The Economics Book

LONDON, NEW YORK, MELBOURNE, MUNICH, AND DELHI DK LONDON DK DELHI First American Edition, 2012 PROJECT ART EDITORS SENIOR ART EDITOR Published in the United States by Anna Hall, Duncan Turner Ivy Roy DK Publishing SENIOR EDITORS ART EDITOR 375 Hudson Street Janet Mohun, Rebecca Warren Arijit Ganguly New York, New York 10014 EDITOR ASSISTANT ART EDITORS 07 08 09 10 11 10 9 8 7 6 5 4 3 2 1 Lizzie Munsey Sanjay Chauhan, Kanika Mittal 001 - 186345 - Sep/2012 US EDITOR CONSULTANT ART DIRECTOR Copyright © 2012 Kate Johnsen Shefali Upadhyay Dorling Kindersley Limited MANAGING ART EDITOR SENIOR EDITOR All rights reserved. Michelle Baxter Anita Kakar Without limiting the rights under MANAGING EDITOR EDITORS copyright reserved above, no part of Camilla Hallinan Rupa Rao, Priyaneet Singh this publication may be reproduced, stored in or introduced into a retrieval PUBLISHER DEPUTY MANAGING EDITOR system, or transmitted, in any form, or Sarah Larter Alka Thakur by any means (electronic, mechanical, photocopying, recording, or otherwise), ART DIRECTOR EDITORIAL MANAGER without the prior written permission Philip Ormerod Rohan Sinha of both the copyright owner and the ASSOCIATE PUBLISHING DIRECTOR DTP MANAGER above publisher of this book. Liz Wheeler Balwant Singh Published in Great Britain by PUBLISHING DIRECTOR DTP DESIGNERS Dorling Kindersley Limited. Jonathan Metcalf Vishal Bhatia, Bimlesh Tiwary A catalog record for this book is available ILLUSTRATIONS produced for DK by from the Library of Congress. James Graham TALLTREE LTD ISBN: 978-0-7566-9827-0 PICTURE RESEARCH Louise Thomas MANAGING EDITOR DK books are available at special David John discounts when purchased in bulk PRODUCTION EDITOR Ben Marcus COMMISSIONING EDITOR for sales promotions, premiums, Sarah Tomley fund-raising, or educational use. PRODUCTION CONTROLLER For details, contact: DK Publishing Sophie Argyris SENIOR DESIGNER Special Markets, 375 Hudson Street, Ben Ruocco original styling by New York, New York 10014 or SENIOR EDITORS [email protected]. STUDIO8 DESIGN Rob Colson, Deirdre Headon Printed and bound in China by Leo Paper Products Ltd Discover more at www.dk.com

CONTRIBUTORS NIALL KISHTAINY, CONSULTANT EDITOR JAMES MEADWAY Niall Kishtainy teaches at the London School of Economist James Meadway works at the New Economics and specializes in economic history and Economics Foundation, an independent British development. He has worked for the World Bank and think tank. He has also worked as a policy adviser the United Nations Economic Commission for Africa. for the UK Treasury. GEORGE ABBOT CHRISTOPHER WALLACE George Abbot is an economist who worked in 2012 on Christopher Wallace is Head of Economics Barack Obama’s presidential reelection campaign. He at the UK’s prestigious Colchester Royal Grammar previously worked with Compass, the influential UK School. He has been teaching economics for more think tank, on strategic documents such as Plan B: than 25 years. A New Economy for a New Society. MARCUS WEEKS JOHN FARNDON Marcus Weeks studied philosophy and worked as a John Farndon is the author of many books on teacher before embarking on a career as an author. contemporary issues and the history of ideas, He has contributed to many books on the arts and including overviews of the booming economies popular sciences. of China and India. FRANK KENNEDY Frank Kennedy worked for over 25 years in investment banking in the City of London as a top-ranked investment analyst and as a managing director in capital markets, where he led a European team advising financial institutions. He studied economic history at the London School of Economics.

CONTENTS 10 INTRODUCTION THE AGE 66 Divide up pin OF REASON production, and you LET THE TRADING get more pins BEGIN 1770–1820 The division of labor 400 BCE–1770 CE 52 Man is a cold, rational 68 Population growth calculator keeps us poor 20 Property should be Economic man Demographics private Property rights and economics 54 The invisible hand 22 What is a just price? of the market 70 Meetings of merchants Markets and morality brings order end in conspiracies to Free market economics raise prices 24 You don’t need to barter Cartels and collusion when you have coins 62 The last worker adds The function of money less to output than 74 Supply creates its the first own demand 26 Make money from money Diminishing returns Gluts in markets Financial services 63 Why do diamonds cost 76 Borrow now, tax later 30 Money causes inflation more than water? Borrowing and debt The quantity theory of money The paradox of value 78 The economy is a yo-yo 34 Protect us from 64 Make taxes fair Boom and bust foreign goods and efficient 80 Trade is beneficial Protectionism and trade The tax burden for all Comparative advantage 36 The economy can be counted Measuring wealth 38 Let firms be traded Public companies 39 Wealth comes from the land Agriculture in the economy 40 Money and goods flow between producers and consumers The circular flow of the economy 46 Private individuals never pay for street lights Provision of public goods and services

INDUSTRIAL AND WAR AND ECONOMIC DEPRESSIONS REVOULTIONS 1929–1945 1820–1929 154 Unemployment is not 90 How much should I a choice Depressions and produce, given the competition? unemployment Effects of limited competition 126 Companies are price 162 Some people love risk, 92 Phone calls cost takers not price makers others avoid it more without competition The competitive market Risk and uncertainty Monopolies 130 Make one person better off 164 Government spending 98 Crowds breed collective without hurting the others boosts the economy by insanity Efficiency and fairness more than what is spent Economic bubbles The Keynesian multiplier 132 The bigger the factory, 100 Let the ruling classes the lower the cost 166 Economies are embedded tremble at a communist Economies of scale in culture revolution Economics and tradition Marxist economics 133 The cost of going to the movies is the fun you’d 168 Managers go for perks, have had at an ice rink not their company’s profits Opportunity cost Corporate governance 106 The value of a product 134 Workers must improve 170 The economy is a comes from the effort their lot together predictable machine needed to make it The labor theory of value Collective bargaining Testing economic theories 108 Prices come from supply 136 People consume to 171 Economics is the science and demand be noticed of scarce resources Supply and demand Conspicuous consumption Definitions of economics 114 You enjoy the last chocolate less than 137 Make the polluter pay 172 We wish to preserve the first External costs a free society Utility and satisfaction Economic liberalism 138 Protestantism has made 116 When the price goes up, us rich 178 Industrialization creates some people buy more Religion and the economy sustained growth Spending paradoxes The emergence of modern 140 The poor are unlucky, economies 118 A system of free markets not bad The poverty problem is stable 180 Different prices to different Economic equilibrium 142 Socialism is the abolition people Price discrimination of rational economy Central planning 124 If you get a pay raise, 148 Capitalism destroys the buy caviar not bread old and creates the new Elasticity of demand Creative destruction

POST-WAR CONTEMPORARY ECONOMICS ECONOMICS 1945–1970 1970–PRESENT 186 In the wake of war 262 It is possible to invest and depression, nations without risk must cooperate International trade and Financial engineering Bretton Woods 220 Policies to correct markets 266 People are not 188 All poor countries need can make things worse 100 percent rational is a big push The theory of the second best Behavioral economics Development economics 222 Make markets fair 270 Tax cuts can increase 194 People are influenced by The social market economy the tax take irrelevant alternatives Taxation and Irrational decision making 224 Over time, all countries economic incentives will be rich 196 Governments should do Economic growth theories 272 Prices tell you everything nothing but control the Efficient markets money supply Monetarist policy 226 Globalization is not 273 Over time, even the inevitable Market integration selfish cooperate with 202 The more people at work, others Competition the higher their bills 232 Socialism leads to and cooperation Inflation and unemployment empty shops Shortages in planned economies 274 Most cars traded will 204 People smooth be lemons consumption over their 234 What does the other man Market uncertainty life spans Saving to spend think I am going to do? Game theory 276 The government’s 206 Institutions matter promises are incredible Institutions in economics 242 Rich countries impoverish Independent central banks the poor Dependency theory 208 People will avoid work if 244 You can’t fool the people they can Market information Rational expectations and incentives 248 People don’t care 210 Theories about market about probability efficiency require many when they choose assumptions Paradoxes in decision making Markets and social outcomes 250 Similar economies can 214 There is no perfect voting benefit from a single system Social choice theory currency Exchange rates and currencies 216 The aim is to maximize happiness, not income 256 Famine can happen The economics of in good harvests happiness Entitlement theory

278 The economy is chaotic 302 Businesses pay more 316 Pessimism can destroy even when individuals than the market wage healthy banks are not Incentives and wages Bank runs Complexity and chaos 303 Real wages rise during 322 Savings gluts abroad 280 Social networks are a recession fuel speculation at home a kind of capital Sticky wages Global savings imbalances Social capital 304 Finding a job is like 326 More equal societies 281 Education is only a finding a partner or a grow faster signal of ability house Searching and Inequality and growth Signaling and screening matching 328 Even beneficial economic 282 The East Asian state 306 The biggest challenge reforms can fail governs the market for collective action is Resisting economic change Asian Tiger economies climate change Economics and 330 The housing market 288 Beliefs can trigger the environment mirrors boom and bust currency crises Housing and the Speculation and 310 GDP ignores women economic cycle currency devaluation Gender and economics 332 DIRECTORY 294 Auction winners pay 312 Comparative advantage over the odds is an accident 340 GLOSSARY The winner’s curse Trade and geography 344 INDEX 296 Stable economies contain 313 Like steam, computers the seeds of instability have revolutionized 351 ACKNOWLEDGMENTS Financial crises economies Technological leaps 314 We can kick-start poor economies by writing off debt International debt relief

