History of Economic Thought I

/Econ 3141/

By: Aklilu Abebe (MSc.)

Dilla University, 2022

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 1. Introduction
 Course objectives
 The main objective of this course is to provide students

with a general picture of the development of economics

until the emergence of MARGINALIST thinking.

 The course demonstrates the contributions of

mainstream thinkers and deviants from the orthodoxy of
this era in shaping contemporary economic thought.

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 History of Economic thought in light of the
subject matter of Economics
 Economics is a social science that examines the problems of relative
scarcity societies face in material requisites of life.
 Scarcity arises because of the desire to consume more goods and
services than are available or because of unlimited wants and limited
resources.
 To mitigate the problem of scarcity, three directions were pursued
 restrict wants (by inducing moral restraint on demand) or

 increasing the supply of resources (through discovery of new

sources or through increasing productivity and output)

 Installing a social mechanism for allocating limited resources

among unlimited alternative wants.

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 Introduction cont’d
 whichever way scarcity is addressed with the first two
directions ,the third (social mechanism) was necessary to
determine
 Who gets and who does not get resources.

 Which want gets satisfied and which does not

 Historically we identify four social mechanisms: Brute force,

Tradition, Authority, Market
 Regardless of which mechanism is used to allocate

resources, the harsh reality of scarcity necessitates that

some wants among the alternatives remain unmet.
 History of economic thought charts the development of

economic thinking about the various economic problems

of coping with scarcity through ages.
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Introduction cont’d
History of economic thought Versus economic
history
 Economic history tells us about the various

economic activities, in contrast to economic

thinking.
 Economic History is an objective study of the
development of economic life of a particular society.
 It studies the origin and growth of commerce,
manufacturing, trade, banking, transportation and
other economic phenomena and institutions.
 History of economic thought consults economic
history to understand and interpret economic
thinking in the past and present.
 In short, Economic History treats of facts; History of
Economic Thought treat of the theory of these facts.
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 Introduction cont’d
 The central focus of modern economic thought
 Modern economic theory examines the problems of

allocation , distribution, growth and stability (analyzes the

various ways in which contemporary societies cope with the problems
that flow from relative scarcity)
 The theories on the problems associated with relative scarcity
are commonly divided into micro and macro economics.
 Micro economics considers questions of allocation and

distribution (ideas about what to produce and how to produce, how

real income and goods are divided among the members of society).
 Macroeconomics considers questions of stability (issues of

business cycles, inflation and unemployment) and growth.

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 Introduction cont’d
 Modern economic theory focuses largely on market
processes of allocating resources . This economics is known as
mainstream or orthodox economic thinking.
 Although the mainstream modern economics (orthodox
economic thinking), focuses on the use of markets to cope
with the problems associated with relative scarcity , some
economists are interested in broader philosophical issues ,
straddling disciplines within social sciences such as between
economics and political science, between economics and
sociology etc.
 This economics is sometimes called heterodox economic
thinking.

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 Introduction cont’d
 Differences between Orthodox and Heterodox
economists mainly lie in the questions they try to answer.
 Orthodox thinking
 Assumes specific social, political and economic

institutions (free and competitive market at its best, democratic

politics , sovereign and rational individual consumers, respect for the
as given and studies
rule of law and private property, etc)
economic behavior in the context of these institutions
 focuses on the problems of market allocation,
distribution, stability and growth in the context of the
assumed specific institutions.

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 Introduction cont’d
 Heterodox thinking
 Focuses on forces leading to the development of the

institutions in society (Note that these institutions are assumed as

given in the orthodox economics, meaning that it is not the interest of
Orthodox economics to study how they come and go)
focuses on the forces that produce changes in society
and the economy, given the functioning of markets and
other forces.
 The differences are often differences of focus i.e. what
one tries to explain is taken as given by the other.

