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Economics 107 Final UCLA
for murphys class winter 10
Undergraduate 2

Additional Economics Flashcards




1) Rational Reconstructions
2) Cognitive Stabilities
3) Methodological Precepts
4) Complexity and new Thought
5) Smith's natural sytem of Liberty
The natural system of liberty is the thought that when all else (government, obligations, etc) is stripped out from society, humans will still have "just" behavior and a lower order of virtue. He goes farther to say that each person can pursue his own interest, yet be able to benefit the greater good of society without even knowing it.
6) Smith on "division of labor"
He thinks division of labor is unfulfilling to the worker. He says that a peasant on a farm leads a richer life than one who works in a factory only performing one function. The peasant is able to make multiple decisions during the day, while the factory worker mindlessly does his one duty.

However, he thinks that it's effective since division of labor lowers unit cost. It increases proficiency of workers in their task, saves time, and mobilizes machniery to further increase efficiency.
7) Smith on Capital
Real capital helps labor. Monetary capital finances labor during the production process. Capital extends the market.
8) Smith on "economic growth"
Economic growth is acheived through the division of labor, which will lower unit costs and expands the market, allowing for even more division of labor. With increasing wealth, new capital can be implemented to facilitate more labor to further extend the market. First prominent use of per capita consumption as an economic measure.
9) Smith on "welfare"
Economic welfare, or "ecfare", is the maximization of social benefit along with the desirable distribution of income. Smith's way of acheiving this is through growth of consumption and proper distribution of income. Welfare is acheived when the laboring poor are happy and comfortable.
10) "law of equal return"
People operating within the system of natural liberty will try to improve their well being, but the benefits they receive from different activities will be equalized. If workers from Germany find out there are higher wages in London, they will move there, but then with an increase in labor in London, the wage rate will decrease. In Germany, the wage rate increases since there is a decrease in labor, and workers will move back and forth between the two places until wages equalize. This idea leads to the idea of general equilibrium.
11) "labor theory of value"
Marx borrowed from Ricardo, not Smith.
Thinkers in 18th century were interested in finding
o absolute measure for value of commodities
o providing theories of relative value
Smith has three theories of value (influenced by Vico):
o labor theory of value - relative prices (deer and beaver)
o labor command theory - Cost of good is equal to quantity labor which can enable them to purchase or command
o cost of production theory
* major production costs = labor costs
* marginal costs of production determine relative prices, given that there are trivial/no labor costs & no land costs (fixed costs)
12) "cost of production theory of value"
* [P1/P2] = ([W1+P1+R1]/Q1) / ([W2+P2+R2]/Q2)
* relative prices determined by relative costs
* consistent with Marshallian equilibrium
* in terms of land, labor, capital during 18th-19th cent.
* now in terms of land, labor, capital, & management
* costs of management = in terms of "wages of superintendence"
* Management receives profit as rewards, Capital receives interest as rewards
13) Smith on Government
* education provided by marketplace = best, but gov't should provide education (depending on circumstances)
* ministers of dissenting religions who relied on parishioners' collections looked after parishioners better than Established Anglican Church clergy who had sinecures
* gov't should provide goods when marginal private benefits < marginal private costs BUT social benefits > social costs
* Three duties according to the natural system of liberty:
o a.) Protection against violence - government must provide defense of the country
# standing army > militia (funded by general revenues
# later saw militia as able to protect w/o severe abuses

