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week 1: 2. classical school (1776-1871): Adam Smith continued (Price…
week 1: 2. classical school (1776-1871):
Adam Smith continued
Price Theory 2.
Natural price corresponds to normal levels of costs
Market price is the price that prevails in the market:
• Supply vs effectual demand
Smith: Wages/rents/profits all tend towards the “natural price”
(Inheritance scholastics)
Excess supply: natural price > market price
Little supply: natural price < market price
Long term:
market price < (doorgestreept) natural price
market price > natural price
Return to production factors 1:
Wages
Employment contracts
At least subsistence level
Wages may differ as to reflect noneconomic (dis)advantages:
Regularity of employment
Difficulty/expensiveness to learn employment
Level of trust and responsibility
Probability of success in employment
Ease or hardship of employment
→Foundation of theory of compensating wage differentials
Returns to production factors 2
Profits
Differences in risk
Compensation for management and supervision of business
Rents
Tenant’s income – natural costs (wages/profit) →residual pay
Hence, wages/profits cause high prices, but rents are effect of high prices.
Assumptions:
Free and unregulated markets
→ Invisible hand: inheritance physiocrats
Market mechanism and competition
: Perfect competition: “system of perfect liberty”
Free entry and exit
Profit maximization by producers
Absence of monopoly
Degree of competition increases with the number of sellers
Competition is key to understanding Smith’s invisible hand mechanism.
Public Interest
Competition is good for economic efficiency,
•As resources are devoted to most efficient uses, and hence output is maximized
but a just distribution of resources could not be achieved by the market alone •Inequalities may arise
International trade
Main criticism of Mercantilis
m
•Smith: Laissez-faire principle also applied to international trade
•Trade policies prevent the market from functioning efficiently:
•Import restrictions create monopoly for domestic producers
•Export subsidies direct money to less productive use