Factors and the Classical Model
The cat story. Seeing the cat.
The economy is like a jumbled picture, where once one sees what the picture is - e.g. a cat - then the jumble all makes sense.
* What is the classical school of economics?
The major school of thought 1776 to 1890
Adam Smith, David Ricardo key classical economists
The classical-school model of economics, David Ricardo
Learn how to use a model
Class will include material not in the book
* What is a "factor" of production?
Factor - a resource category that is an input for the production of wealth.
* What are the three factors of production?
3 classical factors of production.
Land - natural resources \ / Rent
Labor - human effort - Real Wealth - Wages
Capital goods - produced means / \ Capital return
* What is "land" in economics?
Land - natural resources, prior to being altered by human action.
Land includes all natural opportunities.
Land includes: space, minerals, oil, water, atmosphere, electro-magnetic spectrum (radio, TV), airline routes, satellite orbits.
* What is "labor" in economics?
Labor - human exertion in the production of wealth.
Includes skill, education: "human capital."
Includes entrepreneurship.
The converse is leisure.
* What are capital goods?
Capital goods: produced goods used to produce other goods. Not money or other financial capital.
Real wealth consists of goods, not financial capital.
Money is financial, not economic wealth.
What if we burned all the money?
Burn all money, and can be restored in bank accounts.
What if we burned all the capital goods?
Burn all buildings and machines, and the loss is real.
Wealth is distributed to the owners of the factors.
* What are wages?
Wages is the return on labor. Includes salaries, tips, commissions, in-kind. If you are self-employed, you pay yourself wages from profits.
* What is land rent?
Land rent is the return on land.
Includes rent paid to owner-occupant.
It is the economic rent, what would be bid in a market.
* Owners of capital goods get a capital rental return, also called a "return on capital goods". This is different from interest because interest can be a return on any factor. The return on capital goods includes interest and depreciation.
* What determines land rent?
The Ricardian classical model, originated by David Ricardo: Start with island - 11 grades of fertility.
One crop, corn. Equal workers.
Omit capital goods at first.
The first workers go to the best land.
Land is free, rent is zero, wages are 10.
* What is the extensive margin of production?
The the least productive land quality in use.
When 10-land is taken, margin moves to 9, wages=9. Rent=?
And so on to subsistence.
* What is the marginal product of labor?
What an extra typical worker adds to production, keeping other factors equal.
* As the margin moves to ever less productive land, what happens to rent and wages?
Wages go down and rent goes up.
* What is the effect on the margin, wages, and rent when land can claimed without using it?
Such land specualtion moves the margin out farther and faster.
Wages decrease more, rent increases more.
* What is an effective remedy for the income ineqality caused by the concentrated ownership of land?
Minimum wages create more unemployment. The collection of the rent and its equal distribution equalizes incomes. Whether this is distribution or redistribution depends on the morally rightful ownership of the land rent.
* What is the total product in the classical economy?
Add the total product for each grade of land.
For each grade of land, multiply the output of a typical plot by the number of plots.
The output minus wages and capital-goods rentals is rent.
* Is there any unemployment in the classical model?
No. So long as there is free land available, workers can apply their labor to land to product wealth.
* What is the effect on wages and rent of more and better capital goods?
Example: Suppose a plow costs two bushels.
Suppose it doubles production everywhere.
If the margin is at 4, half of additional production is needed to pay for the good.
Wages up by 50%.
The other 50% is the return on capital goods.
Production at supermarginal land also doubles.
Rent doubles, while wages go up by 50%.
* What is the law of wages?
The law of wages: the wage level is set at the margin of production.
* What is the wage level?
The basic wage level is that of unskilled labor.
Higher skills, talents, etc., create a wage premium.
* What is the law of rent?
The law of rent. The rent of land is determined by the excess of its produce over that which the same quality of application and time can secure from the least productive land in use.
* What is the law of capital goods?
Capital goods will be produced if their cost is less than the additional wealth produced.
* Why can people be poor in a rich economy?
The margin of production has a low marginal product of labor, yielding a low wage level, with the rest of the wealth going to rent.
Does this explain income inequality in third-world countries?
How about in the U.S.?
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Readings: Chapters 1 to 5 are review of material you probably already learned in econ 11.
Skim it if you are already familiar with it, but make sure you understand the main concepts and the vocabulary.
I may occasionally have a different viewpoint than the textbook.
There is no textbook with which I agree with 100 percent.
Economics is not a unified subject, but is divided into various schools of thought.
The authorities in economics or any science are not persons or texts, but reason.
The foundations of reasoning are logic and evidence.
The two key questions to ask are: What do you mean? How do you know?
Socratest asked these; these are called the Socratic questions.
These are good questions for arguments. Instead of saying "you are wrong," ask WDYM? HDYK?
On your papers, I will often ask these.