INTRODU

CTION

12 INTRODUCTION F ew people would claim workplace or over the dinner table. seem to be at the mercy to know very much about So to some extent, we do all take of risk-taking banks and big economics, perhaps seeing an interest in economics. The corporations, do we know how it as a complex and esoteric arguments we use to justify our they came to be so powerful or subject with little relevance to opinions are generally the same understand the reasons for their their everyday lives. It has been as those used by economists, so a original and continued existence? generally felt to be the preserve of better knowledge of their theories The discipline of economics is at professionals in business, finance, can give us a better understanding the heart of questions such as these. and government. Yet most of us of the economic principles that are becoming more aware of its are at play in our lives. The study of management influence on our wealth and well- Despite the importance and being, and we may also have Economics in the news centrality of economics to many opinions—often quite strong Today, with the world in apparent issues that affect us all, economics ones—about the rising cost economic turmoil, it seems more as a discipline is often viewed with of living, taxes, government important than ever to learn suspicion. A popular conception is spending, and so on. Sometimes something about economics. Far that it is dry and academic, due to these opinions are based on an from occupying a separate section its reliance on statistics, graphs, instant reaction to an item in the of our newspaper or making up a and formulas. The 19th-century news, but they are also frequently small part of the television news, Scottish historian Thomas Carlyle the subject of discussions in the economic news now regularly described economics as the makes the headlines. As early as “dismal science” that is “dreary, In economics, hope and faith 1997, the US Republican political desolate, and, indeed, quite abject coexist with great scientific campaign strategist Robert Teeter and distressing.” Another common pretension and also a deep noted its dominance, saying, “Look misconception is that it is “all at the declining television about money,” and while this has a desire for respectability. coverage [of politics]. Look at the grain of truth, it is by no means the John Kenneth Galbraith declining voting rate. Economics whole picture. and economic news is what moves Canadian-US economist (1908–2006) the country now, not politics.” So, what is economics all about? The word is derived from the Yet how much do we really Greek word Oikonomia, meaning understand when we hear about “household management,” and it rising unemployment, inflation, has come to mean the study of the stock market crises, and trading way we manage our resources, and deficits? When we’re asked to more specifically, the production tighten our belts or pay more taxes, and exchange of goods and do we know why? And when we services. Of course, the business

INTRODUCTION 13 of producing goods and providing laws that govern how the economy as “the science which studies services is as old as civilization, behaves, in the same way that human behavior as a relationship but the study of how the process scientists had discovered the between ends and scarce means works in practice is comparatively physical laws underlying natural which have alternative uses.” This new. It evolved only gradually; phenomena. Economies, however, broad definition remains the most philosophers and politicians are man-made and are dependent popular one in use today. have expressed their opinions on on the rational or irrational economic matters since the time behavior of the humans that act The most important difference of the ancient Greeks, but the first within them, so economics as a between economics and other true economists to make a study of science has more in common sciences, however, is that the the subject did not appear until the with the “soft sciences” of systems it examines are fluid. end of the 18th century. psychology, sociology, and politics. As well as describing and explaining economies and how At that time the study was Economics was perhaps best they function, economists can known as “political economy,” defined by British economist Lionel also suggest how they ought to be and had emerged as a branch Robbins. In 1932, he described it constructed or can be improved. of political philosophy. However, in his Essay on the Nature and those studying its theories Significance of Economic Science The first economists increasingly felt that it should be Modern economics emerged as distinguished as a subject in its The first lesson of economics a distinct discipline in the 18th own right and began to refer to it is scarcity: there is never century, in particular with as “economic science.” This later the publication in 1776 of The became popularized in the shorter enough of anything to satisfy Wealth of Nations, written by the form of “economics.” all those who want it. great Scottish thinker Adam Smith. However, what prompted interest A softer science The first lesson of politics in the subject was not so much Is economics a science? The is to disregard the first the writings of economists as the 19th-century economists certainly lesson of economics. enormous changes in the economy liked to think so, and although Thomas Sowell itself with the advent of the Carlyle thought it dismal, even Industrial Revolution. Previous he dignified it with the label of US economist (1930– ) thinkers had commented on the science. Much economic theory management of goods and services was modeled on mathematics and within societies, treating questions even physics (perhaps the “-ics” that arose as problems for moral ending of “economics” helped to or political philosophy. But with lend it scientific respectability), the arrival of factories and mass and it sought to determine the producers of goods came a new ❯❯

14 INTRODUCTION era of economic organization that in terms of output and income, and brought and advocated a “hands-off” looked at the bigger picture. This its policies for international trade, or laissez-faire approach to allow the was the beginning of the so-called taxation, and controlling inflation competitive market to create wealth market economy. and unemployment. In contrast, and stimulate technological what we now call “microeconomics” innovation. Others were more Smith’s analysis of the new looks at the interactions of cautious in their estimation of the system set the standard with a individual people and firms within market’s ability to benefit society comprehensive explanation of the economy: the business of and identified failings of the system. the competitive market. Smith supply and demand, buyers and They thought these could be suggested that the market is guided sellers, markets and competition. overcome by state intervention and by an “invisible hand,” where the argued for a role for governments rational actions of self-interested New schools of thought in providing certain goods and individuals ultimately give the wider Naturally, there were differences services and in curbing the power society exactly what it needs. Smith of opinion among economists, and of the producers. In the analysis was a philosopher, and the subject various schools of thought evolved. of some, notably the German of his book was “political economy” Many welcomed the prosperity that philosopher Karl Marx, a capitalist —it stretched beyond economics to the modern industrial economy economy was fatally flawed and include politics, history, philosophy, would not survive. and anthropology. After Smith a Economics is, at root, new breed of economic thinkers the study of incentives: The ideas of the early “classical” emerged who chose to concentrate how people get what they economists such as Smith were entirely on the economy. Each of want, or need, especially increasingly subjected to rigorous these built upon our understanding when other people want examination. By the late 19th of the economy—how it works and or need the same thing. century economists educated in how it should be managed—and science were approaching the laid the foundations for the various Steven D. Levitt subject through the disciplines branches of economics. Stephen J. Dubner of mathematics, engineering, and physics. These “neoclassical” As the discipline evolved, US economists (1967– and 1963– ) economists described the economy economists identified specific areas in graphs and formulas, and to examine. One approach was to proposed laws that governed the look at the economy as a whole, workings of the markets and either at a national or international justified their approach. level, which became known as “macroeconomics.” This area By the end of the 19th century of economics takes in topics economics was beginning to such as growth and development, develop national characteristics: measurement of a country’s wealth centers of economic thinking had

INTRODUCTION 15 grown as university departments agreed. Although the majority again shifting, and no doubt new were established, and there were of economists had faith in the economic thinking will evolve to distinguishable differences stability, efficiency, and rationality help manage our scarce resources. between the major schools in of the markets, there were some Austria, Britain, and Switzerland, who had doubts, and new One prominent casualty of the particularly on the desirability of approaches arose. recent economic crises is Greece, some degree of state intervention where the history of economics in the economy. Alternative approaches started, and where the word In the late 20th century new areas “economics” comes from. In 2012, These differences became even of economics incorporated ideas protesters in Athens pointed out more apparent in the 20th century, from disciplines such as psychology that democracy also comes from when revolutions in Russia and and sociology into their theories, the Greeks but is in danger of China brought almost a third of the as well as new advances in being sacrificed in the search world under communist rule, with mathematics and physics, such for a solution to a debt crisis. planned economies rather than as game theory and chaos theory. competitive markets. The rest of These theorists also warned of It remains to be seen how the the world, however, was concerned weaknesses in the capitalist world economy will resolve its with asking whether the markets system. The increasingly severe and problems, but, armed with the alone could be trusted to provide frequent financial crises that took principles of economics outlined prosperity. While continental Europe place at the beginning of the 21st in this book, you will see how we and Britain argued about degrees of century reinforced the feeling that got into the present situation, and government intervention, the real there was something fundamentally perhaps begin to see a way out. ■ battle of ideas was fought in the wrong in the system; at the same US during the Great Depression time scientists concluded that our The purpose of studying after the Wall Street Crash of 1929. ever-increasing economic wealth economics is …to learn how came at a cost to the environment In the second half of the 20th in the form of potentially disastrous to avoid being deceived century the center of economic climate change. by economists. thought shifted from Europe to the US, which had become the As Europe and the US begin to Joan Robinson dominant economic superpower deal with perhaps the most serious and was adopting ever more economic problems they have ever UK economist (1903–83 ) laissez-faire policies. After the faced, new economies have collapse of the Soviet Union in emerged, especially in Southeast 1991, it seemed that the free market Asia and the so-called BRIC economy was indeed the route countries (Brazil, Russia, India, and to economic success, as Smith China). Economic power is once had predicted. Not everyone

