HET-I - Handout

History of Economic Thought – I Handout
CHAPTER 1: INTRODUCTION
1.1 Definition of History of Economic Thought
History of economic thought is a discipline that shows the development of various economic
thinking about the various economic problems of coping with scarcity through ages. It works on
the development and growth of economic ideas or economic thinking. It is a historical account of
the development of economic ideologies as also of their effect on the improvement or
development of economic institutions and activities.
History of Economic Thought deals with opinions and desires concerning on economic subjects,
especially concerning on economic policy with different economic thinking upon these subjects
that at different time and place, create in the mind of society. The ideas or concerns of History of
Economic Thought in a time of economic crisis, a reflection of the roots of economic theory and
methods prevents us from following the wrong way. In general, History of economic thought
consults economic history to understand and interpret economic thinking in the past and present.
History of Economics, Economic History and History of Economic Thought are separate
branches of study having different subject matters and varying in their emphasis on different
aspects of the subjects. Economic History tells us about the various economic activities in
contrast to economic thinking. It is an objective study of the development of economic life of a
particular society. History of Economics and History of Economic Thought have an element of
subjectivity in studies relating to them.
Economic history makes an account of not only of economic activities that prevailed to create
wealth in the past, but also about the various resource allocation mechanisms employed by
society to cope with the problem of scarcity across ages and also it studies the origin and growth
of commerce, manufacturing, trade, banking, transportation and other economic phenomena and
institutions. Economic history is the study of historical events using the lens of economics
(including the theoretical tools of economics). Economic History focuses on facts; History of
Economics and History of Economic Thought evaluates the theory of these facts. History of
economic thought goes beyond the History of Economics. The latter deals with the development
of economic thinking (intellectual efforts) and consults economic history to understand and
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interpret economic thinking in the past and present. In short, History of economics is a sub-
component of History of Economic Thought.
1.2 Scope and Significance of History of Economic Thought
The area coverage or scope of History of Economic Thought is very wide. It provides or
develops with a general picture of the development of economics with the improvement of
different economic thinking. It contains the study of human thinking from the time man started
formulating and expressing their ideas through times. The thinking does have to be traced from
customs, institutions and laws having a particular bearing on economic theory. The conclusions
have to be drawn, even when they were not functionally formulated or create economic theory.
Social structures, professions, customs and practices prevailing in a society provide a valuable
source and serve as a mirror reflecting the ideas and conditions of the times. It is difficult to
understand the development of economic doctrines in a proper perspective without referring to
the changing structure of a society and to its economic history. The primitive society economic
activities were intentionally related to and truly reflected the economic conditions of the existing
society. For History of Economic Thought, all these activities and thinking‘s are important as
one source or the foundation of some economic theory by economists. Many of the modem
doctrines are re-established or refinement of ancient theories and History of Economic thought
would be consults economic history to understand and interpret economic thinking in the past
and present.
Why Study of the History of Economic Thought?
First, such a study enhances one‘s understanding of contemporary economic thought. As just one
example, the historical development of the numerous intricate concepts that underlie
contemporary supply-and-demand analysis will be traced. More specifically, we will see how
such ideas as diminishing returns and returns to scale paved the way for modern short- and long-
run supply analysis, and how marginal utility and indifference curve models led to the
emergence of modern demand theory. You will discover that, as stated by Mark Blaug,
―contemporary theory wears the scars of yesterday‘s problems now resolved, yesterday‘s
blunders now corrected, and cannot be fully understood except as a legacy handed down from
the past.‖5 Second, the vast amounts of analysis and evidence that economists have generated
over the decades can provide a closer check on irresponsible generalizations. This should enable
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us to make fewer errors than in the past when making personal decisions and when formulating
national and local economic policies. Yet numerous unsolved problems and unanswered
questions remain in economics. Our understanding of past successes, errors, and dead ends will
be useful in solving these problems and answering these questions. Finally, and above all, the
study of the history of economic thought provides perspective and understanding of our past, of
changing ideas and problems, and of our direction of movement. It helps us appreciate that no
group has a monopoly on the truth and that many groups and individuals have contributed to the
richness and diversity of our intellectual, cultural, and material inheritance. A study of the
evolution of economic thought and the changing social background associated with it can
illuminate changes in other areas of concern to us, such as politics, art, literature, music,
philosophy, and science. A reciprocal relationship, of course, exists here—a better understanding
of these areas of knowledge can help explain changing economic ideas.
CHAPTER TWO: METHODOLOGICAL ISSUES IN ECONOMICS
Q1: Is economics a science or Art?
Q2: what do you know about the history of economics as a profession?
Q3: Identify what a positive economics, normative economics and their relationship with the
methodology of Art of Economics.
Q4: Discuss what empirical verification is, its role as a scientific method and its categories.
2.1. Methodological Controversies in Economic and Evolution of Various

Methodologies
In thinking about the history of the discipline, one is naturally led to ask, “What do economists
know and how do they know that they know it?‖ – the methodological decisions. Methodology
significantly influences what economists do. There are varieties of methodological issues that
have arisen in the philosophy of science from the ancient Greeks to modern-day thinkers.
2.1.1. The Rise of Logical Positivism
Logical positivism is the methodology of science moved into the 20th century with the
development of logical positivism, which provided the scientific method with philosophical
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foundations. It linked with deductive reasoning which is a positivist desire to let the facts speak
for themselves. It was originated by a group known as the Vienna Circle, which attempted to
formalize the methods of scientists by describing the methods scientists actually followed. The
logical positivists argued that scientists develop a deductive structure (a logical theory) that leads
to empirically testable propositions. A deductive theory is accepted as true, however, only after it
has been empirically tested and verified. The role of the scientist, they said, is to develop these
logical theories and then to test them. Although there was debate among the logical positivists as
to what constituted truth, all concurred that it would be discovered through empirical
observation. Logical positivism reigned in the philosophy of science only from the 1920s
through the 1930s, but its influence in economics continued much longer. It was logical
positivism that formalized the distinction between normative and positive economics, first made
by Nassau Senior in 1836 and later by J. S. Mill and John Neville Keynes. Normative
discussions were purged from economics as unscientific.
2.1.2. From Logical Positivism to Falsificationism
Logical positivism represented a culmination of the belief that the purpose of science is to
establish ―truth.‖ The methodology of science has since progressively removed itself from that
view. The first departure resulted from a concern about the ―verification‖ aspect of logical
positivist theory. This concern is best expressed in the writings of Karl Popper, who argued in
the 1930s that empirical tests do not establish the truth of a theory, only its falsity—which is why
Popper’s approach is sometimes called falsificationism. According to Popper, it is never
possible to “verify” a theory, since one cannot perform all possible tests of the theory. For
example, assume that a theory predicts that when the money supply increases, prices will
increase by an equal percentage. Then, assume that in an appropriate experiment the predicted
result does in fact occur. According to Popper, this indicates only that the theory has not yet been
proved false. The theory may or may not be true since the next experiment may produce a result
that is not consistent with the theory‘s prediction. Popper asserts, therefore, that the goal of
science should be to develop theories with empirically testable hypotheses and then to try to
falsify them, discarding those that prove false. The progression of science, according to Popper,
depends upon the continuing falsification of theories. The reigning theory will be the one that
explains the widest range of empirical observations and that has not yet been falsified.
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2.1.3. From Falsificationism to Paradigms
The limitations with falsificationism have led to rise of the paradigm‘s method. Falsification has
several serious problems. First, empirical predictions of some theories cannot be tested because
the technology to test them does not exist. Second, it is difficult to determine when a theory has
or has not been falsified. For example, if an empirical test does not produce the expected results,
the researcher can and often does attribute the failure to shortcomings in the testing procedure or
to some exogenous factor. Therefore, one negative empirical test often will not invalidate the
theory. A third problem arises from the mindset of researchers, who may fail to test the
implications of an established theory, assuming them to be true. Such a mindset can block the
path to acceptance of new and possibly more tenable theories. Partly in response to these
problems, Thomas Kuhn, in The Structure of Scientific Revolutions (1962), moved methodology
away from falsificationism by introducing the concept of the paradigm into the debate. A
paradigm, as Kuhn uses the word, is a given approach and body of knowledge built into
researchers‘ analyses that conforms to the accepted textbook presentation of mainstream
scientific thought at any given time.
Kuhn argued that most scientific work is normal science, in which researchers try to solve
puzzles posed within the framework of the existing paradigm. This work often leads to the
discovery of anomalies that the paradigm fails to account for, but the existence of such anomalies
is not sufficient to overthrow the reigning paradigm—only an alternative paradigm that is better
able to deal with the anomalies can do so. Once such a superior paradigm is developed, a
scientific revolution becomes possible. In revolutionary science, first the existing paradigm is
rejected by part of the scientific community, and then the old and the new paradigms begin to
compete and communication between researchers in the opposing camps becomes difficult.
Ultimately, if the revolution is successful, new questions will be posed within the new
framework and a new normal science will develop.
Whereas in Popper‘s view ―truth‖ (or the closest we can get to truth) will win out, in Kuhn‘s
view a superior theory might exist but not be adopted because of the inertia favoring the existing
paradigm. Hence the reigning theory is not necessarily the best. Those who disagreed with
mainstream theory quickly adopted Kuhn‘s analysis, because it suggested that the paradigm they
preferred might prove to be superior to, and thus able to supplant, the mainstream view.
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Moreover, Kuhn‘s work suggested that changes occur by revolutions; it offered hope that
change, when it came, would come quickly. Although Kuhn focused on the natural sciences, he
had a significant influence on the social sciences, such as economics. Methodological
discussions throughout the 1970s and 1980s were peppered with the term paradigm.
2.1.4. From Paradigms to Research Programs
The view that the existing theory might not embody the truth was extended by Imre Lakatos
during the late 1960s and 1970s. He tried to grasp and articulate the procedures good scientists
were actually following; he observed that scientists are engaged in the development of
competing research programs, each of which involves analyzing and attempting to falsify a set of
data but also involves unquestionably accepting a set of hard-core logical postulates. Each study
derives a set of peripheral implications from the hard core and then attempts to falsify them.
Falsification of a single peripheral implication will not require rejection of the theory but will
occasion a reconsideration of the logical structure and, perhaps, an ad hoc adjustment. Only if
―sufficient‖ peripheral implications are falsified will the hard-core assumptions are reconsidered.
Lakatos called research programs progressive if the process of falsifying the peripheral
implications was proceeding, degenerative if it was not. Lakatos’s work has two significant
features: (1) It recognizes the complexity of the process whereby a theory is falsified; and (2)
whereas earlier analyses required that one theory predominates, Lakatos provides for the
simultaneous existence of multiple workable theories whose relative merits are not easily
discernible.
2.1.5. From Research Programs to Sociological and Rhetorical Approaches to

Method
In one way, the developments we have just outlined move progressively away from logical
positivism, but in another way, they are refinements of it that recognize the limitations of
empirical testing. A much more radical departure from previous methodology can be found in
Paul Feyerabend‘s Against Method: An Outline of an Anarchistic Theory of Knowledge (1975).
Feyerabend argues that the acceptance of any method limits creativity in problem solving and
that the best science is therefore to be confined to no method—in other words, anything goes.
Though his radical argument at first seems crazy, he has provided some new perspectives on
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knowledge that throw light on the rhetorical and sociological approaches that have influenced
recent developments in the methodology of economics. Although earlier approaches
acknowledged the difficulty of discovering truth, they did not question the Platonic vision of
truth as absolute. The rhetorical and sociological approaches do just that. Since they refuse to
assume the existence of an ultimate and inviolable truth, they searched out other reasons to
explain why people believe what they believe. The rhetorical approach to methodology
emphasizes the persuasiveness of language, contending that a theory may be accepted not
because it is inherently true but because its advocates succeed in convincing others of its value
by means of their superior rhetoric. The sociological approach examines the social and
institutional constraints influencing the acceptability of a theory. Funding, jobs, and control of
the journals may have as much influence on which theory is accepted as the theory‘s ability to
accurately explain phenomena. Those who adhere to the sociological approach contend that most
researchers are interested less in whether the theories they advance are correct than in whether
they are publishable. What these two theories most notably share is skepticism about one‘s
ability to discover truth, or even whether truth exists at all. According to these approaches, a
theory has not necessarily evolved because it is the closest to the truth; it may have evolved for a
variety of reasons, of which truth—if it exists—is only one.
2.1.6. Post-rhetorical Methodology
Following the progress of epistemology through the past few decades, we have seen the answers
to questions about how and what we know become progressively vaguer until methodology is all
but annihilated: the most persuasive researchers win out regardless of the value of their work.
Fortunately, however, we need not accept such a view as total reality. Although such extreme
viewpoints provide interesting insights, they clearly need to be tempered by common sense.
Even admitting the social and rhetorical influences on the direction of science, one need not
accept that Feyerabend‘s ―anything goes‖ attitude necessarily follows. Methodology, moreover,
is not going to end here. A post-rhetorical methodology will probably combine insights such as
Feyerabend‘s with more workable approaches and emphasize abduction rather than deduction or
induction. Although researchers may never know with certainty whether a given theory is true or
false, they must accept the most promising ideas as tentatively true working hypotheses. They
may revert to certain elements of logical positivist and falsificationist methodology to do this.
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They may even accept all the arguments of the rhetorical and sociological schools and still
behave as they always have toward the truth or falsity of their research. The difference will be in
perspective: post-rhetorical economists will be more skeptical of their knowledge, less likely to
dismiss an argument as false before they have closely considered it, and A post-rhetorical
economist will scrutinize the incentives of researchers to study particular theories and will view
with skepticism the results of studies that coincide with the researcher‘s own interests or
preconceived beliefs. Finally, a post-rhetorical economist will be much more likely than a logical
positivist or a falsificationist to follow Bayesian, rather than classical, statistics. Bayesians
believe one can discover higher or lower degrees of truth in statements, but not ultimate truth.
The Bayesian influence will engender a reinterpretation of classical statistical tests, rendering
them less exact, less persuasive, and not independently representative of a specific confidence
level. For both the Bayesian and the rhetorical economists, understanding ultimately rests on
faith.
2.1.7. Approach to the History of Economic Thought
Relativist and Absolutist Approaches
Can one formulate a theory to explain the development of economic theory—a sociology of
knowledge for economics? How does economic theory arise? There are two approaches to
answering this question: the relativist approach and the absolutist approach.
Relativist historians concern themselves (1) with the historical, economic, sociological, and
political forces that brought men and women to examine certain economic questions and (2) with
the ways in which these forces shape the content of emerging theory. They hold that history
plays a part in the development of every economic theory.
Absolutist writers (in this context called Whigs by some) stress internal forces, such as the
increasing professionalism in economics, to account for the development of economic theory.
The absolutists claim that the progress of theory does not merely reflect historical circumstances
but depends on the discovery and explanation of unsolved problems or paradoxes by trained
professionals reacting to intellectual developments within the profession. According to this view,
it is possible to rank theories absolutely according to their worth; the most recent theory is likely
to contain less error and be closer to the truth than earlier theories. In modern era, neither the
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absolutist nor the relativist position is convincing in and of itself. A more fruitful approach is to
view the history of economic thought as a dynamic process of interaction between forces
external and internal to the discipline that bring about new theoretical developments.
Orthodox and Heterodox Economists
One way to understand the issues separating orthodox and heterodox writers is by examining the
questions they were trying to answer. Whereas, modern orthodox theorists have largely focused
on the four problems of allocation, distribution, stability, and growth, heterodox economists have
studied the forces that produce changes in the society and economy. Often, what orthodox
writers take as given, heterodox writers try to explain; and what heterodox writers take as given,
orthodox economists try to explain. Thus, the differences between heterodox and orthodox
economists are often differences in focus, not diametrically opposed theories.
Orthodox writers have taken things as given (something they are not interested in explaining) the
specific social, political, and economic institutions and have studied economic behavior in the
context of these institutions. However, heterodox writers have focused on the forces leading to
the development of these institutions.
Among the modern heterodox schools that are included are the Austrians, institutionalists, post-
Keynesians, and radicals. Heterodox economists have often ventured beyond the boundaries of
orthodox economic theory into a no man‘s land among economics, sociology, anthropology,
psychology, political science, history, and ethics. Modern economics is only now beginning to
see the need to do that.
CHAPTER THREE: PRE-CLASSICAL ECONOMICS
3. The General Themes of Pre-classical Economic Thinkers

