HISTORY OF ECONOMIC HOUGHT

INTRODUCTION

A ‘History of Economic Thought’, as the title itself suggests, is a probe into the origin
and growth of economic ideas. It is a historical account of the development of
economic doctrines as also of their impact on economic institutions and activities.
Thus the history of economic thought deals with the origin and development of
economic ideas and their interrelations.

1. The history of economic thought studies the origin of economic ideas and
their .interrelation. It also traces the contributions made by scholars and economists
in terms of theories and economic concepts from the ancient times to the present.
2. As human knowledge accumulates, it is analyzed and categorized into different
sciences. Economic science is also a result of the same process and includes
doctrines and generalizations which deal with economic phenomena of our life.
3. Economic science, like other sciences, has had to undergo a process of evolution and
is the result of contributions by various thinkers. In many cases, specific
contributions went unnoticed for a period of time, while certain other contributions
were recognized during the very life-time of their contributors.
4. The role played by different thinkers in the process of its evolution has been uneven.
Some thinkers contributed more than others. However, even when the contributions
by some thinkers were not big, every contribution has its own place and relevance
in the development of economic science and in improving our comprehension of
economic phenomena.
5. Economic thought covers theories, doctrines, laws and generalizations, and analyses applied
to the study and solutions of economic phenomena and problems.
6. Economic thought is not a given and fixed set of economic theories or tools and
techniques of analysis. Economics is a dynamic science. This characteristic of it partly
follows from the fact that it is a social science.
7. Since human society is a complex phenomenon, a large number of causes are likely
to be at work in most cases and different investigators could differ as to the choice
of the most ‘relevant’ causes at work.
8. Moreover, the identification of the causal forces at work does not imply that these causes
would not change. Over time, the roles of specific forces are likely to undergo a change. The
responses of economic units (individuals, firms, governments, etc.) would vary from one
situation to the other in view of the prevailing moral, political, religious and social
philosophy as also the institutional framework of the society.
9. An economy is a dynamic phenomenon and therefore economic science is a dynamic
one. With social change, new economic questions present themselves.

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10. People’s thinking is influenced by their social and physical environment. Economic
thought ,therefore, develops within the basic framework of a given economy and its
institutional setup.
11. The very dynamism of an economy provides a basis for further investigation. In a static and
stagnant economy, there is no scope for furthering the science of economics. But a changing
economy poses newer challenges which economic thinkers have to investigate. The result is
that economic science is always undergoing a change.
12. Over successive time intervals, specific sets of economic ideas, theories, doctrines, tools and
techniques acquire recognition and acceptance implying that in different contexts we have
different systems of economic thought.
13. The study of economic thought, therefore, may be defined as a critical account of the
development of economic ideas, searching into their origins, interrelations, and
manifestations.
14. With the passage of time, there has been a development in the concepts and tools and
techniques of analysis. New concepts are continuously introduced to cope with the
emerging theoretical and practical problems.

15. Individual economic ideas are almost always problem-oriented. There are generalizations
about certain facts and problems and the desirable solutions thereof. Among various
problems which man faces in his daily environment, there are economic problems also.
Accordingly he has to try to solve them along with other problems. We find, therefore, that
traces of economic ideas have always been there in the total thought system of mankind.
16. In economic science, there is a good deal of theorizing and generalization about the nature
of economic problems; the typical response which different economic units (individuals,
firms etc.) show to various stimuli are recognized and categorized and the types of feasible
and actual solutions get listed.
17. There is also a concern with the ‘efficiency’ of the economic system and the way in which it
could improve its working. All this involves the use of numerous concepts and their
definitions become progressively rigorous as time passes.

18. The study of the subject gives one an insight into the evolution of economic theory and the
formulation of policies which controlled economic life, from the earliest time to present day.
19. Every science grows and evolves over time and during the process of its refinements and
expansion, attracts numerous debate and controversies which not only relate to the subject
matter of the discipline itself, but also to its application to the problems of actual life.
20. Economic thought evolved through feudalism in the Middle Ages to mercantilist theory
during the Renaissance (A Period when people were concerned to orient trade policy to
further the national interest).

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 21. The modern political economy of Adam Smith appeared during the industrial revolution,
when technological advancement, global exploration, and material opulence that had
previously been unimaginable was becoming a reality.
22. All these and further developments are subject matter of history of economic thought.
Changes in economic thought have always lead to changes in the economy and changes in
economic policy.

Relationship Between Economic Thought and the Environment

1. Economic thought is closely related to economic environment. The growth of economic

science can be traced along with the growing complexity of the world economies.
2. Economics has its main roots in specific economic framework of a society. Economic theory
may be in the context of a market economy, a centrally planned economy or mixed
economy.
3. The development of economic science, therefore, is intimately related to the development
of economic environment; and the two interact with each other.
4. Economics assumes the framework of technology and resources available to the society as a
whole as also the set of relationships with other economies.
5. The appropriate identification, description and analysis of the responses of economic units is
an important stage in the formulation of economic generalizations. The exact nature of
responses depends upon the institutional framework of the society
6. Economic theorizing and investigation, therefore, have to be in the context of and within the
framework of an economy.
7. Through economic theorizing and investigation the efficiency of an economy in the context
of its particular institutional framework is judged and remedial actions, if any, prescribed.

Lack of Agreement in Economic Thought

There are several reasons why there is no uniformity of conclusions and
opinions amongst economists which include the following:
(a) Economics is a social science in which controlled experiments are impossible.
Accordingly there is always a possibility of difference of opinion regarding the choice
of relevant causal forces and the process of their interaction.
(b) Differences would exist with reference to the assessment of facts. Determining the
precise direction and strength of a particular force is a matter of investigation,
judgement and opinion.
(c) Relevant phenomena are investigated and estimated with the help of available data
and tools and techniques of analysis. All these things are subject to a modification.
Data keep on changing; old data are replaced or supplemented by new ones.
Similarly, there is a constant improvement in the tools and techniques of analysis.

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 (d) Economic analysis admits a wide variety of methods. As a result, even with given tools and
objectives, the method of analysis may vary from one analyst to the other and yield non-
identical results.
(e) Differences arise on account of the purpose for which an economic investigation is being
undertaken. This is more so in the case of practical problems and their solutions. The cause-
effect relationship between different forces would be assigned to suit a particular
philosophy and purpose.
(f) Divergence of opinion may arises on account of the materialistic and idealistic attitudes of
the economists. Economists, in the ultimate analysis, are as much human beings and
individuals as anyone else, and they are quite frequently swayed by the final conclusions
which they would like to press forth.

SIGNIFICANCE/IMPORTANCE OF HISTORY OF ECONOMIC THOUGHT

The Study of History of economic thought is important for the following reasons:

1. The study of history of economic thought clearly shows that there is a certain
unity in economic thought and this unity connects us with ancient times.
2. The study helps us to avoid committing the same mistakes of the earlier
economic thinkers.
3. The significance of history of economic thought is that it is an important tool
of Knowledge.
4. The study will help students realize that economics is different from
economists.
5. It helps students to know that economic ideas are conditioned by time, place
and circumstances.
6. The study enables us to know the economic thinker responsible for the
formulation of certain important economic principles and concepts.
7. The study of History of economic thought will help us to understand the origin
of economics as a discipline.
8. The study will help students to know that economic ideas have been
instrumental to the shaping of economic and political policies of different
countries of the world.
9. A study of the History of economic thought will help to provide a broad basis
for comparison of different economic ideas. It will enable a person to have a
well-balanced and reasonable judgment.

INDUCTIVE AND DEDUCTIVE METHODS OF ANALYSIS

1. The place of abstraction in economics may also be noted via the distinction between
inductive and deductive methods of analysis.
2. In the inductive method, economic phenomena are investigated and data are gathered,
interrelationships between different interacting forces are ‘found out’ and then
corresponding inferences and generalizations are derived. This approach proceeds on

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 empiricism and relies on ‘correct’ interpretation of the interrelations between economic
forces.
3. On the other hand, deductive method relies on abstraction. A set of causes is chosen as the
one which is relevant to the problem in hand and the process of interaction between these
forces is determined on the basis of set rules.
4. So long as we have only economic ideas, there is hardly any generalization, or deductive
analysis or abstraction. On the other hand, in economic science proper, there is a good deal
of scope for generalizations, deductive analysis and abstraction.
5. Actually, even empiricism or inductive analysis becomes acceptable only if it satisfies well
accepted rules of analysis and theorizing and when it uses acceptable techniques and tools.

The difference between the History of Economic thought and Economic History

1. There is a difference between ‘History of Economic Thought’ and ‘History of Economics’.

History of economic thought deals with the development of economic ideas. Economic ideas
have been there ever since the birth of mankind. History of economics deals with the science
of economics.

2. While History of Economic Thought deals with the development of economic ideas,
Economic History is a study of the economic development of a country.

