True or False?

"When I give food to the poor, they call me a saint.
When I ask why the poor have no food, they call me a communist".

Patience serves as a protection against wrongs as clothes do against cold. For if you put on more clothes as the cold increases, it will have no power to hurt you. So in like manner you must grow in patience when you meet with great wrongs, and they will then be powerless to vex your mind.

Sunday, January 20, 2008

Classical versus Neoclassical Economics: Is there a difference/overlap of ideas and issues that they use to develop models of International Trade?

Classical economics The dominant theory of economics from the 18th century to the 20th century, when it evolved into NEO-CLASSICAL ECONOMICS. Classical economists, who included Adam SMITH, David RICARDO and John Stuart Mill, believed that the pursuit of individual self-interest produced the greatest possible economic benefits for society as a whole through the power of the INVISIBLE HAND. They also believed that an economy is always in EQUILIBRIUM or moving towards it. Equilibrium was ensured in the LABOR market by movements in WAGES and in the CAPITAL market by changes in the rate of INTEREST. The INTEREST RATE ensured that total SAVINGS in an economy were equal to total INVESTMENT. In DISEQUILIBRIUM, higher interest rates encouraged more saving and less investment, and lower rates meant less saving and more investment. When the DEMAND for labor rose or fell, wages would also rise or fall to keep the workforce at FULL EMPLOYMENT. In the 1920s and 1930s, John Maynard KEYNES attacked some of the main beliefs of classical and neo-classical economics, which became unfashionable. In particular, he argued that the rate of interest was determined or influenced by the speculative actions of investors in BONDS and that wages were inflexible downwards, so that if demand for labor fell, the result would be higher UNEMPLOYMENT rather than cheaper workers. (Economist.com http://www.economist.com/research/Economics/alphabetic.cfm?letter=C as visited on 01/20/2008) Neo-classical economics The school of ECONOMICS that developed the free-market ideas of CLASSICAL ECONOMICS into a full-scale model of how an economy works. The best-known neo-classical economist was ALFRED MARSHALL, the father of MARGINAL analysis. Neo-classical thinking, which mostly assumes that markets tend towards EQUILIBRIUM, was attacked by KEYNES and became unfashionable during the Keynesian-dominated decades after the second world war. But, thanks to economists such as MILTON FRIEDMAN, many neo-classical ideas have since become widely accepted and uncontroversial. (Economist.com http://www.economist.com/research/Economics/alphabetic.cfm?letter=N#neo-classicaleconomics as visited on 01/20/2008) Classical economics was oriented towards the advancement of the common interest as defined by the political institutions of the state, whereas neoclassicism is defined in a social and political vacuum. Furthermore, the former related realistically to an excess supply of labor, while the latter assumes full employment. These differences have significant implications for income distribution, accumulation, growth and development. Classical economists advocated free trade to increase domestic productivity and employment at stable or growing real wages. Contemporary globalization recreates the classical surplus labor economy to reduce domestic wage levels through moving domestic production from high to low wage areas around the globe. Free trade becomes necessary so that the goods produced abroad can be imported into capital exporting countries. However, without a corresponding growth of exportables, the trade balance must be adversely affected. Furthermore, adverse changes in income distribution diminish domestic demand for goods. The policy of globalization must become self-defeating. (Ingenta Connect http://www.ingentaconnect.com/content/imp/hpt/2000/00000021/00000003/19 as visited on 01/20/2008) NEO-CLASSICAL ECONOMICSWhile classical economics (Smith, Ricardo, Marx) was concerned withlong-run developments of economies as a whole, and in particular therelationship between the distribution of the economic surplus and thepattern of development, NEO-CLASSICAL value theory became essentiallya theory of the allocation of scarce resources in a static economy. Neo-classical utilised Ricardo's economic model to extend it and createthe MARGINALIST MODEL (the concepts of 'marginal utility' and'marginal productivity') to analyse the pricing of goods, services andfactors of production in competitive markets. The founders of theneo-classical system were J. M. Clark, F. Y. Edgeworth, I. Fisher,A. Marshall, V. Pareto, L. Walras and K. Wicksell They emphasized that the market prices of goods and factors were relatedto their scarcity. The neo-classical scheme is based on the idea ofa PERFECTLY COMPETITIVE ECONOMY IN EQUILIBRIUM. Prices of commodities, derived from individual rational maximizingbehaviour in the markets, distinguish NEO-CLASSICAL approach from bothCLASSICAL ECONOMICS and KEYNESIAN ECONOMICS. In common with many classical theorists the 19th century neo-classicaleconomists accepted that there exist market forces which tend tomaintain full employment. This contrast sharply with the Keynesian viewthat involuntary unemployment may exist even in spite of market forces. THE MAIN TENETS OF NEO-CLASSICAL ECONOMICS Three assumptions are made by neo-classical economists: a) supply creates its own demand, because it is assumed that prices behave in such a way that the value of all commodities produced is just equal to the value of expenditure on commodities as a whole. This notion is known as the Say's law (from a French economist, 1767-1832) b) market always clear. That is, they are always in equilibrium. Supply equals demand. c) both capital and labour create value. Therefore both capital and labour are "rightly" rewarded in the process of production. The relative mix of capital and labour will allow to treat economics as a set of mathematical equations forming 'the production function'. -from a), the conclusion is that there are no business cycles. Therefore, the economy is always in equilibrium and at full employment. Or, even better, any level of unemployment in the economy is "voluntary". People unemployed are those who do not want to work or do not accept a given level of wages. -from b), it follows that there is always a right price for everything, including factors of production (capital and labour) -from c) two conclusions: 1.