The pre-classical thinkers reflected on aspects of their Economic lives and focused on non-
market allocating mechanisms and also, they focused on general philosophical questions of
fairness, justice and equity. The Ancient Greek and Roman Economic ideas were dominated with
Economic ideas in connection to concerns for justice, fairness, equality and non-market methods
of resource allocation. Medieval (scholastic) economic ideas were concerned with reconciling
the philosophy of the ancient classical philosophers with medieval Christian theology and
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provide religious guidelines to be applied to secular activities with a general orientation to non-
market methods of resource allocation. The brief discussion of the pre-classical economic
thoughts is given hereunder.
3.1. Ancient Economic Thoughts
The early thinkers include Hebrews and Greeks that had a great contribution to the development
of economic thought.
3.1.1. The Hebrews prophets
The beginnings of the science of economics and economic institutions are often traced back to
the Hebrews. They belong to the ancient civilizations of the world. Their period dates back to
2500 B.C. It is believed by some scholars that Western Civilization has its origin in Hebrew
civilization. Division of labour, market, exchange, money etc., were the institutions of those
times. The philosophers of those times were real founders of all social theories even though their
writings were in a scattered form. The economic philosophy of the Hebrews was simple. The
society in which they lived was also a simple one. Economic problems were never studied
separately. Economics, Politics, Ethics and Philosophy were interconnected. But religion and
ethics were given greater importance. Economic life was controlled by priests. They gave
importance to agriculture. The Hebrews had definite ideas on subjects such as interest,
agriculture, property, taxation etc.
The Mosaic Law prohibited interest taking or usury (high rate of interest). The law applied only
to the Hebrews. Lending of money at interest to strangers was allowed. Collecting interest from
poor people was prohibited because the poor borrowed money mainly for consumption purposes.
This rule was modified in the times of Solomon when charging of interest at low rate was
justified. Security for loans was in the nature of a ―pledge‖ with well-defined rules for it.
They exercised great care in formulating laws against false weights and measures and
adulteration of articles of consumption. These were strictly prohibited by the Hebrews.
Monopoly and speculation were even more strictly prohibited. Raising market prices for
speculative means was disapproved. There were also ceiling on the profits of retail shopkeepers
which could not exceed the limit. The export of food grains was also prohibited and in times of
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scarcity and famine, hoarding of food grains was not permitted. Thus, the concept of just price
included correct weight, competitive price and reasonable rate of profit.
As far as labour and wages was concerned, the Hebrews realised the dignity of labour but the
pride of place was given to agricultural labour. There was no labour problem as we have these
days. Wage workers were common. The Hebrews did not lay down rules for regulating the
relation between the employer and employee. The chief regulations were concerning mercy and
justice to them. Payments were made in kind. Agriculture had was the supreme occupation for
the ancient Hebrews.
There was a very peculiar institution of Seventh and Jubilee year among the Hebrews. The
Hebrews left their land fallow in the seventh year after cultivating it for six years. This was done
with the object of preserving the fertility of the soil. The slaves serving for six years were freed
in the seventh year. In this year, all debts should be cancelled. The Jubilee year was the fiftieth
year. According to this provision, the land sold or transferred to someone was to be returned to
its owners in the 50th year. In those days land was the main form of wealth. They tried to prevent
concentration of wealth and also the acquisition of land of small holders by owners of large
estates. By the institution of Seventh and Jubilee year, the Hebrews desired to prevent inequality
in wealth.
The Hebrews seemed to have understood the functions of money. Money was used mainly in the
form of bullion. There was no question of stamped money. The Sabbath was the cornerstone of
Hebrew Economic thought. It was their weekly day of rest, relaxation and good living. It was
enjoyed by the masters of the house and his family as well as the slaves and the servants.
According to Spiegel, ―the institution of the weekend was a social invention that has no parallel
in the civilization of Greek, Rome or other ancient culture‖.
In those days land was the main form of property. Wealth was measured in lands, slaves, talents,
silver, and other precious metals. The owner of a plot of land was the owner of all resources
above and below the surface of land. According to the Law of Inheritance, the first claim on
property went to the eldest son. If there was no son, it went to the daughter and in the absence of
a daughter, it might go to the close relatives like brothers, uncles etc.
Only surplus corn was sold in the market. The Hebrew wives were Craft – Women who used to
spin wool and flax. Commerce flourished in the reign of King Solomon. He made successful
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voyages to distant lands, including India. Taxes did not exist in the Hebrew economy. Labour
service was utilised for the construction of bridges, roads and other public utility services.
Customs and toll tax were also collected. The toll tax was known as a tribute realised from every
male for the maintenance of temples. Hebrew laws helped the dependents, fatherless and
widows. The corner portion of the fields and vineyards were available for the poor.
3.1.2. The Greeks
The Greeks were among the first to develop an economic theory the Greek philosopher, who
really laid the foundation of economics as a science, was Aristotle. Now we discuss one by one.
Plato (427-347 B.C.)
Plato was born in Athens and was a pupil of Socrates. He founded the first great school of
philosophers the Academy. According to Plato, the ruling class should not possess private
property, the necessity of division of labor based on the best natural ability for efficiency and
also the republic and The Laws are the most important sources of his economic thought. He
sponsored one of the two fundamental theories of money. He thought of money as a symbol
devised for the purpose of facilitating exchange, the value of which is on principle independent
of the stuff it is made of. (Cartal theory), the canons of his monetary policy, i.e., his hostility to
the use of gold and silver and his idea of a domestic currency that would be useless abroad were
logical consequences of this principle.
In his most celebrated book, The Republic, Plato gives the theory of an ideal state. As far as a
state is concerned, Plato gives ideas about how to build an Ideal commonwealth, who should be
the rulers of the Ideal state and how to achieve justice in the Ideal state. Plato finds the state as
the more suitable place to discuss about the morality than an individual, because everything is
easier to see in the large than in the small. A state, says Plato, is a man ‗writ‘ large against the
sky. The elements that make up a city correspond to the elements that constitute the individual
human soul.
Economic Basis of Origin of the State: Plato finds the origin of the state in the various needs of
people, for Plato traced the origin of the State to economic considerations.
Theory of Education: Plato supports state regulated system of education. According to Plato,
education does not mean the storing up of external knowledge but the bringing of the soul into
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proper environment for the development of the state. For Plato, a state can regulate crime by
adopting a proper system of education. Plato gives more importance to education than any other
Greek thinker. Plato stated that both boys and girls should receive the same kind of education.
His idea on education is more important in the modern days.
Division of Labour: For Plato, by ‗division of labour‘ simply meant the division of
employments or professions as an aid to social organization. Plato‘s main contribution was in his
account of division of labour. The division of labour into various trades was thus recognised as a
necessary condition to economic welfare even though division of each trade into various tasks
was not conceived by him. Moreover, he did not consider the necessity of a wider market for the
application of the principles.
Thus, Plato‘s idea of division of labour is different from that of Adam Smith. Smith‘s division of
labour is determined by the market, but Plato‘s division of labour determines the market.
According to Adam Smith the advantages of division of labour go to only the employers, but to
Plato it is beneficial to the entire society. The cost of division of labour according to Plato is the
difference in skill and talent. Nonetheless, to Adam Smith division of labour leads to differences
in skill and talent.
Communist social system: Plato‘s ideas regarding communism are extremely remarkable.
Plato‘s communism is the most talked about and misunderstood part of his philosophy. In his
ideal state, the property should be collectively owned. Plato advocated communism to eliminate
the evils of caste system. Plato‘s ideal state was not a communist state in the strict sense of the
term. Though the aim was to abolish class conflict, it was not to be achieved on the basis of
equality of opportunities. There were two classes: the ruler comprising of guardians and
auxiliaries and the ruled called artisans. The members of the ruling class were to be well
educated in the arts of war and philosophy. According to Prof. Haney, ―Plato‘s communism did
not stand for an absolute mechanical equality, but recognised authority and class distinctions‖.
Plato propounded theory of communism of wives and property. Plato suggest communism for
guardian and ruling class as he thinks both the community of property and the community of
families tend them to make truly ruling class. Plato was of the opinion that the ruling elite class
should not have any property of their own beyond what is absolutely necessary. The views of
Plato regarding division of labour lead us to what is known as ‗communism‘ the most talked
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about and grossly misunderstood part of his philosophy. It may at once be stated that Plato‘s
communism is so queer that in his ideal state, not only property was to be collectively owned but
also wives and children. The main objective underlying his communism was to create conditions
in which citizens of the ideal state would be bound by common interests. He advocated
communism of wives and children not only to promote harmony of interests but also to control
population. The main aim, however, was to eliminate some of the evils of the caste system.
Inheritance and Population: According Plato, the succession of property and control of
population are also interesting. In his ideal state, each citizen was to be given an in alienable plot
of land with the right to choose a single heir either by birth or by adoption. The problem of
population was also analysed by Plato. The size of population in his state was assumed on the
basis of the best results of division of labour. He provided a careful regulation of population to
maintain stability in the economy.
Value: According to Plato‘s view, the value of a product or factors of productions are
determined by an inherent quality of the product or factors.
Agriculture: Like the Hebrews, the Greeks too considered agriculture as the most desirable
occupation.
Money and Interest: For Plato money recognized as a medium of exchange. However, he did
not favour the idea of allowing gold and silver to be used by the common man. Instead he
suggested the use of domestic coins for payment of wages and other transactions. Plato
prohibited interest taking for loans, but later on he permitted interest taking as a penalty for
delayed payment.
Riches and Poverty: According to Plato, riches made a man indolent and careless, while
poverty led to inefficiency, and did not allow the full use of craftsmanship and skill. He opposed
accumulation of wealth on ethical grounds also. According to him, Great riches and happiness
are incompatible, for a rich man cannot be a perfectly good man. Plato criticized riches and
poverty. He was of the view that riches made a man careless while poverty led to inefficiency.
To him great riches and happiness cannot exist together because the rich people spend a part of
their wealth without any justice.
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Plato had suggested an ideal property arrangement. Only farmers and artisans were allowed to
get property while the rulers and the administrators were not allowed to enjoy the property rights.
He realised that, the city was divided into two parts namely, city of the poor and the rich. These
two parts were always at war with each other. Plato regarded slavery as a permanent factor in the
civilization of mankind. In his book ‗The Laws‘ he stated that the treatment of the slaves should
be liberal. Foreigners who were defeated in war and were taken as prisoners should be made
slaves. In his city state, the slaves formed about 1 /3 of the population and they performed most
of the economic functions.
To Sum up, Plato‘s contributions made definite progress in economic thinking of his time. His
economic ideas show that he was essentially a child of his time. He recognised division of labour
and it was adopted as a means of easier and better production.
However, he did not recognise acquired skill, elimination of waste etc., as later economists were
to admit its merits. Plato was a man of peace. He was the first thirteen who made economics a
handmaid of ethics. At best, we could consider Plato not as an economist but only as a social
reformer.
Aristotle (384-322 B.C.)
Aristotle (384 BC – 322 BC) was a Greek philosopher who was a student of Plato and teacher of
Alexander the Great. He was the first analytical economist who laid the foundation of the science
of Economics. His analyses Economics according to ethical principles and examines it micro
economically and macro economically. He based economics on needs, analyzed their nature and
proceeded to isolate the economic goods by which economic needs are satisfied. He also
examines the phenomenon of economy of an area, of economic development and prosperity on
the basis of the financial policy. According to Aristotle, there should be no regulation to limit
private property but also condemned the pursuit of economic gains. Scarcity can be addressed by
reducing consumption, by changing human attitudes (the basis for utopians and socialists‘ hopes
of eliminating conflicts that are inherent in scarcity and self-interested behavior).
Origin of the State: According to Aristotle, the origin of the state is to be explained not in terms
of economic needs and their satisfaction, but as an outcome of the natural instinct of man to
associate with his fellow beings. Man is a social animal and the State is a creation of nature.
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Value and Exchange: According to Plato, value was an inherent quality of the commodity.
Aristotle went still further and held that the value of a commodity depended upon its usefulness.
Aristotle on Value and exchange rrecognized the distinction between value in use and value in
exchange & the latter is derived from the former. He promoted the idea of Justice in price
(Commutative justice) as equivalence of what a man gives and receives. Aristotle defined
monopoly as a single seller and condemned it as unjust but failed in formulating a theory of
price.
Interest and Money: Aristotle sponsored the second theory of money (Metallist theory) Money
is a medium of exchange (catallactic theory of money). In order to serve as a medium of
exchange in the market of commodities, money must be one of these commodities. Thus, the
money commodity goes by weight and quality leading to metallism or the Metallist theory of
money as opposed to Cartal theory of Plato. He recognized money as measure of value and
implicitly as a store of value. Money as a standard of differed payments was not suggested by
Aristotle. Aristotle condemned interest, as usury, on the ground that money is a medium of
exchange the value of which does not change as it crosses hands. He didn’t ask why interest was
being paid anyway.
Agriculture and Industry: Aristotle laid down that agriculture and stock-raring was natural
arts; exchange, commerce, usury, and hiring services were unnatural arts; and mining and
lumbering lay in between.
Poverty and Riches: Like Plato, Aristotle also believed that poverty was the breeding ground of
revolution and crime. He also opposed too much concentration of wealth. To quote him, ―Many
make a mistake not only in giving too much power to the rich, but in attempting to overreach the
people. There comes a time when out of a false good there arises a true evil, since tile
encroachments of the rich are more destructive to the State than those of the people.
Xenophon
The third Greek writer to contribute certain embryonic elements to an economic science is
Xenophon. Wealth, for Xenophon, is to be interpreted in relation to needs: the man of simple
tastes and little substance is wealthy in comparison with the man of great possessions on who
excessive claims rest.
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He is known for his praise of agriculture. He said ―If husbandry flourishes, all the other arts are
in good shape, but whenever the land is compelled to lie waste, the other arts of landsmen and
mariners alike will perish.‖ He approaches (or seems to approach) in a fumbling (mishandling)
way the law of diminishing returns. He said, ―The landowners could all tell you how many
teams and how many laborers are required for their estates. If anyone employs hands in excess
of requirements, it is reckoned (computed) as a loss.” He saw foreign residents as a source of
revenue, and he argues for the abolition of all regulations that inflict disabilities on this class. No
less significant is his suggestion to raise a capital sum to provide accommodation for merchants
and shops and houses for retail dealers. He said, in peace wealth in accumulated, in war time it is
spent.
Xenophon associated a property of increasing returns with silver mining. The greater the
number of people employed; the more prolific (fruitful), or yielding becomes the ore. ‗There is
no limit to the demand for silver. ‗Silver ore will never give out, and silver will never lose its
value.‘ Gold does not have this marvelous property. ―When an abundance of gold makes its
appearance, its value depreciates, and it sends up the price of silver. In order to overcome the
risks (interest in opening new cuttings, i.e., new silver mines) he suggests something
approaching to a joint stock method of operation.
3.1.3. The Romance