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 Introduction cont’d
Scope of History of Economic Thought
 The scope of History of Economic Thought is very wide.
 It includes the study of human ideas from the time man
started formulating and expressing them down to the
present times.
 It also include a study of the various approaches adopted
by scholars and philosophers from time to time in tile
study of the science of economics or in analyzing
economic phenomena.

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Introduction cont’d
The rationale for studying HET
 Providing perspective and understanding of our
past as contributed by various schools with no
monopoly of the truth by a single source
 Guarding oneself from irresponsible
generalizations
 Enhancing ones understanding of contemporary
economic thought
 Anticipate changes in the future

Origin …. Progress …. future

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 Introduction cont’d
Questions to be asked in studying HET

 What was the historical background of the school? Or the

pushing-Dhiibuu factors behind
 What were the basic tenets/views of the school?
 Whom did the school benefit?
 How was the school valid, useful, or correct in its time?
 Which tenet of the school became long lasting
contribution?

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 1.2 Methodology of economics
 The methodology of economics defines what economists
know, and extends to defining how they know that they
know it!

 Economics is both a science and art.

 It is a science in its methodology (theories and models)
and an art in its application (of various models and
theories in to reality).
 As a science economics is both a positive and normative
science.

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 Methodology in economics : What
economists know and how they know
that they know it
 What economists know” has remained as an important
point of distinction in methodological differences among
economists.
 What economists know:
 how the economy works (positive economics )

The aim of economics is to know how the economy works

 how the economy should work (normative
economics )
The aim of economics is to know how the economy should work
 how to mix the two above (the art of economics)
 Knowing how the economy works and given the normative goals,
the aim of economics is to know how best to achieve these goals

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 Methodology in economics Cont’d

 Positive economics
 The methodology of positive economics is formal and abstract.

 It tries to separate economic forces from political and social forces

 It poses economics as a science rather than art

 Normative economics
 relies on ethical judgments on what is best for society

 It integrates economics with ethics

 The art of economics

 The methodology of the art of economics concerns policy, mixing

positive and normative economics.

 It addresses interrelationships among politics, social and

economic forces.

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 1.3 Overview of schools of thought
 Classical economics is dated from the publication
of the Adam Smith’s Wealth of Nations in 1776.
 The period of Pre classical economics (the period
before 1776) is divided in to two parts:
 an early pre classical period before 1500AD &

 A pre classical era between 1500 and 1776

 The first part of the period includes the economic ideas of the
Ancient Hebrews, Greeks, Romans, and the Medieval
Economics of the Scholastics
 The second part includes the Mercantilists and the
Physiocrats

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 The general themes of Pre classical
economic thinkers

 Reflected on aspects of their Economic lives and focused

on non- market allocating mechanisms
 Focused on general philosophical questions of
fairness, justice and equity.
 Ancient Greek and Roman Economic ideas was dominated
with Economic ideas in connection to concerns for justice,
fairness, equality and non market methods of resource
allocation
 Medieval (scholastic ) economic ideas were concerned with
reconciling the philosophy of the ancient classical philosophers
with medieval Christian theology and provide religious
guidelines to be applied to secular activities with a general
orientation to non market methods of resource allocation

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 Merchantilism and Physiocracy
 Mercantilism is a body of economic doctrine reflecting the
interest of the mercantile capitalist, giving dignity and
importance to the merchant and trade , characterized by its
promotion of nationalism, a strong government and
justification of a policy of economic and military expansion,
which is a manifestation of the less importance attached to
market forces.
 Physiocracy was a reaction to Mercantilism and feudalism
in France characterized by its emphasis on agriculture and
laissez faire, an advance in economic thinking towards the
recognition of the role of the markets

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 The Classical school
 Classical thinking fully developed:
 the role of markets
 value and distribution theories
 the importance of all economic resources and
activities
 as fundamental assumption of self interested
economic behavior as basic to human nature
 Statements on various “economic laws”

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 The German Historical school
 Emphasized
 the role of government and the protection of infant
industries from competition
 Evolution of economies and the corresponding
policies
 Inductive and the historical method

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 The Socialist school
 Socialist thinking Opposed and repudiated the classical
concept of laissez-faire, the market mechanism of
capitalism as doomed to periodic crisis or general
stagnation and denied the concept of self interested
actors and advocated collective action and collective
property.