3. The history of economics studies the origin and growth of commerce, manufacture, trade,
banking, transportation and other economic phenomena and institutions. In short it is a
study of the material or industrial development of the people in the past
4. Economic history is different from history of economic thought. Economic history is the
study of the economic aspects of societies in the past such as the history of the economic
use of resources or the examination of the past performance of economies.
5. It is concerned with how people lived most of their lives, how many were born and died,
how they earned and spent, worked and played.
6. Economic history asks economic questions – be they about the demand and supply of goods
and services, about costs of production, levels of income, the distribution of wealth, the
volume and direction of investment, or the structure of overseas trade – it inevitably deals
with large numbers, with aggregates.
7. A study of economic history is important because the historical economic phenomena to be
examined in any given period depends on the social, political, cultural, religious and physical
environment in which they occurred.

Advantages of Studying the History of Economic Thought

The advantages of the study of history of economic thought include the following:

1. The study of ‘History of Economic Thought’ reveals that there is a certain unity in thinking of
man right from the earliest times to the present day. The economic thought and this unity
connects us with ancient times.
2. The study of economic thought assists us in tracing the origin and development of
economics, and in understanding its nature, scope and relationship with other sciences.

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 3. 3. The study of economic thought leads to a change in the outlook of the reader. He no more
remains dogmatic. He starts examining and assessing critically the practical value of each
idea and theory in the context of his own times and conditions. Thus it is clear that most of
the economic ideas are relative. They are conditioned by time, place and circumstances.
4. The study of the history of economic thought reveals that there has never been an age in
which ideas have not developed.
5. A study of economic thought provides a broad basis for comparison of different ideas which
proves to be of great value. It will enable a person to have a well-balanced and reasonable
judgment.
6. By the study of the History of economic thought, students will realise that old doctrines
never die. For example, some ideas of Keynes, one the greatest of modern economists, may
be traced back to socialist writers such as Sismondi and Proudhon and to Malthus.
7. By the study of History of economic thought, we come to know the persons responsible for
formulation of various economic principles .
8. The study of ‘History of Economic Thought’ also reveals the differences in the points of view
of various thinkers and shows how a particular point of view has been built, difference in
opinion and points of view are bound to occur owing to the difference in the basic
philosophy of life and the method adopted by each thinker in studying a problem.
9. It enables him to realize that economics as a science is a comprehensive whole and that
individual theories, tools and techniques have their meaning, importance and rationale only
in the context of that overall totality

Ways of Presenting the History of Economic Thought

There are several ways to present the history of economic thought:

(i) To analyse the changing nature of economic theory in conjunction with the social and
economic development of society
(ii) To emphasize economic thinking as part of the main currents of philosophical and
political ideas.
(iii) To emphasize the internal dynamics of the science where new insights and results
emerge as a consequence of economists’ awareness of the shortcomings of the present
state of the subject.
The Blended Approach
1. It is obvious that any one such approach would only serve particular purposes and may not be
fully satisfactory from other points of view.
2. It would ,therefore ,be preferable if a blended approach of the development of economic
science is taken in which due emphasis is accorded to the individual economists, to the schools
and also to the development of important strands of economic thought.

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 MERCANTILISM

Definition of Mercantilism

1. Mercantilism as an economic ideology started in Europe in the 18th century. It had its roots
in the commercial revolution that had started in the 16th century. Its main aim was to
increase a nation’s wealth by government regulation of all of the nation’s commercial
interests.
2. No universal definition of mercantilism is completely satisfactory; however, it may be
thought of as a compilation of policies made to keep the state affluent by economic
regulation. These policies may or may not have been applied at the same time or place.
Introduction
1. Mercantilism is an economic nationalism for the purpose of building a wealthy and
powerful state.
2. Adam Smith coined the term “mercantile system” to describe the system of
political economy that sought to enrich the country by reducing imports and
promoting exports.
3. This system dominated Western European economic thought and policies from
the sixteenth to the late eighteenth centuries.
4. The goal of these policies was, to achieve a “favorable” balance of trade that
would bring gold and silver into the country and also to maintain domestic
employment.
5. 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.
6. The most important economic rationale for mercantilism in the sixteenth century was
the consolidation of the regional power centres of the feudal era by large, competitive
nation-states.
7. During the mercantilist period, military conflicts between nation-states were both
more frequent and more extensive than at any other time in history.
8. Each government’s primary economic objective was to command a sufficient
quantity of hard currency to support a military that would deter attacks by other
countries and aid its own territorial expansion.
9. Most of the mercantilist policies were the outcomes of the relationship between
the governments of the nation-states and their mercantile classes. 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.

10. The mercantilists argued for a positive balance of trade. Many early mercantilists
defined the wealth of nation not in terms of nation’s production or consumption, but in
terms of its holdings of precious metals such as gold or silver.
11. A related issue concerned the exports of precious metals or bullion (that is gold or

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 silver in bars). Early mercantilists recommended that the export of bullion be
strictly prohibited.
12. Mercantilists believed that every aspect of life was subject to regulation by rulers
for widening of market beyond medieval limit. 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.
13. For protecting the domestic trade and for expanding the foreign market a strong
central government becomes an important element in mercantilist doctrine.
14. So the mercantilists gave much importance for the creation of a strong Nation.
Thus the mercantilists demanded a state strong enough to protect the trading
interests and to break down the medieval barriers to commercial capitalism.
15. 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 abundance of silver, gold and jewels, which are not perishable.
16. They were in favour of a strong King who could support a large army and maintain a
powerful navy. Hence the mercantilist attached great importance to treasure and
bullion as the most useful and generally accepted form of wealth.
17. Thus the mercantilist considered foreign trade as the only source for acquiring
gold and silver. They believed that treasure gained by the balance of our foreign
trade remained in the kingdom. In respect of its exports a country must receive
payments in the form of silver or gold.
18. Exports represent money coming into the country and imports represents money
going out. 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. Imports were considered evil . The primary principle of typical
mercantilists was to maximize exports and to minimize imports. The mercantilist
supported a favourable balance of trade as the means to acquire more treasure.

19. The fundamental aim of the mercantilist was to make his country strong. It was felt
that a strong country must have well equipped army and navy to defend itself and to
protect its political interests in the outer world. It was found that maintaining armed
forces implied having adequate financial resources, which in those days were
equivalent to having adequate stocks of precious metals. The state power was the
military power which in turn needed wealth. Only wealthy country could have and
maintain strong forces and nation’s unity is a pre-requisite for state’s power.
20. The mercantilist theory was nothing but the philosophical expression of the capital needs of
the rising merchant class. They needed a strong state to protect them and they needed capital
for trade which in those days consisted of gold and silver.
21. Mercantilists regarded money and bullion as the sign of wealth. They believed that if country
has mines, it can get gold and silver and it can accumulate those precious metals by imposing

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 restrictions on export of gold. But if a country has no mines, it can get gold and silver only
through trade. Trade must be conducted and regulated in such a way that gold and silver may
come into the country. In order that a country may have more bullion, there must be a
“favourable balance of trade.” In other words, there should be an excess of exports over
imports.
22. According to mercantilists, trade was the most important occupation. Industry and
manufacture were ranked second in importance Agriculture was least important of all. Though
agriculture might feed the population it brought no money in the form of gold and silver into
the country. Therefore, they thought that it was not as important as trade and industry.
23. A series of trade regulations and policies were framed by the mercantilists to
support their business operations. These policies were aimed at export promotion
and import restriction and they included the following.
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
d. Restriction on the industries which interfere with other industries or trades of
greater national importance.
e. Ban on the export of bullion ( gold and silver)
f. Establishment 'of banks and the promotion of use of credit instruments.

Role of Government
1. In order to execute all their schemes and programmes, the mercantilists looked to a supportive
government which can interfere everywhere.
2. There was nothing the govt. might not do; if its activities help to promote the general wellbeing. So
the mercantilists attached great importance to state as the centre of all economic activities.
3. The control and regulation of the govt. are essential for the attainment of favourable balance of
trade. Government regulations reflect the protectionist philosophy prevailing in the mercantilist
literature.
4. The mercantilist protection arguments can be summed up as follows:
(a) Protection may be granted to strategic industries. These industries which are
strategic to the nation both in terms of their export contribution and also in terms
of their contribution to economic development,
(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 defence industries
(d) Those industries should be given protection which help for the attainment of self-
sufficiency 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. From this,
Factors Responsible for the Rise of Mercantilism
Economic Factor.
1. Towards the end of the 15th century, economic changes were taking place in
European countries.

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 2. The important economic change was the decline of feudalism and its gradual
replacement by Commercial Capitalism.
3. The domestic self-sufficiency was giving way to the development of a system of
exchange.
4. The market economy was slowly emerging, replacing the feudalistic self-sufficient
local economy.
5. Agriculture was being replaced by trade and commerce.
6. Monetary transactions were rapidly expanding.
7. 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.