LET TRA BEGIN 400 BCE–1770 CE

DING

18 INTRODUCTION Plato describes his Thomas Aquinas Bills of exchange The British East ideal state, where argues that the price of become a standard India Company, an property is owned by a product is “just” only method of payment international trading if profit is not excessive in European trade, company and the world’s all and labor is and there is no deception first global brand, specialized. redeemable by involved in the sale. merchant banks. is established. C.380 BCE 1265–74 CE C.1400 1599 C.350 BCE 1397 1492 C.1630 Aristotle argues in The Medici Bank is Christopher Thomas Mun favor of private founded in Florence, Columbus arrives in advocates a Italy—one of the first the Americas; soon mercantilist policy, property but against gold is flowing into using foreign exports accumulating money of the financial Europe, increasing as a way of increasing institutions built on the money supply. a nation’s wealth. for its own sake. international trade. A s civilizations evolved in specialty producers providing Aquinas considered the morality of the ancient world, so too products for the common good. prices, arguing for the importance did systems for providing However, his pupil Aristotle of “just” prices, where no excessive goods and services to populations. defended the concept of private profit was made by the merchant. These early economic systems property, which could be traded in emerged naturally as various trades the market. These are arguments The ancients lived in societies and crafts produced goods that that have continued to the present where labor was composed largely could be exchanged. People began day. As philosophers Plato and of slaves, and medieval Europe ran to trade, first by bartering and later Aristotle thought of economics as a on a feudal system—where with coins of precious metal, and matter of moral philosophy: rather peasants were protected by local trade became a central part of life. than analyzing how an economic lords in exchange for labor or The business of buying and selling system worked, they came up with military service. So the moral goods operated for centuries before ideas for how it should work. This arguments of these philosophers it occurred to anyone to examine kind of approach is said to be were somewhat academic. how the system worked. “normative”—it is subjective and looks at “what ought to be” the case. Rise of the city-states The ancient Greek philosophers A major change occurred in the were among the first to write about The normative approach to 15th century, as city-states developed the topics that came to be known economics continued into the in Europe and became wealthy collectively as “economics.” In Christian era, as medieval through international trade. A new, The Republic, Plato described the philosophers such as Thomas prosperous class of merchants political and social makeup of an Aquinas (p.23) attempted to define replaced the feudal landowners ideal state, which he said would the ethics of private property and as the important players in the function economically, with trading in the marketplace. economy, and they worked hand-in-

LET TRADING BEGIN 19 A speculative William Petty Gregory King François Quesnay and bubble in the Dutch shows how the compiles a statistical his followers, the economy can be market for tulips measured in summary of the physiocrats, argue that bursts, leaving Quantulumcunque trade of England in land and agriculture thousands of Concerning Money. the 17th century. are the only sources of investors ruined. economic prosperity. 1637 1682 1697 1756 1668 1689 1752 1758 Josiah Child describes John Locke argues that David Hume argues Quesnay produces free trade—he wealth is derived that public goods his Economic Table, not from trade, but should be paid for the first analysis for the advocates increasing from labor. by governments. imports as well workings of a as exports. whole economy—the “macroeconomy.” hand with dynasties of bankers, As trade increased, it moved beyond which prized rationality above who financed their trading and the hands of individual merchants all, took a scientific approach to voyages of discovery. and their backers. Partnerships and “political economy.” Economists companies were set up, often with attempted to measure economic New trading nations replaced government backing, to oversee activity and described the working small-scale feudal economies, and large trading operations. These firms of the system, rather than looking economic thinking began to focus began to be split into “shares” so only at moral implications. on how best to control the exchange they could be financed by many of goods and money from one investors. Interest in buying shares In France a group of thinkers country to another. The dominating grew rapidly in the late 17th century, known as the physiocrats analyzed approach of the time, known as leading to the establishment of the flow of money around the mercantilism, was concerned with many joint-stock companies and economy and effectively produced the balance of payments—the stock exchanges, where the shares the first macroeconomic (whole- difference between what a country could be bought and sold. economy) model. They placed spends on imports and what it agriculture rather than trade or earns from exports. Selling goods A new science finance at the heart of the economy. abroad was seen as good because The huge increase in trading also Meanwhile, political philosophers it brought money into the country; prompted a renewed interest in the in Britain shifted the emphasis importing goods was seen as working of the economy and led to away from mercantilist ideas of damaging because money flowed the beginnings of the discipline of trade, and toward producers, out. To prevent a trade deficit and economics. Emerging at the consumers, and the value and protect domestic producers against beginning of the 18th century, the utility of goods. The framework foreign competition, mercantilists so-called Age of Enlightenment, for the modern study of economics advocated the taxing of imports. was beginning to emerge. ■

20 PROPERTY SHOULD BE PRIVATE PROPERTY RIGHTS IN CONTEXT W e learn about ownership potential for personal gain—there is and personal property no reason even to enter the market. FOCUS from our earliest There is, in effect, no market. Society and the economy childhood tussles over toys. This concept is often taken for granted, Types of property KEY THINKER yet there is nothing inevitable “Property” encompasses a wide Aristotle (384–322 BCE) about the idea. Private property range of things, from material is fundamental to capitalism. Karl goods to intellectual property (such BEFORE Marx (p.105) noted that the wealth as patents or written text). It has 423–347 BCE Plato argues in generated by capitalism presents entered realms that even free The Republic that rulers should societies with “an immense market economists would not hold property collectively for collection of commodities” that are defend, such as slavery—where the common good. privately owned and may be traded people were viewed as commodities. for profit. Businesses are also AFTER privately owned and operated for Historically, material property 1–250 CE In classical Roman profit in a free market. Without the has been organized three different law the sum of rights and idea of private property, there is no ways. First, everything can be held powers a person has over a in common and used by everyone thing is called dominium. Defending private ownership is as they wish, on the basis of mutual important in capitalist countries. This trust and custom. This was the case 1265–74 Thomas Aquinas house in Warsaw, Poland, is the most in tribal economies, and it is still argues that owning property is secure home ever built; it turns into a practiced by the Huaorani people of natural and good, but private steel cube at the touch of a button. the Amazon. Second, property can property is less important than be held and used collectively; this the public good. is the essence of the communist system. Third, property can be held 1689 John Locke states that in private, with each person free to what you create by your own do with it as they choose. This is the labor is yours by right. concept at the heart of capitalism. 1848 Karl Marx writes the Modern economists tend to Communist Manifesto, justify private property on pragmatic advocating the complete grounds, arguing that the market abolition of private property. simply can’t operate without some division of resources. Earlier thinkers made more of a moral case

See also: Markets and morality 22–23 ■ Provision of public goods and LET TRADING BEGIN 21 services 46–47 ■ Marxist economics 100–05 ■ Definitions of economics 171 How private? When property … it prevents is held in people from acting In every modern society some common… things are shared as collective benevolently property, such as streets and (people cannot be parks. Others, such as cars, generous if they are private property. Property don’t have anything rights, or legal ownership, normally confers on the owner to give away). exclusive rights over a particular resource, but this … it provides is not always the case. little incentive for The owner of a house in a individuals to trade historic district, for instance, might not be allowed to knock and invest. it down and replace it with a skyscraper or a factory, … no one maintains Property should or even change the use of it (everyone will be private. the current building. The governments of every country act self-interestedly in the world reserve the right and assume to override private ownership when this is deemed necessary, someone else will for reasons varying from the do the work). needs of infrastructure to national safety issues. Even in the US, a staunchly capitalist nation, the government may force a property owner to relinquish his or her rights. However, the 14th amendment to the Constitution softens this blow by stating that the owner must be compensated with the market price. for private property. The Greek dominion over our own bodies, we It is clearly better that property philosopher Aristotle argued that also have dominion over the things should be private, but the “property should be private.” He we make. The German philosopher use of it common; and pointed out that when property Immanuel Kant (1724–1804) later the special business of the is held in common, no one takes argued that private property is a responsibility to maintain and legitimate expression of the self. legislator is to create in men improve it. Moreover, people can this benevolent disposition. only become generous if they have Another German philosopher, something to give away. however, rejected the notion of Aristotle private property entirely. Karl Marx A right to property insisted that the concept of private In the 17th century all land and property is nothing but a device by housing in Europe was effectively which the capitalist expropriates owned by monarchs. The English the labor of the proletarian, keeps philosopher John Locke (1632–1704), him in slavery, and excludes him. however, spoke out for individual The proletariat is effectively locked rights, saying that as God gave us out of the select group that controls all wealth and power. ■

22 WHAT IS A JUST PRICE? MARKETS AND MORALITY IN CONTEXT M any people know what it people are prepared to pay. For is like to be exploited or market economists there is no FOCUS “ripped off” by a vendor, moral dimension to price at all— Society and the economy such as when buying overpriced pricing is simply an automatic ice-creams at a tourist venue. Yet function of supply and demand. KEY THINKER according to prevailing economic Merchants who appear to be Thomas Aquinas (1225–74) theory, there is no such thing as a overcharging are simply pushing rip-off. The price of anything is the price to its limits. If they push BEFORE simply the market price—the price their price further than people are C.350 BCE In Politics, Aristotle says that all goods must be What is a just price? measured in value by one thing—“need.” The market needs goods. Traders will only supply goods if there is a 529–534 CE Roman courts reward (a profit). protect landowners from being forced to sell land below the But there is a moral just price, at “great loss.” dimension too. To avoid prices AFTER being “unjust”… 1544 The Spanish economist Luis Saravia de la Calle argues … profit should … no deception … the buyer must that price must be set by not be excessive, can be involved in freely accept “common estimation” founded setting the value the price. on quality and abundance. because avarice is a sin. of the goods. 1890 Alfred Marshall proposes that prices are automatically set by supply and demand. 1920 Ludwig von Mises argues that socialism cannot work because prices are the only way to establish need.

