(M) 8/19/2013 10:21:00 AM
Tried to illustrate the change from the Guild system of production to
Factory system of production (Industrial Revolution)
o The Pin Factory metaphor gave Smith the opportunity to hone
in on that huge macro transformation. Dealing out a very
specific example to then apply to broader contexts.
Arrival of factory system in the national economy and
taking over of guild system.
The Wealth of Nations was written to show that the
factory system was a) more efficient, and b) more
Not necessarily agreeing with Smith, but he has had a huge
influence in the way economists approach the developing world.
Reference to Social Cost hints at an economist in the Adam Smith
o Main Idea: Market-based solutions are superior to
o Main Question: What are the costs of a certain action? And
who will bear the cost?
Tax on consumers? Tax on Producers?
If you can devise a market-based solution, you want to complete
the action at minimal cost to society, so extra resources can be
diverted to addressing another need.
o The market-based solution: Assigning property rights
Gets rid of need to create vast bureaucracy
The more bureaucracy, the more you leave a society
available to economic corruption.
o Final outcome would be the same despite who had to bear the
cost of an action.
Market-based approaches come at less of a cost to society than any
other approach. Superiority of market-based approaches to guild
system or any other system.
A. Krueger o Hidden cost of corruption is that it incentivizes families not to
invest savings in improvement of production, but in the
acquisition of bureaucratic jobs.
Reversal of cost and effect
Corruption arises as a means to address a certain
regulation of economic performance.
Sometimes arises because regulation of economic
performance confers corruption.
Accepted the notion of market failure and it happened all the time.
Much of his writing had the Great Depression as its background:
General Theory of Employment, Interest and Money was published
The Depression was a low-level trap in an industrial economy.
o Markets are not self-correcting/self-improving.
o Government intervention is not a “social cost”; i.e.
o Low level trap in developing countries especially requires
government intervention, but not permanent involvement.
Examples of Market Failures:
o Full Employment, Education, Healthcare, Environment,
Infrastructure, Business Cycle (including depressions).
Business Cycle – Keynes was aware of the dangers of inflation as
o Prophetically warned that requirements of German
reparations following WWII might cause level of inflation that
would wipe out Germany‟s middle class and set the stage for
o Called for a lowering of reparation requirements.
o Favored orderly sustainable growth.
1950s and 60s
World divided into four different schools of public thought
o Orthodox (18 C.): Based in Adam Smith and David Ricardo.
Assumes that low-level trap will come to an end. Relevant to advanced industrial societies with good
economic performance; i.e. high rates of growth and
Principal emphasis that government intervention makes
o Keynesian (1930s): Dealt with industrial societies in the low-
level trap. Shares basic supposition of market failure with
Relevant to industrial societies performing poorly
Principal emphasis: vital role of government in
That government can stabilize the business cycle and
achieve a “high level trap.”
o Development Economics: About countries in the third-world
doing poorly. Shares basic supposition of market failure with
Keynesian Economics. One reason it thrived is because it had
the intellectual legitimization of the Keynesian School.
Development means changing over from an agricultural
economy to an industrial Economy „The Great
Agriculture as a percent of GDP is going down.
Involved shrinking of the agricultural sector, not
about shrinking the amount of agricultural
products being produced.
Development Economics is about enabling societies to
reach a time when they can go through „The Great
Taking a society which is overwhelmingly agricultural
and moving them into an industrial situation.
Best way to attain „The Great Transformation‟ is to
invest in industrialization.
Efficiency of capital is greater if it is invested in
the industrial sector.
o Agricultural Economics: 80% of the population is involved in
agriculture. The biggest obstacle to small-holder farmers is climate. The impact of policy on well-being is much smaller
than the impact of climate on well-being.
Use of “production functions” to demonstrate marginal
Government Policy Instruments- to apply shock therapy to stagnant
o Budget surpluses
o Budget deficits
o Money supply
o Interest rates
Deflation occurs when interest rates go too low.
o Exchange rates
Period of rapid economic growth: danger of inflation that might
wipe out the middle class.
o 1. Fiscal Policy
Tax revenues would rise and a government should run
budget surpluses; i.e. not spend the additional
This would lower aggregate demand and reduce risk of
o 2. Monetary Policy
Raise short-term interest rates: this would choke off
borrowing and lower demand.
Contract the money supply: this would lower demand
and counter the tendency to rising prices.
Raise the reserve requirements on banks; i.e. lower the
amount of money banks can lend out.
The Low-Level Trap
o 1. Budget Deficits
When an economy is in recession, government revenues
drop; government should continue to spend at constant
levels, thereby injecting a demand stimulus
o 2. Government Programs Unemployment Compensation; people continue to have
some earnings when they lose their jobs so they can in
turn spend on material consumption.
Welfare programs; people continue to have income.
Boost economy in such a way that it favors the industrial sector. (W)- Review 8/19/2013 10:21:00 AM
Why did the Industrial Revolution take place in Western Europ