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 Marginalist school
 Opposed socialism, trade unionism, and government
intervention stating that, although the value and
distribution theories of the classical economists were
inaccurate, their policy views were correct.
 Thus the marginalists defended market allocation and
objected to government intervention.

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 2. Pre classical Economic
thought
2.1. Hebrew, Greek and Roman economic
ideas
The Hebrews
 The Hebrew was a nation of ancient civilization whose history dates
back to 2500 B.C.
 The economic ideas of the Hebrew prophets as expressed in their
commands and laws can be summarized as follows:
 Usury or Interest:
 Although the prophets did not use the term ‘interest’; they

prohibited the “usury of money, usury of victuals, and usury of

anything that is lent upon usury.”
 If the thing accepted in return was more in value than what was

given to the borrower, it was considered to be an act of usury.23

 The Hebrews
 Commerce and Just price:
 Hebrews exercised great care in formulating laws against false
weight measures and adulteration of articles of consumption. The
rules for curbing monopoly and speculation were even stricter.
 The export of food was prohibited and in times of scarcity and
famine, hoarding of food grains was not permitted. Retailers’ profits
were fixed. All these provisions aimed at safeguarding the interest of
the poor. Thus, the Hebrews developed the basic concept of a just
price in its rudimentary form.
 Labour:
 The Hebrews regarded all kinds of labour as dignified, but the pride
of place was given to agricultural labour.
 Payments were mostly in kind.

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 The Hebrews
 Agriculture and Industry:
 The saying goes that, “He that tilleth the soil shall have plenty of
bread.” “In the Jewish Encyclopaedia agriculture was the basis of the
national life of the Israelites: State and Church both being founded
upon it.”
 It is, thus, clear that their laws were conducive to the growth of
agriculture while they discouraged industry and trade.
 Seventh and Jubilee Years:
 The seventh year was one in which the land lay fallow, i.e., after
tilling it for six consecutive years, the land was not to be cultivated
for one year. The Hebrews even attached some religious sanctity to
this measure but in the mean it was designed to conserve the
fertility of the soil.

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Greeks
 The Greeks were the first to develop an economic
theory
 Credit goes to Plato for paying some attention to the
economic aspects of social organization.
 The Greek philosopher, who really laid the foundation
of economics as a science, was Aristotle.
 Like the Hebrews, the Greeks too considered
agriculture as most desirable occupation.

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Greeks
 Xenophon (400BC)
 coined the word Oeconomicus- efficient management at the
level of the household
 discussed efficiency at the household, the producer, the
military and the public administrator level.
 Discussed efficiency and division of labor

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Greeks
 Plato (427-347 B.C.)
 The ruling class should not possess private property.
 The necessity of division of labor based on the best natural
ability for efficiency. By ‘division of labour’ he simply meant
the division of employments or professions as an aid to
social organization/Communism.
 He thought of money as a symbol devised for the purpose
of facilitating exchange, the value of which is on principle
independent of the stuff it is made of. (Cartal theory)
 Plato considered value as an inherent quality of the product.
 As regards interest, he thought that neither interest should
be given nor the principal or a loan repaid.