Political Factors:
1. The major political change was the transition from feudalism to nationalism.
2. 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.
3. There was need for a unified national state under a strong king
4. The merchants and trading community were looking forward for a strong centre
to protect them from rivals and to support their trading interests.

Religious Factors:

1. During the Middle Ages, both economic and political life was dominated by religion and
ethics. The Church was more powerful than the king.
2. The reformation movement raised a voice against the supremacy of Roman Catholic Church
and challenged the absolute authority of the Pope in religious and political matters.
3. Protestantism gave more rational meaning to Christianity and pointed out the importance of
money, economic efforts as against Catholicism which preached total detachment of man
from material things.
4. In Europe, the king and the flourishing merchant class adopted the protestant
religion and revolted against the supremacy of Roman Catholic Church and the
authority of the Pope.
5. These religious changes helped a lot in developing property rights and contract
rights which were essential for the growth of commerce.
6. The new Protestant religion allowed the acquisition of material goods and
property.
7. The new religion was in favour of complete liberty and freedom of the
individuals.
8. The Protestant religion became very strong and it was embraced by the
merchants.

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Cultural Factors

1. Medieval theology laid emphasis on heavenly happiness. It preached that the people
should detach themselves from material wealth.
2. Against this, Medieval theology, two important cultural changes arose in the
society. namely renaissance and humanism.
3. The renaissance gave a new light and learning to the people. According to the
theological teachings of the Middle Ages, the miserable life on this earth was not
to be considered source of worry, as it will be compensated by the pleasures in
heaven. But under the impact of the reformation and the renaissance, people
were made to realise that this life was more important than the life of the other
world.
4. These cultural changes gave emphasis to creative human activities, acquisition of
wealth, and trade and commerce.
5. This new ideology was able to uphold the spirit of the traders and merchants to
accumulate wealth.
6. In fact mercantilism was a reaction against the moral and idealistic attitude of the
medieval period.
Discoveries and Inventions
1. Various discoveries and inventions played an important role in the promotion of
trade and commerce and helped the development of mercantilist thought.
2. Scientific and Technological Changes- In the field of science and technology, great
advancements and inventions were made which helped in strengthening mercantilist
philosophy and policies.
3. The discoveries of new continents such as Africa, India and America opened up the gates to
a great variety of raw materials, a wide market and a wider field for regional specialization.
4. 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.

Economic Ideas of Mercantilism.

The Role of Money
1. Money was considered to be the most important source of strength to the nation.
The mercantilists were of the view that money, usually in the form of precious

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 metals or treasure, had played an important role in determining the economic well-
being of a nation.
2. Therefore, the mercantilists paid a lot of attention to the accumulation of precious
metals. It was felt that an adequate supply of gold and silver in the form of bullion
was .
Nationalism-
1. Nationalism was the pivot on which their main ideas were centered and they emphasised on the
national strength and prosperity.
2. The stress was on national economic unity, which naturally implied the enhancement of the
power of the state.
3. Every aspect of life was made subject to regulation by the ruler.
4. The mercantilists believed that state intervention was necessary for the proper management of
society’s economic affairs.
5. Military aggression and the exploitation of new countries were the chief aims. Economically,
the expansion of commerce and trade, and politically, success in wars were the natural goals
which could not be achieved without a strong navy.

Balance of Trade
1. Foreign trade was considered to be the only source of acquiring gold and silver.
2. All those nations which did not possess their own mines could become rich after getting
gold and silver from foreign countries through trade.
3. They advocated foreign trade as a tool for increasing a nation’s wealth and treasure.
Population-
1. Mercantilists favoured a large and rapidly increasing population for making the nation
militarily strong and for increasing its productive capacity.
2. They believed that an increasing population meant both an increase in potential number of
soldiers and sailors and an increase in the number of productive workers .
3. They felt that cheap and abundant supply of labour force would help in keeping the cost of
production low thus enabling the country to compete successfully with the world market.

Production
1. The ideas of mercantilists on production were most primitive.
2. They felt that the process of production was one which involved the application of human
labour to resources. Consequently, they advocated an increase in both labour and resources
of production. Mercantilists regarded agriculture as insignificant.
3. They argued that agriculture did not contribute directly to the strength and prosperity of the
nation like foreign trade.

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 4. Mercantilists believed that foreign trade and commerce were the most productive
professions and that agriculture was the least productive

Decline of Mercantilism

Mercantilism declined in England and other parts of the world towards the end of
eighteenth century. The following were the main reasons for the decline of mercantilism:

i) Under the influence of the teachings of Adam Smith, the ‘policy of plenty’ began to
replace the ‘policy of power’.
ii) The development of banking, both domestic and international, reduced the importance
of bullion (gold and silver) and coins.
iii) The expansion of market economy showed that real estates, factories and machinery
were more important items of wealth than gold and silver.
iv) The economic growth that took place during the Industrial Revolution made it possible
for the society to rely on competitive forces and laissez faire and rather than promoting
and regulating monopolies.
v) The great progress made in science and technology taught people that a country could
become richer not only by impoverishing its neighbours but also by mastering the forces
of Nature in a more efficient way. It was also Mercantilism found that the wealth of all
nations could be increased simultaneously.
vi) During the period of mercantilism, economic life was highly regulated. There were many
regulations protecting the quality of goods. But these regulations which were once
necessary ultimately became a barrier to progress so the regulations were withdrawn.

Criticism of Mercantilism

The criticism against mercantilism and their policies were as follows:

1. The Mercantilists are accused of a static approach in which the gain

of one nation could be only at the loss of the other.

2. The mercantilists went wrong in supposing that a favourable balance

of trade was the only source for bringing prosperity to the country.

3. They laid too much stress on gold and silver and neglected the

importance of other commodities.

4.They overestimated the importance of commerce and underestimated

the usefulness of agriculture and other branches of human industry.

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5. Their ideas regarding ‘value’ and ‘utility’ were not clear.

6. Their ideas about capital and interest were imperfect.

7. They advocated lower wages because it was through lower wages

that the cost of production could be kept low and exports could be

made at high profits.

10.The most misleading doctrine of mercantilism was the often repeated proposition that a country
can get rich only at the expense of other countries.

Check Your Progress

1. What was the commercial revolution spanning from the 16th to the 18th century marked by?

2. What was the development of mercantilism a consequence of?

3. List the means through which governments tried to encourage mercantilism.

4. What did the fast growing exchange and trade during the Middle Ages necessitate?

5. List two features of the economic doctrine of mercantilists.

6. Why did mercantilists favour a large and rapidly increasing population?

FURTHER READINGS

Hajela, T.N. 2000. History of Economic Thought. New Delhi:

Konark Publications Loganathan, V. 1998. History of Economic Thought. New Delhi:

S. Chand and Company. Sankaran, S. 2000. History of Economic Thought. Chennai: Margham
Publications.

PHYSIOCRACY

1. Physiocracy is a school of thought founded by François Quesnay (1694-1774).

2. The actual members of the Physiocratic school referred to themselves not as
Physiocrats but as économistes or economists.
3. The term is a combination of “physio” (nature) and “cracy” (rule). Physiocracy,
therefore, means the “rule of nature.” This expresses the school’s fundamental
idea that there is a natural order, as opposed to artificial systems.
4. Physiocracy (Government of Nature) is an economic theory developed by the
Physiocrats, a group of economists who believed that the wealth of nations was
derived solely from the value of “land agriculture” or “land development.”
5. Physiocracy was basically a revolt of the French against mercantilism. At that

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 time, the condition of agriculture was miserable. There was need for an
economic theory to prove that the pursuit of mercantilist policies was harmful
to the progress and wealth of the nation. And the physiocrats provided the
theoretical basis to attack mercantilism.
6. Mercantilist policies had outlived their importance. In England, agriculture was
being revolutionised with the introduction of large scale farming and scientific
techniques of production. So in France too attention was diverted to the
strengthening of agriculture.
7. People in France realised that trade and manufactures had been given too
much importance at the cost of agriculture. These trends in the thinking of the
people shook the roots of mercantilism and enhanced the importance of
agriculture..
8. Physiocracy was perhaps the first well developed theory of economics. They
called themselves économistes (economists) but are generally referred to as
Physiocrats in order to distinguish them from the many schools of economic
thought that followed them.
9. 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.
Other forms of economic activity, such as manufacturing, were viewed as less
important.
10. ’ Physiocrats developed the doctrine that agriculture was the sole source of all
wealth, the only productive occupation.
11. Though the physiocrats wrote only for a relatively short period, their ideas had
a profound influence on the economic thought. That is why they are regarded
as the founders of the science of political economy.

