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Marxist Economics
David L. Prychitko, Economics Professor at Northern Michigan University, The Concise Encyclopedia of Economics

Labor Theory of Value (1) The labor theory of value is a major pillar of traditional Marxian economics, which is evident in [Karl] Marxs masterpiece, Capital (1867). The theorys basic claim is simple: the value of a commodity can be objectively measured by the average number of labor hours required to produce that commodity. (2) If a pair of shoes usually takes twice as long to produce as a pair of pants, for example, then shoes are twice as valuable as pants. In the long run, the competitive price of shoes will be twice the price of pants, regardless of the value of the physical inputs
Karl Marx

(3) Labor power is the workers capacity to produce goods and services. Marx, using principles of classical economics, explained that the value of labor power must depend on the number of labor hours it takes society, on average, to feed, clothe, and shelter a worker so that he or she has the capacity to work. Suppose five hours of labor are needed to feed, clothe, and protect a worker each day so that the worker is fit for work the following morning. If one labor hour equaled one dollar, the correct wage would be five dollars per day. (4) Marx then asked an apparently devastating question: if all goods and services in a capitalist society tend to be sold at prices (and wages) that reflect their true value (measured by labor hours), how can it be that capitalists enjoy PROFITSeven if only in the short run? How do capitalists manage to squeeze out a residual between total revenue and total costs? (5) Capitalists, Marx answered, must enjoy a privileged and powerful position as owners of the means of production and are therefore able to ruthlessly exploit workers. Although the capitalist pays workers the correct wage, somehowcapitalist makes workers work more hours than are needed to create the workers labor power. If the capitalist pays each worker five dollars per day, he can require workers to work, say, twelve hours per daya not uncommon workday during Marxs time. The bottom line: capitalists extract surplus value from the workers and enjoy monetary profits Alienation (6) Marx believed that people, by nature, are free, creative beings who have the potential to totally transform the world. But he observed that the modern, technologically developed world is apparently beyond our full control. Marx condemned the FREE MARKET, for instance, as being anarchic, or ungoverned. He maintained that the way the market economy is coordinatedthrough the spontaneous purchase and sale of private property dictated by the laws of SUPPLY and DEMANDblocks our ability to take control of our individual and collective destinies.

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(7) Marx condemned capitalism as a system that alienates the masses. His reasoning was as follows: although workers produce things for the market, market forces, not workers, control things. People are required to work for capitalists who have full control over the means of production and maintain power in the workplace. Work, he said, becomes degrading, monotonous, and suitable for machines rather than for free, creative people. In the end, people themselves become objectsrobotlike mechanisms that have lost touch with human nature, that make decisions based on cold profit-and-loss considerations, with little concern for human worth and need. Marx concluded that capitalism blocks our capacity to create our own humane society (8) Marx predicted that competition among capitalists would grow so fierce that, eventually, most capitalists would go bankrupt, leaving only a handful of monopolists controlling nearly all production. This, to Marx, was one of the contradictions of capitalism: competition, instead of creating better products at lower prices for consumers, in the long run creates MONOPOLY, which exploits workers and consumers alike. What happens to the former capitalists? They fall into the ranks of the proletariat, creating a greater supply of labor, a fall in wages, and what Marx called a growing reserve army of the unemployed. Also, thought Marx, the anarchic, unplanned nature of a complex market economy is prone to economic crises as supplies and demands become mismatched, causing huge swings in business activity and, ultimately, severe economic depressions. (9) The more advanced the capitalist economy becomes, Marx argued, the greater these contradictions and conflicts. The more capitalism creates wealth, the more it sows the seeds of its own destruction. Ultimately, the proletariat will realize that it has the collective power to overthrow the few remaining capitalists and, with them, the whole system. (10) The entire capitalist systemwith its private property, money, market exchange, profit-and-loss accounting, labor markets, and so onmust be abolished, thought Marx, and replaced with a fully planned, self-managed economic system that brings a complete and utter end to exploitation and alienation. A socialist revolution, argued Marx, is inevitable. Questions: 1. What does Karl Marx believe about the role of government in the economy?