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Greeks
 Plato Cont’d …
 Like the Hebrews, the Greeks in general and Plato in
particular, too considered agriculture as most desirable
occupation.
 Plato decried riches as well as poverty. To him riches made
a man indolent and careless, while poverty led to
inefficiency

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 Greeks
 Aristotle (384-322 B.C.)
 According to Aristotle the origin of the State is to be explained not
in terms of economic needs and their satisfaction, but as an
outcome of the natural instinct of man to associate with his fellow
beings. Man is a social animal and the State is a creation of
nature. There were three stages in the development of the State.
First, people organized themselves in a household, then came the
village and last of all the State.
 There should be no regulation to limit private property. Property
should be private, unlike Plato. But also condemned the pursuit of
economic gains- didn’t hate the use of it common

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 Greeks
 Aristotle Cont’d…
 Aristotle’s ideas regarding division of labour were more or less the
same as those of Plato. Like Plato, he believed in class distinctions
and accepted ‘slavery’ as a natural institution.
 According to Plato, value was an inherent quality of the
commodity, while Aristotle held that the value of a commodity
depended upon its usefulness. Values in commodities can be
compared through the intensity of wants. The greater the
intensity of want for a commodity, the more will be paid for it
(Metallist theory).
 While money serves as a medium of exchange, it cannot be
regarded as productive. Aristotle argued that as one piece of
money could not produce another, interest was unjust.
Condemned interest, as usury, on the ground that money is a
medium of exchange the value of which does not change as it
crosses hands.

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 Greeks
 Aristotle Cont’d …
 Agriculture is the most desirable occupation.
 Like Plato, Aristotle also believed that poverty was the breeding
ground of revolution and crime. He was also opposed to too much
concentration of wealth.
 Scarcity can be addressed by reducing consumption, by changing
human attitudes (the basis for utopians and socialists hopes of
eliminating conflicts that are inherent in scarcity and self interested
behavior )
 Promoted the idea of Justice in price (Commutative justice) as
equivalence of what a man gives and receives.
 Defined monopoly as a single seller and condemned it as unjust.

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 The Romans
 The Roman period was characterized by the absence of
analytic work in spite of expanded economic activities,
markets and administrative concerns
 The probable cause could be the structure of
the Roman society which might not allow
analytic works by a class of people who could see such an
engagement as their vocation rather than avocation
 What is recognized from this period is the importance of
Roman law that recognizes private property and commerce.

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 2.2 Scholasticism and Medieval Economic ideas
 Scholastic writers were educated monks who tried to
provide religious guidelines to be applied to secular
activities
 Scholasticism originally began to reconcile the philosophy of
the ancient classical philosophers with medieval Christian
theology.
 Scholasticism is not a philosophy or theology in itself, but a
tool and method for learning.
 It puts emphasis on dialectical reasoning.
 The primary purpose of scholasticism was to find the answer to a
question or resolve a contradiction.

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 Scholasticism
 Historical context of the school
 Market was not playing a dominant role in everyday life
 There was feudal, subsistence agriculture
 Society was bound together by tradition, custom and
authority (not by market)
 Land, labor and capital were not market commodities as they
are today.
 Main themes of the school
 Scholastic writing represented a gradual acceptance of certain
aspects of economic activity as compatible with religious doctrine.
 This acceptance was achieved by subtle modifications of that
doctrine to fit the economic conditions
 Fusion of religious teaching with writings of Aristotle

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 Development of Value theory under
scholasticism

 Albertus Magnus :planted in western thought the notion that

value in exchange must comply with cost of production (labor and
expenses)
 Thomas Aquinas (Albert’s Pupil) introduced need, human wants,
in to value theory marking the earliest root of an analytical
demand theory of value. The notion roughly meant amount
desired in relation to what is available (demand in relation to
scarcity)
 Henry of Friemar introduced aggregation and scarcity notion
of value where value is determined by the common need of
something scarce (roughly sketching market demand for scarce
thing as the determinant of value of the thing)
 Jean Buridan took the scholastic notion of human want to a
concept much closer to the modern concept of effective demand

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 Value theory and the scholastics cont’d
 All through the middle ages value theory continued to pose the two
competing concepts of labor and demand theory as explanations of
value.
 The school initiated the debate, which took more than half a
millennium period to solve, on cost of production theory of value and
utility based theory of value which ended with Alfred Marshall’s
Synthesis about the beginning of the 20th century.
 The concept of the Just price of scholastics taken from Aristotle has
left behind differences in interpretation
 Just price equivalent to labor cost?
 Just price equivalent to utility?
 Just price equivalent to total cost of production?
 Just price equivalent to the prevailing market price?
 The harsh scholastic view on USURY gradually moderated from fairly
strict prohibition to its acceptance, at least to business purposes.