12. 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
13. Their theories originated in France and were most popular during the second
half of the 18th century. Physiocracy was the first well-developed theory of
economics.
14. The Physiocrats, or the “Economists” as they called themselves, were the first
school of economic thought. They represented a reaction against the policies of
mercantilists who advocated strict regulation of commerce, protective tariffs.
15. They made important contributions to the theory of taxation. They advocated direct taxes
rather than indirect taxes which affected the poorer people of the French society of their
time badly.

Factors Responsible for the Rise of Physiocracy

Physiocracy was a revolt against mercantilism in France. This was due to the

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deteriorating economic and social conditions at that time which were chiefly due to
mercantilist policies.
The factors responsible for the growth of physiocracy in France are given below:
Tyranny and Extravagant Life Kings
1. 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.
2. Public expenditure was very extravagant and wasteful. The result was an
increasing indebtedness of the government and the need to levy extra taxes to
finance the public expenditures.
3. The deteriorating economic conditions provided a new ground for new ideas and
desire for change.

Regressive Taxation
1. In France, during the reigns of Louis 14, taxation was heavy, unjust and
inequitable.
2. The rich and the 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 land rents.
3. The farmers were hardly left with any surplus which they could use for
improvement of land or for improving their own consumption standards.
4. There were many other oppressive taxes like the salt tax, poll tax, the tithe tax
which were equally burdensome for the poor sections of the community.
5. The tortured life led by the farmers gave an impetus to the physiocratic policies
and doctrines.

Decay of Mercantilism
1. Mercantilist policies had outlived their importance. Its policies were severely
criticized and people were looking for an alternative system.
2. In England agriculture was being revolutionised with the introduction of large
scale farming. The achievements of this revolution reached the ears of the French
people through various writers.

Neglect of Agriculture
1. Agriculture in France was in a state of stagnation compared with its increasing
usefulness and profitability in England.
2. Industrial development was taking place in France at the cost of agriculture.
Investments were diverted from agriculture to manufacturing.
3. The value of agricultural produce fell on account of restricted markets.
4. Lower prices of agricultural products prevented capital accumulation in
agriculture. Agriculture suffered due to lack of capital and initiative.

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 Emergence of a Group of Ambitious Agriculturists
1. 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 the king.
1. The on-going Agricultural Revolution in England influenced very much these
ambitious French landowners. They thought that a similar revolution can be
brought about in France.
Subjective Factors
1. There were great subjective factors at work for change and progress discarding
mercantile policies.
2. During the period of Louis 14, the people could not criticise 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.

Existence of Socio-economic Inequality

1. France witnessed an extreme form of inequqlity between different classes of people and
between different sectors of the economy.

2. There were both privileged and unprivileged classes. The common people were
underprivileged who wanted an escape from this unwanted situation.

Influence of the Writers

1. Thinkers concerned with the ills of the society were trying to figure out and convey
suggestions for the reformation of the system.
2. There were analytical discussions regarding the ill- effects of the existing system and the
type of the ideal system which should replace. There was consensus the ideal system is
physiocracy.

The Basic Principles of Physiocracy:

The following are the fundamental principles and policies of physiocracy:
1. Agriculture is the only productive occupation. Industry and trade are secondary
occupations.

2. There is a natural order which makes life happy and meaningful.

3. There should be harmony among all classes of people.
4. The individual should get maximum liberty and State action should be limited to the
minimum.
5. Trade is a necessary evil, and there should be free trade.
6. Value and price are the same things and Value depends on utility.

7. The wage level should be at the subsistence level.

8. There is interdependence in the economic system.

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 9. Real wealth lies in tangible and consumable goods.
10. Private initiative must be encouraged.
11. Distribution of products is very essential.
12. Money is a medium of exchange.
13. Rent is a perfectly legitimate income of the landlords.
14. There should be a single and direct tax on land, as it is the only productive source.
15. Private property is essential.
16. There is the possibility of over population on land.
Physiocrats and the government
1. Functions of the state- In the ‘natural state should be reduced to the minimum.
2. There should be very little legislation. They wished to reduce legislation to the barest
minimum and to abolition useless laws
3. They believed that the government run by many persons leads to discord and
commotion. They were not in a favour of democratic government. Similarly, they did not
support a parliamentary form of government. They were in favour of strong
authoritarian rulers with enough powers to protect their commercial activities.
4. The best form of the government which they advocated was single authority, vested
with sovereign powers.

Criticism Levelled Against Physiocracy Include the Following :

1. Physiocrats placed too much emphasis on agriculture and neglected the non-agricultural
sectors.
2. They were wrong in considering agriculture alone as the productive occupation because
commerce and industry are equally important and productive as agriculture.
3. The physiocrats failed to consider the working class as a productive class. Moreover
their contention that manufacturing class is sterile is also subject to severe criticism
4. The physiocrats did not have a correct notion of production. According to modern
economists, production meant the creation of utilities or values. But physiocrats felt that
Production does not create value.
5. They believed in individual freedom. They did not want restriction of any type in the life of
individuals.
6. The physiocrats advocated complete freedom of trade and industry. But absolute freedom
of trade and industry are not advisable. If we follow the laissez –faire doctrine, there will be
little scope for social action.
7. The aim of physiocrats was to develop agriculture. They regarded land as the only source of
wealth. For them land alone yielded a surplus. It followed that the land owner alone should
bear the burden of taxation.
Check Your Progress 1.

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 What was the main objective of physiocrats in France?
2. Why were the markets for agricultural commodities restricted?
3. Which ideas did physiocracy contain in its theoretical aspect?

Difference between Mercantilism and Physiocracy

1 Mercantilists regarded money and bullion as the sign of wealth. They believed that Gold, silver and
valuable metals are the source of prosperity and power. Physiocrats believed that natural resources
and production power are real wealth.

2 According to Mercantilists, trade is the most productive occupation. They wanted expansion of
foreign trade. They aimed at maximising exports and minimising imports. According to Physiocrats,
agriculture is the most productive occupation. The physiocrats regarded foreign trade as evil. They
wanted to reduce foreign trade.

3 The mercantilists thought that foreign trade is the only means of increasing the wealth of a nation.
According to them, only raw materials should be imported and finished commodities should be
exported. But the physiocrats thought that foreign trade produced no real wealth. Physiocrats said
that a country should exchange with other countries those goods which it cannot produce and those
that are in excess of its own consumption.

4 The mercantilists were in favour of balance of trade. Therefore, they suggested that import should
be lesser than exports. To physiocrats, foreign trade was unproductive. They said that the balance of
trade is not always possible.

5 The mercantilists believed in regulation of trade and industry. The physiocrats advocated freedom
of trade and industry. They did not want any type of state intervention in foreign trade.

6 According to mercantilists, agriculture is unproductive and only trade is productive. Physiocrats

believed that agriculture is productive and trade and commerce are sterile.

7 The mercantilists were in favour in multi tax system. The physiocrats advocated a single tax on the
net product from the land.

8 The mercantilists allowed interest on capital . The physiocrats allowed interest on the loans which
were taken for agricultural purposes, because such loans were productive.

SUMMARY

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 Physiocracy had its root in the then existing economic conditions of France which were mainly the
result of mercantilist policy. There were many economic, political and social factors responsible for
its origin.

 The policies followed during the supremacy of King XV and King XVI led to steep deterioration of
economic and social conditions in France. Corruption and degeneration of life was at very high level.

 Mercantilist policies had outlived their importance. In England, agriculture was being
revolutionised with the introduction of large scale farming and scientific techniques of production.
So in France too attention was diverted to the strengthening of agriculture.

 The physiocrats were opposed to almost all forms of government restrictions. They advocated
laissez faire. It means freedom of business enterprise at home and free trade abroad. According to
this doctrine, the only function of government is to protect life, liberty and property.

 According to physiocrats, land occupied a predominant position as an agent of production. They

thought that agriculture was supreme among all occupations. To them, the origin of all wealth lay in
agriculture and this wealth consisted of real produce.

 In the ‘natural order’ of physiocrats, the functions of the state would be reduced to the minimum
with very little legislation.

 The physiocrats were in favour of a national assembly but without any legislative power. The
national assembly would be just a council of state whose main concern would be to look after the
public works and to apportion the burden of taxation.

 The physiocrats advocated complete freedom of trade and industry. But absolute freedom of trade
and industry are not advisable. If we follow the laissez –faire doctrine, there will be little scope for
social action.

KEY WORDS

 Physiocracy: It is an economic theory developed by a group of 18thcentury Age of Enlightenment

French economists who believed that the wealth of nations derived solely from the value of “land
agriculture” or “land development” and that agricultural products should be highly priced.

 Laissez faire: It is an economic system in which transactions between private groups of people are
free from or almost free from any form of economic interventionism such as regulation and
subsidies.