LET TRADING BEGIN 23 See also: Property rights 20–21 ■ Free market economics 54–61 ■ Supply and demand 108–13 ■ Economics and tradition 166–67 Medieval communities felt strongly simply the price the buyer freely Thomas Aquinas about the prices merchants charged. agrees to pay, given honest In 1321, William le Bole of London was information. The vendor is not St. Thomas Aquinas was one punished for selling underweight bread obliged to make the buyer aware of the greatest scholars of the by being dragged through the streets. of facts that might lower the price Middle Ages. He was born in in the future, such as the shiploads Aquino, Sicily, in 1225, to an prepared to pay, people stop of cheap spice due to dock shortly. aristocratic family, and began buying, so the merchants are forced his education at the age of to bring down their prices. Market The issues of price and morality five. At the age of 17 he economists consider the marketplace are very much alive today, since decided to leave worldly to be the only way to establish both economists and the public wealth behind and join an price, as nothing—not even gold— discuss “the just price” of a CEO’s order of poor Dominican has an intrinsic value. bonus or the minimum wage. Free monks. His family was so market economists, who reject shocked that they kidnapped A price freely accepted interference in the market, and him on his way to join the The idea that the marketplace those who advocate government order and held him captive for should set prices seems to contrast intervention—whether for moral two years. His determination, sharply with the view expressed by or economic reasons—continue to however, remained unbroken, Sicilian scholar Thomas Aquinas argue about the rights and wrongs and eventually the family gave in his Summa Theologica, one of of imposing restrictions on pricing. ■ in, letting him go to Paris, the first studies of the marketplace. where he came under the For Aquinas, a scholar monk, price No man should sell tutelage of the scholar monk was a deeply moral issue. Aquinas a thing to another man Albert the Great (1206–80). recognized avarice as a deadly sin, for more than its worth. Aquinas studied and taught in but at the same time he saw that if France and Italy, and in 1272, a merchant is deprived of the profit Thomas Aquinas founded a studium generale (a incentive, he would cease to trade, type of university) in Naples, and the community would be Italy. His many philosophical deprived of goods it needed. works were hugely influential in paving the way to the Aquinas concluded that a modern world. merchant may charge a “just price,” which includes a decent profit, but Key works excludes excessive profiteering, which is sinful. This just price is 1256–59 Disputed Questions on Truth 1261–63 Summa contra Gentiles 1265–73 Summa Theologica

24 YOU DON’T NEED TO BARTER WHEN YOU HAVE COINS THE FUNCTION OF MONEY IN CONTEXT I n many parts of the world The Tiwa tribal people of Assam, people are increasingly moving India, exchange goods through barter FOCUS towards a cashless society in during the Jonbeel Mela, an age-old Banking and finance which goods are bought with credit festival to preserve harmony and cards, electronic transfers, and brotherhood between tribes. KEY EVENT mobile-phone chips. But dispensing Kublai Khan adopts fiat with cash does not mean that money money in the Mongol Empire is not used. Money remains at the during the 13th century. heart of all our transactions. BEFORE The disturbing effects of money 3000 BCE In Mesopotamia are well known, inciting everything the shekel is used as a unit of from miserliness to crime and currency: a unit of barley of warfare. Money has been used as a a certain weight equals a tribute (sign of respect), in religious certain value of gold or silver. rites, and for ornamentation. “Blood money” is paid as recompense for 700 BCE The oldest known murder; brides are bought with coins are made on the Greek “bride money” or given away with island of Aegina. dowries to enrich their husbands. Money lends status and power to AFTER individuals, families, and nations. 13th century Marco Polo brings promissory notes from A barter economy your new car? Barter depends on China to Europe, where they Without money, people could only the double coincidence of wants, are used by Italian bankers. barter. Many of us barter to a small where not only does the other extent, when we return favors. person happen to have what I want, 1696 The Bank of Scotland is A man might offer to mend his but I also have what he wants. the first commercial operation neighbor’s broken door in return to issue bank notes. for a few hours of babysitting, for Money solves all these problems. instance. Yet it is hard to imagine There is no need to find someone 1971 President Nixon these personal exchanges working who wants what you have to trade; cancels the convertibility on a larger scale. What would you simply pay for your goods with of the US dollar to gold. happen if you wanted a loaf of money. The seller can then take the bread and all you had to trade was money and buy from someone else.

See also: Financial services 26–29 ■ The quantity theory of money 30–33 ■ LET TRADING BEGIN 25 The paradox of value 63 Shelling out Money is transferable and deferrable China in the 10th century, is money —the seller can hold on to it and buy that is simply a token of exchange Wampum were strings of when the time is right. Many argue with no value other than that white and black shell beads that complex civilizations could assigned to it by the government. treasured by the indigenous never have arisen without the A paper bank note is fiat money. North Americans of the flexibility of exchange that money Eastern Woodland tribes. allows. Money also gives a yardstick Many paper currencies were Before the European settlers for deciding the value of things. If all initially “promises to pay” against arrived in the 15th century, goods have a monetary value, we gold held in reserve. In theory dollars wampum was used mainly for can know and compare every cost. issued by the US Federal Reserve ceremonial purposes. People could be exchanged for their gold might exchange wampum to Different kinds of money value. Since 1971, the value of a dollar record an agreement or to pay There are two kinds of money: has no longer been convertible to tribute. Its value came from commodity and fiat. Commodity gold and is set entirely by the US the immense skill involved money has intrinsic value besides Treasury, without reference to its in making it, and in its its specified worth, for example gold reserves. Such fiat currencies ceremonial associations. when gold coins are used as rely on people’s confidence in a currency. Fiat money, first used in country’s economic stability, which When Europeans arrived, is not always assured. ■ their tools revolutionized wampum making, and Dutch With barter a person With money an individual colonizers mass-produced the can only exchange can buy from anyone beads by the million. Soon, with someone who they were using wampum to wants what he or she who is willing to sell. trade and buy things from the native peoples, who had no has to offer. With money a seller can interest in coins, but valued sell to anyone who wants wampum. Wampum soon But you don’t became a currency with need to barter if what the seller has. an accepted exchange rate. you have coins. In New York eight white or four black wampum equaled one stuiver (a Dutch coin of the time). The use and value of wampum diminished in the 1670s. Money can be held until the time is right to buy. Money helps us measure This Shawnee shoulder bag is the value of things. decorated with wampum beads, which developed into a currency for some North American tribes.

26 IN CONTEXT MAKE MONEY FOCUS FROM MONEY Banking and finance FINANCIAL SERVICES KEY THINKERS The Medici family (1397–1494) BEFORE 13th century Scholastic writers condemn usury. AFTER 1873 British journalist Walter Bagehot urges the Bank of England to act as “lender of last resort” to the banking system. 1930 The Bank for International Settlements is founded in Basel, Switzerland, leading to international rules of banking regulation. 1992 US economist Hyman Minsky publishes The Financial Instability Hypothesis, which has proved useful in explaining the 2007–08 financial crisis. H umans have long engaged in borrowing and lending. There is evidence that these activities took place 5,000 years ago in Mesopotamia (present- day Iraq) at the very dawn of civilization. But modern banking systems did not emerge until the 14th century in northern Italy. The word “bank” comes from the Italian word for the “bench” on which the bankers sat to conduct business. In the 14th century the Italian peninsula was a land of city- states that benefited from the influence and revenue of the papacy in Rome. The peninsula was ideally located for trade between Asia, Africa, and the emerging nations

LET TRADING BEGIN 27 See also: Public companies 38 ■ Financial engineering 262–65 ■ Market uncertainty 274–75 ■ Financial crises 296–301 ■ Bank runs 316–21 of Europe. Wealth began to to banking today. The first is Merchant bankers of the late 14th accumulate, especially in Venice “economies of scale.” It is expensive century arranged deposits and loans and Florence. Venice relied on sea for an individual to draw up a single but also converted foreign currencies power: institutions were created legal loan contract, but a bank can and watched over the circulation for there to finance and insure voyages. draw up 1,000 such contracts at signs of forged or forbidden coins. Florence focused on manufacturing a fraction of the “per-contract” and trade with northern Europe, and cost. Dealings in money (cash here merchants and financiers came investments) are suitable for together at the Medici Bank. economies of scale. The second is “diversification of risk.” The Florence was already home to Medicis lowered the risk of bad other banking families, such as lending by spreading their lending the Peruzzi and the Bardi, and to geographically. Moreover, because different types of financial bodies— the junior partners shared in profits from pawnbrokers, who lent money and losses, they needed to lend secured by personal belongings, to wisely—in effect they took on some local banks that dealt in foreign of the Medici risks. The third currencies, accepted deposits, and concept is “asset transformation.” lent to local businesses. The bank Merchants might want to deposit founded by Giovanni di Bicci de’ earnings or borrow money. One ❯❯ Medici in 1397 was different. Use your wealth to The Medici Bank financed long- found a bank. distance trade in commodities such as wool. It differed from existing Gather deposits and Lend wisely, and banks in three ways. First, it grew keep enough cash to monitor your loans. to a great size. In its heyday under cover withdrawals. the founder’s son, Cosimo, it ran branches in 11 cities, including Spread your risks across London, Bruges, and Geneva. Second, different investments. its network was decentralized. Branches were managed not by As the bank grows, Make money an employee but by a local junior average costs fall from money. partner, who shared in the profits. and profits multiply. The Medici family in Florence were the senior partners, watching over the network, earning most of the profit, and retaining the family trademark, which symbolized the bank’s sound reputation. Third, branches took in large deposits from wealthy savers, multiplying the lending that could be given out for a modest amount of initial capital, and so multiplying the bank’s profits. Economics of banking These elements of the Medici success story correspond to three economic concepts highly relevant