2. What does Karl Marx believe about the actions the government can take to fulfill that role?

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Adam Smith
Why Adam Smith is important (1) Adam Smith (1723-1790) was a Scottish philosopher and economist who is best known as the author of An Inquiry into the Nature and Causes of the Wealth Of Nations (1776), one of the most influential books ever written. The old view of economics (2) In Smiths day, people saw national wealth in terms of a countrys stock of gold and silver. Importing goods from abroad was seen as damaging because it meant that this wealth must be given up to pay for them; exporting goods was seen as good because these precious metals came back. (3) So countries maintained a vast network of controls to prevent this metal wealth draining out taxes on imports, subsidies to exporters, and protection for domestic industries. The same protectionism ruled at home too. Cities prevented artisans from other towns moving in to ply their trade; manufacturers and merchants petitioned the king for protective monopolies; labour-saving devices were banned as a threat to existing producers. The productivity of free exchange (4) Smith showed that this vast mercantilist edifice was folly. He argued that in a free exchange, both sides became better off. Quite simply, nobody would trade if they expected to lose from it. The buyer profits, just as the seller does. Imports are just as valuable to us as our exports are to others. Because trade benefits both sides, said Smith, it increases our prosperity just as surely as do agriculture or manufacture. A nations wealth is not the quantity of gold and silver in its vaults, but the total of its production and commerce what today we would call gross national product. (5) The Wealth of Nations deeply influenced the politicians of the time and provided the intellectual foundation of the great nineteenth-century era of free trade and economic expansion. Even today the common sense of free trade is accepted worldwide, whatever the practical difficulties of achieving it. Social order based on freedom (6) Smith had a radical, fresh understanding of how human societies actually work. He realised that social harmony would emerge naturally as human beings struggled to find ways to live and work with each other. Freedom and self-interest need not produce chaos, but as if guided by an invisible hand order and concord. And as people struck bargains with each other, the nations resources would be drawn automatically to the ends and purposes that people valued most highly.

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(7) So a prospering social order did not need to be controlled by kings and ministers. It would grow, organically, as a product of human nature. It would grow best in an open, competitive marketplace, with free exchange and without coercion. (8) The Wealth Of Nations was therefore not just a study of economics but a survey of human social psychology: about life, welfare, political institutions, the law, and morality. The psychology of ethics (9) It was not The Wealth Of Nations which first made Smiths reputation, but a book on ethics, The Theory Of Moral Sentiments. Once again, Smith looks to social psychology to discover the foundation of human morality. Human beings have a natural sympathy for others. That enables them to understand how to moderate their behaviour and preserve harmony. And this is the basis of our moral ideas and moral actions. Self-interest and virtue (10) Some people wonder how the self-interest that drives Smiths economic system can be squared with the sympathy that drive his ethics. Here is his answer: How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. (11) In other words, human nature is complex. We are self-interested, but we also like to help others too. Smiths books are complementary: they show how self-interested human beings can live together peacefully (in the moral sphere) and productively (in the economic). (12) The Wealth Of Nations is no endorsement of economic greed, as sometimes caricatured. Self-interest may drive the economy, but that is a force for good provided there is genuinely open competition and no coercion. And it is the poor that economic and social freedom benefits most. Questions: 1. What does Adam Smith believe about the role of government in the economy?