THE CLASSICAL SCHOOL

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1. Its main thinkers and contributors are Alfred Marshall, J.B. Say, Adam Smith, David Ricardo, John Stuart
Mill and Malthus. These eminent thinkers basically advocated that the market systems were primarily
self-regulating systems and that freedom of the market was essential with minimum intervention by the
state.
2. Adam Smith is the founder of the classical school. He has been described as the “father of
political economy”. His work “Wealth of Nations” is generally regarded as the starting point of
classical school.
3. In 1776, he published his Wealth of Nations (An Inquiry into the Nature and Causes of the
Wealth of Nations). Adam Smith’s Wealth of Nations was a challenge to mercantilism.
4. They developed theories about the way markets and market economies should
work .
5. They stressed economic freedom and promoted ideas such as laissez-faire and
free competition.
6. 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
7. Historically, laissez-faire was a reaction against mercantilism, a system of
commercial controls in which industry and trade, especially foreign trade, were
seen as means of strengthening the state. Navigation laws, trade monopolies,
taxes, and paternalistic regulations of all kinds bore heavily upon the rising class of
merchants in the period of European colonial expansion.
8. The French physiocrats were the first school of thought to formulate the principles
of laissez-faire. With the physiocrats, state non-interference became a cardinal
teaching; they especially opposed the taxation of commercial activities.
9. Laissez-faire economics , therefore, originated in the 18th century from France
where physiocrats became hostile to subsidies and discriminatory economic
measures of then prevalent mercantilism.
10. Adam Smith’s Wealth of Nations, published in 1776 can be used as the formal
beginning of Classical Economics but it evolved over a period of time and was
influenced by Mercantilist doctrines, Physiocracy, and early stages of the
industrial revolution.
11. While Adam Smith would be regarded as the originator and leader of the school,
David Ricardo should be credited with establishing the form and methods of the
school.
12. Smith was concerned about the nature of economic growth. Malthus, Ricardo and
other classical economists were concerned about the question of ‘distribution.’

Adam Smith’s Economic Ideas

Smith’s Invisible Hand Theory
1 . It is a term coined by Adam Smith in his 1776 book ‘An Inquiry into the Nature
and Causes of the Wealth of Nations’.
2. One of the greatest contributions of Adam Smith was the invisible hand theory.

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 He said that if the government doesn’t do anything, there’s a controlling factor of
people themselves who can guide markets.
3. He believed that the government should be responsible in defining the property
rights, to set up honest courts, to impose minor taxes and to compensate for well
defined ‘market failures’
4. He explained that the substitution effect should automatically regulate the
behaviour of sellers. In order to compensate for a loss a seller should be forced to
lower his price to stay alive in the business. Sellers and buyers should be guided
by an invisible hand or self-interest.
5. The theory of the Invisible Hand states that if each consumer is allowed to choose
freely what to buy and each producer is allowed to choose freely what to sell and
how to produce it, a market equilibrium that is beneficial to all the individual
members of a community will be established
6. The reason for this is that self-interest drives actors to beneficial behaviour. Efficient
methods of production are adopted to maximize profits. Low prices are charged to
maximize revenue by undercutting competitors.
7. Investors invest in those industries most urgently needed to maximize returns, and
withdraw capital from those less efficient in creating value.
8. Students prepare for the most needed (and therefore most remunerative careers.
9. By pursuing his own interest he frequently promotes that of the society more
effectually.
10. Self-interest drives people to create more and better ideas to overcome the other
competitors as long as they do so in a legal way.
11. Every individual is motivated by self-interest. Every man, is the maximiser of gain
and minimizer of loss. Therefore, every man undertakes that activity which
appears to him to be the most profitable.
12. Everybody wants to make his conditions better. Being guided by such a rationale,
when people undertake different activities, society benefits from such activities
and social welfare improves.
13. Every man is naturally the best judge of his own interest and should, therefore, be
allowed to pursue his own way. Adam Smith pointed out that in pursuing his own
advantage, every individual is led by an invisible hand to promote an end which is
beneficial to him/her.

Smith’s Theory on Division of Labour

1. Adam Smith, emphasised the importance of labour as the source of wealth of a nation.
According to him, the wealth of a nation can be increased by adopting the principle of
division of labour . Division of labour necessitates exchange.
2. Smith believed that division of labour increased productivity and it has the following
advantages-
a. Division of labour increases output per worker.
b. By doing the same kind of work constantly, the worker gets a great skill in
his particular line. Practice makes a man perfect.

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 c. A man can work continuously on a single operation. He need not spend
time in changing tools or passing from one process to another. It saves time
because the worker does not have to change his job frequently
d. The fact that workers do not have to switch tasks during the day saves
time and money
e. Division of labour can lead to more inventions and innovations..

3. Specialization of the labour force, means the breaking down of large jobs into
many tiny components.
4. Under this regime each worker becomes an expert in one isolated area of
production, thus increasing his efficiency.
5. Division of labour also implies assigning each worker to the job that suits
him best.
6. Adam Smith, explains the optimum organization of a pin factory. Traditional
pin makers could produce only a few dozen pins a day. However, when
organized in a factory with each worker performing a limited operation,
they could produce tens of thousands a day.

Smith’s contribution to the Concept of Laisse-Faire

1. Laissez-faire describes an economic system in which there is minimal intervention from
governments and regulations. This is similar to what physiocrats advocated for.
2. 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 in the 19th century.
3. Adam Smith coined the term ‘Laissez-Faire’ in his book ‘The Wealth of Nations’ to
describe an economic system in which the markets are completely unregulated and
individuals are economically free to do as they please with no government interference.
4. Smith believed that individual welfare rather than national power was the
correct goal he, therefore, advocated that trade should be free of government
restrictions.
5. When individuals are free to pursue self-interest, the ‘invisible hand’ of
competition would become more effective than the state as a regulator of
economic life.

6. He argued that every individual knows his interest best and is more competent to
realise his interest and better understands the direction of his own action than the
government.
7. According to him, governments are wasteful, corrupt and incompetent. So he
advocated minimum role for the government
8. Simith ,therefore, advocated minimum role for the state in economic affairs. He
considered non-intervention by government in economic matters as a wise policy.

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9. In his view, governments are always and without any exception, the greatest
spending units in the society. According to Smith, state could perform only the
following three major functions:
a. To protect society from foreign attacks
b. To establish the administration of justice within the country
c. To erect and maintain the public works and institutions that private
entrepreneurs cannot undertake privately.
10. Though he advocated free trade, he favoured two kinds of protectionist tariffs-
a. Those tariffs that protect a domestic industry essential to the defence of the
country.
b. Those that equalise the tax burden on a particular domestic industry by imposing
a tariff on imports of that good
11. Smith also suggested that if free trade is to be introduced in a country after a long
period of protectionism, it should be done gradually in order to avoid
unemployment.
12. Smith did not believe in laissez-faire in an absolute sense; he found a place for
government activity in public works, such as the building of canals and docks
to facilitate trade, and in the regulation of foreign commerce to protect certain
home industries.

13. By the mid19th century, opposition to laissez-faire economics began and

governments in all industrialized countries intervened on behalf of workers and
general population. Factory laws and consumer protection laws were enacted and
growth of monopolies was checked.

14. Keynesian economics (which advocates government intervention in the national

economy) further undermined the laissez faire doctrine.
15. From 1970’s, however, the pendulum swung back to laissez-faire economics
(renamed ‘market economy’ or ‘free enterprise’ in the disguise of globalization) and
brought deregulation of business, and progressive removal of trade barriers, which
is continuing.

Smith’s theory on MONEY

1. He attacked mercantilists because they over emphasised the role of money in an economy.
According to Smith, “a nation’s true wealth consists not only in its gold and silver but in its
land, houses and consumable goods of all different kinds.”
2. Money is a medium of exchange which is essential to trade and commerce. It did away with
the inconveniences of barter- it facilitates exchange and without it large scale commerce
would not be possible. It was, therefore, an important factor contributing to the extension of
division of labour.
3. Money only serves as an instrument for the circulation of wealth and measurement of value.

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4. Money does not add to the revenue of society but it is a great wheel of circulation. It
facilitates the circulation of goods.
5. Although the gold and silver coins that circulate in an economy form a valuable part of the
capital of the country, they are dead stock and produce nothing. Smith linked money to a
highway over which the goods (produce) of a town is carried, but which itself does not
produce a blade of grass.