28 FINANCIAL SERVICES merchant might want a safe place from what has been called the Bills of exchange, such as this one to store his gold, from where he can “fundamental problem of exchange” from 1713, later developed into the withdraw it quickly if necessary. —the danger that someone will run common bank check. All types Another might want a loan—which off with the goods or the money promise to pay the bearer a specific is riskier for the bank and may tie after a deal has been struck. To amount of money on a certain date. up money for a longer time. So the solve this problem, the “bill of bank came to stand between the exchange” was developed. This is its ability to lend wisely, and two needs: “borrowing short, and was a piece of paper witnessing a then to monitor borrowers to deter lending long.” This suited everybody buyer’s promise to pay for goods in “moral hazard”—when people —the depositor, the borrower, and a specific currency when the goods succumb to the temptation not to of course the bank, which used arrived. The seller of the goods could repay and default on the loan. customer deposits as borrowed also sell the bill immediately to raise money (“leverage”), to multiply money. Italian merchant banks Geographical clusters profits and make a high return became particularly skilled at Banks often cluster together in on its owners’ invested capital. dealing in these bills, creating an the same place to maximize international market for money. information and skill. This explains However, this practice also makes the bank vulnerable—if a By buying the bill of exchange, large number of depositors demand a bank was taking on the risk that their money back at the same time the buyer of the goods would not (in “a run on the bank”), the bank pay up. It was therefore essential may be unable to provide it for the bank to know who was because it will have used the likely to pay up and who was not. depositors’ money to make long- Lending—indeed finance in term loans, and it retains only a general—requires specialized, small fraction of depositors’ money skilled knowledge, because in ready cash. This risk is a a lack of information (known as calculated one, and the advantage “information asymmetry”) can of the system is that it usefully result in serious problems. The connects savers and borrowers. borrowers least likely to repay are the ones most likely to ask for loans; Financing long-distance trade and once they have received a loan, was a high-risk business in there are temptations not to repay. 14th-century Europe. It involved A bank’s most important function time and distance, so it suffered A 21st-century banking crisis Granting mortgages to “subprime” The global financial crisis, which Significantly, the crisis followed borrowers (people unable to repay) began in 2007, has led to rethinking a period of banking deregulation. led to a wave of house repossessions about the nature of banking. A variety of financial innovations and the financial crisis of 2007–08. Leverage, or borrowed money, lay seemed lucrative in a rising at the heart of the crisis. In 1900, market. However, they led to about three-quarters of the assets poor lending standards by two of a bank might be financed by groups: those providing housing borrowed money. In 2007, the loans to poor US families, and proportion was often 95–99 bond investors overly reliant on percent. The banks’ enthusiasm the advice of credit rating for placing financial bets on future agencies. These are the issues movements in the market, known faced by all banks since the as derivatives, magnified this Medicis: poor information, leverage and the risks it carried. financial incentives, and risk.

LET TRADING BEGIN 29 A banker is a fellow customers at a time of social Depression. As a result banks need who lends you his umbrella change. Because the members of to be regulated, and most countries these organizations checked up on have strict rules about who can when the sun is shining, each other, and the managers had form a bank, the information they but wants it back the good local knowledge, they could must disclose, and the scope of provide the long-term loans that their business activities. minute it begins to rain. their customers needed. In some Mark Twain countries, such as Germany, they Finance broadly thrived. The Dutch bank Rabobank Banking is just the largest part of US author (1835–1910) is an example of a cooperative finance, but all finance is about model, as is India’s “micro-finance” connecting people who have more the development of financial Grameen Bank, which makes many money than they need with people districts in large cities. Economists loans of small amounts. who need more money than they call this phenomenon “network have—and will use it productively. externalities,” which refers to the However, clustering can also Stock exchanges connect these fact that, as a cluster starts to form, lead to risky competition and needs directly, through equities all the banks benefit from the crowdlike behavior. It is especially (shares conferring ownership of a network of deepening skills and important for banks to have a good company), bonds (lending that can information. Florence was one such reputation because they have an be traded), or other instruments. cluster. The City of London, with its asset transformation role—they goldsmiths and shipping experts, transform deposits into loans—and These exchanges are either became another. In the early their loan-assets are riskier, longer, physical places, such as the New 1800s the remote northern inland and less easy to turn into cash (less York Stock Exchange, or regulated province of Shanxi became “liquid”) than their deposit-liabilities. markets where trading takes place China’s leading financial center. through phone calls and computers, Today, the internet creates new Bad news can lead to panics. like the international bond market. ways of clustering online. Bank failures can have severe The clustering created by exchanges consequences for other banks, and makes these long-term investments The benefit of specialization for government and society, as more liquid: they can easily be sold explains why there are so many witnessed in the failure of and turned into money. Savings can different types of banks—covering Creditanstalt Bank in Austria in also be pooled to lower transaction savings, mortgages, car loans, and 1931, which led to a run on the costs and diversify risks. Mutual so on. The form a bank takes can German mark, UK sterling, and then funds, pension funds, and insurance also address information problems. the US dollar, triggering further bank companies all perform this role. ■ Mutual societies and credit unions, runs and contributing to the Great for instance, which are effectively owned by their customers, first arose in the 19th century to increase trust between the bank and its The City of London is home to a dense cluster of banks built over medieval streets. Today it is the world’s largest center for foreign-exchange trading and cross-border bank lending.

30 IN CONTEXT MONEY FOCUS CAUSES The macroeconomy INFLATION KEY THINKER THE QUANTITY THEORY OF MONEY Jean Bodin (1530–96) BEFORE 1492 Christopher Columbus arrives in the Americas. Silver and gold flow into Spain. AFTER 1752 David Hume states that the money supply has a direct relationship to the price level. 1911 Irving Fisher develops a mathematical formula to explain the quantity theory of money. 1936 John Maynard Keynes says that the velocity of money in circulation is unstable. 1956 Milton Friedman argues that a change in the amount of money in the economy can have a predictable effect on people’s incomes. I n 16th-century Europe prices were rising inexplicably. Some said that rulers were using an old practice of “debasing” currencies by minting coins with ever-smaller amounts of gold or silver in them. This was true. However, Jean Bodin, a French lawyer, argued that something much more significant was also happening. In 1568, Bodin published his Response to the Paradoxes of Malestroit. The French economist Jean de Malestroit (?–1578) had blamed the price inflation solely on currency debasement, but Bodin showed that prices were rising sharply even when measured in pure silver. He argued that an

LET TRADING BEGIN 31 See also: The function of money 24–25 ■ The Keynesian multiplier 164–65 ■ Monetarist policy 196–201 ■ Inflation and unemployment 202–03 Money circulates at a constant speed. If more money is put … people have more Jean Bodin into the system… money in their pockets and wish to buy more goods The son of a master tailor, Jean Bodin was born in 1530 and services. in Angers, France. He was educated in Paris, and went … leading to This results in too on to study at the University price rises. much money chasing of Toulouse. In 1560, he became a king’s advocate in too few goods… Paris. Bodin’s scholarship (he read law, history, politics, Money causes inflation. philosophy, economics, and religion) attracted royal favor, abundance of silver and gold was waste; greedy merchants able to and between 1571 and 1584, to blame. These precious metals restrict the supply of goods through he served as aide to the were entering Spain from its new monopolies; and, of course, the powerful Duke of Alençon. colonies in the Americas and then rulers adulterating the coins. spreading throughout Europe. In 1576, he married The money supply Françoise Trouilliart and Bodin’s calculations of the Bodin was not the first to point succeeded his brother-in-law increase in coinage were to the new influence of American as the king’s procurator in remarkably accurate. Later treasure and the effect of the Laon, northern France. economists concluded that prices abundance or scarcity of money In 1589, King Henry III was in Europe quadrupled during the on price levels. In 1556, a Spanish assassinated, and religious 16th century, at the same time as theologian named Martín de civil war broke out. Bodin the amount of physical silver and Azpilcueta (better known as believed in tolerance, but in gold circulating in the system Navarrus) had come to the same Laon was forced to declare for tripled; Bodin had estimated the conclusion. However, Bodin’s essay the Catholic cause, until the increase in precious metals at more also discussed the demand for and victorious Protestant King, than 2.5 times. He also highlighted the supply of money, the operation Henry IV, took control of the other factors behind the inflation: a of these two sides of an economy, city. Bodin died of the plague, demand for luxuries; a scarcity of and how disturbances to the ❯❯ aged 66, in 1596. goods for sale due to exports and Key works 1566 Method for the Easy Comprehension of History 1568 Response to the Paradoxes of Malestroit 1576 Six Books of a Commonwealth

32 THE QUANTITY THEORY OF MONEY supply of money led to inflation. His will lead to a doubling of prices, but The abundance of gold and thorough study is considered the not real value. Money will be neutral silver… is greater in this first important statement of the in its effect on the real, relative value kingdom today than it has quantity theory of money. of goods and services—for example, been in the last 400 years. on how many jackets can be bought Jean Bodin The reasoning behind this theory for the price of a computer. is partly based on common sense. However, the money they want Why is the price of a cup of coffee in Real price, nominal price is not nominal money, but “real a rich part of town so much higher After Bodin, many economists money”—money that can buy more. than in a poor area? The answer is developed his idea further. They that customers in the rich part have came to recognize that there is a Fisher’s equation more money to spend. If we consider distinct separation between the The fullest statement of the the population of a whole country real side of the economy and the quantity theory of money was made and double the money in people’s nominal, or money, side. Nominal by the US economist Irving Fisher pockets, it is natural that they will prices are simply money prices, (1867–1947), who used the want to use their increased which can change with inflation. mathematical formula MV = PT. spending power to buy more goods This is why economists focus on Here “P” is the general level of prices, and services. But goods and services real prices—on what quantity of a and “T” is the transactions that take are always in limited supply, so there thing (jackets, computers, or time place in a year, so PT (Prices × will be too much money chasing too spent working) has to be given up few goods, and prices will rise. in return for another kind of thing, no matter what the nominal price This chain of events shows the is. In the extreme quantity theory, important relationship between changes in the money supply may the quantity of money in an economy influence prices, but it has no effect and the general price level. The on the real economic variables, such quantity theory of money states that as output and unemployment. What a doubling of the supply of money is more, economists realized that will result in a doubling in the value money is itself a “good” that people of transactions (or income or want to own for its spending power. expenditure). In the theory’s more extreme form, a doubling of money Money circulation Price level 25 25 20 15 10 5 5 10 15 20 Irving Fisher used the analogy of a scale to illustrate the quantity theory of money. If there is an increase in the amount of money in circulation, the bag gets heavier, and the price of goods rises and moves to the right, balancing the scale.

