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Samenvatting The Economy - Economics (ECONOM01)
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ECON0002 notesUnit 1: The Capitalist Revolution
Economists
Adam Smith
Coordination between individuals on a large scale in order to allocate resources efficiently
can spontaneously occur due to individuals pursuing their own self interests.
‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our
dinner, but from their regard to their own interest,’
The invisible hand means that individuals acting in their own self-interest results in benefits
to everyone.
A significant source of prosperity is specialisation or the division of labour leading to much
greater production and then this effect is compounded by the expansion of trade as such a
large amount of goods require larger markets to be sold. This is a virtuous cycle as prosperity
leads to greater trade and greater trade encourages greater specialisation which leads to
greater prosperity.
He understood that the market system had failings and advocated for government
intervention, particularly to break up monopolies
Historical trends
A thousand years ago, the world was economically flat; there were big differences in income
within countries but barely any difference between countries.
Living standards did not experience any sustained growth until the 1800’s when the so called
hockey stick upturn can be observed – before this time most goods were produced by
families for families.
However, this growth started at different times in different countries leading to vast
differences in living standards around the world in the present day.
In some countries, the hockey stick upturn can be seen to occur after they acquired
independence from colonialist rule.
o India: Angus Deaton, when 300 years of British rule of India ended in 1947: ‘It is
possible that the deprivation in childhood of Indians … was as severe as that of any
large group in history’. In the closing years of British rule, a child born in India could
expect to live for 27 years. Fifty years on, life expectancy at birth in India had risen to
65 years.
o China: It had once been richer than Britain, but by the middle of the twentieth
century GDP per capita in China was one-fifteenth that of Britain.
o Latin America: Neither Spanish colonial rule, nor its aftermath following the
independence of most Latin American nations early in the nineteenth century, saw
anything resembling the hockey-stick upturn in living standards experienced by
other countries.
The hockey stick upturn coincided with the Industrial Revolution in Britain and other
western countries. It can be observed in trends of:
o Technological progress
o GDP
o productivity of labour (e.g. light per hour of work)
, o connectivity of the various parts of the world (the speed at which news travels)
o impact of the economy on the global environment (carbon emissions and climate
change)
o The amount of time required for producing most goods fell generation after
generation – increases living standards
Hockey stick upturn observed in the growth of communications, improvements in light
sources, labour productivity
At first natural resources were regarded as freely available in unlimited quantities, with the
only factor being the cost of extracting them. This was partly due to the low rates at which
people were using them.
As production soared, the use of natural resources and production of waste also soared
leading to a depletion of resources and a degradation of our natural environment.
This too follows the hockey stick upturn e.g. CO2 in the atmosphere, temperatures
However, technical progress can also be a solution by conserving natural resources e.g.
improvement in light sources has increased the amount of light produced per unit of heat
Countries differ in the effectiveness of their institutions and government policy and this
results in differences in outcomes from the capitalist revolution
Explanation
Capitalism: an economic system characterised by a particular set of institutions
Previously these institutions were: Private property, markets and family where most goods
were produced by families working together.
o The extent of private property varied over time, in some countries including land, in
others just cattle and in some even humans.
Or centrally planned systems where the government was the institution controlling
production and deciding how and to whom goods should be distributed.
In a capitalist economy an important kind of private property are capital goods – enable the
production of consumer goods
o Inputs and outputs are private property: The firm’s buildings, equipment, patents,
and other inputs into production, as well as the resulting outputs, belong to the
owners.
Markets are a means of transferring goods or services from one person to another and
encourage competition
o Firms use markets to sell outputs: The owners’ profits depend on markets in which
customers may willingly purchase the products at a price that will more than cover
production costs
The third institution that distinguishes the capitalist system from previous ones is the firm.
o Growth in the number of firms led to a boom in the labour market
o An important characteristic of the firm is how fast they can be created, expand and
then die.
o Firms can do this because they are able to hire additional employees on the labour
market, and attract funds to finance the purchase of the capital goods they need to
expand production.