The Roman period was characterized by the absence of analytic work in spite of expanded
economic activities, markets and administrative concerns. The probable cause could be the
structure of the roman society which might not allow analytic works by a class of people who
could see such an engagement as their vocation rather than avocation. What is recognized from
this period is the importance of Roman law that recognizes private property and commerce. As a
record of social struggle, the history of Rome is of the highest importance, but the specific
contribution that Rome made to theory is meager to the extent of being negligible. Most of
whatever is contributed to theory by Rome is largely an echo of Greece.
It is indeed in accordance with the genius of the Roman people that their theory should be
implicit in their actions, their laws and their jurisprudence, rather than explicit in the works of
professional theorists.
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The contribution of Rome to the discussion of economic topics (even if it may not amount to
theory) falls under three groups: the philosophers, the agricultural writers, and the jurists.
Among the philosophers we can site some ideas from Cicero and Seneca. Cicero condemned
usury on the feeble ground that it incurs people‘s ill will. He wrote in praise of agriculture and in
dispraise of other occupations. Seneca, another Roman philosopher, views money as the root of
most evils. For him, envy and greed are the sources of all injustice. But their ideas as stated
above are not original but largely an echo of Greece.
The agricultural writers (like Cato, Varro and Columella) are concerned above all with the
technique of agriculture and only incidentally with the economics of agriculture. Basically, these
writers had a high regard for agriculture. They wrote in praise of agriculture.
Jurists and the Roman law:
It might indeed be argued that Roman Law represents the greatest legally of Rome to the
civilized world, inasmuch as a large portion of the daily transactions of the world are still
regulated in accordance with the principles laid down by the Roman jurists and embodied in the
Roman Law. In relation to the Roman law, the following points appear of relevant to economic
theory:
i. Roman lawyers evolved the idea of a ‗Jus gentium‘, an idea not in itself of economic
importance, though later it impinges on the development of economic ideas. The ‗Jus gentium‘,
the body of law common to different nations, readily passes into the idea of natural law, that is to
say, the idea of a body of law, which, being common to all peoples, is ‗natural‘ to them, and can
therefore claim a higher sanction than that of any earthly legislature. It is an idea, which, in the
varying shades of meaning of which it is, susceptible, never wholly faded out.
ii. The other is the one which promotes harsh individualism. This arises from the belief that
everyone has the right to do what he likes with what is his own; that the conception of private
property necessarily includes the right not merely to enjoy, but also to abuse and destroy
arbitrarily. By doing so, Rome (the Roman law) left a bias towards unfettered and irresponsible
individualism as against the possible claims of the family or the nation.
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3.2. The Medieval Economics and Feudalism
The Middle Ages extend from the fall of the Roman Empire [476 AD] to the late 15 Century
[discovery of America by Columbus in 1492]). The Scholastic writers were educated monks who
tried to provide religious guidelines to be applied to secular activities. Scholasticism originally
began to reconcile the philosophy of the ancient classical philosophers with medieval Christian
theology. It is not a philosophy or theology in itself, but a tool and method for learning. It puts
emphasis on dialectical reasoning and the primary purpose of scholasticism was to find the
answer to a question or resolve a contradiction.
Middle Ages are more or less synonymous with the feudal system. The theory of feudalism in its
essence implied a system in which society was held together by mutual obligations and services
so that each one had his place assigned to him, and his tenure of that place involved the giving
and receiving mutually of support and assistance. On the whole the accepted theory was that the
members of society held their places in society on condition that they rendered certain specified
services to their fellows. There was thus a considerable element of status. Rank, imposed
obligations, but it also conferred privileges. Each one should not merely discharge the
obligations resting on him; he should also live as his position in life required.
The Middle Ages are characterized by small volume of trade and money transactions. It was a
society in which the members were expected to maintain themselves by rendering services to the
community, and in which to a large extent the possibility of making gains, or laying up treasure
on earth was excluded.
On the religious side the great all-dominant fact was the Church. The Church sought to regulate
all human relationships on the postulate that this earthly life is but a preparation for another, and
that the only reality is eternal solution. The Church was, in its very nature, a cosmopolitan
organization. The national atmosphere of the Middle Ages [in contrast to the presuppositions of
the later mercantile period) is in part the gift of the Church which thus conferred a certain unity
on Europe before centralized nations found satisfaction in the misfortunes of their neighbor in
later periods.
Market was not playing a dominant role in everyday life and Society was bound together by
tradition custom and authority (not by market). The system was feudal, which rely on subsistence
agriculture. Land, labor and capital were not market commodities as they are today. Among the
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medieval thinkers, St. Thomas Aquinas (1225-1274) (known as Angelo doctor) the Italian
theologist and writer, was one whose thought governed an epoch.
St. Thomas‘ views on economic matters were highly influenced by Aristotle and Christianity:
with regard to the nature and functions of money, the inequity of money and the principles which
should govern exchange.
An important implication of Christianity is the principle that men are equal in the sight of God;
that all men are the children of a common father, and hence brothers. This belief goes beyond
the distinctions of race, class, and nationality. This attitude of tolerance led to accepting
inequality as part of the arrangement ordained by the almightily, and viewing life in relation to
the light of eternity. Christianity has also brought another reversal to the traditional Greece view
with regard to the dignity of work which in the period of Greece was considered as a mark of
slave.
The New Testament indicated ―work with your own hands,‖ and this led people to conclude that
if any man would not work, neither should he eat. Thus, the attitude towards the dignity of work
has changed significantly. The two cardinal economic doctrines of the Middle Ages are found in
the notion of the ‗Just Price‘ and in the ‗prohibition of usury‘.
Just price emanates from the understanding that we are brothers and should behave as brothers,
respecting each other‘s rights and positions in life. Each should receive that to which he is
entitled. No one, under any circumstances, should take advantage of his neighbors. This is the
sum and substance of mediaeval economic teaching. This in itself contains the prohibition of
usury.
In relation to private property, St. Thomas holds, (following Aristotle) that possession is natural
to man. Under natural law, he contends, in relation to the argument that seeks in natural law for
community of possession, there can be no justification for distinction of possessions. Thus,
private property is not contrary to natural law; rather it is added to natural law by a further
creation of human reason. St. Thomas distinguishes the two kinds of right which men may have
in things: the power of acquisition and administration (i.e., the right to acquire and administer
property) and the right to use.
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Justice implies equality, equality in exchange. In effecting exchanges, therefore, a measure is

necessary, and it is for this purpose that money has been invented. Money is thus primarily, and
almost merely, a measure of values. If the price exceeds the value of a thing, or conversely if the
value of a thing exceeds the price, justice is violated; and therefore, to sell a thing at a higher
price or buy it at a lower price than it is worth is unjust and impermissible.
The principle of the ‗just price‘ includes the idea of the ‗just wage‘, the payment of due wages
for services rendered. That the laborer was worthy of his hire was a living Principe in the Middle
Ages (and it might even be said the doctrine of the just price was built up on that of the just
wage). By the just wage was meant that the rate of remuneration, which was required to enable
the worker to live decently in the station of life in which he was placed.
Usury had been condemned by Aristotle on the grounds of the barrenness of money; to use
money which was properly merely a means of exchange as a device for making more money,
was unnatural, and therefore to be condemned. In the Bible there are various prohibitions of
usury. There was above all the passage in the Gospels which was more frequently cited than any
other authority, to the effect that the Christian should lend, hoping for nothing again. (Luke vi.
35). The early condemnation of usury rested in part on the authority of the Bible and Aristotle,
being compounded of the Aristotelian doctrine of sterility and the view that usury represents a
grinding of the faces of the poor in their distress. Usury as to St. Thomas Aquinas involves an
offence against justice.
Bearing in mind the foregoing analysis, the offence of the usurer, according to St. Thomas, may
be variously expressed as:
- Either he is selling something that does not exist (the use, apart from the
consumption, when the two are identical)
- Or he is charging for the same thing twice
- Or, if the lapse of time be invoked, he is selling time, which belongs to God, and
which no man may appropriate.
Q6: What are the concepts of damnum emergens; lucrum cessans; poena
conventionalis and periculum sortis in St. Thomas‘s theory of usury?
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3.3. Mercantilism
Mercantilism is a body of economic doctrine reflecting the interest of the mercantile capitalist,
giving dignity and importance to the merchant and trade, characterized by its promotion of
nationalism, a strong government and justification of a policy of economic and military
expansion, which is a manifestation of the less importance attached to market forces. It appeared
between the Middle Ages and the period of the triumph of Laissez-Faire. Belief in gold and
silver as the most desirable form of wealth, emphasis on export and restriction on import in the
interest of the mercantile capitalist. Rise of trade and higher interdependence, increasing
importance of cities the use of money expanded. The development in navigation and great
geographical discoveries expanded the sphere of commerce. National states were rising and
expanding their sphere of influence and colonies, which intensified the rivalry between nations.
Q7: What are the lasting contributions of Mercantilist ideologies?
Q8: What were factors for the rise of mercantilists?
Important Mercantilists and Their Views
1. Sir Thomas Mun. Thomas Mun (British mercantilist) who lived between 1571-1641 was a
merchant in Italian and near east trade and later was elected as a director of the East India
Company. Because he was involved in the controversy over the company‘s policy of exporting
gold, he published a tract in its defense. He argued that as long as the total export exceeded total
imports, the drain of species from a country in any one trade area did not matter. A chapter in an
exposition of the mercantilist doctrine by Mun, entitled ―the means to enrich the Kingdom, and
increase our treasure‖ states that the means lay neither in production nor in the accumulation of
capital goods, but rather in a surplus of exports. As to Mun, although England was rich, it could
be still richer if it used waste land to grow hemp, flax, lumber, tobacco and other things which
now we fetch from strangers to our great impoverishing. The exports should be carried in
English ships to gain insurance and freight charges and argued for multilateral trade than
bilateral trade and analyzed England‘s overall balance of trade rather than its separate account
with each foreign country.
His emphasis on importing treasure led to the strange conclusion that trade at home could not
enrich a country. Sir Thomas Mun, listed the invisible items that should be included in an overall
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balance if it were to show whether ‗We prosper or decline in this great wealthy business‖. He
included in the balance of payments;
 The freight charges for shipping goods, Ships lost at sea, Insurance
 Money paid up in supporting foreign wars, international payment of bribes and funds for
espionage
 Expense of travelers, Gifts for foreigners and ambassadors
 Interest on money, smuggling to evade tariffs and also Contributions to religious orders that
secretly sent the money abroad
Q9: who are other mercantilists in addition to the Sir Thomas Mun and what are their main
economic thoughts?
3.4. Physiocratic School of Thought

Physiocracy was a reaction to Mercantilism and feudalism in France characterized by its
emphasis on agriculture and laissez faire, an advance in economic thinking towards the
recognition of the role of the markets. The term physiocracy means the rule of nature. It was
appeared in France toward the end of the Mercantilist epoch around 1756 and ended in 1776.
The influence of the physiocrats lasted well beyond the two decades during which they led the
world in economic thinking.
Major tenets or central ideas of Physiocracy

 Natural Order: In their protest against the artificial conditions created by mercantilist
doctrines and policies, the physiocrats advocated the establishment of the natural order.
In fact this concept was the focal point of physiocracy 'as the science of the natural
order'. According to physiocrats the natural order was an ideal order of things, which
was arranged in conformity with the laws of nature (laissez faire, emphasis on
agriculture, taxation on land owner and inter relatedness of the economy).
 The physiocrats introduced the concept of natural order to economic thinking, i.e., the
idea that the laws of nature govern human societies just as those discovered by Newton
govern the physical world (Natural order)
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 In the economic sphere the laws of nature conferred to the individual the natural
right to enjoy the fruits of their labor, provided that such enjoyment was
consistent with the rights of others.
 Governments should never interfere in economic affairs beyond the minimum required to
maintain freedom of contract and the protection of life and property. (Laissez faire)
 Industry trade and the professions were useful but sterile, simply reproducing the value
consumed in the form of raw materials and subsistence for the workers, while agriculture
was productive because it produces a surplus, a net product above the value of the
resources use in production. (Emphasis on agriculture)
 Emphasis on taxation of the land owner (only agriculture produced surplus) the land
owner should be taxed.
 The economy was believed to be interdependent and the circular flow of goods and
money was analyzed. ―Tableau economique‖ of Quesnay was a table that traces
spending, revenue received, by farmers, landlords, manufacturers and merchants.
Whom did the school benefit or seek to benefit

 Peasants, businesses (from the removal of the of all restrictions on production and the
movement of goods), promotes industry though it was not the intensions of the
physiocrats.
 Physiocrats favored capitalist farms.
 A single tax to all land in production would benefit the landlords.
Usefulness, validity or correctness of the school in its time

 Industry was an activity that was extremely low in productivity and appeared to be sterile
as compared to agriculture that has sometimes bountiful harvest.
 By emphasizing agriculture they departed away from the mercantilist thinking of only
commerce creates and augments wealth.
 The school emphasized production rather than exchange as a source of wealth.
 The support for direct tax was a valid reaction to the cascaded indirect taxes that corroded
the society at the time.
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Lasting contribution of the Physiocratic school

 Physiocrats laid a foundation for economics to be a social science by examining society
as a whole and analyzing the laws that governed the circulation of goods and wealth,
which were the precursor of the flow and national accounts concepts of the modern time.
 The law of diminishing returns actually originated from the physiocrats (particularly
Turgot)
 Physiocrats originated the idea of tax shifting and incidence
 Through the idea of laissez faire, they directed attention to the analysis of the proper role
of governments in the economy.
The Physiocrats
(1) Francios Quesnay
 Hoped to transform the king to enlightened despot
 Expressed that small farms were incapable of the most productive method, and favored
large farms managed by entrepreneurs.
 Analogous to the natural organism and conforming to the natural order, the circulation
of wealth and goods in the economy was like the circulation of blood in the body.
 Laws made by people should be in harmony with natural laws.
 Constructed Tableau Economique, which was the first systematic analysis of the flow
of wealth. A.Smith. K. Marxs and M. keynes, who later on also described the economy
in terms of large aggregates, paid tributes to Quesnay.
Quesnay‘s Tableau Economique foreshadowed national income analysis and the modern circular
flow of wealth and goods. It was also the predecessor of the input- output analysis of Leontief.
The physiocrats advanced their theory of circulation of wealth in the society. They must be
credited with being the first school of economists who analyzed the problem of distribution. The
idea was first mooted by Quesnay through his Tableau Economique. He skillfully made use of
his knowledge of biological concept of circulation of blood, discovered by Harvey, to solve the
sociological problem. How much importance the physiocrats attached to the circulation of wealth
is evident from what Turgot said that it "constituted the very life of the body politic just as the
circulation of the blood did of the physical."
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The ideas regarding the circulation of wealth have been given by Quesnay in the form of a table
called the Tableau Economique. Economics had till then been a conjectural science, subject to
inductive reasoning the Tableau Economique attempted to make Economics an exact science.
Quesnay presupposes a realm, headed by a monarch assisted by a small number of councilors
who interpreted the physical and moral laws inherent in nature. This realm is constituted in
accordance with the laws of nature. Physiocrats called it the Ordere Naturale. Agriculture forms
the basis of social life. It is carried on will the sole purpose of securing prosperity to the whole
realm.
Francios Quesnay on other issues,

 Regarding rent, he believed that nature, not the worker, produced the surplus and
hence the land lord has the right to the surplus product.
 Quesnay defended the interest of the land lord but landlords took his proposal of
taxing only the lard lords as an attack on their interests.
 Quesnay argued against excess luxury in the way of decoration, and preferred
spending on raw materials.
 Quesnay‘s thinking had medieval flavor in his glorification of agriculture, in fixing
of the interest rate by government, in favoring the ―Just price‖. However, he
believed the free market rather than regulation by authority would best achieve the
―Just price‖
CHAPTER FOUR: CLASSICAL SCHOOL
4.1 Introduction
The classical school is the body of doctrines which held sway in England during 100 years after
the decline of Physiocracy. Adam Smith is known as the founder of classical school. The
followers of Smith while following the basic principles articulated by him, helped the
development of the science of political economy by formulating new theories and expanding,
illustrating, and elaborating the theories lied down by Smith.
Even though most classical economists made a lot of contributions for the development of
economics, each of them is celebrated for different things. Adam Smith is celebrated for his
laissez-faire of the ideology and the superiority of the market mechanism and the invisible hand.
Bentham is remembered for his contribution on utility and the law of diminishing utility.
Malthus is known for his population theory, especially concerning the population checks.
Ricardo is known for his more abstract economic theories, especially for his theory of value and
26
theory of international trade and distribution of the gains from trade. Baptist Say is known for the
law of the market which is known as ―Says law‖. Finally, J.S. Mill is known for his theory of
distribution and relatively interventionist distribution ideologies.
These doctrines were propounded by Adam Smith and his followers during the latter half of the
eighteenth century and after. The 'school' comprised many illustrious writers and economists
among whom' the most important were besides Smith, Ricardo, Malthus, Mil1, and Senior.
These writers, while following the basic principles enunciated by Smith, helped the development
of the science of political economy by formulating new theories and expanding, illustrating, and
elaborating the theories propounded by their leader.
The classical school began in 1776 when Adam Smith published his Wealth of Nations. It ended
in 1871 when books on marginalist theories were published by Stanley Javons, Carl Menger, and
Leon Walras independently.
The Historical back ground of the school
 The scientific revolution has discovered and advanced Natural laws, planetary motion,
Universal Gravitation and laws of motion etc.
 Scientists like Newton popularized the already existing idea that the universe is governed by
natural laws.
 This view served as a framework for the classicists that the natural laws would guide the
economic system and the actions of people.
 The Devine will have created a mechanism that works automatically without interference.
This applies to society and hence laissez faire was the highest form of wisdom in social
affairs.
 The industrial revolution was beginning and gaining momentum in England
 England was gaining supremacy in both commercial and industry and stood to benefit
greatly by free international trade.
 As English Entrepreneurs became stronger, they no longer were dependent on government

subsidies, monopoly privileges and tariff protection
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 The entrepreneurs were increasing in number and hence monopoly agreements could no
more be easy to realize.
 Competition began to ensure moderate prices and good quality
 Wage and labor regulations by government had given way to market forces and conditions
of labor supply and demand were dictating low market determined wages.
 The enclosure law brought land and strict private ownership regime and encouraged larger
scale and more capital-intensive agriculture that turned peasants into wage earners
 The factory system displaced handicrafts men, driving them to the labor market as wage
earners.
CHAPTER FIVE: THE RISE OF SOCIALIST THOUGHT