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 Examples of Scholasticism
St. Thomas Aquinas and later Medieval thought.
 In an attempt to reconcile religious doctrine with the institution

of private property and with economic activity he argued

against those teachings and beliefs condemning private
property, wealth and the pursuit of economic gain.
 In his argument, although Communal property accorded with

natural law as exemplified by Jesus and his disciples, he

maintained that private property is an addition not a
contradiction to natural law..
 But advocated poverty and communal living for those

committed to religious living as ideal.

 Aquinas and others focused on the ethical aspect of prices

(equity and justice)

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 2.3. Mercantilism
 The body of economic doctrine known as mercantilism, appeared
between the Middle Ages and the period of the triumph of Laissez-
Faire. It came with the ascendance of the mercantile capitalist and
trade in western Europe.
 It was characterized by its promotion of nationalism, giving dignity and
importance to the merchant, justification of a policy of economic and
military expansion, belief in gold and silver as the most desirable form
of wealth, emphasis on export and restriction on import in the interest
of the mercantile capitalist.
 The historical background of the mercantilist school
 The self-sufficiency of the feudal community gave way slowly to trade and
higher interdependence,
 Merchants interceded between the small scale producers and consumers,
and merchant capitalists were becoming key figures in the world of
business
 Cities became increasingly important
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 The historical background cont’d

 The use of money expanded.

 New sources of gold discovered, which facilitated the growing
volume of commerce and stimulated theorizing about precious
metals.
 The development in Navigation and great geographical discoveries
expanded the sphere of commerce.
 National states were rising and expanding their sphere of influence
and colonies, which intensified the rivalry between Nations.
 Under these circumstances a body of mercantilist doctrine evolved
 superseding the feudal concepts, dignifying the merchant,

promoting Nationalism and justifying a policy of economic and

military expansion, aiming at the accumulation of bullion of gold
and silver as the most desired form of wealth.

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 Major tenets of Mercantilism
 Gold and silver as the most desirable form of wealth
 Emphasis on export, duty-free importation of raw materials
and protection of internal manufactures
 Opposition of internal tolls, taxes and restrictions on internal
movement of goods
 Nationalism and Beggar-thy- neighbor- policy ( i.e in order
to be rich you must make your neighbor poor)
 Colonization and monopolization of colonial trade
 Strong Central government
 Emphasis on large, hardworking population

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 Major Tenets cont’d
 Gold and silver as the most desirable form of wealth
 Mercantilists tended to equate the wealth of a nation with the
amount of gold and silver bullion that it possessed. All of them
valued bullion as the ways to achieve power and riches.

 Mercantilism is known for its emphasis on exports and

restriction on imports (the fear of goods).
 Duty free importation of raw materials that could not be produced
domestically, protection for manufactured goods and raw materials
that could be produced domestically , and export restriction on raw
materials

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 Major Tenets of the school
 Opposed to internal tolls and taxes and other restrictions on the
internal movement of goods,
 They recognized that tolls and taxes could

 bottle neck business activities and enterprise

 drive up the prices of the country’s export
 Removal of internal tools and taxes and exports all stood in the

interest of the merchant.

 In mercantilism the interest of the merchant took precedence over

those of domestic consumers.