Thus capitalism refers not to a unique system but to a combination of three economic
systems, the three institutions
How did capitalism lead to an increase in living standards?
, Technology: the permanent technological revolution coincided with the transition to firms as
the predominant means of organizing production. Firms competing with each other in
markets had strong incentives to adopt and develop new and more productive technologies,
and to invest in capital goods that would have been beyond the reach of small-scale family
enterprises.
Specialization: The growth of firms employing large numbers of workers—and the expansion
of markets linking the entire world in a process of exchange—allowed historically
unprecedented specialization in the tasks and products on which people worked.
o Learning by doing: We acquire skills as we produce things.
o Difference in ability: For reasons of skill, or natural surroundings such as the quality
of the soil, some people are better at producing some things than others.
When is a capitalist system less dynamic?
Private property is not secure: There is weak enforcement of the rule of law and of
contracts, or expropriation either by criminal elements or by government bodies.
Markets are not competitive: They fail to offer the carrots and wield the sticks that make a
capitalist economy dynamic.
Firms are owned and managed by people who survive because of their connections to
government or their privileged birth: They did not become owners or managers because
they were good at delivering high-quality goods and services at a competitive price. The
other two failures would make this more likely to occur.
If any of the three main institutions of the capitalist system aren’t working properly the
system won’t lead to long term growth in living standards.
Individuals and groups often have more to gain by spending time and resources in lobbying,
criminal activity, and other ways of shifting the distribution of income in their favour. They
have less to gain from the direct creation of economic value.
Monopolies: incentive for innovation and the discipline of prospective failure are dulled
o Also too-big-to-fail firms that know they will be bailed out by the government if
anything goes wrong
A certain level of government intervention is also necessary to establish, enforce and change
the rules and regulations that influence how the economy works.
o Resulting profits from innovation and ideas must be protected from theft by a well-
functioning legal system
o Property rights must be protected
o Adjudicate disputes over ownership
o Preventing or breaking up monopolies
Dynamic system when it combines:
Private incentives for cost-reducing innovation: These are derived from market competition
and secure private property.
Firms led by those with proven ability to produce goods at low cost.
Public policy supporting these conditions: Public policy also supplies essential goods and
services that would not be provided by private firms.
A stable society, biophysical environment and resource base:
, Calculations/Measures/Models
90/10 ratio: the average income of the richest 10% divided by the average income of
the poorest 10%.
o A measure of inequality
GDP per capita is used as a measure of living standards
o This is an average measure that does not account for inequality.
o It doesn’t include the value of unpaid work such as household chores and caring for
family members – work traditionally done by women
o Public goods and services are included in GDP but are difficult to value as they are
not bought or sold
o But: good for comparing over time or between countries as data is standardised
o GDP:
o Real GDP:
Disposable income: the amount of wages, profit, rent, interest and transfer payments from
the government (e.g. unemployment/disability benefits) or from others (e.g. gifts) received
over a given period such as a year, minus any transfers the individual made to others
(including taxes paid to the government)
o Doesn’t include: The quality of our social and physical environment such as
friendships and clean air.
o The amount of free time we have to relax or spend time with friends and family.
o Goods and services that we do not buy, such as healthcare and education, if they are
provided by a government.
o Goods and services that are produced within the household, such as meals or
childcare (predominantly provided by women).
o People also care about their relative position in an income distribution so their
happiness cannot be measured by disposable income alone.
Purchasing power parity (PPP): A statistical correction allowing comparisons of the amount
of goods people can buy in different countries that have different currencies.
o Takes account of different price levels and levels of inflation between countries
Growth rate: Calculated by dividing the change in income by the original level of income in
the base year you are measuring from
Price index: define base year zero and show changes in prices across economy
o
o
o Can be split to account for different individuals within the economy and weighted
o Total price index = (𝑃_𝑙𝑜𝑤) + (𝑃_ℎ𝑖𝑔ℎ)
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