By Thomas, Peter, Jake & Anant

Evolution of Economic Ideas:

The Classical Foundations
BY THOMAS NASSIF, PETER RYAN,
JAKE DAVIS & ANANTNATH
THAKUR 10 COMMERCE Z

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Evolution of Economic Ideas

The Classical Foundations

1. Define The Following Terms:

A) Capitalism
An economic and political system in which a country's trade and industry are
controlled by private owners for profit.
B) Market Economy
A market economy is an economy that relies mainly on forces to allocate goods
and resources and to determine prices.
C) Mercantilism
The main economic system used in the sixteenth to eighteenth centuries. This
approach assumes the wealth of a nation depends primarily on the possession of
precious metals such as gold and silver. This type of system cannot be maintained
forever, because the global economy would become stagnant if every country
wanted to export and no one wanted to import. After a period of time, many
people began to revolt against the idea of mercantilism and stressed the need for
free trade, resulting in the implementation of laissez faire economics in the
nineteenth century.
D) Physiocrats
A group of eighteenth-century French
economists who believed that the land is
the ultimate source of all wealth, and also
in free trade in grain. The latter belief, but
not the former, influenced Adam Smith’s
development of classical economics.
E) Laissez-Faire
In economics, laissez-faire describes an
environment in which transactions
between private parties are free from state
intervention, including restrictive
regulations, taxes, tariffs and enforced
monopolies.

2. What Is Meant By An Economics Surplus?

Economic Surplus is the overall benefit a society composed of consumers and

producers receives when a good or service is bought or sold, given a quantity
provided and a price attached. Economic Surplus is divided into two parts: consumer
and producer surplus.
Consumer Surplus: Refers to the benefit consumers receive from purchasing a good
or service that they would have been willing to pay more for,
Producer Surplus: Refers to the benefit a producer receives from providing a good

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or service at a market price that they would have been willing to sell at a lower price.
3. Outline How Mercantilists and Physiocrats Differed On The Nature Of This
Economic Surplus?
 
Physiocrats - Physiocrats a group of 18th century French philosophers developed the
idea of the economy as a circular flaw of income and output. They opposed the
mercantilist policy of promoting trade at the expense of agriculture because they
believed that agriculture was the sole source of the wealth in an economy.
 
Mercantilists - Mercantilism was the economic philosophy adopted by the merchants
and statements during the 16th and 17th centuries. Mercantilists believed that a nation’s
wealth came primarily from the accumulation of gold and silver. Nations without mines
could obtain gold and silver only by selling more then they bought from abroad.
Accordingly, the leaders of these nations intervened extensively in the market, imposing
tariffs on foreign good to restrict import trade, and granting subsidies to improve export
prospects for domestic goods.
 
Physiocrats Mercantilists
Believed that wealth came more from Believed that the growth of crops and the
profit, hard work of man would sustain economic
gaining more for a good then you paid surplus in the community.
for it
Took a more anarchist approach to their Took a more communist approach to their
economic surplus economic surplus.
 
The physiocrats made a laisser-faire policy which called for minimal government
interference.

4. What Policies Were Advocated By The Mercantilists And The Physiocrats?

Mercantilists:
Mercantilists believed that a Nation’s wealth was determined primarily from the
accumulation of gold and silver. Mercantilism was an economic philosophy of the 16 th
and 17th centuries and, during this period; money was represented largely by silver coins,
with gold being used for larger transactions. Therefore, Mercantilists advocated that
Nations without mines could obtain gold and silver only by exporting more goods than
they imported. As a result, the leaders of such Nations exercised great control over the
market:
 Taxes were placed on foreign goods to restrict importation.

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 Subsidies, such as cash grants, were provided to domestic goods

providers in order to improve exportation.
Physiocrats:
Physiocrats were 18th century French philosophers who developed the idea of the
economy being a circular flow of income and output. They opposed the Mercantilists’
policy of promoting trade at the expense of agriculture. The Physiocrats believed that
agriculture was the sole source of economic wealth. While the Mercantilists advocated
strict trade regulations, the Physiocrats developed a system of a free market. Their policy
of laissez-faire (meaning “let [them] do”) called for an economic environment in which
transactions between private parties were free from government interference of any kind.
Therefore, in stark contrast to Mercantilist policy, the Physiocrats stood for minimal
government involvement in the economic market.