o b.) Protection from injustice and establishing an administration for this.
o c.) Erecting and maintaining certain public works. (education/roads)
14) Smith on Taxes
* Five Principles
1. taxes should be economical (not costly to collect)
2. taxes should be convenient
* ex.: tax farmers after the harvest so that they are able to pay taxes
3. taxes should be moderate
4. taxes should be clear and certain
* taxpayers should know their obligations & be able to adjust to the burden of taxation in their own way
5. taxes should be proportionate to the ability to pay
15) Smith on Distribution
o distribution theory:
+ how wages, rents, interests, & profits are determined
+ relative shares of those factor returns in the Gross National Income
o not a strong area
o WAGES: complex, sometimes contradictory
+ wage fund theory of wages
# fixed amt. of money capital available for wage payment; determined by ratio of wages fund to labor force
+ productivity theory
# wages determined by relative productivities of labor
+ subsistence theory
# wages will drop to floor determined by how much laborers need in order to live & reproduce
+ residual claimant theory
# labor gets what is left over from the returns of selling commodities when all other claimants are paid.
+ bargaining theory
o RENTS: four theories of rent - Rents are:
+ determined by landlord's demand
+ are a monopoly return
+ due to differential advantages
+ due to the bounty of nature
o PROFITS: no distinction between wages & profits
+ workers must finance those who superintend them
16) The Adam Smith Problem
* Smith identified human action as being influenced by moral sentiments in Theory of Moral Sentiments but abandoned moral sentiments in The Wealth of Nations
* scholar & statesman to stand guard over the natural system of liberty while they themselves displayed behavior driven by moral sentiments
17) A first "classical situation"
18) Malthus's Principle of Population
* An Essay on the Principle of Population
* Early Basic Arguments (1st ed.):
o Population increases by a geometric progression
+ population would double every 15 yrs.
o Agricultural production increases only by an arithmetic progression
* (very Neo-Aristotelian) - makes self-evident truths about Nature, then deduces consequences of the assumed situations... and does this without empirically verifying such self-evident truths

* Problem with Early Arguments
o Real situation in agriculture: diminishing returns to scale
o economic development varies over time in accord w/ a logistic curve
o Powerful economic forces work to restrict population growth:
1. Opportunity cost of raising children
2. Higher survival rates
3. Wealth, Social Security = children aren't needed to provide for elders
4. Child Labor laws
5. Green Revolution --> flourishing agricultural productivity
6. Technology & mass marketing --> more effective contraception
* cycle of growth:
o dependence on population growth --> # people grow @ faster rate than subsistence grows --> same amt. of food shared among all people --> worsened living conditions for poor, huge labor surplus --> workers work more, due to lower labor costs --> time of distress = stagnant population --> cheap labor encourages more agricultural employment --> subsistence mean = initial population mean --> loosened population restraints --> encouragement for population growth --> etc. (repeat)
* Gloomy view was reinforced by doctrine of checks:
o Preventative Checks - lowered the birth rate
o Positive Checks - raised the death rate
* Classes of checks:
o Misery - came with famine
o Vice - contraception, infanticide, prostitution, and war.
19) Pinkerton on Malthus
* Sees Malthus as influential on many aspects of academics, but is too pessimistic and melancholy in his views
* Encourages people to probe further before believing Malthus' population theory
* CONCLUSION: Malthusians should read Malthus more closely & thoroughly because Malthus altered his views towards the end of his life.
o original belief =
+ "The power of population is indefinitely > the power in Earth to produce subsistence for man"
+ "Population (when unchecked) increases the geometrical ratio; subsistence only increases in arithmetical ratio"
o Later claimed that economic growth would also improve the prosperity of the populace
+ Though this was revision is more accurate, it is less remembered than the outrageous original assertion
20) Malthus Today
* forerunner in analysis of fluctuations in aggregate demand
o disagreed w/ Say's Law ("every supply --> own demand")
* model of 'economic development' = cyclical
o 'economies' stalled because of over/under-investment
* remedy for unemployment = public works & expenditures by landlords
* was first seen by Canaan & Schumpeter as unreasonable in his debates against Ricardo, but gained much more acclaim later on, thanks to the works of Leijonhufvud & Clower on Keynes + Malthus
21) Ricardo on Comparative Advantage
· Smith: distinction between absolute (natural) & comparative (some) advantage
· “the relative value of the commodities exchanged between two countries”
· comparative adv produces trade; absolute adv. = wealthy
· his explanation is linear (like cont. textbooks) but he considers given Q of output & the inputs needed to generate that Q (ex the same as Econ2 problem)
· Ricardo’s solution to TERMS OF TRADE: to put it midway between the 2 boundaries on graph
o Stuart Mill shows this is not correct later
· Faults with his theory today: professions are not so easily changed; assumed capital does not move; there were no large flows of labor between countries
22) Ricardo on "Stationary State"
· 3 factors of prod: land, labor, capital (land fixed, L&K in constant proportions, linear diminishing returns to increased amounts of L&K, wage=subsistence)
o Equilibrium: MPP = subsistence wage
-conclusions of the model
-as the need for food develops, rent to landlords will increase
-there will be a point where it is no longer profitable to add factors to a given farm.
-profits will fall to zero. the motivation for further accumulation of capital ceases.
· Ricardo does not believe that it is inevitable that Stationary State be achieved
o Natural gravitation to 0 profits is checked by tech. & science improvements
-a small but fertile country, particularly if it freely permits the importation of food, may accumulate a large stock fo capital without any great dimunition in the rate of profits, or any great increase in the rent of land.
23) Ricardo on law of equal return
24) Ricardo on Machinery
· 1811-16: Luddite Movement: wrecking textile machines
· Ricardo realize a labor displacing effect of machinery
· But it cannot be discouraged: if capital not allowed to get greatest net revenue, it will go to other countries abroad
o Machines create labor (if exporting it to another country, all labor demand lost), even if it decreases labor demand progressively
o Lowers cost of production so can sell goods abroad for a cheaper price
25) Why not a Ricardian "Classical Situation"
26) Mill on Comparative Advantage
· Great contribution to international trade; First to make a case for import surpluses
· Terms of trade between 2 countries determined by the relative demands of the 2 countries for imports
o Introduced transportation cost into analysis (could wipe out comparative advantage altogether)
o Analyzed effects of tariffs on the terms of trade
27) Mill on markets with inelastic supply
· Demand determines price (S is vertical, D goes through it)
· Use the case for monopoly analysis also
· Ex he used: rare books, site value of land, land as population density rose
- also look over graph
28) Mill on Industrial Markets
· Unit cost determines prices; unit costs are constant
· Manufacturing
· S curve is horizontal, D can shift
-also look at graph
29) Mill on Agricultural Markets
· Unit costs are increasing
- also look over graph
29) Mill on Agricultural Markets
· Unit costs are increasing
- also look over graph
29) Mill on Agricultural Markets
· Unit costs are increasing
- also look over graph
30) Nassau Senior
· Believed that “pure” political economists should stay out of politics
· 4 basic propositions: (repeat of Malthus)
o People are wealth maximizers
o We can understand population from Malthusian principles
o There are constant returns in industry
o Diminishing returns in agriculture
· Interest = factor payment from profit (interest = reward for ‘abstinence’)
31) Bentham
- "certain things have the property of creating happiness or unhappiness. The role of the govt should be to produce the greatest good of the greatest number." "happiness" -> utility
- his discussions:
1. remembered utility: utility that is reported in retrospective evaulations of past episodes.
2. cardinally measured utility. he believed that:
3. One person's utility was the same as any other person's
4. you could aggregate utility to arrive at total social utility
4. "pushpin is as good as poetry." - pretty much he doesn't give a shit if you choose to study econ tonight or go pluck your eyebrows if that's what makes you happy
32) Gossen's First Law
"for all goods the marginal utility eventually drops to zero or to satiation"
basically, MU will increase at an increasing rate (concavity: up), then increase at a decreasing rate (concavity: down), then decrease at a decreasing rate (concavity: down)
33) Gossen's Second Law
"is the assertion that an economic agent will allocate his or her expenditures such that the ratio of the marginal utility of each good or service to its price (the marginal expenditure necessary for its acquisition) is equal to that for every other good or service"

