Smith (cont.) and Ricardo Justice in Political Economy: The Market, - PowerPoint PPT Presentation

Smith (cont.) and Ricardo Justice in Political Economy: The Market, Free Trade and Comparative Advantage

The Theoretical “Freedom” Vision 1780 Last Witch burned in Europe 1784 American Society to Abolish Slavery 1787 British Society to Abolish Slavery 1792 Wollstonecroft “Vindication of Rights of Women Locke Mill Hobbs John Stuart Mill Jefferson Locke Thomas Jefferson Rousseau Political Individual Liberalism Freedom Happiness Reason Individualism ____ Wealth and Capitalism natural freedom Adam Smith

Review: Competition (production side) • Natural self-interest makes us ruthless……. • Competition, not protest dampens effects of greed..no need for integrity • Competition lowers price Consumer and raises quality • But Producers always try to find a way around competition

Who gets what? Through competition society gets what it wants • Producers must heed society’s demands

Justice: Who gets what and who says? The Consumer :What do they do? They govern • production, distribution and consumption of goods and services of an economy. competition At one extreme, if competition is chosen, production is carried in • a private-enterprise system such that all resources are privately Production owned. It was described by Adam Smith as frequently promoting a Distribution social interest, although only a private interest was intended. At the other extreme, if equal distribution is chosen, socialist or- • communist system, such that all resources are publicly owned with Price intent of minimizing inequalities of wealth among other social objectives". [2] Market economy (the basis for several "hands off" systems, such • as capitalism). Mixed economy (a compromise economic system that incorporates • some aspects of the market approach as well as some aspects of the planned approach). Planned economy (the basis for several "hands on" systems, such • Consumer as socialism, or a command economy). Traditional economy --a communalist ethos, (Holmes)—primitive • communism Consumption Demand Supply (production) is driven by demand for Consumer products: justice is served when society gets what it wants through market freedom

What is Justice in the production of goods? goods worth more than they cost to produce get produced, goods • worth less than they cost to produce do not; In a perfectly competitive private property system, producers pay • the value of the inputs they use when they buy them from their owners and pay the value of labor from the workers That value is determined by overall demand and supply conditions • in the market Producers receive the value of what they produce when they sell • their goods. If a good sells for more than it costs to produce-- because it is demanded by consumers, the producer receives more than he pays and makes a profit; if the good sells for less than it costs to produce (low demand) he • takes a loss. So goods that should be produced are produced and goods that should not be produced are not. •

What is justice in the distribution of goods? The Decision Rule for Distribution and for how we should treat each • other in economic society: Freedom The Market Model: • – Markets arise spontaneously – Distribution is impersonal and takes place through exchange – Distribution is voluntary and non-coerced – All parties to exchange will benefit – Coordination in allocation without coercion – Private Property is respected and required – Value is determined by price—market value – The state should have a minimal role Effects: Freedom, Efficiency, Growth, and Social Welfare •

Price as information about whether justice is done • Price is determined by supply-demand ratio • no “just price” but rather a “market price” • Price is information upon which free choice is made

Digression on Price and Value • From intrinsic value to labor value to exchange –market--value • Value is expressed as price

Who does NOT decide what economic justice is? The State! • Smith’s Doctrine of “Laissez Faire” • But Smith was not opposed to some government intervention in society – Protection against violence and invasion – Exact administration of justice—to protect competition and private property – Creation of public institutions—public works (public goods) • The Big Enemy is not the state but rather state monopolies and collusion that distorts the market! “People of the same trade seldom meet together, but the conversation ends in a conspiracy against the public, or in some diversion to raise prices.”

Who DOES decide? The Market • The market is self- regulating • The Market is it’s own “guardian” • It is the paragon of “freedom” but the strictest taskmaster • Is Economic freedom an illusion?

Example: Is the Illegal Drug Trade unjust? In an ideal economic system, goods worth more than they • cost to produce get produced, goods worth less than they cost to produce do not; In a perfectly competitive private property system, producers • pay the value of the inputs they use when they buy them from their owners and receive the value of what they produce when they sell it. • If a good sells for more than it costs to produce, the producer receives more than he pays and makes a profit; if the good sells for less than it costs to produce he takes a • loss. So goods that should be produced are produced and goods that should not be produced are not. •

Demand for illegal drugs is High and steady

Supply is abundant…..production costs low… processing is specialized Production Distribution Consumption

Market is large. Should price be high or low in a perfect competitive market for cocaine?

Illegality represses demand and supply, raising the price

Repressed demand distorts prices • Hard-to-get drugs means demand is high but supply is restricted • Raising the price artificially • Producers are rational….. So……. • High prices encourage production

So It’s rational to produce cocoa….. Corn: $150 per acre Livestock: few $ per acre Cocoa: $5-10,000 What crop would a per acre rational farmer grow?

And rational to sell it….. Production Distribution Consumption

Ricardo’s Theory of Comparative Advantage Specialization + Trade

Production without specialization and division of Labor Wine Cloth England 3 5 (Total production =8) Portugal 9 6 (Total production=15) Total goods produced = 23

Production with specialization but before trade • Before Trade: Resources put where they are most efficient (specialization) Wine Cloth England 1 10 Portugal 16 0 Total goods produced = 27 note: efficiency increases total number of goods available

With Specialization and Trade England trades Portugal 4 units of cloth for 4 units of wine Exchange rate is 1 to 1. Wine Cloth England 5 6 (available goods =11) Portugal 12 4 (available goods =16) Total goods produced is still 27 but each country is better off than before trade and both are better off than before “efficiency”

Assumptions of Ricardo’s Theory • assumes static givens in a country’s economy • and doesn’t discuss technology as a factor of production. • labor theory of value • What about technology, etc.? David Ricardo 

Krugman defends Ricardo and wins Nobel Prize ….. “Ricardo’s difficult idea” Krugman noticed that the accepted model • economists used to explain patterns of international trade did not fit the data. The Hecksher-Ohlin model predicted that trade – would be based on such factors as the ratio of capital to labor, with "capital-rich" countries exporting capital-intensive goods and importing labor-intensive goods from "labor-rich" countries. Mr. Krugman noticed that most international • trade takes place between countries with roughly the same ratio of capital to labor. The auto industry in capital-intensive Sweden, for – example, exports cars to capital-intensive America, while Swedish consumers also import cars from America.

Free Trade leads to growth in Exports which leads to economic development

Sum: Effects of Free Trade • Efficiency  Growth  Good life for everyone • Harmonious International Relations • Role of the State: To let producers produce most efficiently—to separate politics and economics: • the key actors are firms and consumers, not states. • Commerce  Peace Why? • Efficiency should be the basis of all political relations • Does Free Trade make the state obsolete?