The tenets and policy pronouncements of classical political economy drew criticism from several
diverse socialists‘ thinkers. Socialism arose in the late 18th and early 19th century as a reaction
to the economic and social changes associated with the Industrial Revolution. While rapid wealth
came to the factory owners, the workers became increasingly impoverished. The term
‗Socialism‘ made its appearance in print in England in 1827. Five years later, the term was used
for the first time in a French publication. It is no accident that the socialist idea --and the socialist
movement--first appeared in England and France. For socialism was a product of two revolutions
in human affairs, each with their respective roots in those two countries: the industrial revolution
in England and the popular-democratic revolution in France.
The French revolution of 1789-1799 rooted in popular hatred of an oppressive monarchy, the
revolution rose on the backs of the masses of poor people in Paris who united under the banner
of ‗liberty, equality and brotherhood‘. Beginning as a rebellion against the abuses of the
monarchy, the revolution grew into a massive challenge to all forms of oppressive authority--
whether it was that of lords, priests or factory owners.
5.1. Commonalities of socialism

The common Beliefs of Socialists are
• Resources should be controlled by the public, NOT by private businesses and investors.
• Co-operation is favored over competition.
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• Socialists rejected the lack of equality and humanitarianism under classical liberalism.
• Unlike Utopians, many socialists wanted fundamental changes to society‘s structures
• Private ownership of the means of production permits (to allow) EXPLOITATION
• The state should direct the economy to achieve economic EQUALITY for all citizens
• Society should be CLASSLESS
5.2. The rise of socialist ideologies

Basically, the socialist movement is a reaction, opposition against capitalism. Capitalism has as
its essential characteristics private ownership of capita and land and the predominance of the
project motive as a guiding force.
The classical economist believed capitalism to be an ideal system because of two reasons:
i) It abolishes unnecessary government regulations and restrictions and restores
individual liberty.
ii) Individuals, guided by self-interests and acting under the competitive conditions, can
work most efficiently and produce maximum wealth. Enormous increase in wealth as
a result of industrial renovation confirmed this belief.
Q10: What were the lasting contributions of socialism?
5.3. Pre-Marxian Socialist Thinkers:

The socialist movement developed in two phases. In the early phase, the workers combined to
form a common front against the employer and demanded the abolition of various evils of
factory system (such as unemployment, long hours, unsanitary working conditions, etc). This
explains how the trade union movement began. In the later phase, the working-class movement
was impregnated with the broad socialist objective. Now, the socialists revolted against the
capitalist system (and the classical economics) as a whole along with its foundations of
competition and private property and demanded its replacement with a new and better social
order.
No one individual can be signed out as the founder or ‗father‘ of socialism. Socialism, according
to taste, begins with Plato, in virtue of his advocacy of communism; or with More‘s Utopia,
where the evils of private property are denounced and the doctrine of exploitation expounded.
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There are many types of socialism. But one thing is common with all the socialists and that is
they show dissatisfaction with the working of the capitalist system and aim at the transformation
of the social order. We can identify the following as the main types of socialism.
i) Utopian Socialism:
Utopian socialism dates back to the beginning of the 19th Century with Individuals such as
Robert Owen (1771-1858) in Great Britain, Charles Fourier (1772-1837) and Claude Saint-
Simon (1760-1825) in France, and Horace Greeley in the United States as key figures. They
developed their ideas at a time when the industrial workers were still weak and unorganized and
believed that education and improved working conditions could peacefully eradicate the worst
aspects of capitalism, and lead to an ideal socialist society where all could live happily.
The utopia socialist regarded the competitive capitalist market economy as unfair and partial.
They worked out concepts of perfect social arrangement and then appealed to the whole world to
adopt them. They preached universal brotherly love rather than class struggle and looked to the
capitalists to cooperative with and even finance their schemes.
A) Utopian Socialists: Henri Comte de Saint Simon
He developed his socialist ideas before the working-class movement took shape in France
and hence didn‘t appeal to the workers to rise against their employers and also made a
religion of work. He suggested an industrial parliament consisting of three chambers,
invention (composed of artistes and engineers), reviewing (composed of scientists), and
execution (composed of leaders of industry). This was one of the earliest proposals for
central planning.
B) Utopian Socialists: Charles Fourrier
In his book Fourier criticized the immorality of the business world, arguing that ‗truth
and commerce are as incompatible as Jesus and Satan.‘ In the book Fourier advocated a
new socialist system of cooperation. He suggested that ‗phalanxes‘ should be established.
These would be scientifically planned to offer a maximum of both cooperation and self-
fulfillment to their members.
C) Utopian Socialists: Robert Owen
He was essentially humanitarian who advocated an end to the appalling conditions of the
average worker in the industrial capitalist states of the time (idealist rather than
30
pragmatic). Utopian socialists wished to modify classical liberalism, not overturn the
systems that supported it.
Utopian Socialism started in the early 1800‘s and gained the name ‗Utopians‘ from the book
Utopia, written by the English statesman Saint Thomas Moore in 1516. The book spoke of an
ideal society where everyone possessed equality. Utopians desired a classless society where
everyone possessed the same amount of power under the government. They believed everyone
deserved a decent house to live in and food on the table. No one owned private property because
it all belonged to the public. While they wanted material equality for all men, the amount of
work required from each man differed. While some performed much manual labor, others
performed small tasks. Because Utopians required each man to give up his profits as public
property, they destroyed the work ethic. Man made no personal gain, so he felt no need to work.
This also stunted the invention of new items. It pulled man‘s desire to better himself to a halt
because, ideally, he received all he needed from the government. Utopians seemed to live in a
fantasy world with equality, rather than a realistic world where men desire individual power.
B) State Socialism
This involves government ownership and operation of all or specific sectors for purposes of
achieving overall social objectives rather than profit. For example, the former Soviet Union (all
of the major sectors) state owned and operated. But state socialism also can occur within a
capitalist framework. Examples within the United States are the federal Social Security system,
the Tennessee Valley Authority, and the postal service. Louis Blanc was the chief early
proponent of state socialism.
C) Christian Socialism
This version of socialism developed in England and Germany after 1848, with Charles Kingsley
being its leading advocate in England. It arose after the defeat of radical movements in both
countries. The workers were offered the solace of religion to assuage their pain and to provide
hope. The Bible was to form the manual of the government leader, the employer, and the worker;
God‘s order was mutual love and fellowship. Property owned by the rich was to be held in trust
for the benefit of everybody. This movement, repudiating violence and class struggle, advocated
sanitary reform, education, factory legislation, and cooperatives.
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D) Anarchism:
With Pierre-Joseph Proudhon (1809–1865) as one of its earliest proponents, anarchism held that
all forms of government are coercive and should be abolished. According to Proudhon:
Anarchists did not advocate that society have no order but rather that society‘s order arise out of
self-governing groups through voluntary or associate effort. Human nature, they contended, is
essentially good if not corrupted by the state and its institutions. Private property should be
replaced by collective ownership of capital by cooperating groups. Anarchists envisioned
communities engaging in production and carrying on trade with other communities, with
associations of producers controlling agricultural, industrial, and even intellectual and artistic
production. Associations of consumers were expected to coordinate housing, lighting, health,
food, and sanitation. Mutual understanding, cooperation, and complete liberty would characterize
anarchist society. Individual initiative would be encouraged, and every tendency to uniformity
and centralized authority would be effectively checked.
E) Communism
According to Marx, communism is the stage of society that eventually supersedes socialism.
Under socialism, the slogan is ―From each according to his ability, to each according to his
work.‖ Under communism the slogan becomes ―From each according to his ability, to each
according to his need.‖ This presupposes a superabundance of goods relative to wants the
elimination of money payments based on work performed, and a devotion to society as selfless
as a person‘s loyalty to his or her family.
F) Revisionism
In Germany, revisionism was advocated by Eduard Bernstein (1850–1932). In England, the
Fabian socialists led by Sidney and Beatrice Webb (1859–1947; 1858–1943) were revisionists,
but unlike the German left-wing movement they had never adhered to Marxism to any significant
degree. Revisionism abjured the class struggle; denied that the state is necessarily an instrument
of the wealthy class; and pinned its hopes on education, electioneering, and gaining control of
government through the ballot. The government was to regulate monopolies, control working
conditions in factories, take over some public utilities, and gradually extend its ownership of
capital. Because the revisionists, especially the Fabian branch, favored municipal ownership of
public utilities, revisionism has sometimes been called ―gas and water socialism.‖
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G) Syndicalism
Georges Sorel (1847–1922) promoted and popularized this form of socialism in labor circles in
the Latin countries of Europe. Syndicalists were anti parliamentarian and antimilitarist. They
believed that socialism deteriorates into bourgeois beliefs when it engages in political and
parliamentary activity. If represented in parliament, the movement will degenerate into
opportunism to gain political influence. What the workers require is one big union that will not
play the bourgeois game of seeking social reform and the amelioration of conditions.
Syndicalism differed from anarchism in that the former relied exclusively on revolutionary
unionism and the general strike for the overthrow of government.
H) Guild Socialism
G. D. H. Cole (1889–1959), a professor of economics at Oxford University, was the major
advocate of this type of socialism. It remained primarily a British movement, one of gradualism
and reform, and reached its zenith around the time of World War I. The guild socialists accepted
the state as a necessary institution for expression of the general interests of citizens as
consumers. The government was to develop overall economic policy for the whole community,
not merely for the workers.
I) Scientific Socialism (Marxian Socialism)

The socialist critics of classical economics preached dramatic reform; their objection to
capitalism and its alleged evils was moral. Karl Heinrich Marx (1818–1883), the leading
theoretician of ―scientific socialism,‖ dismissed that approach. He sought to show that capitalism
had internal contradictions that would ensure its eventual demise. Marx believed that social
revolution was inevitable within advanced capitalist countries, and he and his compatriot
Friedrich Engels (1820–1895) advocated that the workers of the world unite to hasten this event.
Karl Marx clearly interpreted the recent and current economic phenomena and foretold the
future. His appearance on the scene, therefore, marks a transition of socialism from 'utopian' to
'scientific.' The earlier socialists could not succeed in establishing what they wanted simply
because they appealed to sentiments to prove "the desirability of the aesthetic beauty of
socialism.'" They never endeavored "to prove, by economic reasoning, the inevitability of
socialism; to mingle together economic argument and an interpretation of history, and thereby to
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show that, things being as they are, their consequences will be what they will be; and that the
only outcome, ineluctable and inescapable, is the establishment of the socialist state."
Major tenets of the Marxian school

The central idea of Marxian thought can be described as a theory of value and of exploitation,
submerged into the study of the progress of history and the prophecy regarding the decay of the
capitalistic system. Following are the chief tenets of his thought:
1. The materialistic conception of history, i.e., history of the society is determined by the
economic factor.
2. History is simply a record of class struggle. One class comes into existence and the other is
extinguished. Materialistic conception of history and the class struggle are the two pillars on
which the entire Marxian sociological system rests. The theory of value, i.e., value of a
commodity is determined by the amount of labour invested in its production.
4. The concept of surplus value, i.e., the worker produces more than what he receives in the form
of wages. The difference between the two is the surplus value which "is appropriated by the
capitalist. This is the root cause of the conflict between the capitalists and the workers. The
labour theory of value and that of surplus value formed the pivot of the Marxian economic
system.
5. The thirst of the capitalist to increase the surplus value leads to the creation of Industrial
Reserve Army, unemployment and underemployment, thus increasing the miseries of the
working classes.
6. Under the capitalist system of production, a stage is reached when the capital is concentrated
in fewer hands, and a stage will come when the 'have-nots' will dominate the 'haves'.
Economic Ideas of Marx

For Karl Marx, the basic determining factor of human history is economics. According to him,
humans - even from their earliest beginnings - are not motivated by grand ideas but instead by
material concerns, like the need to eat and survive. This is the basic premise of a materialist view
of history. At the beginning, people worked together in unity and it wasn‘t so bad. But
eventually, humans developed agriculture and the concept of private property. These two facts
created a division of labor and a separation of classes based upon power and wealth. This, in
turn, created the social conflict which drives society. All of this is made worse by capitalism
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which only increases the disparity between the wealthy classes and the labor classes.
Confrontation between them is unavoidable because those classes are driven by historical forces
beyond anyone‘s control. Capitalism also creates one new misery: exploitation of surplus value.
For Marx, an ideal economic system would involve exchanges of equal value for equal value,
where value is determined simply by the amount of work put into whatever is being produced.
Capitalism interrupts this ideal by introducing a profit motive - a desire to produce an uneven
exchange of lesser value for greater value. Profit is ultimately derived from the surplus value
produced by workers in factories.
A laborer might produce enough value to feed his family in two hours of work, but he keeps at
the job for a full day - in Marx‘s time, that might be 12 or 14 hours. Those extra hours represent
the surplus value produced by the worker. The owner of the factory did nothing to earn this, but
exploits it nevertheless and keeps the difference as profit. In this context, Communism thus has
two goals:
1. It is supposed to explain these realities to people unaware of them;
2. It is supposed to call people in the labor classes to prepare for the confrontation and
revolution.
This emphasis on action rather than mere philosophical musings is a crucial point in Marx‘s
program. As he wrote in his famous Theses on Feuerbach: ‗the philosophers have only
interpreted the world, in various ways; the point, however, is to change it.‘
Basic characteristics of communism:
Marx believed that history could be explained through CLASS STRUGGLE. Marx was
convinced that history would pass through certain phases (i.e., Feudalism, Capitalism, Socialism)
until finally a COMMUNIST society would emerge.
• Collective ownership of land and the means of production.
• Classless society (Everyone is EQUAL (=)
• Everyone would work according to their abilities and…
• Everyone receives according to their needs.
Father of international socialism
Karl Marx (1818–1883) was the father of international socialism and he became international
accepted or considered as a father of Socialism. Rodberts and Lassalle have also been
considered by a few writers as the founders of scientific socialism, but Rodbertus was primarily
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a philosopher. He was an aristocrat and a conservative. He did not believe in class struggle or
revolution. Lassalle was essentially a propagandist and agitator. These people had not left much
impression on the minds of the masses. They just came and went away. "The indubitable fact is
that all subsequent socialism has been dominated by Marx; and that even when subsequent
schools have disowned him, they have owned their existence to a reaction from Marx."
Karl Marx's focus on detail study of economic problems, his passion, his generosity of ideas, his
strategies, his approaches and his all-rounded personality to reach the bottom of every matter, all
have made him an important figure in tile world of economic ideas. "To his powerful intellect,
the interest in tile problem as a problem was paramount in spite of himself; and however, much
he may have bent the import of his final results, while at work he was primarily concerned with
sharpening the tools of analysis, proffered by the science of his day, with straightening out of
logical difficulties, and with building on the foundation thus acquired, a theory that in nature and
intent was truly scientific whatever its shortcomings may have been." His socialism was; thus,
scientific socialism and he was considered as the father of the world socialist movement.
i. Marxian political economy: stages of development