basically MU/P = MU/P = MU/P
34) Marshall and time (Set #9 p6)
- market period: during which there is no change in the marketplace of the stock of commodities being sold; there could be no change in the factors of production supplying the commodity.
- short run period: during which at least one factor of production continued in emplyment at the same level of its input to the firm.
- long run period: during which all factors of production could be altered in the amount they were employed by the firm
- secular period: when the firm altered its production function because of changes in technology or the state of the laws or other historical happenings.

as a practical matter, virtually all production is in the Marshallian short run.
35) Marshall pure profit (PP)
PP = TR- TC when TR > TC
example: if we assume the avg rate of return in the economy is 8%, the firm is earning more than 8%. This will attract other firms to enter the industry, thus adding more marginal cost curves to the horizontally summed. Supply function will shift to the shift, price will fall. Once the trate of return to all the firms is 8%, there will be no incentive for other firms to enter -> pur profit is now zero
36) Marshallian quasi-rents
· ‘The income realized by a sunk cost investment that exceeds the amount that would be realized in the next best use of the sunk cost investment’
· When firm is earning less than average ROR, but earning positive quasi-rents
· TR > TVC (covering more than variable costs)
37) Distressed industries
· TC > TR > TVC (covering more then variable costs but not fixed cost)
· Uneconomical to shut down if AR >=AVC
· Firm may not be earning ordinary ROR, but still earning some positive ROR
o Gordon: if PV of expected quasi-rents > residual value of current firm
38) Marshall and the residuum
the residuum was difined as those in "extreme poverty" which burden the "higher faculties" and who have no knowledge of the orordinary decencies of life
39) Marshall and a 3rd classical situation
The 3rd classical situation is basically Marshallian economics; however Schumpeter did not think much of Marshall. Schum was a purist and Marshall was a mathematician but put the math in the footnotes since he was trying to appeal to the businessmen and politicians (who are relatively considered to be "laymen")
40) Adding up
Example of something that is very simple, yet first sighted through a haze of ambiguities.