5. What Were the Three Major Objectives of Adam Smith’s Book, Wealth of Nations?

Adam Smith’s book, An Inquiry into

the Nature and Causes of the Wealth
of Nations first published in 1776,
details his search for the reasons for
economic growth. The three major
objectives of Adam Smith’s book
were:
 To explore what factors
cause economic growth.
Smith believed these factors
were based around the
division of labour and the
accumulation of capital.
 To outline how economic growth can be measured. Smith created his Theory of
Value, he believed that value was constant and could be determined by required
labour. This led to the Labour Theory of Value.

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 To show that natural liberty and free markets were necessary for growth. Adam
Smith was the great champion of Laissez-Faire; he advocated a free market which
would be driven by self-interest. Smith believed that self-interest could be
translated into social interest through the market mechanism, being the “invisible
hand” (the competition among buyers and sellers).
6. Briefly Outline The Historical Basis Of Capitalism.

Capitalism is an economic and political system in which a country’s trade and

industry are predominantly privately owned and operated for profit. The occurrence of
a number of historical events led to being the basis of capitalism, these include:
 The development of a banking system.
 Protestant attitudes towards wealth.
 The accumulation of wealth.
 Feudalism’s breakdown.
 The emergence of trading companies.
 More land becoming privately owned.
 The Industrial Revolution.
 The growth of towns (urbanisation).
 The enclosure of land.
 Increased rates of trade.
 Development of a merchant class.
 Imperialism.

7. Outline Smith’s Concept Of The Division Of

Labour.

The Division of Labour:

Adam Smith believed labour could be divided into two categories:

 Productive (those who were manufacturers e.g. factory workers, carpenters,
etc.)
 Non-Productive (those who provided services e.g. professors, lawyers, etc.)
Smith argued that there were two components to productive labour:
 The first was that it had to lead to producing tangible goods.
 The second was that the labour must create a surplus, which could then be
reinvested into production.
Adam Smith argued that the specialisation of the labour force would be the
foundations for economic growth. Essentially, large jobs were to be broken down into
many small components. Each worker would then become an expert in one isolated

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area of production, thus increasing his efficiency. Furthermore, not having to switch
tasks throughout the production process would save further time and money.
8. Give A Brief Critique Of The Above From A Modern Perspective.

From a modern perspective, while Smith’s theories on the division of labour were
obviously successful as evident in the growth of Victorian factories throughout the
19th century, they are losing relevance. As technology has improved, the required
working force for productive labour has decreased. This is largely due to the fact that
Smith’s concept of labour specialisation led to worker’s performing repetitive simple
tasks, making them easily replaceable with machines.

Since the era of Adam Smith, factory working opportunities have suffered a steady
decline with the present day seeing a vast increase in non-productive labour, mainly
requiring a high level of education. Therefore, I believe that, while Adam Smith’s
theories on the division of labour were successful due to the context of their time, the
requirements of the modern world no longer base economic growth upon productive
labour with the same emphasis as seen in past eras.

9. Briefly Outline Smith’s Concept Of The Accumulation Of Capital

Adam smith’s account of Primitive-original accumulation depicted a peaceful process.

Smith’s concept of the accumulation of capital was summarised as "there were some
people who were hard working and some people who were not. Some people who
could be bothered and some who could not". His concept outlined that those who
were hard working, bit by bit, accumulated some wealth from their work, whereas
those who were unable to meet the required amount of work necessary did not gain
wealth. It became very important in smith’s account not to bring in the state as an
agent of primitive account. The pillar of smith’s argument, like most classical political
economists, was to let the state withdraw which would allow societies to flourish by
letting laissez-flaire markets allocates goods and
services.
His concept summarised, those who are willing to
work hard and put in the effort will gain more
wealth then those who are not as hard working.

10. How Does The Above Concept Apply Today? Are

There Any Differences?

Today the concept is present to an extent. Those who

work hard in their education and schooling will be able to gain the sufficient marks to allow
them to gain more wealth than those who don’t not work as hard at school. But the concept
ends there as wealth also can give an unfair advantage to those who are unable to pay for say
a "first class" education.
Therefore this can affect the education of some who are hardworking but not in a fair
environment to learn such as others who are less deserving of a high education but are
wealthy enough to afford it. Also reputation of schools will also influence the university's

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decisions on who is allowed into their education if there was to be a similar mark between
two people of differing schools.
 