According to Marx, human civilization has manifested itself in a series of organizational
structures, each determined by its primary mode of production, particularly the division of labor
that dominates in each stage.
– Primitive Communism--…………. No Classes
– Slavery------------------------………Slave Owner Vs. Slave
– Feudalism--------------------………Landowner Vs. Serfs
– Capitalism-------------………………Bourgeoisie Vs. Proletariat
– Socialism---------------……………. State Managers Vs. Workers
• Temporary Totalitarianism
– Communism-----------------………...No Classes
Karl Marx treated man as a social producer of means of his living. Social production necessarily
involves certain social relations which depend upon the degree of development of social
productive powers. The entire structure of political and legal institutions is based upon these
social relations. He, therefore, said that political economy was the study of the anatomy of
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society, i.e., of the social productive relationships which constitute the economic structure of
society. According to Marx, man enters into social relationship for the purpose of social
The Production function i.e. labor and capital relationship lead to the development of his
productive powers. This productive power brings him into clash with the social interest, and
which instead of leading to progress in the society and to the utilizations of his faculties and also
potentialities to produce all the means of his livelihood, starts hampering his progress.
Consequently, man must create this social relationship, and thereby political and legal
institutions, his thinking and modes of thought, so that his productive powers may find proper
scope to expand. This is what he calls social change. "This social change involves at some stage
a political revolution to complete the preceding evolution; the abolition of an existing political
structure and its replacement by one more appropriate to the new economic order."
The social interaction is essentially connected to the distribution of the ownership of material
means of production among the members of society. According to him, a society where there is
property is divided into two classes, haves and have-nots, in reference to the ownership of
means of production. The economic structure is, therefore, a particular social arrangement of
production by which all social and economic relations are determined. Social and economic
relations change according to the process of production. For Marx capitalism is the existence of
some contradictions in the economic system which leads to conflict, movement and change and it
is the task of political economy to discover these contradictions. In a capitalist system, the basic
contradiction is the division of labor which leads to the increasingly social and co-operative
nature of production, and to the individual ownership of the means of production. Hence, there
are two classes: capitalists and workers. The antagonism between these classes is essentially a
product of the antagonistic social productive arrangement.
Karl Marx‘s Critique on Political Economy has analyzed by departments into which the
economic activity has been classified by economists i.e. production, consumption, distribution,
and exchange. He has recognized that all these four departments are inter-connected. In his
analysis he has distinguished between the universal qualities of these categories and those which
are applicable to a particular stage of development. Marx, however, does not agree with these
relationships and regards it as superficial. He regards the universal connection between
production and consumption, as the most valid. Marx has divided consumption into productive
consumption, which is to use all the products for a new production, and consumptive production
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which is the reproduction of human life itself. And also, production supplies the material for
consumption leading to further production. Finally, consumption is the final act of production
and production itself is a part of consumption because it leads to the creation of wants. But he
says that we can identify production and consumption only if we ignore, the social relationship,
i.e., the distribution which mediates between the two. Distribution means, firstly, distribution of
means of production, and secondly, the distribution of the members of society among the
different branches of production. Production, therefore, must take into account this type of
distribution.
According to Karl Marx, human civilization has manifested itself in a series of organizational
structures (1) Tribal society has no social classes but is structured around kinship relations, with
hunting the province of men and domestic work the province of women. (2) Primitive
communism: ‗the ancient communal and State ownership which proceeds especially from the
union of several tribes into a city by agreement or by conquest‘. During this stage, the concept of
private property begins to develop. (3) Feudal or estate property: ‗Like tribal and communal
ownership, it is based again on a community; (4) Capitalism: because of the eventual growth of
commerce (and of human populations), feudal society began to accumulate capital, which, along
with the increased debt incurred by the aristocracy, eventually led to the English Revolution of
1640 and the French Revolution of 1789, both of which opened the way for the establishment of
a society structured around commodities and profit (i.e. capitalism).
ii. Dialectical materialism

According to Karl Marx and Frederick Engels, Dialectical materialism is the most popular
metaphysical doctrine of our age. It is today the official philosophy of the Soviet empire and of
all the schools of Marxism outside of this empire. It dominates the ideas of many people who do
not consider themselves Marxian‘s and even of many authors and parties who believe they are
anti-Marxian‘s and anti-communists. It is this doctrine which most of our contemporaries have in
mind when they refer to materialism and determinism.
Marx‘s theory of social development is also known as ‗dialectical materialism.‘ Marxian
‗materialism implies that ideas, institutions, philosophies, religions, etc., all are determined by
real material condition of life. This materialism is also at the root of Marxian concept of social
classes. Marxian materialism simply means that men's economic activities are fundamental and
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they determine the general way the character of everything else they do. Marx got the idea of
‗dialectics‘ from the German philosopher Hegel. According to the dialectical principle
everything includes it‘s opposite or negative. A thesis has an antithesis. The conflict of these
opposites leads to the transformation of this thesis into a synthesis. In other words, the basic
cause of change in all things in their self-movement lies in the struggle of opposites or in their
internal contradiction. The contradiction gives rise to a synthesis between the thesis and
antithesis. Human societies proceed from stage to stage of their development so that within each
stage fundamental contradictions arise. When these contradictions are resolved, the society
passes from one stage to another.
According to this method, change occurs in the society because of the conflict of antagonistic
elements which are ultimately synthesized. Owing to their fusion, the opposite elements are
transformed into a new and better concept. According to Hegel, thing against which the
antagonism prevails is the 'positive' while the antagonistic element is the 'negative'. He regards
this antagonism or negation as the "source of all movement and life; only in so far as it contains a
contradiction can anything has movement, power and effect." Hegel, however never
demonstrated the practical application of this method. It was Marx who applied it to sociology
and economics, and that is why, his method is known as materialistic interpretation of history or
dialectical materialism.
Theories of Karl Marx
a) The Marxist theory on the origin of state
Marxism believed that in per-class society people were living communally. There was no private
property, no market and no institutions. According to the Marxist theory historically, the state
was originated from the split of society in to social classes with sharp and polarized economic
interests. The formation of social classes is associated with the emergence of private property.
The rise of the state with its agent-the government- established to make laws, is, therefore,
directly related with the emergence of private property and the need to safeguard it
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b) Marxian population theory

In his theory, Marx stated that there could be no population problem under a socialist mode of
production and of ownership of resources. He believed that population becomes a problem of
surplus people only under capitalist modes of production. His view was that the capitalist system
not only views some of the population as surplus in an economic sense, but also causes this
phenomenon: When existing food supplies are inadequate to support some of the population,
capitalism calls the unsupported people surplus population. However, Marx stated, such food
scarcities are purely the result of unequal distribution of resources by capitalism.
Marx believed that the capitalist system can produce food and other necessities for an
indefinitely expanding population, and that it is only capitalism‘s unequal distribution of social
wealth that makes it seem as though these resources were limited and, therefore, that population
growth must have a natural limit.
Moreover, in Marx‘s view, the system of capitalist production is not targeted to meet the needs
of poor people. Instead, its aim is to increase the accumulation of capital for the wealthy. Along
the same lines, Marx stated that capitalism benefits from the conditions that produce a so-called
surplus population. Those conditions create competition for jobs, thus driving down wages and
therefore maximizing profits for the wealthy. Marx‘s solution to the problem of overpopulation
was socialism with a new economic structure of society within a new social order.
c) The labor theory of value

Marx‘s starting point was the analysis of ―commodities‖ in capitalist society. A commodity, said
Marx, is something produced for profit and capable of satisfying human wants, whether the
wants ―spring from the stomach or from fancy.‖ This commodity may satisfy these wants
directly, as means of subsistence, or indirectly, as means of production. Use values constitute the
substance of all wealth. Marx did not try to measure use values quantitatively, nor did he
consider diminishing utility
With increasing quantities of a commodity, He would therefore have said that a large wheat crop
represents greater utility, and therefore greater wealth, than a small wheat crop. This would be
true even though, if demand is inelastic, the more abundant crop might have lesser value in
exchange. In addition to use value, or utility, a commodity has exchange value, commonly
abbreviated simply as ―value.‖ What determines the value of a commodity? Marx‘s important
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answer: the socially necessary labor time embodied in the commodity, considering normal
conditions of production and the average skill and intensity of labor at the time. The socially
necessary labor time includes the direct labor in producing the commodity, the labor embodied in
the machinery and raw materials that are used up during the process of production, and the value
transferred to the commodity during this process. Suppose the average labor time contained in a
pair of shoes is 10 hours. This average socially necessary labor determines the value of the shoes.
If a worker is incompetent or lazy and takes 20 hours to produce a pair of shoes, its value is still
only 10 hours. Suppose a worker or an employer leads the field in technology and efficiency, and
a pair of shoes is produced with 5 hours of labor; its value is nevertheless 10 hours, the average
labor cost for society as a whole—that is, the socially necessary labor time. A product‘s value is
measured in units of simple average labor. Skilled work counts as multiple units of unskilled
labor. Thus, 1 hour of an engineer‘s productive effort might contribute as much value to a
commodity as 5 hours of simple labor. The marketplace equalizes the labor time of different
skills to one common denominator of unskilled labor. The market also determines the prices that
are based on the underlying labor cost. One commodity, such as gold, becomes the universal
equivalent that reflects all values. One coat will exchange for 2 ounces of gold because both
require the same amount of socially necessary labor time in their production. If 2 ounces of gold
are coined into 2 monetary pounds, then one coat will sell for 2 pounds. Temporary fluctuations
of supply and demand will cause prices to deviate from true values, sometimes rising above
value and sometimes falling below. The continual oscillation of prices allows them to
compensate each other and reduce themselves to average prices that reflect the values of
commodities.
d) Theory of surplus value

Marx himself considered his theory of surplus-value his most important contribution to the
progress of economic analysis. It is through the theory that the wide scope of his sociological and
historical thought enables him simultaneously to place the capitalist mode of production in his
historical context, and to find the root of its inner economic contradictions and its laws of motion
in the specific relations of production on which it is based.
The price of commodity produced is determined by the labour involved in that commodity. In the
complex capitalist environment labourer provides his services to his boss in order to produce a
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commodity but in response to it he just gets a small chunk of the profit. The remaining profit
goes to the boss or who is responsible to conducting that business. The theory of surplus value
says that this labourer, his efforts are helpful, meaningful to the owner of that business as the
surplus amount goes to the boss instead of that labourer who is actually responsible for carrying
out the whole business. Thus, Karl Marx is of the view that a labourer and the person who is
carrying out the business be treated on the equal grounds but the capitalist economy does not
take care of this fact.
According to Marx, exploitation of labor arises only when workers can produce more in a day
than they must consume in order to maintain themselves and their families. Then employers pay
the workers the full market value of their labor power, but the daily pay equals only part of the
value the laborers create. Through their ownership of capital, employers possess that which
worker need to gain subsistence: jobs that pay wages. Hence, capitalists are in a position to set
the length of the workday and in a sense say to workers, ―Work the number of hours that we set
or choose not to work for us at all.‖ Necessity forces the workers to opt to work. But the labor
time they spend during the workday creates a larger sum of values than the value of their own
labor power, the costs of subsistence. The owners of the means of production garner a surplus
value.
Marx argued that the value of labour like any other commodity is determined by the number of
hours of labour required for its production. By this, he meant that the quantity of necessaries
required to keep the worker in full productive efficiency during a particular period represented
the quantity of labour required to produce the labour force. This can be symbolically explained
as follows:
VL (Value of Labour)=CL (Cost of Labour)
CL=QS (Quantity of goods required for subsistence)
VL=QS (The quantity of labour required for producing the quantity of goods required for his
subsistence)
But the labour whose exchange value is measured by the amount of labour necessary to produce
QS always produces more than the QS. This excess is called by Marx as surplus value, with goes
into the pockets of the capitalists. Under the capitalistic system, the capitalist only pays to the
labourer that much which is necessary for his subsistence during the time he spent in producing
the commodity, while the labourer has actually produced much more than this. This can be
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illustrated with the help of an example. Suppose, a labourer works for ten hours in a day the
produce of his labour will be equal to the value often hours' labour. It is not of much importance
to find out the commodities produced by him since the capitalist takes all the commodities
produced by him under his possession and sells them for its full value which is 10 hours' labour
(since labour is the sole source of value). Suppose the value of the commodities required by the
labourer for his subsistence can be produced in 5 hours' labour. The capitalist, therefore, pays to
the labourer only the value of 5 hours' labour and keeps the rest with him. In this example,
during the first five hours the workman thus produces commodities whose value is equal to his
wages, but after this he produces, is expropriated by the capitalist This merely means an extra
strain on his energies which are wasted on increasing the wealth of the capitalist.
Note: The number of hours during which the 'workman produces the surplus value, is called by
Marx as 'surplus labour'.
According to Marx, the rate of surplus value is the proportion of the surplus value to the variable
capital. It may be mentioned here that Marx has divided capital into constant and variable. By
constant capital he means raw materials and machinery and by variable capital, that amount
which it spent on purchasing the labour power. The capital which does not alter the value of the
commodity in the process of production is constant while that which alters its value is variable.
So, coming back to our point, the ratio of the surplus value and variable capital is the rate of
surplus value. If C stands for total, C and v are its two component parts, and s is the surplus
value, then, the total value will be =c+ v+ s. In other words, s+ v, originally employed will at the
end be transformed into c+v+s. The rate of surplus value will be s/v. The rate of surplus value
expresses the degree of exploitation of labour by capital. Marx has also distinguished between
simple rate of surplus value, i.e., s/v and the annual rate of surplus value, sn/v (n represents the
number of turnovers of the variable capital in particular year).
The capitalists compete for achieving higher and higher profits and in their effort, they employ
both constant and variable capital, which are absolutely essential for the creation of surplus
value. According to Marx, competition is of two kinds-one within a particular branch of
production and the other between all branches of production. In the former type of competition,
the market price tends to equal the cost of production while in the latter, the cost of production is
deduced by averaging the rate of profit.
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The rate of profit is equal to the ratio of the surplus value to the total capital, i.e., s/c+v
The ratio of constant capital to total capital c/c+ v is known as the organic composition of capital
v being the variable capital. The higher the organic composition, the lower the rate of profit will
be. If P represents the rate of profit, s the rate of surplus value and c the constant capital, then the
relation between the rate of profit and the rate of surplus value will be:
P=Sv/c+v
According to Marx, it would be beneficial for the entrepreneur to reduce constant capital and to
increase the quantity of variable capital.
e) The law of concentration of capital

The Marx's theory of ―the law of concentration speaks of the tendency of the capitalist process
‗to increase the size both of industrial plants and of units of control.‘ The concentration of capital
implies the tendency for capital as a whole to accumulate. The capitalist has an endless passion
for accumulation. The capitalists converted a large part of their surplus value into capital; In turn
more capital meant the ability to enjoy more workers, more exploitation, more surplus value, and
more capital. According to Marx, under capitalism this process of capital accumulation would
continue far into the future.
During the business cycles there is overproduction and huge stocks of goods remain unsold.
With the increasing use of machinery and increase in labor productivity, goods become cheaper
and cheaper. All these factors give rise to a severe competitive struggle among the producers.
Competitive struggle serves as an agent of centralization. It always ends in the ruin of many
small capitalists, whose capitals pass into the hands of their conquerors, partly vanish. The strong
either crushes or absorbs the weak one. One capitalist kills many. The expropriators are
expropriated. The small capitalists who lose in the battle of competition, drop out of the race and
join the ranks of the proletariat, with the elimination of the smaller enterprises, competition
disappears. The economic scene comes to be dominated either by a single capitalist or a single
giant corporation. The credit system further aggravates the process as finally it transforms itself
into an immense social mechanism for the centralization of capitals. In the development of
capitalist production, concentration and centralization become self-perpetuating.
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Marx‘s concept of capital leads to his theory of the concentration of capital. While tracing the
history of capitalism, Marx says that, prior to the sixteenth century, capital was a mere harmless
factor of production and not 'engine of exploitation' as it is to-day. In the old guild system,
majority of the workers were the owners of the means of production themselves· the propertied
class has created conditions in which this new kind of property has increased day by day.
(1) Large-scale Production: Large-scale production has resulted in the employment of
machinery, and in the development of new forms of organization, such as, cartels and trusts. The
establishment of such organizations has not only swallowed the small independent producers but
also the medium sized industrialists. (2) Over-production: Over-production of commodities leads
to a stage when the production can be stopped for some time, thereby throwing workmen out of
job. (3) The Concentration of Rural Population in Towns: In the course of the last one century,
there has been a growing tendency among rural people to move to towns and work as wage-
earners, consequent upon the disappearance of the small land-holders. This has resulted in
increasing the number of the unemployed laborer.
From this theory of concentration of capital, he drives the following three important concepts.
1. Industrial Crises: The growing contradiction or incompatibility gives rise to a class
struggle, which ensues between the rising class associated with the new means of production
and the old ruling class whose influence is declining. Gradually the contradiction intensifies
until as a result of a social revolution new relations of production compatible with the
superior productive forces are established. In the Middle Ages, the merchants and craftsmen
challenged the feudal lord and wrested the economic power from him. Under capitalism the
wage earners will challenges the capitalist and do the same. ‗The history of all hitherto
existing societies is the history of class struggle.‘
2. Growth of Pauperism: The severity of poverty is another factor which goes to prove that the
capitalist system has outlived its importance. According to the Manifesto, "the bourgeoisie is
unfit to rule because it is incompetent to assure an existence to its slave.
3. The Growth of Companies: Marx application of the joint stock principle and the rate at
which the stock companies are growing, clearly try to prove the fact that the profit is being
earned by people without putting in any labor.
All, those concepts are drive from the theory of law of concentration of capital
Characteristics of Marxism
45
We are now in a position to enumerate the characteristic· features of the Marxian system.
(1) Marxian socialism is socialism proper: This feature is easily distinguishable from other
types of socialism. As said by Marx himself, socialism was 'scientific' and hence quite different
from the nineteenth century utopian socialism. Marxism is a working-class gospel. Marxists
believe in organizing the working classes and in intensifying the class struggle to the extent of
doing away with the capitalist setup. They hold that the future social order will itself be set right
by the working classes when they come in power.
(2) Marxism is purely revolutionary in character: For Marx himself said, "Force is the birth-
pangs of society," and hence some sort of struggle and violent effort are inevitable before the old
social set-up is replaced by the new.
(3) Marxian socialism is scientific: Marxists believe in "a thoroughly scientific demonstration
of the line of progress which has actually been followed by civilized societies.
(4) Marxism is purely materialistic: Marx‘s future-oriented perspective has its basis in his
materialist conception of history. He suggests that the ways societies provide for their material
well-being affects the type of relations that people will have with one another, their social
institutions, and the prevailing ideas of the day.
Q11: What are the shortcomings in Marx‘s theory
Comparison of Idea of Marx with other Contributors
i. Marxism and classicism
According to Marx, the process of economic activity i.e., production under capitalism inevitably
leads to certain contradictions. For Marx, crises under capitalism occur from disproportionality.
This disproportionality takes place due to two basic characteristics of the capitalist system. First,
there is ‗anarchy of production‘. It means that capitalistic economy productive decisions are
made by a large number of independent producers each producer has to anticipate the market
demand for him. He has no knowledge about the moves of his rivals. The only factor to guide
him is the profit motive.
Secondly, there is no systematic plan or orderliness in capitalist production. There is absolutely

no understanding or coordination among the various producers.
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In the Critique of Political Economy, Marx has clearly mentioned that he studied the classical
economics at the time when he was collecting material for his Das Kapital from the British
Museum Library. No better proof can be provided in support of this view than the statement of
Marx himself. His theory of value, his analysis of conflict between profits and wages and his
theory of rent, all obviously are derived from the classical doctrines, and directly from those of
Ricardo. Similarly, we find that he has shown great affection for political economy, although he
has hurled attacks against individual economists. Under capitalism, the relationship between
labor and human expression changes: rather than laboring to fulfill their needs or express ideas,
workers do so at the demands of capitalists. Workers are alienated from their labor because it no
longer belongs to the worker, but rather to the capitalist.
ii. Marx and modern economists