Once it was assumed that factors of production were paid at their marginal product, people started to wonder, how do we know that the sum of these marginal products = the total product?

It made sense that employers would pay factors of production at their marginal rate,

J.B. Clark - In static conditions, the entrepreneur makes no specific contribution, so his earnings are always approacing zero.

Edgeworth: Assume that employees can become employers, and vice versa, with ease. Since you cannot escape what you earn as an "employee", and because as an employee you earn your marginal product,

when at LR equilibirum, will the firm get to pay the opportunity costs with its returns? (the rectangle where LRATC = SRATC = MC).
if you pay VMP (value of marginal product) for each factor, it will add up to the TC (equal to TR)
i THINK that's what he meant? I asked in the review session and he was like.. talking in circles.. sigh
41) Distributive Justice
Central problem of distribution may be defined as the anlaysis of the forces which under free exchange govern the division of the product of industry between those who perform different functions or supply different factors.

We will concern ourselves with functional distribution, not contractual, or personal distribution.

Physiocrats were the first to abstractly study distribution, and used the conception of a closed economy basd on free exchange.

Smith saw three components of price, wages, rents, and profits. Their natural levels govern price.

Wages will tend towards subsistence, but may be maintained indefinitely at a higher level by continued progress.

Ricardian Law of Rent later became the keystone of the Austrian system.


* "Rent is only that part of the payment to landlords which is due to the "original and indestructible qualities of the soil" as distinct from profits on capital improvements.

* Wages are goverened by the "iron law". They are goerned by the ratio between population and hte amoutn of circulating capital available for wage advances.

^Theory is based on inevitable increase in population. With more mouths to feed, a larger amount of capital and lbaor is applied to fertile land and poorer soil is brought under cultivation. Consequentyl, the marginal yield of land declines. It is anticipated therefore that rent will rise, wages will absorb an increasing portion of the remaind and profit will decline. When further accumulation ceases, more workers cannot be supported and "stationary state" has been reached.


* Largely agreed with Ricardo, however felt it more necessary to address the institutional distribution of land for things like inheritance.

* "When land is not intended to be cultivated no good reason in general can be given for its being private property at all".

* Differentiated between personal and functional distribution.

* Improved on his predecessors by making the rate of profit depend upon the cost of labor and by distinguishing in profits the element of interest, insurance and wages of superintendence.

Ricardo saw rent as signifying an increasing impoverishment of society. His view of landowners and captialists was the precise opposite of Smith's view.

Marx: (Surplus Doctrine) "The value of labor itself similarly determiend is the labor time necessary to produce the worker's subsistence. If this represents half a day's work, the other half is appropiated by the employing capitalist as surplus value. Thus if the working day is long and hte productivity of labor high, the capitalist waghe system enables the capitalist to appropiate a part of the value the labor has produced and gives rise to a class struggle between labor and capital for the distribution of the surplus product.

All factors of production are not only prouctive but receive rewqards based ont heir assignable contributions to the joint product.
42) A Marshallian cost ladder
in Marshallian economics, assume competition
different cases of Marshall (4 cases, 4 graphs of ATC, AFC, AVC, MC, P = MR); i'll try to scan this and upload it or something
1. ATC & AVC are below P: earning pure profits (between where MC crosses ATC & P) -> entry of other firms in industry; positive quasi rent
2. ATC = P, AVC below P: no entry, can cover every cost, most optimal equilibrium in LR
3. ATC above P, AVC below P: continue producing if QR (quasi rent) > value of fixed capital assets; no positive QR, distressed industry; covers VC but not FC
4. ATC & AVC are above P: no covering VC, therefore go out of business.
43) The ordinal revolution
can't add utilities (because they cannot be measured) but can order the bundles in order of preference
- in a graph with goods X & Y, there are different indifference curves (IC) and the budget constraint.
- higher ICs have more utility, but bundles along the IC have the same utility.
- Py/Px = MUx/MUy
44) keynes on monetary policy
The economic consequences of Peace:
Keynes advised the Prime Minister of Britain to keep Germany reparations within reason. He advised this because "Germany did not have enough stocks of wealth to pay the reparations. Nor could Germany earn enough as the allies were not going to make it easy for Germany to export. In addition, Germany needed its exports earnings for essential imports that it could not produce itself".

