History of Economic Thought

Course Outline:
1. Introduction
2. Aristotle (384 – 322 BC)
3. Thomas Mun (1571 – 1641)
4. John Locke (1632 – 1704)
5. Adam Smith (1723 – 1790)
6. Jeremy Bentham (1748 – 1832)
7. David Ricardo (1772 – 1823)
8. Thomas Robert Malthus (1766 – 1834)
9. John Stuart Mill (1806 – 1873)
10. Karl Marx
11. Alfred Marshall (1842 – 1924)
12. John Maynard Keynes (1883 – 1946)
13. Thorstein B. Veblen (1857 – 1929)
14. John R. Commons (1862 – 1945)
Ancient Economic Ideas
• Ancient economic ideas were based on the Holy Scriptures and Codes
of Laws.
• The Bible and the Holy Men regulated economic practices and
relationships.
• Justice and mercy were encouraged. Greed and extortion were
despised.
• The pursuit of excessive wealth met social disapproval.
 Plato
- He was against the accumulation of wealth through lucrative trade or
commerce.
- Agriculture is very important, and was in favor of specialization of
production.
- He said that there is a need for diversity of occupations since no person is
self-sufficient, and people have unique and innumerable number of
wants.
- In his book, The Republic, he explained an ideal state. He said that the
members are to be educated from childhood for their responsibility, and
they are to be chosen through competitive examination.
* There should be no gap between the rulers and the ruled because the
former are not allowed to own properties, except for what is necessary
to support them.
Aristotle
- He stressed the value of management of agriculture.
- He was not in favor of too much wealth.
- He did not like usury and trade.
- He disagreed with Plato about communal property. He claimed
that this is not feasible and that it destroys individual incentives.

Communal – shared or used by members of a group or community

 Xenophon
- Was in favour of capitalism.
- He proposed that the government should promote trade and shipping.
-He also encourage the formation of more silver mining companies to
increase general wealth.
- He was in favour of joint-stock companies, specialization and division of
labor.
- Just like the other ancient intellectuals, he considered agriculture as the
basis of wealth.
Medieval Economic Thoughts
• Feudalism reached its peak during the Middle Ages in Europe.
Feudalism – A social system that existed in Europe during the
Middle Ages in which people worked and fought for nobles who
gave them protection and the use of land in return.

- With the rebirth of trade and commerce in the Mediterranean

region, and its rapid subsequent growth, the merchant class
became wealthy and powerful.
Medieval Economic Thoughts
• During the later part of the medieval period, the church became
very powerful.
- It was an active participant not only in religious affairs but also in
political affairs but also in political and economic activities.
- Most of the scholars and writers were churchmen. The most
admired of them was St. Thomas Aquinas.
 St. Thomas Aquinas
- He preached distributive justice and compensatory justice.
- Distributive Justice (fair distribution of goods among the members of
society).
- Compensatory Justice ( just wage and price).
- He condemned usury and other unfair practices of capitalism.
- Usury – the practice of lending money and requiring the borrower to pay a
high amount of interest.
- Capitalism – a way of organizing an economy so that the things that are used
to make and transport products (such as land, oil, factories, ships, etc.) are
owned by individual people and companies rather than by the government.
* The position of the church regarding capitalism appeared ridiculous because
it also actively participated in profitable businesses.
 The Economic Doctrines of Mercantilism

Mercantlism – An economic system developing during the decay of

feudalism to unify and increase the power and especially the
monetary wealth of a nation by a strict governmental regulation of
the entire national economy usually through policies designed to
secure an accumulation of money, favourable balance of trade, the
development of agriculture and manufacturing industry, and the
establishment of foreign trading monopolies.
The Economic Doctrines of Mercantilism
• The great thinkers of Europe, like Machiavelli, Bodin, and Serra,
influenced much the growth of capitalism.
- They asserted the supremacy of the state over all other sources
of powers, including the church.
- Economic ideas then were focused on the vital role of the state in
economic development. They claimed that it is the duty of the
state to create and accumulate wealth.
- Wealth came from gold and silver. A wealthy nation was
considered powerful and prestigious.
The Economic Doctrines of Mercantilism
• Countries without gold and silver mines could acquire such
precious metals through favourable international trade, colonies
with gold and silver mines.
• As a result, the big European nations fought one another in
getting more colonies.
• To achieve the objectives of mercantilism, manufacturing was
given top priority.
• Agriculture was no longer appreciated because of its natural
shortcomings.
The Economic Doctrines of Mercantilism
• Serra claimed that manufactured products could be sold readily
abroad than agricultural products.
• He further stated that agricultural goods are perishable and
bulky, and he mentioned other limitations, like limited areas of
land and the great dependence of agriculture on the weather
conditions.
 The Economic Doctrines of Mercantilism
• It was Thomas Mun who provided the ways of achieving favourable
foreign trade.
- Being an experienced foreign trader himself, he was a real expert. In fact,
he contributed the idea of the balance of payments.
Balance of Payments – A summary of the international transactions of a
country or region over a period of time including commodity and service
transactions, and gold movements.
- He explained about the exports and imports of goods and services.
- He said that foreign trade is favourable if exports are greater than
imports.
* The writings of Mun, an Englishman, dominated the whole concept of
mercantilism in Europe.
 Physiocracy
Physiocrat ? A member of a school of political economists founded in 18th century
France and characterized chiefly by a belief that government policy should not
interfere with the operation of natural economic laws and that land is the source of all
wealth.