To Marx, economics are what constitute the base of all of human life and history - generating
division of labor, class struggle, and all the social institutions which are supposed to maintain the
status quo. Those social institutions are a superstructure built upon the base of economics, totally
dependent upon material and economic realities but nothing else. All of the institutions which are
prominent in our daily lives - marriage, church, government, arts, etc. - can only be truly
understood when examined in relation to economic forces. Marx had a special word for all of
the work that goes into developing those institutions: ideology. The people working in those
systems - developing art, theology, philosophy, etc. imagine that their ideas come from a desire
to achieve truth or beauty, but that is not ultimately true. In reality, they are expressions of class
interest and class conflict. They are reflections of an underlying need to maintain the status quo
and preserve current economic realities. This isn‘t surprising -those in power have always wished
to justify and maintain that power. To some historians, Marx's thinking is akin to that of modern
economists. Marx anticipated the theory of imperfect competition, while formulating his theory
of concentration of capital and that of exploitation. Although, he never stated in clear terms the
theory of trade cycle, he was one of the first few who discussed the subject of business
fluctuations under the capitalistic system. Economists of such diverse views as Keynes,
Schumpeter, Sombart, Veblen and Mitchell, owed more to Marx than to their other predecessors.
Marx appears to be one of those first few writers who maintained that the periodic recurrence of
industrial crises, depression, and revival of business and employment were related to
47
technological progress. He has expressed this relationship in the words: "organic structure" of
capital. During the course of his analysis, he also mentioned that a period of the cycle depends
on the life and rate of machinery. How much his ideas are in close resemblance with the present-
day theory, more especially in the domain of business cycles, is very well clear. His analysis of
the process of concentration of capital is also very important.
CHAPTER-SIX
THE MARGINALIST REVOLUTION
7.1 Introduction
The beginning of the marginalist school is dated at 1871, the year Jevons and Menger published
their influential books on marginal utility theory. Several forerunners predated Jevons and
Menger in the use of marginal analysis in economics. English economist David Ricardo
employed the marginal approach in his theory of rent Subsequent contributions that fit within
this analysis developed in several countries and through the efforts of numerous individuals
largely working independently of each other. Among these forerunners were Antoine Cournot
and Jules Dupuit in France and Johann von Thünen in Germany. This school eventually became
part of neoclassical economics, or contemporary microeconomics.
The historical background of the Marginalist
Serious economic and social problems remained unsolved even a hundred years after the
beginning of the industrial revolution. Poverty was widespread, although productivity was
increasing dramatically. The extremely uneven distribution of wealth and income created much
dissatisfaction even though the general standard of living was rising. Business fluctuations
affected many people adversely; individuals could no longer depend exclusively on their own
initiative and ability to overcome conditions that were thrust upon them. Farmers and farm
laborers had their difficulties; many drifted into cities, lured by the carrot of better opportunities
and driven by the club of rural poverty. Industrial accidents often brought serious hardships to
workers and their families before adequate workers‘ compensation laws were enacted. Long
hours of labor, dangerous and unhealthy working conditions, the preponderant economic power
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of employers in bargaining with workers, the rise of monopolistic enterprises, and insecurity in
old age were among the many problems that caused people to seek solutions beyond the narrow
confines of classical economic thinking.
The trend of the 19th century in Europe was to develop three approaches of attack on pressing
social problems, and all three flouted classical economic precepts. These approaches were to
promote socialism; to bolster trade unionism; or to demand government action to ameliorate
conditions by regulating the economy, eliminating abuses, and redistributing income. The
marginalists opposed all three ―solutions.‖ They theorized with seemingly Olympian impartiality
and concluded that, although the value and distribution theories of the classical economists were
inaccurate, their policy views were correct. The marginalists defended market allocation and
distribution, deplored government intervention, denounced socialism, and sought to discourage
labor unionism as either ineffective or pernicious. To the leading early marginalists, classical
value and distribution theories erred in seemingly concluding that land rent is an unearned
income and that exchange value is based on the labor time involved in the production process.
The first idea was seized and expanded by the American economist Henry George, the second by
Karl Marx. If classical economics could be made to say what its creators never intended—
namely, that rent is immoral and labor creates all value—then the science of economics was
overdue for a thorough revision.
Major tenets of the Marginalist school

A. Focus on the margin. This school focused its attention on the point of change where
decisions are made; in other words, on the margin. The marginalists extended to all
economic theory the marginal principle that Ricardo developed in his theory of rent.
B. Rational economic behavior. The marginalists assumed that people act rationally in
balancing pleasures and pains, in measuring marginal utilities of different goods, and in
balancing present against future needs. They also assumed that purposeful behavior is
normal and typical and that random abnormalities will cancel each other out. The
approach employed by the marginalists had its roots in the works of Jeremy Bentham, in
that they assumed the dominant drive of human action is to seek utility and avoid
disutility (negative utility).
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C. Microeconomic emphasis. The individual person and firm take center stage in the
marginalist drama. Instead of considering the aggregate economy, or macroeconomics,
the marginalists considered individual decision making, market conditions for a single
type of good, the output of specific firms, and so forth.
D. The use of the abstract, deductive method. The marginalists rejected the historical
method in favor of the analytical, abstract approach pioneered by Ricardo and other
classicists.
E. The pure competition emphasis. The marginalists normally based their analysis on the
assumption of pure competition. This is the world of small, individualistic, independent
entrepreneurs; numerous buyers; many sellers; homogeneous products; uniform prices;
and no advertising. No one person or firm has enough economic power to influence
market prices perceptibly. Individuals can adapt their own actions to demand, supply, and
price as worked out in the market through the interactions of thousands of people. Each
person is such a tiny operator relative to the size of the market that no one notices his or
her presence or absence.
F. Demand-oriented price theory. For the early marginalists, demand became the primary
force in price determination. The classical economist emphasized cost of production
(supply) as the significant determinant of exchange value. The earliest marginalists
swung to the opposite extreme and emphasized demand to the virtual exclusion of supply.
G. Emphasis on subjective utility. According to marginalists, demand depends on marginal
utility, which is a subjective, psychological phenomenon. Costs of production include the
sacrifices and irksomeness of working, managing a business, and saving money to form a
capital fund.
H. Equilibrium approach. The marginalists believed that economic forces generally tend
toward equilibrium—a balancing of opposing forces. Whenever disturbances cause
dislocations, new movements toward equilibrium occur.
I. Merger of land with capital goods. The marginalists lumped land and capital resources
together in their analysis and spoke of interest, rent, and profits as being the return to
property resources. This had its advantages analytically and also combated the conclusion
drawn by some that land rent is unearned income and an unnecessary payment in order to
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ensure the use of land. Marginalists generally coupled the reward to the landowner with
interest theory.
J. Minimal government involvement. The marginalists continued the classical school‘s
defense of minimal government involvement in the economy as the most desirable
policy. In most cases, no interference with natural economic laws was in order if
maximum social benefits were to be realized.
The marginalists sought to advance the interest of all of humankind through promoting a better
understanding of how a market system efficiently allocates resources and promotes economic
liberty.
The validity and usefulness of the school
 The Marginalist school made economics more exact social science
 Placed demand in its rightful position as determinant of price
 The partial equilibrium approach enabled disentangling complex phenomenon
 The microeconomic approach complements the macro-approach
The Lasting Contributions of the Marginalist School

Several tenets of the marginalist school were subsequently challenged, and some were rejected.
Keynes pointed to the alleged fallacy of composition associated with marginalist and
neoclassical employment theory. If one firm were to cut wages, it could expand its market by
selling more goods at lower prices. The decline in purchasing power among its own employees
would not affect it, because they would normally buy only a negligible portion of its output.
However, if all employers were to cut wages, they might find their markets shrinking rather than
expanding. Also, critics argued that the assumption of pure competition was a reasonable
abstraction looking backward from the 1870s, but it was too restrictive to be useful as
competition declined after the 1870s. Today, pure competition can be found in only a few sectors
of the economy. Institutional economists contended that historical and institutional factors
dominated rational individual calculations in determining such things as length of the workday,
consumer behavior, wage rates, and the like. The marginalist‘s view that the best government is
the one that interferes the least became outdated as new events transpired and new economic
theories developed. The analysis of these thinkers originally was static, timeless, and
unsubstantiated with empirical evidence. There were few attempts at inductive verification of
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theories; in fact, hypotheses often were framed in ways that precluded testing. Business cycles
were generally ignored in the firm conviction that supply creates its own demand and therefore
that full employment is the rule. The school failed to explain economic growth, and its theory
proved to be inadequate for slowly developing countries. But despite these and other criticisms,
many of the marginalist theories remained relatively unscathed, as attested to by the fact that
they can be found in contemporary textbooks on principles of economics and microeconomics.
The school eventually was absorbed by the broader neoclassical school, which, together with
variations of Keynesian macroeconomics, dominates economic analysis in Western counties and
shares the international field with socialism. We will discover in the following discussion, and in
the two chapters that follow, that these economists and their forerunners developed such lasting
contributions as mathematical economics, the basic monopoly model, a theory of duopoly, the
theory of diminishing marginal utility, the theory of rational consumer choice, the law of
demand, the law of diminishing marginal returns as it applies to manufacturing enterprises, the
concept of returns to scale, work-leisure choice analysis, the marginal productivity theory of
factor returns, and so forth. In the past two decades, this ―choice-theoretic‖ approach introduced
by the marginalists has experienced resurgence within economics.
Forerunners of the Marginalist School
a) Antoine Augustin Cournot

Antoine Augustin Cournot (1801–1877) was a French mathematician who published treatises on
mathematics, philosophy, and economics. He was the first economist to apply mathematics to
economic analysis, but his pioneering work
Cournot is considered to be a forerunner to the marginalist school because much of his analysis
focused on the rates of change of total cost and revenue functions. Such rates of change—the
mathematical derivatives—translate to what economists now refer to as marginal cost and
marginal revenue. Unlike the present tendency to begin the analysis of market structures with
pure competition and then introduce market imperfections, Cournot began his analysis with pure
monopoly and then analyzed market circumstances wherein competitors existed. Of his several
contributions to economic analysis, two in particular merit elaboration: his theory of pure
monopoly and his theory of duopoly.
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Cournot’s Theory of Monopoly: Cournot is credited with being the first economist to derive the
now-familiar proposition that a firm can maximize its profits by setting a price at which marginal
revenue equals marginal cost.
Cournot extended his theory to circumstances in which marginal costs are positive. The
monopolist facing positive costs, he said, will also maximize profits—total revenue minus total
cost—at that level of output where MR = MC. This rule also applies in situations where
numerous competitors exist.
Cournot’s theory of duopoly: A market, in which two firms compete, was the first formal
attempt by an economist to analyze the conduct and performance of sellers in an oligopolistic
market structure.
ii) Jules Dupuit

Engineer Arséne-Jules-Emile Dupuit (1804–1866) is a second important French forerunner to
marginalism. Dupuit was born in Fossano, Piedmont, Italy, which in 1804 was a part of the
French empire. He returned to Paris with his parents in 1814, and attended school at Versailles,
Louis-le-Grand, and Saint Louis. Dupuit then earned a degree in engineering from the
prestigious École des Pontset Chaussées. His studies and designs of roadways, water navigation,
and municipal water systems won him wide acclaim within the engineering profession. In 1843,
he was awarded the prestigious French Legion of Honor for his work. In 1850, Dupuit became
the chief engineer in Paris, and in 1855, he ascended to the position of inspector-general of the
French Corps of Civil Engineers. While making his mark in engineering, Dupuit developed an
ardent side interest in theoretical and applied economics. Between 1844 and 1853, he published
significant journal articles concerning diminishing marginal utility, consumer surplus, and price
discrimination. Central to each of these concepts was decision making at the ―margin.‖ Although
Cournot also used this approach, there is no indication that Dupuit and Cournot were familiar
with each other‘s work.
Marginal Utility and Demand Dupuit: stated that the value placed on a good (the water from the
municipal water system) varies from individual to individual. Moreover, the amount of
satisfaction or utility that an individual gets from a specific unit of water depends on how that
particular unit is used. A person first uses water for highly valued uses, then, as the stock of
water grows, for less valuable uses. Water used for drinking gives way to water used for
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gardening. In turn, water used for gardening gives way to water used for washing, and so on,
culminating in its use for decorative purposes, such as water fountains. We know that the ideas
of subjective marginal utility and diminishing marginal utility were not new; recall that Bentham
had discussed them sixty years earlier. But Dupuit surpassed Bentham by directly linking
diminishing marginal utility to individual and market ―curves of consumption.‖ He observed that
as the price of a good falls, people buy more of it to satisfy less pressing, lower marginal utility
wants.
Consumer Surplus: Dupuit‘s curve of consumption led him to an important observation later
stressed by Alfred Marshall. On a per unit basis, the difference between each unit‘s marginal
utility and its price is utility relative or surplus utility. The sum of all such differences between
marginal utility and price is total consumers‘ surplus.
Monopoly Price Discrimination: Many of the roads, bridges, and water systems that Dupuit
engineered were government monopolies. Dupuit thus wondered what price, if any, the
government should charge for these monopolized goods or services. If the goal was to maximize
total utility, he said, and then the price should be zero. under any point on the marginal utility
curve is the total utility associated with that output. Total utility obviously is greatest at a zero
price
Price discrimination can occur only where it is possible to segregate buyers into identifiable
groups and where resale of the product by customers is impossible or prohibitively expensive. It
converts consumer surplus to higher revenues and, in the case of for-profit firms, higher profits.
But, as indicated by Dupuit, price discrimination can also increase total output and enhance total
utility. It is widely practiced by government enterprises and public utilities, precisely the forms
of monopolies Dupuit had in mind.
iii) Johann Heinrich Von Thünen