Smith’s theory on VALUE

1. According to Smith, there are two kinds of value: (1) value- in -use (2) value- in-
exchange. Value-in-use expresses the utility of some particular object, that is, the
capacity of a thing to satisfy human wants. Value in exchange is the power of purchasing
other goods.
2. Smith pointed out that the things which have the greatest value-in-use , that is those
goods with greatest utility such as air and water have generally little or no value of
exchange. Goods with little value-in-use such as diamonds have great value-in-
exchange.
3. Smith believed that labour was the real source of value – in exchange. According to him,
the value of the things depended on the amount and quality of labour expended upon
its production. In other words “The value of any commodity, is equal to the quality of
labour used to produce it.
4. Adam Smith emphasised that “Labour is the real measurement of the exchange value of
all commodities.” This is the famous labour theory of value.
Smith’s theory on WAGES
1. According to Smith, wage is determined by the bargaining power of employers and wage
earners.
2. Employers, being limited in number, can easily organise themselves to form associations
whereas the organisation of labour is not possible.
3. The employers consistently try not to raise wages of labour above the actual rate. Hence,
wages depend on the bargaining strength of both the parties.
4. Since the bargaining strength is on the side of employers, the worker gets only as much
wage as will be sufficient to support him and his family. This is the subsistence level.
According to Smith, “Masters cannot reduce wages below a subsistence rate.”
5. He observed that the market level might be higher than the subsistence level whenever the
society was progressing and the funds for employment were expanding more rapidly than
the population.
6. Since this fund is dependent on the national wealth, the wage of workers will only increase
with the increase in national wealth. In the stationary state, wages may be low.

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 Smith’s Theory on Money Capital
1. He treated capital as an important source of national wealth. Capital accumulation is
essential for the industrial development of a nation.
2. Smith holds the view that the accumulation of “stock” (capital) depends upon the extent of
the application of division of labour.
3. In the opinion of Adam Smith, “the portion of the income that was saved was immediately
employed as a capital.” In other words, an act of saving at once becomes an act of
investment. In this way, saving is equal to investment.
4. Smith classified capital in three portions :
a. The first portion is that portion of money owned by an individual or a society which
yields revenue, as contrasted with that portion of money which is used for immediate
consumption.
b. The second portion of capital is the fixed capital. It generates revenue or profit without
circulating or changing hands, e.g. buildings, machines, or improvement of land.
c. The third portion is the circulating capital which generates a revenue or profit only by
circulating or changing hands, e.g. money, raw material, partly manufactured goods
and finished products.
5. According to Smith, the Capital of a nation may be employed in three different ways-
a. In procuring raw or intermediate products required for further processing .
b. In manufacturing or processing intermediate products for immediate use and
consumption
c. Transporting either the raw or manufactured produce from one place to
another.

Smith’s theory on Trade

1. Smith advocated free trade. Free trade means that trade as among countries is not subject
to restrictions.
2. Smith was opposed to the mercantilist theory of balance of trade. Smith did not accept the
mercantilist view that foreign trade is advantageous because it acquires gold and silver.
3. According to him, gold and silver, just like other commodities and in the natural course of
trade, will come to any country as other commodities do. Therefore, he did not agree that
the export of gold and silver should be restricted.
4. According to him, the only advantage from foreign trade is that it carries out surplus
commodities and brings in commodities which are in demand.
5. He treated foreign trade like domestic trade and considered it important for extending
division of labour. He believed that foreign trade would promote greater division of labour.

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Smith’s Canons of Taxation (Features of a good tax)

Adam Smith laid down four canons of taxation:

1. Canon of Equity- It can also be called the canon of ability to pay. Smith stated it as:
“The subject of every state ought to contribute towards the support of the
government as nearly as possible in proportion to their respective abilities, that is, in
proportion to the revenue which they respectively enjoy under the protection of
state.”
2. Canon of Certainty- Tax which each individual is bound to pay ought to be certain,
and not arbitrary. The time of payment, manner of payment, quantity to be paid
ought all to be clear to every person. The government and the tax payer should have
knowledge about how and when and what taxes are to be levied. It is good for
government because it provides a sort of correct estimate about prospective
income. The certainty about taxes is good for taxpayers because he knows where he
stands.
3. Canon of Convenience –The manner and the time of tax payment should be
convenient to the taxpayer. The idea is that the taxpayer should be psychologically
and financially prepared for the onslaught of the tax. Smith stated, “Every tax ought
to be levied at the time or in manner in which it is mostly likely to be convenient for
the contributor to pay it.”
4. Canon of Economy- This canon states that the cost of the tax collection should be
the minimum possible. The revenue from a tax should be much more than the cost
of its collection. He compared Taxation to production. He felt that both production
and taxation imply the practice of economy. Every producer would try to produce at
the lowest cost. In the matter of taxation also there is need to practise economy.

Jean-Baptiste Say’s law of Markets

1. J. B. Say (1767 – 1832) was a French economist and businessman.

2. He argued in favour of competition, free trade, and lifting restrictions on
business.
3. He is best known due to Say’s Law, which is named after him and at times
credited to him, although he did not originate it.
4. 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.
5. This principle indicated that excess production or insufficient demand for

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 production was unlikely to occur.
6. 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.
7. 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.
8. Say’s law that ‘supply creates its own demand’ is one of the fundamental
principles of classical economics.
9. The law means that the act of production generates enough income for an
equivalent amount of demand for other production.
10. When applied to the macro economy, Say’s law indicates that economic business
cycles 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.
11. This principle was, and still is, one of the key building blocks of the classical
school of economics. It remains essential to any free market.
12. 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 will be no decreases in production, income, or
consumption.
13. The process of reinvestment is fueled 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.
14. 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.
15. 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 but the agent of the transfer of
values.’
16. The law failed to recognize the fact that changes in the supply of money may
affect the relative prices of goods and, thereby, redirect the entire interrelated
structure of production.
17. 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 therefore (c) costs of production represent
an interface between the utility of the good and the productivity of the factors of
production.
18. Most textbooks abbreviate Say’s Law into : ‘supply creates its own demand.’ This
should be Stated as ‘aggregate supply creates its own aggregate demand,’ because

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 the claim is not that the production of commodity X necessarily results in an
equivalent demand for X, but that the production of X leads to demand for
commodities A, B, C, and so forth.
19. The production, or supply, of commodities in general leads to the consumption of,
or demand for, commodities in general.
20. It is certainly possible to have a shortage or a surplus of any particular commodity,
but general overproduction or general underproduction should be momentary or
short term phenomena.
Implications of Say’s Law of Markets:

i. As ‘supply creates its own demand,’ there will be no general overproduction. It

implies that there can be no general unemployment.
ii. According to this law, it will be profitable to have wide markets for they will
increase the demand for goods and raise their prices.
iii. Everyone should be interested in the prosperity of everyone else. ‘It is foolish
to divide the nation into producers and consumers; everyone is both.’
iv. The law of Markets has been used in support of Free Trade doctrine. When
we buy something from foreigners, we will be selling something to them
simultaneously and thus a market will be created for them.
v. Say’s Law became the basis for the laissez-faire policy of the government.
As supply creates its own demand, it implies that there is automatic adjustment
of the economy. So there is no need for State interference in economic
matters.

Thomas Robert Malthus’s Theory of Population

Thomas Robert Malthus was born in 1766 and is famous for his theory of Population.

Chief Influences on Malthus:

Thoughts of Malthus were mainly influenced by the conditions prevailing in England which include
the following:

1. England had seen agricultural prosperity during the first half of the eighteenth century but at
the end of the century, agriculture was in serious crisis. It appeared as if the population had
increased to such an extent that the land fell short for their requirements.
2. Industrial revolution had brought unemployment, poverty, disease, riots etc. Partly as the
result of these evils, various socialistic schemes sprung up especially in France.

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3. The English poor law was also defective both in terms of subsistence and administration. It
had therefore become necessary to investigate into the problem of population growth and
Malthus did this work successfully.
4. Prior to Malthus, it was generally believed that a rapidly increasing population necessarily
led to prosperity and that the wealthiest and strongest countries were often the most
populous. The government as well as the employers favoured a dense population for
recruitment to the armies and the factories.
5. Mercantilists had always regarded a large population as advantageous. They never
entertained any fear of overpopulation because they thought that population will
automatically be controlled by the means of subsistence.
6. The Malthusian theory of population is a well-known theory about the growth of population.
The idea put forward by him in his essay on the Principle of Population in 1798, came to be
known as the Malthusian law (theory) of population.
7. The Malthusian theory of population discusses the relationship between population and
supply of food. In simple words, all that the theory states is that population increases at a
faster rate than food supply.
8. Malthus stated that “the power of population is indefinitely greater than the power in the
earth to produce subsistence for men.” Population, when unchecked, increases in a
geometric ratio (i.e. at the rate of 2,4,8,16…) while the supply of food increases only in an
arithmetic ratio (i.e. at the rate of 2,4,6,8, 10 etc.)
9. Malthus believed that the population of the country, when unchecked, would double itself
in every twenty five years. But food supply will not increase as fast as population on account
of the influence of the law of diminishing returns on land.
10. He further said that if population will increase at a fast rate, there will not be enough food
for all.
11. Because the population outgrows food supply the growth of population has to be checked.
This can be done by the application of some checks by nature or by man himself or by both.
12. Malthus advocated for two kinds of checks on population growth:
a. Preventive Checks- Those checks which are applied by men for checking population
growth are called preventive checks. Preventive checks are major checks to control
birth rate. Malthus suggested that those who cannot afford the upbringing of
children should either postpone marriage or never marry. Malthus disapproved
prostitution and birth control as a preventive checks.
b. Positive Checks- War, famine, starvation and diseases are the positive checks on
population. They increase the death rate. If population is not checked by the
preventive methods, then it will be checked by natural phenomenon such as famine,
starvation and death. Malthus , therefore, presented a dark and pessimistic picture
about the future of mankind.