LET TRADING BEGIN 33 This painting by Dutch master Pieter Bruegel (1559) shows vagrants rubbing shoulders with the rich during Lent. Steep price rises in the 15th century led to much hardship among the poor, a rise in vagrancy, and peasant revolts. Transactions) is the total value that there can be one-time changes is used, not just as a medium of of transactions occurring annually. to M (the supply of money), such as exchange, but also as a “store of “M” is the supply of money. But the flow of New World treasure into value”—something you can keep, because PT is a total flow of goods, Europe. With V (velocity) and T either for buying goods, for security while M represents a stock of money (transactions) fixed, it follows that in case of hard times in the future, that can be used over and over again, a doubling of money will lead to a or for future investments. the equation needs something to doubling of prices. represent the circulation of money. Keynesian economists argue This circular flow, which causes Combined with the difference that these motives are affected less money to rotate through the between nominal and real, the by income or transactions (PT in economy—like the spinning drum quantity theory of money has led to the formula) than by interest rates. of a washing machine—is “V”, the the notion that money is neutral in A rise in the interest rate will lead velocity of money. its effect on the economy. to a rise in the velocity of money. This equation becomes a theory Challenge and restatement In 1956, US economist Milton when we make assumptions about But is money really neutral? Few Friedman (p.199) defended the the relationships between the believe that it is neutral in the short quantity theory of money, arguing letters, which economists do in run. The immediate effect of more that an individual’s demand for real three ways. First, V, the velocity money in the pocket is for it to be money balances (where money of money, is assumed to be spent on real goods and services. buys more) depends on wealth. He constant, since the way in which John Maynard Keynes (p.161) said claimed that it is people’s incomes we use money is part of habit and it was probably neutral in the long that drive this demand. custom and does not change much run, but in the short run it would from year to year (our washing affect real variables such as output Today, central banks print money machine drum spins at a steady and unemployment. Evidence also electronically and use it to buy rate). This is the key assumption suggests that money velocity (V) government debt in a process behind the quantity theory of is not constant. It seems to rise in known as quantitative easing. money. Second, it is assumed booms when inflation is high and Their aim has been to prevent a that T, the quantity of transactions falls in recessions when inflation feared fall in the money supply. in an economy, is driven solely by is low. So far, the most visible effect has consumers’ demand and producers’ been to reduce interest rates on technology, which together Keynes had other ideas that government debt. ■ determine prices. Third, we allow challenged the quantity theory of money. He proposed that money Inflation is always and everywhere a monetary phenomenon. Milton Friedman

34 PROTECT US FROM FOREIGN GOODS PROTECTIONISM AND TRADE IN CONTEXT A country’s wealth F or the last half century is its gold. many economists have FOCUS championed free trade. Global economy Exports bring in gold. They argue that only by removing restrictions on trade (such as KEY THINKER Imports of foreign goods tariffs) can goods and money flow Thomas Mun (1571–1641) cause gold to be lost. freely around the world and global markets develop without inhibition. BEFORE A country should preserve Some disagree, arguing that where c.1620 Gerard de Malynes its stock of gold by there is a huge imbalance of trade argues that England should between two countries, it can regulate foreign exchange to restricting imports. impact jobs and wealth. stop the nation’s gold and silver from going abroad. Protect us from A mercantilist view foreign goods. The argument over free trade dates AFTER back to the mercantilist era, which 1691 English merchant Dudley began in Europe in the 16th North argues that the main century and continued until the spur to increased national late 18th century. With the rise of wealth is consumption. Dutch and English seaborne trade, wealth began to shift from southern 1791 US Treasury Secretary Europe toward the north. Alexander Hamilton argues for protection of young industries. This was also the age when nation-states began to emerge, 1817 British economist David along with the idea of the wealth of Ricardo argues that foreign the nation, which was measured by trade can benefit all nations. the amount of “treasure” (gold and silver) it possessed. Mercantilists 1970s US economist believed that the world drew from a Milton Friedman insists “limited pot,” so the wealth of each that free trade helps nation depended on ensuring a developing countries. favorable “balance of trade,” in which more gold flows into the nation than out. If an excess of gold

LET TRADING BEGIN 35 See also: Comparative advantage 80–85 ■ International trade and Bretton Woods 186–87 ■ Market integration 226–31 ■ Dependency theory 242–43 ■ Global savings imbalances 322–25 flows out, the nation’s prosperity nations is unrestricted. If left French farmers demonstrated on declines, wages fall, and jobs are free, Smith insisted, the market tractors in Paris, 2010, to denounce lost. England sought to cut the would always grow to enrich all a sharp fall in grain prices after import outflow of gold by imposing countries eventually. quotas were liberalized. sumptuary laws, which aimed to limit the consumption of foreign For the last half century Smith’s barriers, as the US, Britain, goods. For instance, laws were view has dominated, because most Japan, and South Korea did passed restricting the types of Western economists argue that before they became economically fabric that could be used for restrictions on trade between powerful. China, meanwhile, clothes, reducing the demand nations hobble their economies. pursues a trade policy that in for fine foreign cotton and silk. Today, free trade areas such as many ways echoes Mun’s thinking the EU (European Union), ASEAN by running large trade surpluses Malynes and Mun (Association of Southeast Asian and building up a huge reserve Gerard de Malynes (1586–1641), an Nations), and NAFTA (North of foreign exchange. ■ English expert on foreign exchange, American Free Trade Agreement) believed that the outflow of gold are the norm, while global amounts of silver, on the should be restricted. If too much organizations such as the World grounds that this generated flowed out, he argued, the value Trade Organization (WTO) and the reexport trade. In 1628, the of English currency would fall. International Monetary Fund (IMF) company appealed to the British urge countries to reduce tariffs and government to protect their However, the century’s greatest other trade barriers to allow foreign trade against Dutch competition. mercantilist theorist, Englishman firms to enter their domestic Mun represented their case to Thomas Mun, insisted that what markets. The creation of barriers Parliament. He had amassed matters is not the fact that to foreign trade is criticized now a considerable fortune by the payments are made abroad, but as protectionism. time he died in 1641. how trade and payments finally balance out. Mun wanted to boost However, some economists are Key works exports and cut imports through concerned that exposure to large more frugal consumption of global businesses has the potential 1621 A Discourse of Trade domestic produce. However, he to damage developing countries c.1630 England’s Treasure by saw no problem in spending gold who are unable to nurture infant Foreign Trade abroad if it was used to acquire industries behind protective goods that were then reexported for a larger sum, ultimately Thomas Mun returning more gold to the country than had initially been spent. Born in 1571, Thomas Mun grew This would boost trade, provide up in a family of wealthy London work for the shipping industry, merchants. His father died when and increase England’s treasure. he was three, and his mother married Thomas Cordell, who Free trade agreements became a director of the East In the 18th century Adam Smith India Company, Britain’s largest (p.61) was to disagree with this trading company. Mun began view. What matters, he insisted trading as a merchant in the in The Wealth of Nations, is not Mediterranean. In 1615, he the wealth of individual nations became a director of the East but the wealth of all nations. Nor India Company. His ideas were is the pot fixed; it can grow over developed originally to defend time—but only if trade between the company’s export of large

36 THE ECONOMY CAN BE COUNTED MEASURING WEALTH IN CONTEXT Wealth includes people Both population and as well as property. a typical person’s FOCUS Economic methods average expenditure can be estimated. KEY THINKER William Petty (1623–87) Deducting an estimated Multiplying average amount for rents and profits expenditure by the BEFORE leaves a sum for the total 1620 English scientist Francis population gives Bacon argues for a new worth of labor. the national income. approach to science based on the collection of facts. The economy can be counted. AFTER T oday we take it for granted work of English scientist William 1696 English statistician that the economy can Petty. His insight was to apply the Gregory King writes his be measured, and its new empirical methods of science great statistical survey of expansions and contractions to financial and political affairs—to England’s population. accurately quantified. But this was use real world data rather than not always the case. The idea of relying on logical reasoning. He 1930s Australian economist measuring the economy dates back decided to express himself only Colin Clark invents the idea of to the 1670s and the pioneering “in terms of number, weight, or gross national product (GNP). 1934 Russian-US economist Simon Kuznets develops modern national income accounting methods. 1950s British economist Richard Stone introduces balanced, double-entry national accounting.