Johann Heinrich von Thünen (1783–1850), a third forerunner of marginalism, was born in
Oldenburg, Germany. He studied briefly at the University of Göttingen and then purchased an
estate in Mecklenburg. There he farmed and wrote his chief work, The Isolated State. In Volume
1 of this work, published in 1826, he developed a theory that considered the location of various
forms of agricultural production in relation to the market in which the produce is sold. In this
respect, he is the founder of location theory and agricultural economics. In Volume 2 of The
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Isolated State, published in 1850, he expanded his analysis and, in the process, established a
crude marginal productivity theory of wages and capital.
Von Thünen’s Location Theory
In developing his location theory, von Thünen first made several assumptions: Imagine a very
large town, at the center of a fertile plain which is crossed by no navigable river or canal.
Throughout the plain the soil is capable of cultivation and of the same fertility. Far from the
town, the plain turns into an uncultivated wilderness which cuts off all communications between
the State and the outside world. There are no other towns on the plain. The central town must
therefore supply the rural areas with all manufactured products, and in return it will obtain all its
provisions from the surrounding countryside.
The mines that provide the State with salt and metals are near the central town which, as it is the
only one, we shall in future call simply ―the Town.‖ Johann von Thünen then addressed his
central question: The problem we want to solve is this: What pattern of cultivation will take
shape in these conditions?,and how will the farming system of the different districts be affected
by their distance from the Town? We assume throughout that farming is conducted absolutely
rationally. It is on the whole obvious that near the Town will be grown those products which are
heavy or bulky in relation to their value and hence so expensive to transport that the remoter
districts are unable to supply them. Here too we shall find the highly perishable products, which
must be used very quickly. With increasing distance from the Town, the land will progressively
be given up to products cheap to transport in relation to value. For this reason alone, fairly
differentiated concentric rings or belts will form around the Town, each with its own particular
staple product. From ring to ring the staple product, and with it the entire farming system, will
change; and in the various rings we shall find completely different farming systems.
Johann von Thünen on Marginal Productivity
Johann von Thünen‘s careful thinking about the location of various types of agriculture led him
to develop a marginal productivity theory of employment. He based this on the principle that
added units of labor lead to successively smaller increases in total agricultural product. Recall
that Ricardo also had used this same notion—the law of diminishing marginal returns—in his
analysis of rent. Johann von Thünen further expanded the applicability of this law. He stated that,
given this principle, the farmer must take care not to hire labor beyond that point at which the
cost of the last addition of labor is matched by the value of the added agricultural yield. In
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contemporary terms, von Thünen was suggesting that the employer should add units of labor
until the marginal revenue product of labor— the extra revenue accruing from the greater yield—
equals the wage expense of hiring the worker. Furthermore, von Thünen understood that it is the
marginal product of the last worker employed that establishes the ―natural wage‖ received by all
workers. This is sophisticated economic reasoning that foreshadowed the later contributions of
John Bates Clark and Alfred Marshall. We will await a discussion of these economists to
examine this theory in depth.
iv) Herman HeindrichGossen

 Got posthumous appreciation on his theory of utility
 He stated two laws
 The first law: The law of diminishing returns, explain how voluntary exchange produces
mutual gains in utility
 The second law: the rational person should allocate his/her money income so that the last
unit of money spent on each product bought yields the same amount of extra utility. The
marginal utility per unit of money spent on a product is marginal utility divided by the
product‘s price. MUx/Px = MUy/PyThis relates to the balancing of marginal utilities
through rational consumption spending to secure maximum satisfaction
A) The First Generation Marginalists

Although Cournot, Dupuit, von Thünen, and Gossen provided path-breaking marginal analyses,
marginalism as a more clearly defined school of economic thought originated with W. Stanley
Jevons in England, Carl Menger in Austria, and Léon Walras at Lausanne, Switzerland. This is
another interesting case of new ideas arising almost simultaneously in different places and from
different people but stemming from a common dissatisfaction with old theories. Here, we will
examine the contributions of Jevons, Menger, and two Austrians who followed in Menger‘s
footsteps. In short, the three marginalist thinkers arrived at same marginalist approaches and
theories independently at about the time: W.S. Javons from England, Carl Menger from Austria
and Leon Walras from France
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i. William Stanley Jevons

William Stanley Jevons (1835–1882) was born in Liverpool, England. He spent five years in
Australia as an assayer at the mint, where he earned enough to return to England to continue his
studies. He was disappointed and bitter when he failed to win a prize in political economy at
University College, London, and attributed this failure to the prejudice of his professors against
the new ideas he was developing. Jevons published several books on logic and became professor
of logic, political economy, and philosophy, first in Manchester and later at University College,
London. He invented a logic machine, exhibited before the Royal Society in 1870, that could
yield a conclusion mechanically from any given set of premises. Jevons was also famous as a
historian of science, and he made outstanding contributions to the development of index
numbers. Jevons was extremely introverted and did not have great influence on his immediate
peers or students. At the age of forty-seven he drowned while swimming.
Jevons on Value Theory
To explain Jevons’s value theory, we must therefore begin with his theory of the law of
diminishing marginal utility. Then our attention will turn to his related notions of rational
consumer behavior, individual and market exchange, and the optimal amount of work.
Theory of diminishing marginal utility: Jevons‘s theory of diminishing marginal utility is
similar to the earlier ideas of Gossen and Dupuit. Jevons said that utility cannot be measured
directly, at least with the tools at hand. This subjective pleasure or satisfaction can be estimated
only by observing human behavior and noting human preferences. He also rejected any attempt
to compare the intensity of pleasures and pains among different people. But a single individual
can compare utilities of successive units of a single good, said Jevons, and can compare the
marginal utilities of several goods. With respect to the former, Jevons used graphical analysis to
illustrate his ―law of variation of the final degree of utility of a commodity.‖
Jevons’s law of diminishing marginal utility solved the paradox of water and diamonds that
puzzled some of the classical economists. Adam Smith believed that utility has nothing to do
with the magnitude of exchange value because water is more useful than diamonds whereas
diamonds are more valuable than water. The principle of diminishing marginal utility reveals that
whereas the total utility of water is greater than the total utility of diamonds, the ―final degree of
utility‖ or marginal utility of diamonds is far greater than the marginal utility of water. We would
rather have all the water in the world and no diamonds than the other way around; but we would
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rather have an additional diamond than an additional unit of water, given our abundant stock of
the latter.
Rational choice: the equi-marginal rule. Jevons employed his notion of final utility (marginal
utility) to formalize a general theory of rational choice. Notice that in this case the price of the
two commodities is the same regardless of use. Hence, Jevons‘s example is simply a special case
of Gossen‘s second law: the consumer wishing to maximize utility will allocate money income in
such a way that the marginal utility of the last dollar spent on all commodities is equal.
Symbolically this is stated as: MUx/Px = MUy/Py … =MUn/Pn. The role of diminishing
marginal utility is important here. If the ratio of the marginal utility of X to its price is greater
than that for other commodities, then the rational consumer will purchase more of X and less of
other goods. As more of X is obtained, its marginal utility declines; as fewer units of goods such
as Y and Z are consumed, their marginal utilities rise. Eventually the ratios of marginal utilities
to the respective prices of the goods equalize and the consumer‘s total utility is maximized.
Theory of exchange: Jevons also used his principle of utility maximization to explain the gains
from exchange.
Jevons on labor: Recall that Jevons held utility to be the determinant of exchange value. At one
place in his principles, he formulated his idea this way:
A. Cost of production determines supply.
B. Supply determines final degree of utility.
C. Final degree of utility determines value.
Why, therefore, does not cost of production determine value? Jevons, in refuting the labor theory
of value, argued that labor cannot be the regulator of value because labor itself has unequal
value; it differs infinitely in quality and efficiency. ―I hold labour to be essentially variable, so
that its value must be determined by the value of the produce, not the value of the produce by
that of the labour.‖ Labor itself is a subjective, psychological cost, a ―painful exertion.‖ The
problem of economics is ―to satisfy our wants with the least possible sum of labour.‖ To
accomplish this, the worker must compare the pain of work and the pleasure of earnings.
Other topics addressed by jevons
Jevons addressed several additional topics that deserve discussion.
1. Although he did not fully develop a general theory of distribution based on marginal
productivity, nor did he adequately explain the law of diminishing returns on which such
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a theory of distribution could be built, he did understand the rudiments of both ideas.
Successive units of capital investment, he said, are less productive than preceding ones.
Given a fixed number of workers in any industry, the amount of capital employed would
determine the output per unit of capital. This output per unit of capital, said Jevons,
would determine the interest payment to capital. Interest, he said, is one of three
components of profits; the other two are wages of superintendence and insurance against
risk.
2. Jevons contributed to the theory of insurance and gambling. As detailed, he used his
theory of diminishing marginal utility of money to show that gambling in a fair game
does not pay.
3. Business cycles attracted Jevons‘s attention. He theorized that the sunspot cycle
influences the weather, which affects the size of crops. Large crops occur when sunspots
are at a minimum, and the resulting low prices of agricultural products stimulate the
economy. The effects may manifest themselves internationally; a large crop and cheap
food in India will leave wage earners surplus income that can be spent for clothing,
thereby promoting prosperity for the cotton mills of Manchester. This sunspot theory of
the business cycle, of course, did not stand the test of subsequent empirical testing and
often is cited as a good example of the post hoc, ergo proptor hoc (―after this, therefore
because of this‖) reasoning error.
4. As mentioned earlier, Jevons contributed greatly to the development of index numbers. In
particular, he pioneered a method for constructing a general price index that would
provide information on the extent of inflation or deflation from one period to the next. He
then used his method to construct a general index of prices as well as price indexes for
individual classes of commodities.
Jevons on public policy
Jevons favored free public museums, concerts, libraries, and education. He believed that child
labor should be restricted by law and that health and safety conditions in factories should be
regulated. He approved of trade unions as benefit, or friendly, societies because their insurance
functions reduce the need for public relief. But unions should leave the wage rate to the
operation of the natural laws. If they obtain wage increases, it is at the expense of other workers
or of the population
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In general through higher prices ―The supposed conflict of labour with capital is a delusion. The
real conflict is between producers and consumers.‖ Profit sharing is preferable to union efforts to
raise wages, and workers should save to improve their lot. Jevons opposed regulating the hours
of labor of adult males. He advocated excluding mothers with children below school age from
factories and workshops for the sake of their children. But he deplored free hospitals and medical
charities of all kinds because they ―nourish in the poorest classes a contented sense of
dependence on the richer classes for those ordinary requirements of life which they ought to be
led to provide for themselves.‖ He opposed government conservation measures to check the
waste of coal because such modes of interference ―break the principles of industrial freedom, to
the recognition of which, since the time of Adam Smith, we attribute so much of our success.‖
Jevons supported a cautious extension of legislation to improve public sanitation but was
undecided about whether imprisonment for debt should be abolished. Moderate government
regulation of railways won his approval. In his view, consumption taxes, such as the match tax,
are most desirable because they do not affect industry adversely; besides, all people above the
rank of actual paupers should contribute to the state in proportion to their incomes. Believing that
people are essentially hedonistic, Jevons advocated Bentham‘s greatest happiness principle. No
laws, no customs, no rights of property, he said, are so sacred that they must remain if it can be
proven that they stand in the way of the greatest happiness. But, he asked, how can we prove that
a certain change will increase the sum of happiness? Without conclusive evidence, ―the present
social arrangements have the considerable presumption in their favor that they can at least exist,
and they can be tolerated‖
W.S. Javons
 Value theory: Value depends entirely on utility
 Theory of diminishing marginal utility
Total utility
Quantity consumed
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Marginal
utility
Quantity consumed
 Rational choice: the equi-marginal rule
 Theory of exchange: Trade ceases at a point where there is no further possibility of utility
gain from exchange.
 Labor: Its value must be determined by the value of the produce. When exchange value
changes the value of labor used to produce the good changes.
Javons on pain of work and pleasure of earning
Pleasure
Lei
MUe
MUe = MDUw
(Marginal utility of earning)=(marginal disutility of
work)
0
Pain MDUw
Hours of work
The worker compares the marginal utility of earning (MUe) with marginal disutility of work
(MDUw). The optimal amount of work is at a workday length where MUe = MDUw
61
ii. Carl Menger

Carl Menger (1840–1921), born in Galicia and the son of a lawyer, studied at the universities of
Vienna and Prague and received his doctorate at the University of Cracow. As a professor at the
University of Vienna, Menger published his pathbreaking treatise, Principles of Economics. This
book appeared in 1871, the same year that Jevons‘s major work was published. Menger‘s long-
range goal was to produce a systematic work on economics and a comprehensive treatise on the
character and methods of the social sciences in general. His interests and the scope of his
projects continued to expand, and in 1903, he resigned his professorship to devote himself
entirely to his work. During the last three decades of his long life, he published very little
because he was dissatisfied with his writing. On his death, he left voluminous fragmentary and
disordered manuscripts. Menger‘s immediate and lasting impact on economics was substantial.
Numerous later economists, collectively known as the Austrian school, championed and
expanded his principles. Friedrich von Wieser and Eugen von Böhm-Bawerk, two of this
school‘s more prominent early members, are discussed in this chapter. Later members of this
group include such notable economists as Ludwig von Mises, Joseph Schumpeter, and Friedrich
von Hayek. Two of Menger‘s more significant contributions were his theories of value and
imputation.
Menger’s Value Theory: based on the concept of utility, like that of Jevons with no use of
mathematics.
Implicit assumptions
Each unit of commodity represents the same expenditure of money
Economizing individuals are able to rank satisfaction ordinally as well as cardinally
Conclusions arrived: If an individual could afford 5 units of food, the satisfaction he derives will
be from the first 5 items. The usefulness of the 5 items will be the 30 units in contrast to what
Jevon‘s would say. i.e 40. For Menger each unit has the same utility as the marginal unit.
The basis for exchange value for Menger is the difference in relative subjective valuations of the
same goods by different individuals.
According to Menger, producer goods also yield satisfaction to consumers indirectly by helping
produce things that satisfy consumer wants directly. The producer good has usefulness inputed
to it by the usefulness of the consumer goods produced using it.
62
Eg. The rent received by landowners is governed by the utility of the products grown on that
land.
The price of labor service is governed by its value which emanates from the magnitudes of the
satisfaction that would have to remain unsatisfied if we were unable to command the labor
service.
The Theory of Imputation: Menger originated the idea of imputation in pricing factors of
production. The marginalists emphasized the importance of consumer demand, especially in its
subjective psychological aspects, in determining price. The concepts of marginal and total utility
refer to consumer wants; therefore, they apply only to consumer goods and services. What
governs the prices of ―higher order‖ goods used in production, such as machinery, raw materials,
land, and so forth? Menger, in his theory of imputation, held that such goods also yield
satisfactions to consumers, though only indirectly, by helping to produce things that do satisfy
consumer wants directly. The consumers‘ marginal utility for a piece of iron is governed by the
marginal utility of the final product that is made from that iron, say, a thimble; the iron has
usefulness imputed to it by the usefulness of the thimble. The principle of marginal utility is
thereby extended to the whole area of production and distribution. The rent received by
landowners, for example, is governed by the utility of the products grown on that land. The
factors, or agents, of production are assigned use values that govern their exchange values. The
present value of the means of production is equal to the prospective value (based on marginal
utility) of the consumer goods they will produce, with two deductions: a margin subtracted ―for
the value of the services of capital‖ (interest) and a reward for entrepreneurial activity (profit).
The doctrine of imputation was an attack on the labor and real-cost theories of value. Menger
said that it is a most fundamental error to argue that goods attain value for us because goods that
have value to us were employed in their production. This false doctrine, he said, cannot explain
the value of the services of land, the value of labor services, or the value of the services of
capital. On the contrary, the value of goods used in production must, without exception, be
determined by the prospective value of the consumer goods they help produce. Menger denied
that the price of common labor is determined by the cost of minimum subsistence for the laborer
and his family. The prices of labor services, like the prices of all other goods, are governed by
their value. And their values are governed ―by the magnitude of importance of the satisfactions
that would have to remain unsatisfied if we were unable to command the labor services.‖
63
iii. Friedrich Von Wieser

Friedrich von Wieser (1851–1926), a second member of the so-called Austrian trio, was born in
Vienna into a distinguished aristocratic family whose sons usually entered the public service. He
studied law at the University of Vienna, and after graduation he read Menger‘s book on
economics. The ideas contained therein both captivated him and inspired him to study economics
in German universities. Eventually he was appointed, with Menger‘s help, to a professorship of
economics at the German University of Prague. He later taught at the University of Vienna, and
he also held high posts in the Austrian government, serving at one time as minister of commerce.
It was he who introduced the term marginal utility to the economic lexicon, although Dupuit,
Jevons, and Menger had developed the concept before him.
Opportunity Costs: Von Wieser is famous for the doctrine that came to be called the
opportunity-cost principle, or the alternative-cost concept. This idea turned cost of production
into a subjective psychological cost. The entrepreneur who produces something for a market
gives up the opportunity to produce and sell alternative commodities: Economists agree that the
opportunity-cost principle has wide applicability in economic affairs. Producing more
automobiles may mean fewer houses. Building a school may mean giving up a hospital or giving
up certain consumer or investment goods. Buying a personal computer may mean sacrificing a
family vacation. Gaining more hours of leisure may mean smaller earnings from work.
Opportunity costs are involved also when an entrepreneur considers his or her implicit wage,
interest, and rent costs, because those factors could be earned in other employment. This
principle, therefore, helps illuminate the basic economizing problems facing individuals,
enterprises, and nations. Nevertheless, it is not at all clear that this idea explains anything
fundamental about exchange value. It suggests that the value of a commodity is the value of the
commodities forgone, but what determined the value of those alternative goods?
iv. Eugen von Böhm-Bawerk

