ADAM SMITH I. Nature of Smiths Economic System A. combined a theory of nature and a theory of history B.

features of his central analysis 1. division of labor or specialization 2. analysis of price and resource allocation 3. nature of economic growth C. On Natural Law and Property Rights 1. Smiths main problem: the relation of the individual to the state, and the proper function of the state to its members or subjects 2. NATURAL LAW: reflected the mind of the Creator and must not be opposed 3. Divine government of the universe reacts on our political and economic problems the Invisible Hand 4. there is a natural harmony in the economic world that central planning should not disturb as government is always incompetent D. On Human Nature 1. HUMANS ARE SELF-INTERESTED: we are most concerned with our selves and we always work towards making our current condition better 2. competition ensures that self-interest will improve human welfare 3. Monopoly: represents uncontrolled self-interest and disrupts human welfare II. Theory of History A. self-interest, the development of property rights and division of labor contribute to economic growth B. History of Civilization 1. hunting no property rights 2. pastoral authority is established to protect the properties of the rich 3. farming feudalism and the serfs were all against the land barons 4. commercial came about from specialization self interest brings about societal changes changes in the right to property also contribute to the evolution of civilization institutional changes also change the power structure III. Microeconomic Foundations A. Smith focused on growth in national wealth/income sum of market values of final goods and services produced B. initiated a theory of value 1. trade only occurs when surplus occurs specialization yields surplus 2. money facilitates trade 3. proposed a value in use and a value in exchange as represented in his water-diamond paradox C. Labor as a measure of value

1. discussed a measurement of value (price) and a cause of value labor CAN MEASURE value; value in use contributes to the cause of value D. Price 1. money most common measure of value 2. looked into real and nominal prices highlighted real prices since the value of money changes over time 3. labor alone CANNOT explain market price only for labor-intensive economies can this happen because it is the main factor of production E. Market Price vs. Natural Price 1. Market Price determined by the interaction of demand and supply in the short run 2. Natural Price determined by long-run costs of production 3. Smiths effectual demand implies a downward-sloping demand curve 4. proposed a concept of demand elasticity 5. proposed that competition is the check and balance in the abuse of economic power 6. since market price must cover cost over the long run, then value is a function of the resource used in production 7. any form of price regulation imposed by the state keeps the market from going to equilibrium F. Wages-Fund Doctrine 1. that wages are advanced to workers in anticipation of the sale of their output 2. wages could not be increased unless capitalization allocated for wages will also increase 3. capital was determined by savings 4. in the short-run, there were a given number of workers and a given amount of savings to pay their wages these determine average wages 5. in the long run, the supply of labor was related to the subsistence wage if the wage rate rose above subsistence, population will increase the demand for labor was determined by the size of the wage fund and the wage fund was determined by the level of savings G. Factors that affect differences in wages 1. Wages vary in inverse proportion to the agreeableness of the employment 2. Wages vary in direct proportion to the cost of learning the business 3. Wages vary in inverse proportion to the constancy of employment 4. Wages vary in direct proportion to the trust that must be placed in the employees 5. Wages vary in inverse proportion to the probability of success H. Smiths Economic Growth 1. critical changes start at specialization/division of labor this leads to increases in productivity levels 2. greater output leads to higher wages which is easily translated into higher per capita income 3. higher incomes lead to higher levels of consumption which, when summed up, represent greater national income

4. high incomes lead to better propensities to save that will lead to capital accumulation