LET TRADING BEGIN 37 See also: The circular flow of the economy 40–45 ■ Testing economic theories 170 ■ The economics of happiness 216–19 ■ Gender and economics 310–11 measure.” This approach helped the economies and populations William Petty form the basis of the discipline that of England, Holland, and France. would become known as economics. He calculated that none had the Born in 1623 to a humble finances to continue the war they family in Hampshire, England, In his 1690 book Political were then engaged in—the Nine William Petty lived through Arithmetick, Petty used real data Years’ War—beyond 1698. His the English Civil War and rose to show that, contrary to popular figures might have been correct, to high positions in both the belief, England was wealthier than because the war ended in 1697. Commonwealth government ever. One of his groundbreaking and then the restored decisions was to include the value Measures of progress monarchy. As a young man of labor as well as land and Statistics are now at the heart he worked for the English capital. Although Petty’s figures of economics. Today, economists political economist Thomas are open to dispute, there is no generally measure gross domestic Hobbes in Holland. After doubting the effectiveness of his product (GDP)—the total value returning to England, he basic idea. His calculations of all the goods and services taught anatomy at Oxford included population size, personal exchanged for money within a University. A great believer spending, wages per person, the country in a particular period in the new science, he found value of rents, and others. He then (usually a year). However, there universities uninspiring, so multiplied these figures to give a is still no definitive way of left for Ireland, where he made total figure for the nation’s total calculating national accounts, a monumental land survey of wealth, creating accounts for an although efforts have been made the entire country. entire nation. to standardize methods. In the 1660s he returned Similar methods were Economists have now begun to England and began the developed in France by Pierre de to broaden the measurement of work on economics for which Boisguilbert (p.334) and Sébastien prosperity. They have formulated he is now known. For the le Prestre (1633–1707). In England new measures such as the genuine remainder of his life he moved Gregory King (1648–1712) analyzed progress indicator (GPI), which between Ireland and England, includes adjustments for income both physically and in the The Battle of La Hogue was fought distribution, crime, pollution, and focus of his work. Petty is in 1692 during the Nine Years’ War. the happy planet index (HPI), a regarded as one of the first English statistician Gregory King measure of human well-being and great political economists. calculated how long each country environmental impact. ■ He died in 1687, aged 64. involved could afford to fight. Key works 1662 Treatise of Taxes and Contributions 1690 Political Arithmetick 1695 Quantulumcunque Concerning Money

38 LET FIRMS BE TRADED PUBLIC COMPANIES IN CONTEXT M erchant ships have and was borrowing a further always raised funds for $28 million on bonds. Its annual FOCUS voyages by promising sales raised up to $10 million. Markets and firms a share of profits. In the 1500s the rewards could be huge, but these The idea of the public limited KEY THINKER high-risk ventures tied up money company—in which shareholders Josiah Child (1630–99) for years before a profit was are protected from liability beyond realized. The answer was to their investment—developed from BEFORE share the risk, and so joint-stock joint-stock companies. The selling 1500s Governments grant companies were formed, where of shares is an important way of merchants the monopoly of investors injected money into a raising funds. Some argue that trade within specific regions. company in return for becoming shareholders’ power to sell shares joint holders of its trading stock, leads to a lack of commitment, but 1552–71 The Bourse in and a right to a proportional share the joint-stock company remains Antwerp and Royal Exchange of the profits. at the heart of capitalism. ■ in London are set up for shareholders to buy and sell East India Company The high-risk, high-reward potential stock in joint-stock companies. An early joint-stock company, of merchant shipping was shared by formed in 1599, was the East joint-stock companies. Vessels such AFTER India Company (EIC), launched as the John Wood, seen here in Bombay 1680 London stock “brokers” to develop trade between Britain in the 1850s, brought home the goods. meet in Jonathan’s Coffee and the East Indies. Its rights to House to arrange share deals. free trade were so ably defended by the “father of mercantilists,” 1844 The Joint Stock London merchant Josiah Child, Companies Act in the UK that it became a global allows firms to be incorporated phenomenon. By the time of his more quickly and easily. death the company had about 3,000 shareholders, subscribed 1855 The idea of limited to a stock of more than $14 million, liability protects investors in joint-stock companies from See also: Economic equilibrium 118–23 ■ Corporate governance 168–69 ■ scams such as the South Sea Institutions in economics 206–07 Bubble of 1720 (p.98).

LET TRADING BEGIN 39 WEALTH COMES FROM THE LAND AGRICULTURE IN THE ECONOMY IN CONTEXT I n recent years bankers have If we knew the economics sometimes been characterized of agriculture, we would FOCUS as parasites, living off wealth know much of the economics Growth and development created by the labor of others. François Quesnay (p.45), a French of being poor. KEY THINKER farmworker’s son and one of the Theodore Schultz François Quesnay great minds of the 18th century, (1694–1774) might recognize this description. US economist (1902–98) BEFORE Quesnay argued that wealth lies Many economists, including 1654–56 English economist not in gold and silver, but springs Theodore Schultz, have argued William Petty conducts a from production—the output of the that agricultural development is major land survey of Ireland farmer or manufacturer. He argued the foundation for progress in poor to calculate its productive that agriculture is so valuable countries. In 2008, the World Bank potential for the English army. because it works with nature— reported that growth in the which multiplies the farmer’s effort agricultural sector contributes AFTER and resources—to produce a net more to poverty reduction than 1766 Adam Smith states that surplus. Manufacturing, on the other growth in any other sector. But labor, not land, is the greatest hand, is “sterile” because the value economists today also recognize source of value. of its output is equal to the value of that diversification into industry the input. However, later theorists and services, including finance, is 1879 US economist Henry showed that manufacturing can vital for long-term development. ■ George argues that land also produce a surplus. should be held in common by society, and that only The natural order land should be taxed—not Quesnay’s championing of the productive labor. value of agriculture was influential, leading to the development of the 1950s US economist French school of physiocrat thinkers Theodore Schultz’s “efficient who believed in the primacy of the farmer” hypothesis places “natural order” in the economy. agriculture at the heart of economic development. See also: Demographics and economics 68–69 ■ The labor theory of value 106–07 ■ The emergence of modern economies 178–79 ■ Development economics 188–93

MONEY AND GOODS FLOW BETWEEN PRODUCERS AND CONSUMERS THE CIRCULAR FLOW OF THE ECONOMY



42 THE CIRCULAR FLOW OF THE ECONOMY IN CONTEXT Madame de Pompadour (the mistress rights, and low government debt. of Louis XV) installed Quesnay at Where the mercantilists said that FOCUS Versailles as her physician. To him wealth came from treasure, The macroeconomy her lifestyle must have epitomized the Quesnay and his followers viewed lavish surplus of landowners’ wealth. it as being rooted in what modern KEY THINKER economists call the “real” economy François Quesnay wealth from nature, through their —those sectors that create real (1694–1774) agricultural sector. Their leader, goods and services. They believed François Quesnay, was surgeon that agriculture was the most BEFORE and physician to King Louis XV’s productive of these sectors. 1664–76 English economist mistress, Madame de Pompadour. William Petty introduces the His complicated model of the The physiocrats were influenced concepts of national income economy was thought by some by the thinking of an earlier French and expenditure. to reflect the circulation of blood landowner, Pierre de Boisguilbert. in a human body. He said that agriculture is superior 1755 Irish merchant banker to manufacturing, and Richard Cantillon’s Essay, first The mercantilist approach consumables are more valuable published in France, discusses (pp.34–35) dominated economic than gold. He said the more goods the circulation of money from thinking at the time. Mercantilists consumed, the more money moves the city to the countryside. thought the state should behave in the system, making like a merchant, growing business, consumption the driving force in AFTER acquiring gold, and actively the economy. He also said that a 1885 Karl Marx’s Capital interfering with the economy little money in the hands of the describes the circulation of through taxes, subsidies, controls, poor (who spend it) is worth far capital using a model inspired and monopoly privileges. The more to the economy than in the by Quesnay. physiocrats took the opposite view: hands of the rich (who hoard it). they argued that the economy was The movement, or circulation, 1930s Russian-American naturally self-regulating and of money is all-important. economist Simon Kuznets needed only to be protected from develops modern national bad influences. They favored free The Economic Table income accounting. trade, low taxes, secure property The physiocratic system of circulation was set out in Quesnay’s Economic I n economics one can think Table, which was published and small—microeconomics—or revised several times between 1758 one can think as large as the and 1767. This is a diagram that entire system: this is the study of illustrates, through a series of macroeconomics. In 18th-century crossing and connecting lines, the France a group known as the flow of money and goods between physiocrats tried to think big—they three groups in society: landowners, wanted to understand and explain farmers, and artisans. The goods the whole economy as a system. are agricultural and manufactured Their ideas form the foundation products (produced by the farmers of modern macroeconomics. and artisans). Although Quesnay used corn as his example of an The physiocrats agricultural product, he said Physiocracy is an ancient Greek that this category could include word meaning “power over nature.” anything produced from the land, The physiocrats believed that including mining products. nations gained their economic Quesnay’s model is best understood through an example. Imagine each of the three groups starts with $2 million. The