 Merchants received inflows of gold in return for their exports that

were kept cheap by the above mechanisms, while the restrictions

on imports reduced the availability of goods for consumption at
home.
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 Major Tenets of the school
 Nationalism
 Mercantilists believed that there was a fixed quantity of
economic resources in the world; one country could
increase its resources only at the expense of another.
 Therefore one’s own country should promote its exports
and accumulate wealth at the expense of its neighbors.
 Only a powerful nation could compete successfully in
international trade, dominate trade routes, win wars
against rivals, capture and hold colonies.

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 Major Tenets of the school
 Colonization and monopolization of colonial trade
 keeping colonies eternally dependant upon and subservient to
the colonizer to maintain cheap raw material sources and
importers of manufactured goods.
 colonies were not allowed to import from places other than the
colonizer;
 colonies were curbed or outlawed or not allowed to
manufacture their own
 exports from colonies had to first visit colonizers port before
they move to the final destination.

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 Major Tenets of the school
 Strong Central Government
 Mercantilists promoted a strong central government as it
was a means to achieve mercantilist goals of
 colonization,
 securing privileges of monopoly in foreign trade,
 restriction of new entry to businesses at home,
 regulation of methods of production and the quality of export
goods to maintain reputation,
 removal of excessive tolls and taxes in internal trade goods,
 Restriction of imports and promotion of export etc.

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 Major Tenets of the school
 Sizable industrious Population
 Mercantilism promoted a sizable industrious population that
 provide an abundance of soldiers and sailors ready to fight
for the glory and wealth of the nation
 and also to keep labor supply high and wages low.( Idleness ,
begging, theft were punishable by maim and death)

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 Whom did Mercantilists Benefit?
 The doctrine benefited the merchant capitalist, the Kings, and
the government officials
 Some historians of economic thought suggest that mercantilism
can best be understood as an extreme example of rent seeking
behavior
 Here Rent seeking activities simply mean attempts by

private parties to increase their profits by securing favorable

laws and regulations from governments
 The laws took the form of

 grants of monopoly status

 Prohibition of imports
 Entry barriers for new producers

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 How Valid, Useful and correct was the school
in its time ?
 The arguments for bullion , although exaggerated, made sense in
that transition period from middle ages to money and credit
economy of modern times.
 Before the development of international finance and multilateral trade
bullion was of major significance in making international payments.
 Mercantilists were also aware that the influx of precious metals made tax
collection easier.
 They knew that prices would rise or at least would not fall if the
quantity of money increased as trade expanded.
 Not only was the volume of output expanding , but also the self sufficient
household was being drawn in to the market economy and therefore
more money was needed to buy and sell same volume of output.
 Some Mercantilists were also aware that increase in the amount of
gold and silver ni circulation reduced interest rates and promoted
business.

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 Which contribution of the school were lasting
contributions?
 Direct contribution
 Emphasis on international trade and laying the basis for the notion

of the balance of payments

 The macro economic concept that actual output could be lower

than Potential output as a result of imports and domestic demand

deficiency might have served as the intellectual root for Keynesian
economics
 Indirect contribution to economics and economic
development
 They permanently influenced the attitude toward the merchant

 They promoted nationalism, which was necessary for regulations

needed for maintaining uniform weights, measures, coinage, etc;

When financial risks of trade were high providing monopoly
privileges were necessary to induce more risk.
 It helped European economy to transform by bringing in new

products and creating selling outlets for manufactured goods, by 50

 Thomas Mun
 Thomas Mun (British mercantilist) who Lived between 1571-
1641 was a merchant in Italian and near east trade and later
was elected as a director of the East India company.
 Because he was involved in the controversy over the
company’s policy of exporting gold, he published a tract in its
defense.
 He argued that as long as the total export exceeded total
imports , the drain of species from a country in any one trade
area did not matter.