- political: There is no contradiction between owners of capital and labourers, because both are fairly rewarded in the process of production. 2.- economic: wages and gross profits are the outcome of a mathematical equation which will fix the right values for them. There is no room, then, for having labour organizing trade unions to fight for higher wages. This is "unscientific". Moreover, the 'prices' of capital and labour are an outcome of twoseparate markets: the money market and the labour market The money market will clear the right supply of money consistent withthe right demand for money. Thus, the price of money, which will be'the interest rate', will become the PRICE OF CAPITAL. The labour market will clear the right supply of labour consistent withthe right demand for labour. Thus, the price of labour will be equalto the right level of wages for any economy. Owners of capital will invest as long as the rate of profits ishigher than the interest rate. Thus, if a central bank keeps theinterest rate low, more investment will occur, and economic growthwill follow. This model assumes NO INFLATION (because the money market will clearall the time). Assumes full employment, because if wages are too high less demand forlabour will follow as a "punishment by the market" against those whointerfere with it, creating "voluntary unemployment". Because neo-classical school assumes perfect competition, it deniesany role by the government (state) in the economy, except fiddling withinterest rate to protect rate of profits. Because wages and employment are determined by supply and demand, thegovernment does not have any role related to these economic variables. THE KEYNESIAN CRITIQUE In the 1930s, when the market system collapsed into dramatic rates ofunemployment (20-30 percent in the U.S. and Western Europe) and negativeeconomic growth, a British economist, J. M. Keynes, criticised theneo-classical school as follows: a) Say's law was an error, because production and consumption are the outcome of economic actions by different individuals. Keynes said that Say's law is only true in a society of one individual where supply and consumption will be about goods for USE and not goods for THE MARKET. b) in a national economy, aggregate demand is not homogeneous, because is made of: private consumption government consumption investment by business persons and international trade (exports minus imports) c) markets do not always clear, and there exist instances of overproduction and underproduction because supply is disorganized driven by individual efforts to maximize profits producing commodities for the market; d) the economy can reach equilibrium at any level of employment, therefore there can be periods of high unemployment with businesses not interested in investing more. Keynes developed an equilibrium condition defined as follows: If the sum of savings plus taxation plus imports EQUALS the sum of investment plus government expenditure plus exports, THEN, the national economy is in equilibrium and will tend to keep the corresponding level of national output (and level of employment) e) from the above it follows that in times of high unemployment, the government must manage aggregate demand utilizing two main tools: monetary policy and fiscal policy the government can manage aggregate demand as follows: 1.- Private consumption. Through reducing taxation more income will be in the hands of individuals, etc 2.- Government expenditure. Government investments in schools, hospitals, low-price dwellings, public transport and public utilities will increase private investment and push the economy to higher levels of employment. 3.- Investments and international trade. Through monetary policies such us 'managing' exchange rate and interest rates, and fiscal policies such as taxation and subsidies, the government could entice private businesses to invest more, and then, to export more. Therefore, Keynesian economics was about managing aggregate demandto boost employment and economic growth. All industrial countries adopted some form of Keynesian economicpolicies since 1940s until the 1970s. In the 1970s, suddenly, theprice of oil went up several times raising costs of production.The immediate effect was high levels of unemployment parallel tovery high rates of inflation. THE MONETARIST APPROACH Keynesian economics came under heavy criticism by some economists(M. Friedman, F. Von Hayek and others) who create a new school ofthought called "monetarism". The main tenet of this theory is that INFLATION IS A MONETARYPHENOMENON created by excess of money supply (money defined looselyas banknotes and coins in circulation plus credit). This is knownas the QUANTITY THEORY OF MONEY. Too much inflation, monetarists will say, stop businesses from investing, and, therefore, economic growth will slow down. The only role of the government, they say, was keeping inflationdown through controlling money supply, and, particularly, throughreducing government/state expenditures. Because of the above, government spending in welfare state, ineducation, in health, housing and public utilities should bereduced to nil. In order to do that, all those services should beprivatized. Thus the public sector borrowing requirement will bereduced to nil, another correct measure to put inflation down. Monetarist economics accepts all the neo-classical tenets aboutthe market, and, therefore, assumes that markets always clear. Because of the above, they see unemployment as VOLUNTARY. Moreover,they create the concept of NATURAL RATE OF UNEMPLOYMENT, which isthe rate of unemployment that occurs when the labour marketclears. This is rather comfortable, because technically, any rateof unemployment will appear as a 'natural rate'. In the last twenty years, a period of monetarist approach, with themarket taking over all sectors in the economy, one major indicatorof social welfare, unemployment, have been rising constantly, ata faster pace than employment, which worries industrialized societies. (The Robinson Rojas Archive. http://www.rrojasdatabank.org/bothec03.htm as visited on 01/20/2008)

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