!


Say YOU focus on painting where you have the greatest comparative advantage and
the most profit and leave the cabinet making to your neighbour.

YOU: produce 6 paintings = $2,400

Neighbour: produce 4 cabinets = $1,400

Total: 10 units of production = $3,800

Both you and your neighbour would be richer from specialization = 1 production
unit more

Now that’s what I call EXCITING!!
Cabinet Production
(over 6 day work
week)
Painting Production
(over 6 day work
week)
You
6
6
Neighbour
4
2
Total
10
8
You have an absolute advantage in Cabinet production (1.5:1) and
Painting (3:1)
You: 6 cabinets = opportunity cost of 6 paintings
Neighbour: 4 cabinets = opportunity cost of 2 paintings
You:12 cabinets = opportunity cost of 12 paintings
Neighbour: 12 cabinets = opportunity cost of 6 paintings
Therefore your neighbour has a comparative advantage in cabinet
making
Do You have a comparative advantage in painting?
Absolute Advantage
Continued

Examples:


BC has absolute advantage over Sask. in the
manufacturing of wood products. Sask. Has an
absolute advantage over BC in the production of
wheat
NewFound. has a absolute advantage over
Ontario in the production of seafood. Ontario has
an absolute advantage over NewFound. in
automobiles
Comparative Advantage



California has an absolute advantage over
Texas in the production of both cars and
computers.
California absolute advantage in computer
production is 2:1 (ex. 200:100).
California absolute advantage in car
production is 4:1 (ex. 400:100).
One Step further
State
Computer
Production (units
produced in the first
10 days)
Automobile
Production
(units produced in
the remaining 20
days)
California
200
40
Texas
100
10
Total
300
50
In California 600 computers = an opportunity cost of 60 cars
In Texas 300 computers = an opportunity cost of 15 cars
Therefore Texas has a comparative advantage in the production of computers
because less cars will be lost
Does California have a comparative advantage?
Karl Marx
• “From each
according to ability
and to each
according to need”
Biography



Karl Heinrich Marx Born 1818
Born Jewish, chose to be baptised to not loose
his job as a lawyer
Studies



Law at the University of Bonn
University of Berlin
Exiled:




Germany
France
Belgium
London (Died 1883)
Times


Young Hegelian movement which
opposed traditional religion and political
structures
Industrial Revolution lead to
destitution for working class (urban poor)


Creation of massive slums
Structurally unemployed artisans (guilds)
Big Ideas
1.
2.
3.
Communist Revolution
Labour theory of value
Unemployment
Big Idea 1 – Communist
Revolution

Big Idea: Socialism and Communism

In Capitalist economies the working class is
exploited by the ruling classes



Aristocrats (land owners)
Capitalists (capital owners)
Workers need to unite to overthrow the
ruling class to create a just and humane
society
Communism required a
Revolution

The revolution would be violent

The revolution would lead to Socialism


Common ownership of land and capital

STATE OWNED
Socialism would lead to Communism

Worker Governed

NO STATE

Utopian society where everyone contributes to the
best of their ability and is taken care of by the
contribution of others
Rational for the Communist
Revolution



The Capitalist system was morally
bankrupt and would inevitable self
destruct
The industrial revolution in Western
Europe showed the greatest degree of
exploitation
Marx predicted this is where the
Communist revolution would start

Where did it start?
Russia 1917
http://player.discoveryeducation.com/index.cfm?guidAssetId=453d12a2-ae11-4746-a610-4a0ebb006e38
Big Idea 2 - Labour theory of value
Capitalist theory of value
 The value of item is governed by supply
and demand
 A Capitalist will purchase the factors of
production at the lowest price possible



Land
Labour
Capital



Materials
Machinery
Money (Low interest rates)
Capitalist theory of value


A Capitalist will then sell the resulting
product for more than what was paid for
the factors of production
The difference being the profit

Ex Shirt – Market Price $80




$40 – Labour
$5 – Material
$5 – Wear and tear on Machinery (depreciation)
$30 Profit
MARX’s Labour theory of value

The value of item is governed by the
amount of labour that went into it



Direct labour: labour spent making the item
Indirect labour: labour spent making the
items used in the manufacturing process
Profit = Surplus Value = Exploitation
MARX’s Labour theory of value

Ex Shirt – Market Price $80




$5 – Indirect labour of Material
$5 – Indirect labour of Machinery
$70 Direct labour cost
All of that money should go to the
workers who created the value
Big Idea 3 – Unemployment



“The reserve army of the unemployed”
Capitalists always have the option of
hiring desperate unemployed workers at
lower wages
Incentive in ensuring that wages stay at
subsistence levels
Strengths and Weaknesses
Strength
• It is a Utopian idea
• Strives for equality
and justice
– Wealth
– Education
– Health
• Allowed for rapid
industrialisation
•
•
•
•
Weakness
Violent Revolution is not
justifiable
Centrally planed economy
function poorly (no
entrepreneurship)
Did not predict the rise of
middle class and welfare
state
Humans can’t be
educated out of self
interest (biology)
MAYNARD KEYNES (1883 –
1946)

Big Idea



The invisible hand doesn't always work
Government needs to play an active role in
the economy
Counter Cyclical Spending
Business Cycles
Keynesian School of
Economic Thought



Believe that government intervention in economy ( ex.
Public works projects, interest rates) could stimulate
employment, investment, consumer purchasing
Government needed to intervene in the free market to
minimize business cycles
these ideas have been applied by many governments to
fight recessions in the economy.
CRITICS


Leading cause of inflation
Higher government debts


Creation of structural deficits due to
government programs that have no end
date
Positive Side – unemployment rates
have never dropped below levels
seen during depression