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 Thomas Mun
 A chapter in an exposition of the mercantilist doctrine by Mun
that was written around 1630 and published in 1664, entitled “
the means to enrich the Kingdom, and increase our treasure”
states
 that the means lay neither in production nor in the accumulation
of capital goods, but rather in a surplus of exports.
 Although England was rich, it could be still richer if it used waste
land to grow hemp, flax, lumber, tobacco and other things which
now we fetch from strangers to our great impoverishing.
 Exports should be carried in English ships to gain insurance and
freight charges.
 Argued for multilateral trade than bilateral trade and analyzed
England’s overall balance of trade rather than its separate account
with each foreign country.

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 Thomas Mun
 His emphasis on importing treasure led to the strange
conclusion that trade at home could not enrich a country.
 “ we may exchange either amongst ourselves or with strangers; if
amongst ourselves the Commonwealth cannot be enriched
thereby; for the gain of one subject is a loss for another. And if we
exchange with strangers, then our profits is the gain of the
Common wealth.”

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 Other Mercantilists
 Jean Baptiste Colbert (French mercantilist)
 Gerard Malynes (Belgian born from English family )
 Charles Duvenant (British)
 Bernand Mandeville (British)
 Sir William Petty (British)
 Favored freer trade
 Favored taxation of imported goods
 Favored gentle dealing with imported raw materials
 Opposed laws prohibiting the export of money
 Favored large population

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 4 The Physiocratic school
 Physiocracy is the collective name of those economic principles
and policies which developed in France during the 18th century.
 Economic thinkers who contributed to the growth and
development of physiocracy have been designated as physiocrats.
 The term physiocracy means the rule of nature.
 The Physiocrats appeared in France toward the end of the
Mercantilist epoch around 1756 and ended in 1776
 The influence of the physiocrats lasted well beyond the two
decades during which they led the world in economic thinking.
 Physiocracy was a reaction to Mercantilism and feudalism in
France.

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 Physiocracy
The historical background of the school
 The detailed government regulation of production became a fetter to
improvement in manufacturing and impedance to satisfaction of
changing consumer tastes.
 French industry was retarded by imposed local tolls taxes and tariffs
that impeded the movement of goods.
 French agriculture was burdened by taxes on land and profits of
farming that was enforced by landed nobility. Incentives for
individuals to accumulate wealth and expand investment were
seriously impaired.
 For centuries the authorities subjected the grain trade to a severe
regulations. The freedom enjoyed by other trades were denied to
grain trade.
 Merchant and crafts guilds (groups) impeded (supplemented) the free
entry of labor into certain occupations, restricted and regulated
output, fixed prices and opposed competition.
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 Major tenets of Physiocracy
 Natural Order
 Laissez faire

 Emphasis on agriculture

 Taxation on land owner

 Inter relatedness of the economy

 The physiocrats introduced the concept of natural order to

economic thinking, i.e., the idea that the laws of nature govern
human societies just as those discovered by Newton govern
the physical world.( Natural order)
 In the economic sphere the laws of nature conferred to the
individual the natural right to enjoy the fruits of their labor,
provided that such enjoyment was consistent with the rights of
others.

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 Major tenets of the school

 Governments should never interfere in economic affairs

beyond the minimum required to maintain freedom of contract
and the protection of life and property.(laissez faire – let the
people do as they please without government interference)
 Industry trade and the professions were useful but sterile ,
simply reproducing the value consumed in the form of raw
materials and subsistence for the workers, while agriculture
was productive because it produces a surplus, a net product
above the value of the resources use in production.(Emphasis
on agriculture)

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 Major tenets of the school
 Emphasis on taxation of the land owner
 Because only agriculture produced surplus, which the land owner
received in the form of rent, only the land owner should be taxed.
 Although all taxes imposed on others would be passed on to the
landowner anyway ( indirect taxes), directly taxing the land owner
(direct tax) was preferable to indirect taxes as they were increasing
when they were passed along to others.
 The economy was believed to be interdependent and the
circular flow of goods and money was analyzed. “Tableau
economique”(economic table) of Quesnay was a table that
traces spending, revenue received, by farmers, landlords,
manufacturers and merchants.