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 13. Malthus considered the poor to be entirely responsible for their poverty and misery. Poverty
and misery are the natural punishments for the poor class because they have failed to
restrict their numbers. He discouraged the government to provide relief to the poor by
means of “Poor Laws”. His view is that if aid is given to the poor then more children would
survive and provoke the problem of hunger and misery. So Malthus suggested the gradual
abolition of “Poor Laws”.
14. The ideas of Malthus were incorporated in the Poor Law Amendment of 1834. The new poor
law abolished all relief for able-bodied people outside work house. This is almost similar to
the IMF and world Bank lending conditions’

Criticism of The Malthus Doctrine (Theory)

Criticisms of Malthus doctrine are many and they include the following:

1. According to Malthus, population grows in a geometric progression. He tried to prove that

population doubles itself every after 25 years. There is no historical proof for this. Population does
not grow in the manner suggested by Malthus. His ratios have been proved wrong by history.

2. His doctrine has been criticised on the point that the means of subsistence increase in arithmetical
progression. The Malthusian theory is based on the law of diminishing returns. He overlooked the
possibilities of scientific improvement in agriculture for example, Agrarian Revolution took place in

England along with the industrial revolution that brought about a huge increase in the production of
agricultural products and food supply.

3. It is true that in many countries population has increased at a rapid rate. But food supply has also
increased and people have not died of hunger in those countries. In fact, the standard of living today
is much higher than it was a century ago.

4. Malthus overemphasised the relationship between population and food supply. The problem of
population as a whole is then not one of size, but of efficient production and equitable distribution,
i.e. it is not a problem of numbers alone but of wealth.

5. This is an age of International Trade and Commerce. If a country does not grow enough food
grains itself, it can import food grains from other countries.

6. Malthus’ doctrine has been further attacked in respect of positive checks. According to him, when
population outgrows the means of subsistence, excessive population must die of starvation. He has
tried to prove how insufficient nourishment leads to hunger and deaths due to epidemics. He
named these as positive checks. But the truth is that insufficiency of food is due to incapacity of
production and due to excessive population.

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7.Malthus thought that any addition to population is undesirable but “Every mouth brings with it a
pair of hands”. Since man is the source of labour, large numbers may sometimes mean greater
wealth, strength and power.

Conclusion
1. Despite these criticisms it would be fair to say that the Malthusian theory of population, if
seen in its entirety, is still intact. He should be given credit for laying bare the fact that
excessive population was a danger to society.
2. Though the Malthusian theory of population does not apply to most of the western
countries which are highly industrialised, it applies to most underdeveloped countries which
are dominated by agriculture.
3. In the poor countries of the world, overpopulation is a real danger. That is why many
countries of the world today have adopted birth control measures and other family planning
programmes.

Check Your Progress

1. List the assumptions on which the Malthusian theory of population is based.

2. Why did Malthus suggest the gradual abolition of “poor laws”?
3. To which countries does the Malthusian theory of population apply?

Neoclassical Economics?

1. Neoclassical economics is a broad theory that focuses on supply and

demand as the driving forces behind the production, pricing, and
consumption of goods and services. It emerged in the 20 th century to
compete with the earlier theories of classical economics.
2. There are FOUR assumptions that underpin neoclassical economic theory:
a. Rational thinking: People make rational choices between options
based on the value that they identify in each choice.
b. Maximizing: Consumers aim to maximize utility, while businesses
aim to maximize profits.
c. Information: People act independently based on having all the
relevant information related to a choice or action.
d. That markets will self-regulate in response to supply and demand.

3. Classical economists assume that the most important factor in a product's

price is its cost of production. Neoclassical economists argue that the
consumer's perception of a product's value is the driving factor in its price.
4. Neoclassical economists believed that a consumer's first concern is to maximize
personal satisfaction, also known as utility. Therefore, consumers make purchasing

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 decisions based on their evaluations of the utility of a product or service. This theory
coincides with rational behavior theory, which states that people act rationally when
making economic decisions. In other words, people make a logical choice between
two options based on their perception of which one is better for them.

5. Neoclassical economists believe that consumer perceptions of the value of a

product affect its price and demand. They also believe that competition leads
to an efficient allocation of resources within an economy. The forces of
supply and demand create market equilibrium.

6. Under neoclassical theory, markets are self-regulating and competition leads

to efficiently allocated resources. The interaction of supply and demand
creates equilibrium, which allows markets to adjust to changes without
needing to be rebalanced by fiscal or monetary policy
7. Who Was the Founder of Neoclassical Economics? The movement from
classical to neoclassical economic theory grew from the work of William
Stanley Jevons, Carl Menger, and Léon Walras in the late 1800s. The
dominant text of neoclassical economics, Principles of Economics, was
written by Alfred Marshall and used in the early 1900
8. The Difference between Classical and Neoclassical: Unlike classical
economists who believed that the cost of production is the most important
factor in a product's price, neoclassical economists believed that prices
should be based on how consumers perceive the value of a product. They
also believe that consumers make rational decisions to maximize utility.
9. The Difference between Neoclassical and Keynesian Economics?
Neoclassical economic theory believed that markets naturally restore
themselves. That is prices, wages, interest rates and exchange rates adjust
on their own in response to changes in in the market forces of supply and
demand. Keynesian economic theory on the other hand does not believe that
markets can adjust automatically to these changes. It encourages using
government fiscal and monetary policies to impact the economy, specifically
by slowing the economy during booms and stimulating it during recessions.

Criticisms of Neoclassical Economics include the following:

a. Distribution of resources: Resource distribution impacts how people

make decisions, but resources are not distributed equally.
b. Available choices: People may attempt to make rational decisions, but
they can only choose between the available choices.
c. Irrational decisions: People do not always make the most rational
decision, or only consider the benefit to themselves as an individual when
making choices. They may be influenced by social pressure, the needs of

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 others, available choices, income constraints , limited access to
information, and unequal distribution of resources.
d. Pursuit of profit: Maximizing profit is not the only or best way for markets
to function, as this can worsen inequality, exploit workers, and damage
the environment or community. Markets or businesses structured around
solving a problem, such as non-profit organizations function with equal
levels of efficiency and effectiveness.
e. Standards of living: Producing more goods and services (having a
higher GDP) does not always equal a higher standard of living.
Neoclassical economics equates standards of living with "amount of
goods and services consumed," but consuming more does not always
improve measures such as health, life expectancy, social equality,
economic stability, or other factors in quality of life.

Walras's Law

1. The law was named after Léon Walras a French Neoclassical economist
2. Walras's law is an economic theory, which states that the existence of
excess supply in one market must be matched by excess demand in another
market so that both factors are balanced out. Walras's law asserts that an
examined market must be in equilibrium if all other markets are in equilibrium
3. Walras's law implies that, for any excess demand oversupply for a single
good, a corresponding excess supply over demand exists for at least one
other good, which is the state of market equilibrium.
4. Walras's law is based on equilibrium theory, which states that all markets
must be "cleared" of any excess supply and demand to be in equilibrium.
5. Walras's law works on the principle of the invisible hand; where there is
excess demand, the invisible hand will raise prices, and where there is
excess supply, the invisible hand will decrease prices, until equilibrium is
reached.
6. Critics claim that it is difficult to quantify utility, which influences demand,
making Walras's law difficult to formulate as a mathematical equation.

Keynesian Economics

1.Keynesian economics was developed by British economist John Maynard

Keynes during the 1930s in an attempt to understand and address the Great
Depression of 1930s

2. Keynes developed his theories in response to the Great Depression, and he was
highly critical of previous economic theories, which he referred to as classical
economics. Keynes believed that the great depression of 1930s could not be
explained and resolved by classical economic theory

3. Classical economic thinking held that cyclical swings in employment and economic
output create profit opportunities that individuals and entrepreneurs would pursue.
In so doing, they would correct imbalances in the economy. They argued that, in the
wake of any widespread downturn in the economy, a lower level of inflation and

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wages would induce employers to make capital investments and employ more
people, stimulating employment and restoring economic growth. They believed that
lower wages can restore full employment because labor demand curves slope
downward like any other normal demand curve meaning the lower the wage rate the
higher the demand for labour

4. Keynes believed that the Great Depression seemed to counter the classical
theory. Output was low, wages were very low but unemployment remained high
during this time.