LET TRADING BEGIN 43 See also: Measuring wealth 36–37 ■ Agriculture in the economy 39 ■ Free market economics 54–61 ■ Marxist economics 100–05 ■ Economic equilibrium 118–23 ■ The Keynesian multiplier 164–65 landowners produce nothing. They Landowners collect rent spend their $2 million equally from farmers and buy goods from between farming and artisan products, and consume all of them. farmers and artisans. They receive $2 million in rent from the farmers—which the farmers can Farmers use this Artisans use this just afford, since they are the only money to buy goods from money to buy goods from group to produce a surplus—and so artisans and other farmers. farmers and other artisans. the landowners end up back where they started. The farmers are the Those farmers and artisans then use productive group. From a starting the money to buy goods from yet point of $2 million they produce more farmers and artisans. $5 million worth of agricultural products, over and above what This multi-level buying Money and goods they consume themselves. Of and selling activity flow between this $1 million worth is sold to happens continuously. producers and landowners for their consumption. consumers. They sell $2 million worth to artisans, half for consumption and half as raw materials for the goods the artisans will produce. This leaves $2 million worth to be used toward next year’s growing season. In terms of production they are back where they started. However, they also have $3 million from sales, of which they spend $2 million on rent and $1 million they spend their entire revenue on artisan goods (tools, agricultural on agricultural products: implements, and so on). $1 million for their own consumption, and $1 million on Quesnay referred to any group raw materials. They have outside the land-based farmers and consumed everything they have. landowners as “sterile,” because he believed that they could not produce Quesnay’s model does more a net surplus. The artisans, in this than present end-of-year results— instance, use their starting amount it also shows how money and of $2 million to produce $2 million goods circulate through the year worth of manufactured goods over and demonstrates why this is so and above what they consume important. The sale of products themselves. These are sold equally between the various groups to landowners and farmers. But continues to generate revenue, which is then used to buy more Quesnay’s Economic Table shows products, which produces yet the zigzag flow of wealth between more revenue. A “multiplier effect” farmers, landowners, and artisans. occurs (in Quesnay’s diagram it It was the first attempt to explain appeared as a zigzag series of the workings of a national economy. lines), similar to that presented ❯❯

44 THE CIRCULAR FLOW OF THE ECONOMY Let the sum total into their constituent parts and argued that if farmers had to pay of the revenues be then rigorously analyzing the too much tax, either directly or annually returned into relationships between the parts. indirectly, they would cut back and along the entire His model included inputs, outputs, their capital investment in farming course of circulation. and the interdependencies technology, and production would François Quesnay of different sectors. Quesnay fall below the level needed for the suggested that these might exist economy to thrive. This led the by John Maynard Keynes (p.161) in a state of equilibrium, an idea physiocrats to argue that there in the 1930s, when he pointed out that was later developed by should be only one tax: on the the beneficial effects of a Léon Walras (p.120), becoming rental value of land. government spending money one of the foundations of in a depressed economy. economic theorizing. Based on his empirical findings, Quesnay made a host Analyzing the economy Quesnay’s approach to of other policy recommendations, The kinds of questions Quesnay quantifying economic laws makes including investment in agriculture, asked, and the way he went about his Economic Table possibly the the spending of all revenue, answering them, anticipated first empirical macroeconomic no hoarding, low taxes, and free modern economics. He was model. The numbers in his Table trade. He thought capital was one of the first to attempt to were the result of a close study especially important because uncover general abstract laws that of the French economic system, his entrepreneur-farmers needed govern economies, which he did giving them a firm empirical basis. to borrow cheaply in order to pay by breaking economies down This study indicated that farming for land improvements. technology was sufficient for farmers to generate a net surplus Classical ideas of at least 100 percent. In our Quesnay’s idea of sectors being example this is what they achieve productive or unproductive has —starting with $2 million of corn, reappeared throughout the history they receive this back plus a net of economic thought as economists surplus of $2 million, which is then consider industry versus services, paid in rent. Modern economists and the private sector versus the use these kinds of empirical results government. His sole focus on to think about the impact of policy agriculture may look narrow to changes, and Quesnay used his modern eyes, since it is now Table for a similar purpose. He understood that wealth generation from industry and services is vital to an economy’s growth. However, his emphasis on the “real” side of the economy was an important step towards modern economic thinking. He most obviously anticipated modern national income accounting, which is used to assess nations’ macroeconomic performance. This income accounting is based on the circular flow of income and expenditure According to the physiocrats, investment in agriculture was key to ensuring the national wealth of France. Free export was a way of sustaining demand and restricting merchant power.

LET TRADING BEGIN 45 The interdependence of consumers and producers was first illustrated by Quesnay. Consumers rely on producers for goods and services, who in turn rely on the consumers for sales and labor. Goods and services Consumer expenditure Households Wages, rent, Firms François Quesnay dividends Born near Paris, France, in Labor 1694, François Quesnay was the son of a plowman and the around the economy. The value of Quesnay’s circular flow, with eighth of 13 children. At the total product of an economy is its susceptibility to expansion the age of 17 he began an equal to the total income earned and stagnation. apprenticeship in engraving, —a notion that was an important but then transferred to the part of Quesnay’s theory. In the Perhaps most importantly, university, graduating from 20th century much of the analysis Quesnay’s concepts of surplus the college of surgeons in 1717. of macroeconomies has revolved and capital became key to the around the Keynesian multiplier way that the classical economists He made his name as a (pp.164–65). Keynes showed how analyzed economic growth. A surgeon and specialized in government spending could typical classical model focuses on treating the nobility; in 1749, stimulate further spending three factors of production: land, he moved to the royal palace in a “multiplier effect.” This labor, and capital. Landowners at Versailles, near Paris, as idea has obvious links to receive rent and spend wastefully physician to Madame de on luxuries; laborers accept a low Pompadour. In 1752, he saved This system… is, perhaps, wage, and if it rises, they produce the king’s son from smallpox the nearest approximation more children. However, and was awarded a title and to truth that has yet been entrepreneurs earn profit and enough money to buy an estate published on the subject re-invest it productively in industry. for his own son. So profit drives growth, and of political economy. economic performance depends on His interest in economics Adam Smith sectors of the economy generating began in the early 1750s, and in surpluses. Thus, Quesnay 1757 he met the Marquis de anticipated later ideas about Mirabeau, with whom he the growth of economies formed les Economistes—the and inspired Karl Marx (p.105), physiocrats. He died in 1774. who produced his own version of the Economic Table in 1885. Key works Marx said of Quesnay that “never before had thinking in 1758 Economic Table political economy reached such 1763 Rural Philosophy heights of genius.” ■ (with Marquis de Mirabeau) 1766 Analysis of the Arithmetic Formula for the Economic Table

46 PRIVATE INDIVIDUALS NEVER PAY FOR STREET LIGHTS PROVISION OF PUBLIC GOODS AND SERVICES IN CONTEXT Street lights are an example of a public FOCUS Decision making good because… KEY THINKER … it is difficult to stop … one person’s use of David Hume (1711–76) people from benefiting street lighting does not BEFORE from street lighting. diminish another’s c.500 BCE In Athens indirect enjoyment of it. taxes are used to finance city festivals, temples, and Private firms do not provide walls. Occasional direct taxes street lights since they can't stop are levied at times of war. non-payers from using them. 1421 The first patent is granted to Italian engineer Essential public goods … private Filippo Brunelleschi to are usually provided by the individuals never protect his invention of hoisting gear for barges. government, because… pay for street lights. AFTER 1848 The Communist E ven within a well-functioning freely available to all, or where it Manifesto advocates collective market economy, there are would be difficult to prevent their ownership of the means of areas in which markets fail. use by non-payers. These goods, production by the workers. One important example of market which include things such as failure is in the provision of public national defense, are difficult for 19th century Public street goods—goods that are to become a private firm or individual to lighting is introduced in Europe and America. 1954 US economist Paul Samuelson develops a modern theory of public goods.

LET TRADING BEGIN 47 See also: Free market economics 54–61 ■ External costs 137 ■ Markets and social outcomes 210–13 Lighthouses are a public good non-rivalry, meaning that one David Hume from which it is hard to exclude person’s consumption of the good non-payers, and which many people does not diminish the ability of The epitome of the “Scottish can use at the same time. They are others to consume it. A classic Enlightenment,” David Hume invariably provided collectively. example is street lighting; it would was one of the most influential be almost impossible to exclude British philosophers of the supply profitably. This problem, non-payers from enjoying its benefits, 18th century. He was born in known as “free-riding” (where and no individual’s use of it detracts Edinburgh in 1711, and from consumers enjoy the goods without from that benefit to other users. an early age showed signs of paying for them) means that there a brilliant mind: he entered is no profit incentive. However, As industrial economies Edinburgh University at the there is a demand for these goods, developed in the 19th century, age of 12, studying first law and because private markets countries had to overcome the and then philosophy. may not be able to satisfy this problem of free-riding in areas such demand, public goods are usually as intellectual property. Intangible In 1734, Hume moved to provided by governments and goods, such as new knowledge and France, where he set out his funded through taxation. discoveries, have the attributes of major philosophical ideas in non-excludability and non-rivalry, A Treatise of Human Nature. A failure of the market to provide and so are at risk of being He then devoted much of his these goods was recognized by undersupplied by the market. This time to writing essays on the philosopher David Hume in the could discourage the development literary and political subjects 18th century. Influenced by Hume, of new technologies unless they and struck up a friendship Adam Smith (p.61), an ardent can be protected in some way. To with the young Adam Smith, advocate of the free market, do this, countries developed laws who had been inspired by his conceded that a government’s role granting patents, copyright, and writings. In 1763, Hume was was to provide those public goods trademarks to protect the returns given a diplomatic role in that it would not be profitable for from new knowledge and Paris, where he befriended individuals or firms to produce. inventions. Most economists the revolutionary French acknowledge that government has philosopher Jean-Jacques There are two distinguishing a responsibility to provide public Rousseau. He settled in characteristics of public goods that goods, but debate continues about Edinburgh again in 1768, cause them to be undersupplied by the extent of that responsibility. ■ where he lived until his death the markets: non-excludability, in 1776, aged 65 years. meaning that it is difficult to Where the riches are prevent people who don’t pay for engrossed by a few, Key works the goods from using them; and these must contribute very largely to the supplying of 1739 A Treatise of Human the public necessities. Nature 1748 An Enquiry Concerning David Hume Human Understanding 1752 Political Discourses

THE AGE OF REAS 1770–1820