This can be summarized as "requiring Germany to pay heavy reparations for the war, while at the same time making it difficult for them to do this, would be productive of nothing but political trouble".

Keynes was not successful in convincing the Prime Minister.

Beggar my neighbors: Countries try to export their own goods, while not accepting imports from other countries. Keynes -> leads to worldwide depression

Convergence Hypothesis: Keynes saw evidence of the Soviet Union using more market mechanisms, and capitalist countries utilizing more social control private entities, thus the two sides were converging. He suggested a single international organization to control currency and credit (seeds of IMF, World Bank, Bretton Wood's Agreement), and said "national governments ought to accept the responsibility of perfecting economic information".

The Economic Consequence of Mr. Churchill
Churchill put England back on the gold standard at the pre-war par. Keynes correctly assessed this as being disastrous, as exports would become much more expensive, and was the reason for rising unemployment.

Keynes predicted that in 100 years, the quality of life would be 4-8 times better, and that we would then be able to overcome the "money-making neurosis".

Treatise on Money (most classical work)
-Assumes M = kY (standard Cambridge approach)
-There is not necessarily a full time employment equilibrium. Aggregate investment and aggregate savings need not balance.
-Variation in the money supply can handle unemployment

Later, Keynes developed doubts about the efficacy of monetary policy.
"I see no reason to suppose that the existing system seriously misemploys those factors of production that are currently in use".
45) The liquidity trap
Keynes rejected Say's law (Supply creates its own demand), as it implied that the market economy will not automatically balance out at full employment. And if there is unemployment, monetary policy will not help due to the liquidity trap.

Liquidity Trap:
-Gov wants to create money, so buys bonds.
-Banks now see mandated reserves as too risky due to the fear of depression, so they stockpile.
-Investors getting money from the sale of their bonds will not buy other securities, due to fear of the depression or actual depression.
-Gov finds out that sale of bonds is not successful, so they sell more bonds, effectively lowering the interest rate.
-The people who already own bonds will now have suffered a capital loss.
-The created money goes down the Liquidity Trap.
46) The consumption function
Keynes believed that consumption spending (C) was hooked up to the level of GNP. Thus the value of GNP would determine C.
47) Keynes on investment
Keynes believed that investment spending was much more variable and had to do with the "animal spirits" of investors (a term he got from Descartes).

Keynes thought that the government should should step in and stabilize investment spending, so that sufficient funds were available for investment to keep the marginal efficiency of capital equal to the real rate of interest.

This would lead to a fully employed society, with steady economic growth, and small inequalities in income.
48) The multiplier
Multiplier = 1 / (1 - slope of consumption function).

So if C = 100 + .8GNP, then the slope is .8

Multiplier = 1 / (1 - .8) = 5
49) Trygve Haavelmo
· created a theorem
- An increase in government spending with a balanced budget has a multiplier of 1
· Can be proven from the multipliers
- background: there was a political movement to make a constitutional amendment or something.. and this dude used Keynesian economics to show that this movement was stupid
- basically he used the mutliplier effect and consumption function
- example:
if the govt spends $100 billion
C = a + .8 GNP (gross national product)
100 + 80 (which is the marginal propensity to consume) + 64 ..
as a result of the mutliplier effect: 1/ (1- (AC/AGNP) = 1/(1-.8)
AC = aggregate consumption
AGNP = aggregate GNP? [in my other notes, it says GCF = gross capital formation]
so the govt will tax this extra "income" (the multiplier effect), which will reduce income
100 + 80 + 64 + 56 +.. (from above equation
___ - 80 - 64 - 56 - ...
100 = inflationary effect of amount of govt spending
50) A fourth and a fifth classical situation
4th - textbooks have concepts and ideas from Marshall in terms of microeconomics & Keynesian for macroeconomics. The ordinal revolution is also a major part of the 4th classical situation
5th - has not yet happened although there is the application of econometrics and the complexity theory; there has been no major change in economic theories
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