Adam Smith

2. What does Adam Smith believe about the actions the government can take to fulfill that role?

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F.A. Hayek
Library of Economics and Liberty. http://www.econlib.org/library/Enc/bios/Hayek.html (1) Most of Hayeks work from the 1920s through the 1930s was in the Austrian theory of BUSINESS CYCLES, capital theory, and monetary theory. Hayek saw a connection among all three. The major problem for any economy, he argued, is how peoples actions are coordinated. He noticed, as ADAM SMITH had, that the price systemfree marketsdid a remarkable job of coordinating peoples actions, even though that coordination was not part of anyones intent. The market, said Hayek, was a spontaneous order. By spontaneous Hayek meant unplannedthe market was not designed by anyone but evolved slowly as the result of human actions. But the market does not work perfectly. What causes the market, asked Hayek, to fail to coordinate peoples plans, so that at times large numbers of people are unemployed? (2) One cause, he said, was increases in the MONEY SUPPLY by the central bank. Such increases, he argued in Prices and Production, would drive down INTEREST RATES, making credit artificially cheap. Businessmen would then make capital investments that they would not have made had they understood that they were getting a distorted price signal from the credit market. But capital investments are not homogeneous. Long-term investments are more sensitive to interest rates than short-term ones, just as longterm BONDS are more interest-sensitive than treasury bills. Therefore, he concluded, artificially low interest rates not only cause INVESTMENT to be artificially high, but also

F.A. Hayek

cause malinvestmenttoo much investment in long-term projects relative to short-term ones, and the boom turns into a bust. Hayek saw the bust as a healthy and necessary readjustment. The way to avoid the busts, he argued, is to avoid the booms that cause them. (3) Hayek and Keynes were building their models of the world at the same time. They were familiar with each others views and battled over their differences. Most economists believe that Keyness General Theory of Employment, Interest and Money (1936) won the war. Hayek, until his dying day, never believed that, and neither do other members of the Austrian school. Hayek believed that Keynesian policies to combat UNEMPLOYMENT would inevitably cause INFLATION, and that to keep unemployment low, the central bank would have to increase the money supply faster and faster, causing inflation to get higher and higher. Hayeks thought, which he expressed as early as 1958, is now accepted by mainstream economists (see PHILLIPS CURVE) (4) In the late 1930s and early 1940s, Hayek turned to the debate about whether socialist planning could work. He argued that it could not. The reason socialist economists thought central planning could work, argued Hayek, was that they thought planners could take the given economic data and allocate resources accordingly. But Hayek pointed out that the data are not given. The data do not exist, and cannot exist, in any one mind or small number of minds. Rather, each individual has knowledge about particular resources and potential opportunities for using these resources that a central planner can never have. The virtue of the FREE MARKET,

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argued Hayek, is that it gives the maximum latitude for people to use INFORMATION that only they have. In short, the market process generates the data. Without markets, data are almost nonexistent (5) In 1944 Hayek also attacked socialism from a very different angle. From his vantage point in Austria, Hayek had observed Germany very closely in the 1920s and early 1930s. After he moved to Britain, he noticed that many British socialists were advocating some of the same policies for government control of peoples lives that he had seen advocated in Germany in the 1920s. He had also seen that the Nazis really were National Socialists; that is, they were nationalists and socialists. So Hayek wrote The Road to Serfdom to warn his fellow British citizens of the dangers of socialism. His basic argument was that government control of our economic lives amounts to totalitarianism. Economic control is not merely control of a sector of human life which can be separated from the rest, he wrote, it is the control of the means for all our ends. (6) In 1950 Hayek became professor of social and moral sciences at the University of Chicago, where he stayed until 1962. During that time he worked on methodology, psychology, and political theory. In methodology Hayek attacked scientismthe imitation in social science of the methods of the physical sciences. His argument was that because social science, including economics, studies people and not objects, it can do so only by paying attention to human purposes. The Austrian school in the 1870s had already shown that the value of an item derives from its ability to fulfill human purposes. Hayek was arguing that social scientists more generally should take account of human purposes. His thoughts on the matter are in The CounterRevolution of Science: Studies in the Abuse of Reason. In psychology Hayek wrote The Sensory Order: An Inquiry into the Foundations of Theoretical Psychology. Questions: 1. What does F.A. Hayek believe about the role of government in the economy?