• Many significant changes took place in Europe, especially in England and France,
during the 18th century.
• Such developments included the growth of cities, the increase of wealth, the
creation of science, and the search for better ideas.

• The Enlightenment in England and France greatly stimulated thinkers and

philosophers to question the old doctrines and thoughts.
• Eventually, dependence on the Greek philosophy and the church dogma began to
diminish.
 Physiocracy
• The expansion of science and the increasing number of various inventions
opened up some realities of life and the world.
• People started to rationalize human behaviour and the existence of
institutions.
• They concluded that it was not the will of God that created the conditions in
the world. Rather, it was the product of causes and effects which conformed
to the laws of nature.
• Those who still believed in God stated that the will of God was expressed in
the natural law (a body of law or specific principle held to be derived from
nature and binding upon human society in the absence of or in addition to
positive law).
Positive Law – law established or recognized by governmental authority
 Physiocracy
• Philosophers claimed that people are poor because they
violated the laws of nature.
- An example of this is when one is lazy, extravagant or a
drunkard. He is likely to make his life miserable.
- A man who neglects his health has a greater chance of getting
sick.
- Those who obey and follow the laws of nature were believed to
promote their own good.
- In the same manner, an economy or society that conforms to
such laws would be successful, according to the thinkers.
• In France not long before the revolution,. The first modern
school of thinkers to call themselves economists emerged.
• Later on this school was named Physiocracy which means the
rule of nature.
- They stressed the importance of agriculture because they
claimed all wealth came from the land.
- They explained that people could not exist without food and
natural resources.
- The farmers therefore are the real producers. Industrialists,
traders and craftsmen are not in the real sense productive.
- It is only agriculture which can double or create more goods.
* For the physiocrats, the farmers are the backbone of the
whole national economy. Without them, it is really difficult for
the people to survive and the economy to operate.
• The ideas of the Physiocrats were against those of the Mercantilists
who considered money as the real wealth.
- They criticized the theory of the favorable foreign trade of the
Mercantilists.
- To the Physiocrats, favorable trade only drained the resources of the
country, because it gave more goods than it received.
- They believed the real wealth of any nation are the products of
agriculture and not money in the form of gold and silver.
- The economic ideas of the Physiocrats came from the ancient doctrines.
- Since Mercantilism was a failure in Europe, except for England, and that
it had many shortcomings, the Physiocrats argued that their country
should return to agriculture.
Laissez Faire Theory
- It is an economic policy that allows businesses to operate with
very little interference from the government.
- It was introduced by the Physiocrats. It connotes non-
interference, liberty or freedom.
- In economics, it means the government should not intervene in
economic affairs. Just let the forces of the market interact with
one another.
* This is in accordance with the natural law, and the results would
be good for the individuals and society, according to the
Physiocrats.
• Giving grants and subsidies to industries was rejected by the
Physiocrats. They said it is a form of corruption and favoritism since the
industry is non-productive – unlike agriculture.
- Quesnay, the leader of the Physiocrats, stated that prices of
manufactured goods are higher than the prices of their raw materials.
- Quesnay said that, market prices should be based on the cost of labor.
- Individuals should be free to pursue their own particular economic
interests
- They should be free to choose their own economic enterprise or
occupation.
• Physiocrats believed that if such economic freedoms are allowed to
take their own course, they believed businessmen, consumers and the
whole society would be better-off.
Classical Theories
- The real founder of the classical school of economics was Adam
Smith.
Adam Smith
- Well-educated in the classics, mathematics and philosophy and
became a professor of moral philosophy at Glasgow University.
- He lived at the beginning of the industrial revolution. His close
association with the intellectual elite like Quesnay, Rousseau, and
many other great thinkers broadened his perspectives.
- In 1776, his famous book Wealth of Nations was published. It
explains how wealth of the nation is created and distributed.
• Smith being greatly influenced by the ideas of the
Physiocrats believed in the merits of the free competition
concept.
- He said that a free market mechanism could provide
more benefits to individuals and society than an
economy run by the government like in the case of
mercantilism which even established trade monopolies.
- This theory is still a topic of heated debate among many
economists and political leaders.
- Some favor a free enterprise while others advocate
government intervention in the economy.
• Smith was not only able to influence thinkers and scholars in his
country but also in other countries.
- The more popular ones were Thomas Malthus, the author of