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 Whom did the school benefit or seek
to benefit
 Peasants ultimately would gain from the ideas of the
physiocrats.
 Businesses would gain from the removal of the of all
restrictions on production and the movement of goods
 The doctrine of laissez faire promotes industry though
it was not the intensions of the physiocrats.
 Physiocrats favored capitalist farms.
 A single tax to all land in production would benefit the
landlords.

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 Usefulness, validity or correctness
of the school in its time
 Industry was an activity that was extremely low in productivity
and appeared to be sterile as compared to agriculture that has
sometimes bountiful (plentiful) harvest.
 By emphasizing agriculture they departed away from
the mercantilist thinking of only commerce creates and
augments wealth.
 The school emphasized production rather than exchange
as a source of wealth.
 The support for direct tax was a valid reaction to the cascaded
indirect taxes that corroded the society at the time.

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 Lasting contribution of the school

 Physiocrats laid a foundation for economics to be a

social science by examining society as a whole and analyzing
the laws that governed the circulation of goods and wealth,
which were the precursor(pre indicator) of the flow and
national accounts concepts of the modern time.
 The law of diminishing returns actually originated from
the physiocrats( particularly Turgot)
 Physiocrats originated the idea of tax shifting and
incidence
 Through the idea of laissez faire, they directed attention to the
analysis of the proper role of governments in the economy.

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 Physiocrats
 Francios Quesnay
 Hoped to transform the king to enlightened despot (educated
ruler).
 Expressed that small farms were incapable of the most productive
method, and favored large farms managed by entrepreneurs.
 Analogous to the natural organism and conforming to the natural order,
the circulation of wealth and goods in the economy was like the
circulation of blood in the body.
 Laws made by people should be in harmony with natural laws.
 Constructed Tableau Economique, which was the first systematic
analysis of the flow of wealth. A.Smith. K. Marxs and M. keynes, who
later on also described the economy in terms of large aggregates, paid
tributes to Quesnay.
 Quesnay’s Tableau Economique foreshadowed national income analysis
and the modern circular flow of wealth and goods. It was also the
predecessor of the input- output analysis of Leontief.
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Francios Quesnay cont’d
 Regarding rent, he believed that nature, not the worker,
produced the surplus and hence the land lord has the right to the
surplus product.
 Quesnay defended the interest of the land lord but landlords
took his proposal of taxing only the land lords as an attack on
their interests.
 Quesnay argued against excess luxury in the way of decoration,
and preferred spending on raw materials.
 Quesnay’s thinking had medieval flavor in his glorification of
agriculture, in fixing of the interest rate by government,
in favoring the “Just price”. However, he believed the free
market rather than regulation by authority would best
achieve the “Just price”

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 Anne Robert Jacques Turgot
 Turgot pointed out that self-interest is the prime mover of the
process, and that individual interest in the free market must always
coincide with the general interest. He said that in line with the
principles of 5 , the government would not be expected to oversee
every operation in a market, as it would also be unnecessary and
too expensive.
 He pointed out that on a free market, there will always be a
cheating merchant and a duped consumer, but then the cheated
customer will learn and cease to frequent the cheating merchant,
who will fall into discredit and thus will be punished for his
fraudulence.
 Turgot’s theory of production followed the physiocrats – only
agriculture is productive, so there should be a single tax on the
land.
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 Turgot cont’d …
 Also, one of Turgot’s contributions to economics was his brilliant and
almost off-handed development of the laws of diminishing returns.
 He was able to pint out that increasing the quantity of factors raises
the marginal productivity until a maximum is reached, after which the
marginal productivity falls, eventually to zero, and then becomes
negative.
 Turgot pointed out that wealth is accumulated by means of consumed
and saved annual produce. Furthermore, he said that the capitalist-
entrepreneur must first accumulate saved capital in order to advance
their payment to labourers while the product is being worked on.

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