2. What does F.A. Hayek believe about the actions the government can take to fulfill that role?

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John Maynard Keynes


The Concise Encyclopedia of Economics. http://www.econlib.org/library/Enc/bios/Keynes.html (1) o influential was John Maynard Keynes in the middle third of the twentieth century that an entire school of modern thought bears his name. Many of his ideas were revolutionary; almost all were controversial. KEYNESIAN ECONOMICS serves as a sort of yardstick that can define virtually all economists who came after him. (2) Keynes was born in Cambridge and attended Kings College, Cambridge, where he earned his degree in mathematics in 1905. He remained there for another year to study under ALFRED MARSHALL and ARTHUR PIGOU, whose scholarship on the quantity theory of money led to Keyness Tract on Monetary Reform many years later. After leaving Cambridge, Keynes took a position with the civil service in Britain. While there, he collected the material for his first book in economics, Indian Currency and Finance, in which he described the workings of Indias monetary system. He returned to Cambridge in 1908 as a lecturer, then took a leave of absence to work for the British Treasury. He worked his way up quickly through the bureaucracy and by 1919 was the
John Maynard Keynes

Treasurys principal representative at the peace conference at Versailles. He resigned because he thought the Treaty of Versailles was overly burdensome

for the Germans

(3) Keynes became a celebrity before becoming one of the most respected economists of the century when his eloquent book The Economic Consequences of the Peace was published in 1919. Keynes wrote it to object to the punitive reparations payments imposed on Germany by the Allied countries after World War I. The amounts demanded by the Allies were so large, he wrote, that a Germany that tried to pay them would stay perpetually poor and, therefore, politically unstable. We now know that Keynes was right (4) In the 1920s Keynes was a believer in the quantity theory of money (today called MONETARISM). His writings on the topic were essentially built on the principles he had learned from his mentors, Marshall and Pigou. In 1923 he wrote Tract on Monetary Reform, and later he published Treatise on Money, both on MONETARY POLICY. His major policy view was that the way to stabilize the economy is to stabilize the price level, and that to do that the governments central bank must lower INTEREST RATES when prices tend to rise and raise them when prices tend to fall. (5) Keyness ideas took a dramatic change, however, as UNEMPLOYMENT in Britain dragged on during the interwar period, reaching levels as high as 20 percent. Keynes investigated other causes of Britains economic woes, and The General Theory of Employment, Interest and Money was the result.

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(6) Keyness General Theory revolutionized the way economists think about economics. It was pathbreaking in several ways, in particular because it introduced the notion of aggregate demand as the sum of consumption, INVESTMENT, and government spending; and because it showed (or purported to show) that full employment could be maintained only with the help of government spending. Economists still argue about what Keynes thought caused high unemployment. Some think he attributed it to wages that take a long time to fall. But Keynes actually wanted wages not to fall, and in fact advocated in the General Theory that wages be kept stable. A general cut in wages, he argued, would decrease income, consumption, and aggregate demand. This would offset any benefits to output that the lower price of labor might have contributed. (7) Why shouldnt government, thought Keynes, fill the shoes of business by investing in public works and hiring the unemployed? The General Theory advocated deficit spending during economic downturns to maintain full employment. Keyness conclusion initially met with opposition. At the time, balanced budgets were standard practice with the government. But the idea soon took hold and the U.S. government put people back to work on public works projects. Of course, once policymakers had taken deficit spending to heart, they did not let it go. (8) Contrary to some of his critics assertions, Keynes was a relatively strong advocate of free markets. It was Keynes, not ADAM SMITH, who said, There is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them. Keynes believed that once full employment had been achieved by FISCAL POLICY measures, the market mechanism could then operate freely. Thus, continued Keynes, apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before (p. 379). Questions: 1. What does John Maynard Keynes believe about the role of government in the economy?

2. What does John Maynard Keynes believe about the actions the government can take to fulfill that role?