Adam Smith’s Day and Age

Hardworking Not Hardworking

Present Day and Age

Wealthy Poor

11. Briefly Outline Smith’s Theory of Value?

Adam Smith’s Theory of Value:

One of the objectives of The Wealth of Nations was to measure economic progress, in
effect, to put a value on goods and services.
Adam Smith believed value was constant. He distinguished between Value in Use and
Value in Exchange. For example:
 Water has a high value in use, but low value in exchange.
 Diamonds have a low value in use, but high value in exchange.

This is the water-diamond paradox – while water is much more useful than diamonds, it is
much cheaper. Therefore, Smith theorised that usefulness did not define value (value in
use did not coincide with value in exchange).

Adam Smith asserted that value was measured by the required amount of labour used in
production. He wrongly assumed that all “units” of labour were equal (which, in reality,
they are not) and that these units determined a products value in exchange. Adam Smith’s
theories led to the Labour Theory of Value. Simply put, if the construction of a desk took
twice the labour as the construction of a chair, then one desk should exchange for two
chairs.
The second theory of value is the Cost of Production Theory, stating that value is
determined by all involved costs:
 Price = Wages + Profit + Rent (all
measured in Labour terms).

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12. Distinguish Between The Natural Price And The Market Price.

Natural Price:
Adam Smith argued that the natural price of a good or service was equal to the cost of
production. The natural price was, therefore, the lowest price at which an entrepreneur
could continue to sell his goods.

Market Price:
Smith stated that the market price of a good or service was the current value the given
commodity had in the market. In other words, the market price was the current price of an
asset or service could be bought or sold. In accordance with economic theory, the market
price converges at a point where supply and demand meets. Fluctuations to either the
supply and/or the demand could cause for the market price to shift.

For example, if the market price for a chair has been $10 for a number of years, and then
one year it is announced that only half as many chairs will be sold as the previous year, then
the market price of the chair will shift to $20. In this case, a drop in the supply causes the
market price to increase due to a continuation of demand.

13. Outline The Idea Of The Invisible Hand And Says Law.

In economics, "the invisible hand theory" of the market is a metaphor conceived by

Adam Smith to describe the self-regulating behaviour of the market place. The exact
phrase is used only three times in Smith’s work but has come to capture his important
claims that individual efforts to maximize their own gains in a free market benefits
society.
The two meanings of the phrase "the invisible hand theory" Smith created were from
Richard Cantillion who developed both economic applications in his model of the
isolated state.
Smith first introduced the idea of the "invisible hand theory" in his concept of the
theory of Moral Sentiments, written in1759.
Smith described the market mechanism as an invisible hand that leads all individuals
in pursuit of their own self-interests, to produce the greatest benefit for society as a
whole. Smith incorporated some of the physiocrats ideas, including laisserz-faire, into
his own economic theory.
Say's law, or the law of market, is an economic principle of classical economics
named after the French business man and economist Jean-Baptiste Say (1767-1832),
started the "products are paid with products". In Says view a businessman will never
hoard any money; he will use his money as soon as he gets it.

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14. Briefly Outline The Achievements Of Adam Smith And The Wealth Of Nations.

On 1776, Adam smith’s book "an inquiry into the nature and causes of the wealth of
nations" was published. The book quickly became a best seller, with six reprints by
the 1800s. This book made an immediate impact in both political and intellectual
circles and to this day is regarded as the basis for the development of political
economy as a discipline in its own right in England.

The success of this book quickly led to Adam being employed to tutor the young
Duke of Buccleuch, being paid an enormous salary of 300 pounds per annum for life.
He accompanied the young Duke to Rome where he was able to meet many of the
leading French thinkers such as Voltaire and Francois Quesnay. The book formally,
for many years, symbolised the new age of the industrial revolution. His themes of
liberalism and free market and his analysis of growth, factors of production and
taxation have provided stimulus for economists over 2 centuries.

15. What Were the Limitations of Adam Smith’s Economics?

Some of the limitations that Adam smith had were in his free market. Further research
on the subject show that free markets, by themselves, often do not lead to what is best.
As some authors have put into the books, the reason
the title of the invisible hand is given is because it is
often not present, whenever there are "externalities"
markets will not work as well. Also environmental
externalities such as pollution, make free markets
insufficient as they produce too much.

Markets also by themselves produce too little basic

research and a lot of imperfect information and
imperfect risk markets are produced. Government is
also needed to watch over and finalise contracts and

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to enforce these and property rights. Smith was unable to find the perfect balance
between government and market.

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