Smith (cont.) and Ricardo

Justice in Political Economy: The Market, Free Trade and Comparative

Advantage

The Theoretical “Freedom” Vision

Reason Individualism

Political Liberalism

Individual Freedom

Happiness

Capitalism Wealth and natural freedom

____

Hobbs Locke Rousseau

John Stuart Mill Thomas Jefferson

Locke Mill Jefferson

Adam Smith

1780 Last Witch burned in Europe 1784 American Society to Abolish Slavery 1787 British Society to Abolish Slavery 1792 Wollstonecroft “Vindication of Rights of Women

Review: Competition (production side)

• Natural self-interest makes us ruthless…….

• Competition, not protest dampens effects of greed..no need for integrity

• Competition lowers price and raises quality

• But Producers always try to find a way around competition

Consumer

Who gets what? Through competition society gets what it wants

• Producers must heed society’s demands

Justice: Who gets what and who says?

• :What do they do? They govern production, distribution and consumption of goods and services of an economy.

• At one extreme, if competition is chosen, production is carried in a private-enterprise system such that all resources are privately owned. It was described by Adam Smith as frequently promoting a social interest, although only a private interest was intended.

• At the other extreme, if equal distribution is chosen, socialist or-communist system, such that all resources are publicly owned with intent of minimizing inequalities of wealth among other social objectives".[2]

• Market economy (the basis for several "hands off" systems, such

as capitalism). • Mixed economy (a compromise economic system that incorporates

some aspects of the market approach as well as some aspects of the planned approach).

• Planned economy (the basis for several "hands on" systems, such as socialism, or a command economy).

• Traditional economy --a communalist ethos, (Holmes)—primitive communism

Distribution

Consumer Demand

Production

Supply (production) is driven by demand for Consumer products: justice is served when society gets what it wants through market freedom

competition

Price

Consumption

The Consumer

What is Justice in the production of goods?

• goods worth more than they cost to produce get produced, goods worth less than they cost to produce do not;

• In a perfectly competitive private property system, producers pay the value of the inputs they use when they buy them from their owners and pay the value of labor from the workers

• That value is determined by overall demand and supply conditions in the market

• Producers receive the value of what they produce when they sell their goods. If a good sells for more than it costs to produce--because it is demanded by consumers, the producer receives more than he pays and makes a profit;

• if the good sells for less than it costs to produce (low demand) he takes a loss. So goods that should be produced are produced

• and goods that should not be produced are not.

What is justice in the distribution of goods?

• The Decision Rule for Distribution and for how we should treat each other in economic society: Freedom

• The Market Model:

– Markets arise spontaneously – Distribution is impersonal and takes place through exchange – Distribution is voluntary and non-coerced – All parties to exchange will benefit – Coordination in allocation without coercion – Private Property is respected and required – Value is determined by price—market value – The state should have a minimal role

• Effects: Freedom, Efficiency, Growth, and Social Welfare

Price as information about whether

justice is done • Price is determined by supply-demand ratio

• no “just price” but rather a “market price” • Price is information upon which free choice is

made

Digression on Price and Value

• From intrinsic value to labor value to exchange –market--value

• Value is expressed as price

Who does NOT decide what economic justice is? The State!

• Smith’s Doctrine of “Laissez Faire” • But Smith was not opposed to some government

intervention in society – Protection against violence and invasion – Exact administration of justice—to protect competition

and private property – Creation of public institutions—public works (public goods)

• The Big Enemy is not the state but rather state monopolies and collusion that distorts the market!

“People of the same trade seldom meet together, but the conversation ends in a conspiracy against the public, or in some diversion to raise prices.”

Who DOES decide? The Market

• The market is self-regulating

• The Market is it’s own “guardian”

• It is the paragon of “freedom” but the strictest taskmaster

• Is Economic freedom an illusion?

Example: Is the Illegal Drug Trade unjust?

• In an ideal economic system, goods worth more than they cost to produce get produced, goods worth less than they cost to produce do not;

• In a perfectly competitive private property system, producers pay the value of the inputs they use when they buy them from their owners

• and receive the value of what they produce when they sell it. If a good sells for more than it costs to produce, the producer receives more than he pays and makes a profit;

• if the good sells for less than it costs to produce he takes a loss. So goods that should be produced are produced

• and goods that should not be produced are not.

Demand for illegal drugs is High and steady

Supply is abundant…..production costs low… processing is specialized

Distribution

Consumption

Production

Market is large. Should price be high or low in a perfect competitive market for cocaine?

Illegality represses demand and supply, raising the price

Repressed demand distorts prices

• Hard-to-get drugs means demand is high but supply is restricted

• Raising the price artificially • Producers are rational….. So……. • High prices encourage production

So It’s rational to produce cocoa…..

Corn: $150 per acre Livestock: few $ per acre Cocoa: $5-10,000 per acre

What crop would a rational farmer grow?

And rational to sell it…..

Distribution

Consumption

Production

Ricardo’s Theory of Comparative Advantage

Specialization +

Trade

Production without specialization and division of Labor

Wine Cloth

England 3 5 (Total production =8)

Portugal 9 6 (Total production=15)

Total goods produced = 23

Production with specialization but before trade

• Before Trade: Resources put where they are most efficient (specialization)

Wine Cloth

England 1 10

Portugal 16 0

Total goods produced = 27 note: efficiency increases total number of goods available

With Specialization and Trade

Wine Cloth

England 5 6 (available goods =11)

Portugal 12 4 (available goods =16)

Total goods produced is still 27 but each country is better off than before trade and both are better off than before “efficiency”

England trades Portugal 4 units of cloth for 4 units of wine Exchange rate is 1 to 1.

Assumptions of Ricardo’s Theory

• assumes static givens in a country’s economy • and doesn’t discuss technology as a factor of

production. • labor theory of value • What about technology, etc.? David Ricardo

Krugman defends Ricardo and wins Nobel Prize ….. “Ricardo’s difficult idea”

• Krugman noticed that the accepted model economists used to explain patterns of international trade did not fit the data.

– The Hecksher-Ohlin model predicted that trade would be based on such factors as the ratio of capital to labor, with "capital-rich" countries exporting capital-intensive goods and importing labor-intensive goods from "labor-rich" countries.

• Mr. Krugman noticed that most international trade takes place between countries with roughly the same ratio of capital to labor.

– The auto industry in capital-intensive Sweden, for example, exports cars to capital-intensive America, while Swedish consumers also import cars from America.

Free Trade leads to growth in Exports which leads to economic development

Sum: Effects of Free Trade

• Efficiency Growth Good life for everyone • Harmonious International Relations • Role of the State: To let producers produce most

efficiently—to separate politics and economics: • the key actors are firms and consumers, not

states. • Commerce Peace Why? • Efficiency should be the basis of all political

relations • Does Free Trade make the state obsolete?