Adam Smith : The Wealth of Nations/ Theory of Moral Sentiments



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Adam Smith : The Wealth of Nations/ Theory of Moral Sentiments

  • Adam Smith : The Wealth of Nations/ Theory of Moral Sentiments

  • Karl Marx: Capital, Communist Manifesto



Division of Labor is Key

  • Division of Labor is Key

  • Labor is the basis of wealth;

  • The division of labor implies economic interdependence.

  • Markets are self-regulating systems for the orderly coordination of the division of labor.



Invisible Hand

  • Invisible Hand



Invisible Hand – Assumptions:

  • Invisible Hand – Assumptions:

    • Our preferences are consistent
    • We act based on self-interest
    • Individual Good adds up to
    • Social Good
    • Government Ensures Property
    • Rights.


Invisible Hand – Assumptions:



Invisible Hand – Assumptions:

  • Invisible Hand – Assumptions:

    • Perfect Information that backs up our economic decisions


Invisible Hand – Assumptions:

  • Invisible Hand – Assumptions:

    • No Externalities




All societies are divided into two groups

  • All societies are divided into two groups

    • Owners
    • Workers
  • Our society is capitalist.

    • Owners are bourgeoisie
    • Workers are proletarians


‘The history of all hitherto existing society is the history of class struggle.’

  • ‘The history of all hitherto existing society is the history of class struggle.’



Owners exploit workers and live off the money which the workers earn

  • Owners exploit workers and live off the money which the workers earn

  • Members of classes bind together in the pursuit of their common interests.

  • Workers put up with this inequality because:

    • They are oppressed wage slaves and cannot fight the system
    • They are indoctrinated by ideology and religion into believing what they are told by the powerful.


Technical progress, the growth of knowledge, and conflict among classes all foster perpetual change.

  • Technical progress, the growth of knowledge, and conflict among classes all foster perpetual change.

  • Capitalism as an economic system is irrational in the sense that it stands in the way of making good the ability of modern science and technology to meet human needs.



Marxism is an understanding of the nature of social relationships which you are expected to evaluate. Recognise that it has strengths and weakness as a tool of understanding of our culture.

  • Marxism is an understanding of the nature of social relationships which you are expected to evaluate. Recognise that it has strengths and weakness as a tool of understanding of our culture.



Born in 1883 in Cambridge, England

  • Born in 1883 in Cambridge, England

  • Son of John Neville Keynes

    • Neville was a professor of Economics and Logic at Cambridge Univ., and wrote on Economic Methodology
  • Won a scholarship to Eton

  • Boy Genius

  • Part of Eton’s social elite

  • Won a scholarship to King’s College, Cambridge

  • 1911, he became editor of the Economic Journal.

  • Worked at the Treasury during WWI.

  • 1921, he published A Treatise on Probability. This was his dissertation. It won him a fellowship at



Keynes wrote the Economic Consequences of the Peace (1919), regarding reparation payments

  • Keynes wrote the Economic Consequences of the Peace (1919), regarding reparation payments

  • 1923, Tract on Monetary Reform (against returning to the pre-war gold standard)

  • Economic Consequences of Mr Churchill (1925, warned of depression)

  • 1930, Treatise On Money

  • Makes millions in the stock market, commodity, and forex markets.

  • 1936, General Theory of Employment, Interest and Money

  • 1937, he has a serious heart attack







According to the classical model, the consumer has insatiable wants.

    • According to the classical model, the consumer has insatiable wants.
    • The consumer sells his/her labor in exchange for enough income to buy the goods.
    • The money value of the incomes received must be equal to the value of the output produced.
    • So how can unsold goods pile up in warehouses, causing firms to lay off workers?


Say’s Law cannot hold. (“Supply creates its own demand.”)

  • Say’s Law cannot hold. (“Supply creates its own demand.”)

    • If spending constraints are in effect, then there will be a difference between (unlimited) demand and “effective demand”.
    • Actual (effective) demand will usually be “deficient” to purchase total output.


The market system is not self-regulating: left to its own devices the market system fails to make sensible use of our productive potential.

  • The market system is not self-regulating: left to its own devices the market system fails to make sensible use of our productive potential.

  • Unemployment is a chronic problem in a capitalist economy. Government intervention in the economy can reduce unemployment and instability.

  • Ergo Fiscal and Monetary Policy!



Simple neoclassical microeconomic theory allows for little or no role for entrepreneurs

  • Simple neoclassical microeconomic theory allows for little or no role for entrepreneurs

  • A firm is a production function; it transforms inputs into outputs

  • The way the firm transforms inputs into outputs is assumed to be technically and economically efficient

  • Where do techniques come from? How are they improved, and why?

  • Schumpeter emphasizes the role and importance of entrepreneurs



In reality, some firms exploit opportunities for creating profitable competitive positions that other firms either ignore or cannot exploit

  • In reality, some firms exploit opportunities for creating profitable competitive positions that other firms either ignore or cannot exploit

  • Seizing such opportunities is the essence of entrepreneurship

  • Entrepreneurship involves discovery, innovation, and acting on the opportunities that discovery and innovation create (page 132):

  • “To undertake such things is difficult and constitutes a distinct economic function, first, because they lie outside the routine tasks which everybody understands and secondly because the environment resists in many ways that vary, according to social conditions, from simple refusal either to finance or to buy a new thing, to physical attack on the man who tries to product it.”



Schumpeter believed that innovation causes most markets to evolve in a characteristic pattern

  • Schumpeter believed that innovation causes most markets to evolve in a characteristic pattern

  • There are periods of relative stability, when firms that possess superior products, technologies, or organizational capabilities earn positive economic profits

  • These periods are punctuated by fundamental shocks or discontinuities that destroy old sources of competitive advantage (profits above the norm) and replace them with new ones

  • The entrepreneurs who exploit the opportunities these shocks create achieve positive economic profits during the next period of stability



According to Schumpeter, the process of creative destruction implies that static efficiency – the optimal allocation of society’s resources at a given point in time – is less important than dynamic efficiency – the achievement of long-term growth and technological improvement

  • According to Schumpeter, the process of creative destruction implies that static efficiency – the optimal allocation of society’s resources at a given point in time – is less important than dynamic efficiency – the achievement of long-term growth and technological improvement

  • What really counts is competition between new products, technologies, and organizational techniques, not price competition (pages 84-5):

  • “This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference whether [price] competition in the ordinary sense functions more or less properly; the powerful lever that in the long run expands output and brings down prices is in any case made of other stuff”



Schumpeter’s ideas have been used to defend monopoly, on the grounds that high economic profits are a necessary reward to encourage innovation, which results in higher long-run growth

  • Schumpeter’s ideas have been used to defend monopoly, on the grounds that high economic profits are a necessary reward to encourage innovation, which results in higher long-run growth

  • Policy analysis should focus more on the impacts of policies on innovation and less on the impacts on prices and current welfare



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