population theory, and David Ricardo who developed the law of
comparative advantage.
- The economic ideas of Karl Marx came from the writings of Adam
Smith.
Production is the real wealth
Adam Smith explained in his economics book how the wealth of
a nation is increased, and the manner of its distribution.
- According to him, the only source of wealth is production through
labor and resources.
- He wrote that wealth can be increased through division of labor and
the use of machinery.
- He noted that improvements in transportation can promote the
growth of commerce and industry.
- Smith provided the conditions for increasing the wealth of nation,
such as the size of the market, labor efficiency, and the total
population.
- He also said that individual welfare depends on the ratio of total
production to total population.
- Under a free market economy, Smith claimed that
production would be most efficient.
- Through free competition, only the best producers survive.
This means they are the most efficient and the consumers
can get the best quality and the lowest price product.
- Such competition views of Smith also applied to wages
and interests.
- According to him, both are determined by demand and
supply.
Example. If the demand for labor is greater than the supply
of labor, then wage increases.
• Smith, in claiming that production is the only source of
wealth, was more or less referring to industrial production
which was taking place in his society.
- The application of division of labor and machinery is more
appropriate in industry.
• Adam Smith’s theory of wealth has been based on
industrialization and not on agricultural development.
- In this respect, he differed from the other earlier thinkers
who favored agricultural development.
• Although Smith stressed free competition, and the non-
intervention of the government in economic affairs, he
made some exceptions.
For instance. He encouraged the government to promote
shipping.
- He favored the imposition of tariffs for bargaining purposes
and for equalizing competitions.
- Smith also stated the role of the government should be
confined to defense, justice, education, public works and
protection of foreign trade.
- The basic principles of taxation came from Adam Smith.
 The Industrial Revolution which started during the later part
of 1700’s developed in an environment of laissez faire.
- Things did not materialize for the good of individuals and
society. Instead, the powerful capitalists emerged and exploited
the workers.
- There was a great influx of rural people in the urban communities
looking for jobs. This created both social and economic problems.
- The capitalists took advantage of the situation. They gave very
low wages to their workers and forced them to work up to 17
hours.
- The government did nothing to help the workers. Poverty and
squalor became widespread among the workers.
 Theory on Population
• Thomas Robert Malthus, a religious minister, saw the growth
of population and human miseries.
• He stated that population explosion is the root cause of the
problems of society.
• Malthus said that the rate of population growth is higher than
the rate of food production. He did some dismal predictions of
the future of mankind.
• To control population growth, he proposed late marriages and
abstinence. Such ideas constitute what is now the famous
“Malthusian Theory”.
 Malthusian Theory
• The dismal predictions of Malthus have not taken place in
the developed countries. Their higher stage of economic
growth has become a very effective birth control device,
and their modern production technology has given them
enough food supply.

• It is only the less developed countries which are now

afflicted with the Malthusian theory. They have a very high
birth rate but they have very low food productivity.
 Theory of Comparative Advantage
• David Ricardo, one of the famous classical economists, developed the theory
or law of comparative advantage.
- Based on this theory, nations should export the goods which they enjoy the
greatest advantage, and should import the goods which they have the greatest
disadvantage.
- This simply means – do not produce the product if it is cheaper to buy it.
- Ricardo explained this theory by giving two countries and two products as
examples. The comparative advantage refers to the lesser number of hours or
days of producing the product.
Countries Rice Calculator
Japan 120 days 10 days
Philippines 90 days 15 days
- The example shows that Japan has a comparative advantage
in calculator while the Philippines in rice.
- Following the theory it would be better for Japan to
produce calculator and just buy rice from the Philippines.
- In the case of our country, it would be more economical not
to produce anymore calculator. Just import from Japan and
concentrate in rice production.
• The classical economists like Ricardo equated the value of a
product with the cost of labor that went into its
production.
- A product which takes more hours or days in producing has
a higher price or value than a product with lesser hours of
producing it.
 Theory of Comparative Advantage
• The theory of comparative advantage is being practiced in
international trade. Agricultural countries export raw materials and
import finished products from the industrial countries.
• The problem is that the prices of raw materials and other
agricultural products are very low in the world markets. And yet the
prices of finished products are very high.