Eugen von Böhm-Bawerk (1851–1914) was the third member of the early Austrian triumvirate
(along with Menger and von Wieser). He was a professor of political economy at the University
of Vienna and served in the Austrian government as minister of finance. He was married to von
Wieser‘s sister. Among von Böhm-Bawerk‘s contributions to economic analysis one stands out:
his analysis of the element of time—not time in relation to systematic changes in the economy or
64
in relation to economic growth, but time as a significant element in the normal course of
economic affairs, influencing all values, prices, and incomes.
Eugen von Böhm-Bawerk’s Theory of Interest
Eugen von Böhm-Bawerk‘s incorporation of time into economic analysis can clearly be seen in
his famous agio (premium) theory of interest. Interest arises for three reasons, of which the first
two are subjective:
A. Present orientation:Goods are appreciated more highly in the present than in the future.
―We systematically underestimate future wants, and the goods which are to satisfy them.‖
This is a failure of perspective, the only irrationality that von Böhm-Bawerk introduced
into his ―economic man.‖ People underestimate future needs because they have defective
imaginations, because they have limited willpower and cannot resist present extravagance
even when they are aware of future needs, and because they know that life is short and
uncertain and therefore wish to enjoy life today rather than sacrifice for the future.
B. Expectation of rising wealth: The second basis for interest, also subjective, derives from
the idea that we are prepared to borrow and pay interest for present rather than future
consumption because we expect to have greater wealth in the future. Note that this basis
for interest, like the first, focuses on consumption.
C. Roundabout production: The third basis for interest involves production. The process of
production is lengthened, or becomes more roundabout, when more and more capital
goods are produced and used to make final products.
To summarize Eugen von Böhm-Bawerk‘sTheory of Interest:Interest can be paid by the
entrepreneur, because the more roundabout the process of production, the more productive and
efficient it becomes. Interest must be paid because people prefer present to future consumption.
Other Views of Eugen von Böhm-Bawerk’s: he agreed with the other two leaders of the
Austrian marginalist school that the total utility of a good is its marginal utility times the number
of units. He also agreed with them that the value of the means of production depends on the
value of the final goods produced, which in turn depends on the marginal utility of the final
goods. The value of the final product is greater than the value of the services that produce it by
the amount of interest over the period of time that elapses. Like the marginalists in general, von
Böhm-Bawerk accepted Say‘s analysis that the economy normally tends toward full
65
employment. He rebutted criticism of his belief that if all members of a community

simultaneously save one-quarter of their incomes, production will remain unchanged:
v. Léon Walras
He was one of the three originators of marginalism. He independently arrived at the basic
marginalist principles. He developed and advocated general equilibrium analysis; emphasized
the application of mathematics to economic analysis and is credited for calling economists
attention to Cournot‘s earlier work.
vi. The Austrian School

The Austrian school is an economic school of thought that originated in Vienna during the late
19th century with the works of Carl Menger, an economist who lived from 1840-1921. The
Austrian school is set apart by its belief that the workings of the broad economy are the sum of
smaller individual decisions and actions; unlike the Chicago school and other theories that look
to surmise the future from historical abstracts, often using broad statistical aggregates. Also
known as the "Vienna school" and the "psychological school"
The Austrian school uses logic of a priori thinking—something a person can think on his/her
own without relying on the outside world—to discover economic laws of universal application,
whereas other mainstream schools of economics, like the neoclassical school, the new
Keynesians and others, make use of data and mathematical models to prove their point
objectively. In this respect, the Austrian school can be more specifically contrasted with the
German historical school that rejects the universal application of any economic theorem. The
inception of the Austrian School can be traced back to the work of Carl Menger, himself an
Austrian economist. Representatives of this particular economic perspective are therefore often
referred to as ‗Austrians‘ even though they have no geographical attachment to the country.
Menger‘s economic analyses emphasized subjectivism, utility and marginalism.
B) The Second Generation Marginalists
i. Francis y. Edgeworth
Francis Y. Edgeworth (1845–1926) was born in Ireland, attended Trinity College in Dublin, and
studied at Oxford University. He later became the Tooke Professor of Political Economy at
66
Oxford, where he remained throughout his career. He was one of the founders of the Royal
Economic Society, was editor of the Economic Journal for thirty-five years, served a term as
president of the Statistical Society, and was a fellow of the British Academy. His contributions to
economics are found in his Mathematical Psychics, written in 1881, and in numerous articles
collected in 1925 under the title Papers Relating to Political Economy. Edgeworth accepted
Bentham‘s notion that every person is a ―pleasure machine.‖ Consumers, he said, seek to
maximize the utility they can obtain from their limited income, workers seek to maximize the net
gain from their labor, and entrepreneurs seek to maximize their profits by combining resources in
ways that will minimize the costs of any particular level of output. According to Edgeworth, the
most fruitful tool for analyzing this economic behavior is differential calculus. In supporting the
mathematical approach, Edgeworth contrasted the precision of mathematical economics to the
―zigzag windings of the flowery path of literature.‖ In general, then, one of Edgeworth‘s
contributions to modern economics was his popularization of the use of mathematics within the
discipline. Critics of this approach—for example, the Austrians and institutionalists—countered
that a ―zigzag path‖ that leads to new knowledge about economic phenomena or economic
problems is clearly preferable to a ―precise path‖ that leads only to endless refinement of what is
already known. But this methodological debate aside, the importance of mathematics in
formulating and testing theories in contemporary economics can hardly be questioned, and
Edgeworth joins Cournot as one of the early pioneers in this area. Of Edgeworth‘s various
contributions to the content of economic thought, three in particular stand out. First, he
originated the idea of an indifference curve, the importance of which will become increasingly
evident as we progress through the history of economic thought. Second, he was one of the first
economists to show the indeterminacy that we now generally associate with the pricing behavior
of oligopolists. Finally, he elucidated the difference between average and marginal product, thus
aiding in the development of the modern short-run production function and its numerous
applications.
Indifference Curves and Exchange: In his Mathematical Psychics, Edgeworth introduced the
notion of ―curves of indifference,‖ which he said show the various combinations of two items
that will yield an equal level of utility to an individual.
Duopoly Theory Edgeworth’s: idea of indeterminacy is also present in his theory of duopoly.
Recall from our previous discussion that Cournot theorized that, given certain restrictive
67
assumptions, duopolists in the sale of a mineral water would each charge the same price and each
garner one-half of the total sales. In Cournot‘s theory, the maximum profit or reaction curves of
the two parties would produce a determinate equilibrium price. Edgeworth altered Cournot‘s
assumptions in two ways.
1. He assumed that the sellers of the mineral water each have a limited capacity to meet
consumer demand. Stated differently, at a price of zero the quantity demanded is greater
than the amount that either seller singularly can produce.
2. Edgeworth assumed that in the short run the two sellers can charge different prices for the
mineral water.
Marginal versus Average Product: A final significant idea added by Edgeworth was his
distinction between marginal and average product. The concept of a production function—the
relationship between the various quantities of inputs and their corresponding output—was
implied by Ricardo in his theory of rent. You may recall that Ricardo assumed the amount of
land to be constant, added capital and labor, and observed diminishing returns. Also, von Thünen
clearly had in mind a production function when he spoke of the marginal productivity of labor as
it relates to agriculture. But a clear expression of the concept had to await Walras and
Edgeworth. Of these two persons, it was Edgeworth who explicitly distinguished between the
average and marginal products of a production function characterized by variable proportions of
inputs.
Marginal product (MP) is the change in total product associated with a change in the labor input.
It can be found by using calculus or simply by drawing a straight-line tangent to the TP curve at
any point and then determining the slope of the line. The other points on MP are found in a
similar fashion. How then is the average product curve derived? Geometrically, it can be found
by drawing a straight line from the origin to any point on the total product curve and then finding
the slope of the line drawn.
Edgeworth‘s distinctions between total, marginal, and average product Notice that when total
product is rising at an increasing rate, marginal product is rising and is above the average
product. Because MP >AP, average product is also rising. Whenever a number that is greater
than the average is added to a total, the average must also rise. But once the total product rises at
a decreasing rate, marginal product falls; that is, diminishing marginal returns occur. Eventually,
marginal product falls below the average product, thus pulling the average down.
68
ii. Knut Wicksell (1851–1926)

One major contributor to this macroeconomics literature at the turn of the century was the
Swedish economist Knut Wicksell (1851–1926). Wicksell was born in Stockholm and educated
in mathematics at the University of Uppsala. Roughly a decade later, in 1885, he began to travel
on the continent studying economics and, in 1895, and he earned his doctorate from Uppsala and,
subsequent to that, a degree in law. He taught at the University of Lund (Sweden) from 1899 to
1916. But Wicksell‘s interests went far beyond the academic; he was also a social and political
radical. He was deeply influenced by the Malthusian theory of population and wrote in the
popular press on issues of population and family planning, feminism, alcoholism, and the
monarchy. On the economic front, Wicksell was much more the pure theorist than what his
reformist activities might lead one to think. He wrote on a number of topics, including public
finance (his doctoral thesis was on taxation), price theory, marginal productivity theory, and so
on. Wicksell‘s theory that only unanimity in the voting process could guarantee that policy
measures were welfare-improving was a major impetus for the development of modern public
choice theory in the hands of James Buchanan and Gordon Tullock. But Wicksell‘s major
contribution was his attempt to explicate economic instability on the basis of differences between
the ―natural‖ (return on new capital) and ―market‖ (what banks charge) rates of interest, doing so
with an emphasis on what another Swedish economist, Gunnar Myrdal, later called ―cumulative
causation. ‖The basic idea was that if the market rate of interest was below the posited natural
rate, increased investment would take place, leading to both growth that could not be maintained
and inflation, and thereby to a more or less serious adjustment process. Conversely, if the market
rate of interest was above the natural rate, investment, output, and income would fall, leading to
an adjustment process of the opposite kind, a recession or depression. Here, Wicksell moved the
debate beyond the simple quantity theory that linked the price level directly to the supply of
money. The Stockholm School of Economics, which included Bertil Ohlin, Myrdal, and Erik
Lindahl, developed from his work. Wicksell‘s ―The influence of the interest rate on prices,‖
reprinted here, gives a concise statement of his theory of the relationship between price-level
fluctuations and the rate of interest – Wicksell‘s signal contribution to economic theory.
69
iii. John Bates Clark

John Bates Clark (1847–1938) earned a worldwide reputation and represented America‘s great
contribution to marginalist economics. About 1880 Clark, quite independently, seemed to have
thought out the concept of marginal utility and its influence on exchange value; apparently, he
had not read Jevons. Much more significantly, he not only invented the term marginal
productivity but also presented the clearest and best analysis up to his time of the marginal
productivity theory of distribution. We will find that his theory was based on the law of
diminishing returns, which Clark applied to all factors of production.
Marginal Productivity Theory of Distribution: The Distribution of Wealth, Clark summarized
his analysis of distribution and his conclusions: It is the purpose of this work to show that the
distribution of the income of society is controlled by a natural law, and that this law, if it worked
without friction, would give to every agent of production the amount of wealth which that agent
creates. However, wages may be adjusted by bargains freely made between individual men, the
rates of pay that result from such transactions tend, it is here claimed, to equal that part of the
product of industry which is traceable to the labor itself; and however, interest may be adjusted
by similarly free bargaining, it naturally tends to equal the fractional product that is separately
traceable to capital. At the point in the economic system where titles to property originate, —
where labor and capital come into possession of the amounts that the state afterwards treats as
their own, —the social procedure is true to the principle on which the right of property rests. So
far as it is not obstructed, it assigns to everyone what he has specifically produced.
Clark’s marginal productivity theory is concerned with the demand for factors of production, it
says little about factor supply. Alfred Marshall emphasized supply as well as demand for
productive inputs, thereby showing how equilibrium in factor markets results in a price for each
factor of production. Marginal productivity of a factor alone cannot determine its rate of reward
unless the quantity of a factor supplied is assumed to be fixed. Take labor, for example. If the
supply of labor is great relative to the demand for labor, then the wage and the marginal
productivity of labor will be low; if supply is restricted, the wage and the marginal productivity
will be high. It is, therefore, apparent that although Clark‘s wage theory was far superior to those
provided earlier, it required considerable improvement by Alfred Marshall. Clark recognized that
his theory of income distribution is static, best suited to be a purely analytical instrument. The
theory was designed to demonstrate the levels to which prices, wages, and interest tend if labor
70
and capital remain fixed in supply, if improvements in methods of production cease, and if
consumers‘ wants never change. We study such static laws separately in order to understand
what goes on in a dynamic society, he said. The truth that the world is dynamic does not
invalidate the conclusions of a static theory, because static laws are nevertheless real laws that
reassert themselves after every dynamic change in the economy. Clark did not develop any
sweeping dynamic (historical) theories. He relied almost exclusively on what is now known as
the method of comparative statics, because he compared different stationary equilibria. In the
real world, said Clark, a legal monopoly may secure a permanent economic profit for an
entrepreneur. Labor and capital are thus prevented from moving into the favored industry,
despite the pull of natural economic forces. This condition, however, is not a true static state.
Like a body of tranquil water, a static state has perfect fluidity but no flow; factors of production
have perfect mobility but no motion. A monopoly represents an obstruction that prevents the
working of static economic laws. Capital is productive, and therefore interest exists. ―Paying
interest is but buying the product of capital, as paying wages is buying the product of labor.‖
Interest furnishes a motive for abstinence. The motive for accumulating productive wealth is the
desire for permanent income. Abstinence leads to new capital goods, but no additional
abstinence is required to maintain the existing capital stock. Accumulation, said Clark, is a part
of economic dynamics. In the real world, capital increases faster than the supply of labor and
thus real wages rise and real interest rates fall. Capital goods are employed in the order of their
productivity, so far as people judge productivity correctly. The crudest hatchet will enormously
increase people‘s power to get firewood, but better tools developed later will increase
productivity by a smaller percentage
71

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History of Economic Thought – I Handout

1.1 Definition of History of Economic Thought

1.2 Scope and Significance of History of Economic Thought

Why Study of the History of Economic Thought?

CHAPTER TWO: METHODOLOGICAL ISSUES IN ECONOMICS

Q1: Is economics a science or Art?

Q2: what do you know about the history of economics as a profession?

2.1. Methodological Controversies in Economic and Evolution of Various

2.1.1. The Rise of Logical Positivism

2.1.2. From Logical Positivism to Falsificationism

2.1.3. From Falsificationism to Paradigms

2.1.4. From Paradigms to Research Programs

2.1.5. From Research Programs to Sociological and Rhetorical Approaches to

2.1.6. Post-rhetorical Methodology

2.1.7. Approach to the History of Economic Thought

Relativist and Absolutist Approaches

Orthodox and Heterodox Economists

CHAPTER THREE: PRE-CLASSICAL ECONOMICS

3. The General Themes of Pre-classical Economic Thinkers

3.1. Ancient Economic Thoughts

3.1.1. The Hebrews prophets

3.1.2. The Greeks

Plato (427-347 B.C.)

Aristotle (384-322 B.C.)

3.1.3. The Romance

Jurists and the Roman law:

3.2. The Medieval Economics and Feudalism

Justice implies equality, equality in exchange. In effecting exchanges, therefore, a measure is

- Or he is charging for the same thing twice

Q7: What are the lasting contributions of Mercantilist ideologies?

Q8: What were factors for the rise of mercantilists?

Important Mercantilists and Their Views

 Expense of travelers, Gifts for foreigners and ambassadors

3.4. Physiocratic School of Thought

Major tenets or central ideas of Physiocracy

Whom did the school benefit or seek to benefit

Usefulness, validity or correctness of the school in its time

Lasting contribution of the Physiocratic school

Francios Quesnay on other issues,

The Historical back ground of the school

 The industrial revolution was beginning and gaining momentum in England

 As English Entrepreneurs became stronger, they no longer were dependent on government

 Competition began to ensure moderate prices and good quality

CHAPTER FIVE: THE RISE OF SOCIALIST THOUGHT

5.1. Commonalities of socialism

• Private ownership of the means of production permits (to allow) EXPLOITATION

• Society should be CLASSLESS

5.2. The rise of socialist ideologies

5.3. Pre-Marxian Socialist Thinkers:

I) Scientific Socialism (Marxian Socialism)

Major tenets of the Marxian school

Economic Ideas of Marx

Father of international socialism

i. Marxian political economy: stages of development

ii. Dialectical materialism

Theories of Karl Marx

a) The Marxist theory on the origin of state

b) Marxian population theory

c) The labor theory of value