5. The Great Depression inspired Keynes to think differently about the nature of the
economy. Keynes rejected the idea that the economy would return to a natural state
of equilibrium. Instead, he argued that, once an economic downturn sets in, for
whatever reason, this can lead to a sustained period of depressed economic activity
and unemployment.

6. The theories of John Maynard Keynes, center around the idea that governments
should play an active role in their countries' economies, instead of just letting the
free market to operate. The most basic principle of Keynesian economics is that
demand—not supply—is the driving force of an economy. Total spending
determines all economic outcomes, from the production of goods to the employment
rate. In other words , consumption (spending) is the key to economic recovery.
Government spending stimulates consumer demand, which in turn induces
production which in turn ensures full employment.

7. Keynes advocated for government intervention through deficit spending to

boost consumer spending and stabilize aggregate demand.
8. Keynes proposed that the government should spend more money in the
economy and cut taxes, in order to increase consumer demand in the
economy. This would, in turn, lead to an increase in overall economic activity
and a reduction in unemployment.
9. According to Keynes, if aggregate demand in the economy fell, production
would fall and unemployment would also increase . Over production and high
unemployment would lead to lower prices and wages.
10.Keynes argued that, during recessions, business pessimism and certain
characteristics of market economies would worsen economic weakness and
cause aggregate demand to fall further.

11. Similarly, poor business conditions may cause companies to reduce capital
investment rather than take advantage of lower prices to invest in new plants and
equipment. This also would have the effect of reducing overall expenditures and
employment.

12.The central belief of Keynesian economics is that government intervention can

stabilize the economy.

13.Government fiscal and monetary policies are the primary tools recommended by
Keynesian economists to manage the economy and fight unemployment.
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14.Keynes also criticized the idea of excessive saving, unless it was for a specific
purpose. He saw excessive saving as dangerous for the economy, because more
money sitting stagnant meant less money in the economy stimulating growth.

15.Although widely adopted after World War II, Keynesian economics has attracted
plenty of criticism since the ideas were first introduced in the 1930s.One major
criticism deals with the concept of big government that must occur to enable the
government to participate actively in the economy. Rival economic theorists, like
those of the Chicago School of Economics, argue that: economic recessions and booms
are part of the natural order of business cycles; direct government intervention only
worsens the recovery process, and federal spending discourages private investment

Monetarism School

1.Monetarism is an economic school of thought which states that the supply of

money in an economy is the primary driver of economic growth. As the availability of
money in the system increases, aggregate demand for goods and services goes up.
An increase in aggregate demand encourages job creation, which reduces the rate
of unemployment and stimulates economic growth.

Monetarism is a macroeconomic theory which states that governments can foster

economic stability by targeting the growth rate of the money supply.

Essentially, it is a set of views based on the belief that the total amount of money in
an economy is the primary determinant of economic growth.

2. Monetary policy, as an economic tool may be used to adjust interest rates which in
turn, control the money supply. When interest rates are increased, people have
more of an incentive to save than to spend, thereby reducing or contracting the
money supply. When interest rates are lowered following an expansionary monetary
scheme, the cost of borrowing decreases, which means people can borrow more
and spend more, thereby stimulating the economy.

3. According to monetarists, a rapid increase in the money supply can lead to a

rapid increase in inflation. This is because when money growth surpasses the
growth of economic output, there is too much money chasing too few goods and
services. In order to curb a rapid rise in the inflation level, it is imperative that growth
in the money supply falls below the growth in economic output.

4. When monetarists are considering solutions for a staggering economy in need of

an increased level of production, they may recommend an increase in the money
supply as a short-term boost. However, the long-term effects of monetary policy are
not as predictable, so many monetarists believe that the money supply should be
kept within an acceptable level so that levels of inflation can be controlled.

5. Instead of governments continually adjusting economic policies through

government spending and taxation levels, monetarists recommend letting non-

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inflationary policies–like a gradual reduction of the money supply lead an economy
to full employment.

Milton Friedman and Monetarism

1.Monetarism is closely associated with economist Milton Friedman, who argued,

that the government should keep the money supply fairly steady, expanding it
slightly each year to allow for the l growth of the economy. Due to the inflationary
effects that can be brought about by the excessive expansion of the money supply,
Friedman asserted that monetary policy should be done by targeting the growth rate
of the money supply to maintain economic and price stability.

2. According to Friedman inflation is always and everywhere a monetary

phenomenon. While Keynesian theory asserted that prices rose from either "cost-
push" or "demand-pull" sources, monetary theory argue that inflation is mainly due to
excesses supply of money in the economy.

3.In his book, A Monetary History of the United States 1867–1960, Friedman
proposed a fixed growth rate of money supply per year. When money supply grows
moderately, businesses will be able to anticipate the changes to the money supply
every year and plan accordingly, the economy will grow at a steady rate, and
inflation will be kept at low levels.

4. Friedman argued that the government made the Great Depression worse by not
formulating and implementing appropriate monetary policies. He claimed that if the
Federal Reserve (Central Bank) had prevented the dramatic drop in money supply
by bailing out banks in the early 1930s,they could have prevented the wave of bank
failures that made people decide to hold cash rather than make deposits.

5.Friedman's public policy theories are based on two core principles: 1) voluntary
interactions between consumers and businesses often produce results superior to
those crafted by government decree; 2) policies have unintended consequences, so
economists should focus on results, not intentions.

The Quantity Theory of Money

1.Central to monetarism is the "quantity theory of money." The quantity theory of

money can be summarized in the equation called the equation of exchange which is
given below:

MV=PQ

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 where:

M=money supply

V=velocity (rate at which money changes hands)

P=average price of a good or service

Q=quantity of goods and services sold

2.Monetarists believe that changes to M (money supply) are the driver of the
equation. In other words, a change in M directly affects and determines
employment, inflation (P), and production (Q). In this equation V and Q are
assumed to be constant so that there is a direct relationship between M and P.

3.One implication of these assumptions is that the value of money is determined by

the amount of money available in an economy. An increase in the money supply
results in a decrease in the value of money because an increase in the money
supply also causes the rate of inflation to increase. As inflation rises, purchasing
power decreases. Purchasing power is the value of a currency expressed in terms of
the amount of goods or services that one unit of currency can buy. When the
purchasing power of a unit of currency decreases, it requires more units of currency
to buy the same quantity of goods or services.

4. In monetary economics, the chief method of achieving economic stability is

through controlling the supply of money. According to monetary theory, changes in
the money supply are the main forces underpinning all economic activity. So
governments should implement policies that influence the money supply as a way of
fostering economic growth. Because of its emphasis on the quantity of money
determining the value of money, the quantity theory of money is central to the
concept of monetarism

Controlling Money Supply

The main instruments used by the central bank to control money supply are:

1. The reserve ratio: The percentage of reserves a bank is required to hold against
deposits. A decrease in the ratio enables banks to lend more, thereby increasing the
supply of money.
2. The discount rate (Monetary Policy Rate): The interest rate the Central Bank charges
commercial banks that need to borrow money from the central Bank. A drop in the
discount rate will encourage a bank to borrow more from the Central Bank and lend
more to its customers.
3. Open market operations: Open market operations consist of buying and selling
government securities. Buying securities from large banks increases the supply of
money, while selling securities contracts decreases the money supply in the economy.

. Key Takeaways on Monetarism

1. Monetarism is a macroeconomic theory stating that governments can foster
economic stability by targeting the growth rate of the money supply.
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 2. Central to monetarism is the quantity theory of money, which states that the
money supply (M) multiplied by the rate at which money is spent per year (V)
equals the nominal expenditures (P * Q) in the economy.
3. Monetarism is closely associated with economist Milton Friedman, who
argued that the government should keep the money supply fairly steady,
expanding it slightly each year mainly to allow for the natural growth of the
economy.
4. Monetarism emphasizes the use of monetary policy over fiscal policy to
manage aggregate demand.
5. Although most modern economists reject the emphasis on money growth that
monetarists supported in the past, some core aspects of the theory are still
relevant in modern times. For example, excess money supply can lead to
inflation

Criticisms Against Monetarism

1.Critics of monetarism have argued that when interest rates are very low due to an
increase in money supply, there is no incentive to invest. In such a situation any
additional money pumped into the economy would just be held by individuals and
banks without jumpstarting the economy.

2. When Prime Minister Margaret Thatcher, enacted monetary policy to control

inflation in the early 1980s, the inflation rate jumped to 23% and monetarism was
abandoned by 1982.

3. In the U.S., when the Federal Reserve attempted monetarism by steadily

reducing money supply in order to control inflation in the late 1970s interest rates
reached the highest levels and unemployment worsened and by 1982, the U.S. had
abandoned monetarism.

4. Critics of Friedman have argued that he promoted policies that put million out of
work in pursuit of low inflation.

Economic ideas of African philosophers ( not covered yet)

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