• The industrial countries control the operations of the world markets,

and they can manipulate prices of goods to the disadvantage of the
less developed countries which are basically agricultural economies.
Theory of Karl Marx
- The economic ideas of Karl Marx were basically
derived from the classical economists.
- He only qualified his theory of value by emphasizing
that labor must be socially necessary.
- Marx maintained that the workers are the real
producers of goods.
- He also claimed the benefits of production go to the
capitalists and not to the workers.
- Karl Marx developed his theory of scientific social
evolution by saying that in the beginning – when it was
still a primitive society – there was social equilibrium.
- When new ideas and new tools of doing things were
introduced, the old system was disturbed.
- Man became greedy for power and wealth. Man was
greatly concerned with material things.
- This led to a class struggle between the workers and the
capitalists.
- The capitalists have wanted to accumulate wealth at the
expense of the workers.
• In the class struggle between the workers and the
capitalists, Marx predicted the downfall of
capitalism due to its limitations.
- However, such prediction did not come true.
- There were no revolutions in the industrial countries.
- Capitalism has not disappeared, instead it has
expanded and become stronger.
- Compared with other economic systems, countries
with capitalistic societies have high standard of
living, such as the United States, Japan, Canada, and
the others.
- The free enterprise economy still shows the greatest
potential for economic growth.
- Profit motive is still a very good incentive in
encouraging the private individuals to participate in
business.
- In fact, the Russian agriculture is a failure primarily
because of its economic system. Farmers are more
efficient when they are given economic incentives.
• The ideas of Karl Marx are not without significance.
His warnings greatly contributed to the welfare of the
working class.
- Workers have become more united and organized
their labor unions.
- Capitalists have improved their management policies
towards their workers.
- In many parts of the world, capitalists still exploit
their workers. Such abuses are rampant in the less
developed countries where there is over-supply of
labor and poverty is widespread.
• Poor people are forced to accept low wages.
Agricultural workers experience more miserable
working condition, especially the casuals in
plantations.
- Such exploitations are the root causes of many
troubles in the rural areas, like in Central and South
America.
Promotion of Human Values
- Jean Sismondi, a noted Italian writer, disagreed in many
ways with Adam Smith.
- He stated that wealth should not be measured in terms
of material things but in terms of human welfare.
- He (Sismondi) pointed out that no nation can be
considered prosperous if the conditions of the poor have
not been improved.
- He rejected the laissez faire theory which provided
freedoms to individuals to seek their own self-interest for
their own welfare and that of society.
- Sismondi asserted that the state should interfere to
prevent the unfair distribution of wealth spawned by
unrestrained capitalism.
- The main contention of Sismondi is focused on the
welfare of the poor.
- He was more interested in social justice rather than
in the accumulation of wealth by the industrial
system manipulated by the powerful capitalists for
their own materialistic inclinations.
• The economic ideas of Sismondi were the products of
his observations of capitalism.
• Like the other socialist thinkers, he was outraged to
witness the human miseries created by the existing
economic system.
- He proposed an active role for the government in
protecting human values.
Factors of Economic Development
- Friedrich List was a German professor of economics and
political science.
- He also did not agree with the ideas of the classical
economists about production, free trade and free
competition.
- According to List, the progress of a nation is great not in
proportion to the accumulation of wealth, but in
proportion to the development of the productive forces.
- Such forces refer to natural resources, science, arts,
government laws, education, peace and order, morality
and the harmonious relationships of the various
industries and occupations.
 Keynesian Theory of Employment
• Based on the Keynesian theory of employment, employment
determines the necessity of equating the aggregate supply of goods
with the aggregate demand for goods.

- When people buy more goods, it means there is more expenditure

or consumption. This condition stimulates more investments which
also increases employment and production.
- Businessmen put up more factories because they expect greater
demand for their products.
- There are other factors which determine investment, such as price,
cost of production, interest rate, competition, etc.
 Keynesian Theory of Employment
• According to Keynes, as long as returns of investment are
higher than interest rates, there is investment. Even if the
interest rate is very low, it does not follow that investment
increases.

• A very high interest rate does not discourage a borrower if he

feels he will make more profit in his projected investment.

