Chapter 6: J.S. Mill and the Decline of Classical Economics

Questions for Review, Discussion and Research

1, 2, 3, 5, 10, 11

Overview of John Stuart Mill

Tremendous intellectual powers

A social philosopher intent on improving the role of the individual in society

Addressed broader issues of political economy

his contribution was to simultaneously make:

A mature statement of classical school

Initiate a new era of economic thinking

Believed his task was to write a lucid exposition of the Ricardian doctrine and incorporate it into the contemporary ideas of the mid – 1800's

Contemporary Critique of Ricardo

Disparity between doctrine and the empirical evidence of the mature stages of the industrial revolution.

Critique of labour theory of

value treatment of

consumer theory role of capital profits

in the determination of output prices

Humanist and socialist writers rejected the assumption of social harmony. They attacked the classical vision of a market-oriented society in capitalists were the key actors and benefactors.

Nassau Senior

Foundations of economics as a science rested on “self-evident” principles

1. People are rational, use economic calculus in discussion-making and seek to acquire wealth with a minimum of sacrifice

2. Malthusian population doctrine

Discredited by mid 1830’s

Nassau Senior Cont’d

3. Doctrine of diminishing returns in agriculture and other renewable resource sectors failed to foresee an acceleration of technological improvements

4. Principle of historically increasing returns in the industrial sector

pp. 164

Senior’s Theory of “Normal” Profits

Improved logical consistency of value theory by including capital costs.

Developed an abstinence theory of interest

Senior’s value theoryI. Placed more emphasis on

utility on the demand side of output markets

II. Disutility viewed as a real cost of production

Approach of J.S. Mill to Economics

“Pure” economics was a hypothetical science using the a priori method

One makes valid assumptions and the deduces conclusions

Social scientists can not use the inductive method as experimentation is not available

Made clear distinction between

I. Laws of production that cannot be changed by human will or institutional arrangements

II. Laws of distribution that result from social institutions and custom

Approach of J.S. Mill to Economics Cont’d

Overhead pp. 167-68 Read pp.168-73 on your

own Believed his task was to

write a lucid exposition of the Ricardian doctrine and incorporate it into the contemporary ideas of mid 1800’s

Influence of Richard Jones

Forerunner of British historical school

Questioned proposition that Ricardian theory was for all times and places

Advocated empirical approach in accounting for changes in structure of institutions

Emphasized the role of custom (ie. tradition)

Criticism of Ricardo

1. Disparity between doctrine and the empirical evidence from evolving nature of the industrial revolution in G.B.

2. Critique ofI. Labour theory of valueII. Treatment of consumer

demandIII. Role of capitalist profits in

the determination of output prices

Humanist and socialist writers rejected assumptions of social harmony. They attacked the classical vision of a market-oriented society on which capitalist

Mill’s Methodology

Correct the logic of an economic model to make certain that the conclusions followed from given assumptions

Influence of Comte – The founder of sociology – leads Mill to regard “pure” economics as just one discipline within social sciences

Role of Economic Theory in Mill’s Writings

Overhead pp. 175 Used Smithian

techniques of contextual analysis where economic phenomena is only part of all social activity

Mill’s Value of Theory

The purpose of value theory is to explain relative prices in input and output markets

Gave up Ricardian search for absolute value based on invariant measure of value

Mill’s Value of Theory Cont’d

Similar to Senior’s cost of production theory of value where monetary costs represent

I. Real costs of disutilityII. Abstinence theory of

interest in savings – investment process

III. Rent is a social cost of production when land has alternate uses

Mill’s Value of Theory Cont’d

Long-run theory of prices can be represented with a Marshallian, partial equilibrium format and summarized as follows

Price of output almost always depends on the cost of production rather than consumer utility (Figure 6-1)

A. Prices in manufacturing and service sectors (Panel B) Constant costs

Mill’s Value of Theory Cont’d

B. Use value determines exchange value in market transactions of (Panel A)

I. WineII. Rare books, coins,

stamps, art, etc.III. Site value of urban land

C. Intermediate case (Panel C) of agriculture and renewable resources where diminishing returns results in increasing costs and rising LRS

Overhead pp. 178

Original Contributions

1. Theory of non-competing groups in labour market

2. Prices for joint outputs1. Sheep: Mutton and

wool2. Cattle: Beef and hides

3. Rent is Price determining when land has alternate use

4. Economies of scaleOverhead pp. 178

International Trade Theory

Ricardo demonstrated potential gains in aggregate terms but did not show

1. How prices are determined in exchange

2. Distribution of benefits Mill did both by assuming

that the terms of trade depend on the consumer demand

International Trade Theory Cont’d

Set stage for mathematical and geometrical presentations by Marshal and Edgeworth

Mill’s other contribution include

1. Consideration of transportation costs

2. Influence of tariffs Theory only challenged

by Ohlin and Keynes in the 1930’s

Defense of Say’s Law

Two types of economies would never have an insufficiency of aggregate demand

I. BarterII. Monetary system

wherea) Money is a

commodityb) Money’s only

function is a medium of exchange

c) No credit

Temporary disequilibrium and oversupply when money functions as a store of value and credit markets operate

Overhead pp. 181

Mill’s Monetary Theory

Modification of Ricardo’s strict gold standard and quantity theory

Fell betweenI. Currency school

Sought to prevent inflation through strict adherence to gold standard

Necessary during periods of speculative financial booms

Predecessors were Bullionists

II. Banking school Predecessor was Real

Bills Doctrine that sought flexible money supply

Correct during “normal” times

Recantation of Wage Fund Doctrine

The wage ratio is not conclusively predetermined but has a range of possible levels