• Keynes proposed to the United States government to spend

more money in order to solve their depression. Many public
works were constructed which created massive employment.
- The situation generated income for the people. They
started buying more goods and services.
- This encouraged the private business sector to meet
the growing demand of the people.
- As a result, employment was also created by the
private sector. They needed more people in
producing goods and services. Such favorable
conditions accelerated further economic activities.
Innovation Theory
- Joseph Schumpeter is the author of the innovation
theory.
- He placed emphasis on the role of the innovator in
economic development. The Innovator is the
economic leader or the entrepreneur who has the
courage and imagination to handle old systems and
be able to transform theory into practice.
- An innovation can be any change initiated by the entrepreneur
which leads to a faster and better development of an industry.
- Such change may be in the form of an invention, method of
production or marketing strategy.
- In the theory of Schumpeter, the key factor in economic
development is the innovator or the entrepreneur.
- He (entrepreneur) is the planner, organizer, coordinator and
implementor of economic activities.
- In general, people are conservative in their investments. Many
business enterprises are owned by families and these are
managed by their own members.
- Their financial resources are usually invested in safe business
like real estates.
Some Growth Models
- Economic models can be simple or sophisticated. It all
depends on the architect or the situation which the
model tries to improve.
- Such models show the relationships of inputs and
outputs. Their key inputs vary from model to model.
Example. One economic model stresses technology.
Their effectiveness depends on several factors.
- Local conditions like climate, natural resources,
manpower, money, social structure, culture, values and
institutions have to be considered.
- Most economic models were made by the United
States and Western Europe.
- Naturally, these were based on their own local
conditions. Not a few developing countries have been
inclined to copy such models.
- Even Western economic advisers apply these models
in the economies of the less developed countries.
- The result have been failures. This was experienced
by Japan during its formative years. But the country
was quick to modify Western technology to fit its local
conditions.
• Here are some of the more popular growth models:
The Ricardian Growth Model
- This was derived from the law of diminishing returns
of David Ricardo.
Law of Diminishing Returns -- The law states that
when one input is kept constant and the other input
is increasing, total product will initially increase and
reach its saturation(the act or result of supplying so
much of something that no more is wanted) and
begin to decline.
- He stressed the limits of economic growth brought
about by the scarcity of land, its being a fixed input
and its diminishing productivity.
- To reduce the constraints of economic growth,
Ricardo proposed the discovery of more land for
cultivation or more food at lower prices should be
imported.
- The key factor in the growth model of Ricardo is land.
This means the agricultural sector assumes a very
vital role in economic development.
- To the poor countries which are mainly agricultural
economies, this model appears to be relevant.
- Many agricultural countries have been able to increase
their farm production through the cultivation of more
farm lands – not through efficiency.
- In the case of highly developed countries, their
agricultural productivity have greatly increase through
the use of technology and machinery.
Example. The problem of scarcity of farm land in Japan has
been reduced by producing more crops in its limited
available farm.
- It has the highest rice productivity in the whole world.
Harrod-Domar Model
- This model was developed by Sir Harrod of England and
Professor Domar of America.
- The key factor is physical capital like machinery, buildings,
equipment, etc…
- The model shows the relationship between the input and
output.
- The input is capital and its efficiency is reflected in its output.
Example. A certain amount of capital stock or physical
capital has been invested. If the results or outputs have been
substantial in terms of employment, production and income,
then the capital has been used efficiently.
*The rate of growth in the economy can be measured through
the GNP or Real per capita income.
- Evaluating the Harrod-Domar model, the efficiency
of capital in relation to economic growth depends on
several factors.
Example. Values of the workers, their skills,
technology, government policies, and the like
determine whether capital could be productive or not.

- Poor nations are deficient in capital. But this is not

the key factor in their economic growth. It is more on
human and institutional developments.
Kaldor Model
- The author of this economic growth model is Nicholas
Kaldor.
- The key factor is technology. He pointed out that
technology is embodied in physical capital.
- He further stated that technical progress comes from
investment.
Examples. Modern machineries, tools and
equipment.
- These are symbols of technical progress and they are
the products of investments.
- Kaldor claimed that if technical progress grows faster
than capital stock, the additional productivity of capital
increases and this leads to more investments.
Technical - having special knowledge especially of how
machines work or of how a particular kind of work is done.
- A very good example of economic growth due to
technical progress is Japan.
- It has invested a big slice of its national budget for
research and technology.
- As a result it has become very progressive as a nation.
- Technology has greatly improved its industries. It is
now number one in the use of robots in factories.
- In fact, such machines are even used in hospitals as
attendants and in offices as secretaries.
- For the less developed countries of Asia, Japan can
serve as a good economic model. It also started from
a feudal economy.
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