1. SUMMARY OF ADAM SMITH’S “THE WEALTH OF THE NATIONS”

Old view of Economics (Mercantilism: nation’s wealth is the total money it possesses)

National wealth was measured in terms of a country’s stock of gold and silver. Importing goods from abroad was considered as damaging the national wealth and exporting

goods as adding on to national wealth. Trade could only benefit the seller not the buyer. One nation can richer only b making some other nation poorer.

Thus, the culture of ‘Protectionism’ pervaded the domestic country.

The productivity of free exchange

In a free exchange both sides are better off. Imports are as valuable as exports. The wealth of a nation is not the quantity of gold and silver in its vaults, but the total of its

production and commerce “To grow best and to work most efficiently, however, it required an open, competitive

marketplace, with free exchange and without coercion.”

The Wealth of the NationsThe underlying themes:

Regulations on commerce are ill-founded and counterproductive: Unlike the mercantilist view, the real measure of a nation’s wealth is the stream of goods and services that it creates rather than the total money it possesses.

Productive capacity rests on the division of labor and the accumulation of capital: It is efficient to break down production process into small tasks where each task is being taken by specialized labor.

A country’s future income depends upon this capital accumulation: The more that is invested in better productive processes, the more wealth will be created in the future.

System is automatic: When there is free trade and competition industry remains focused on the nation’s most important needs.

Competition and free exchange are under threat from the monopolies, tax preferences, controls and other privileges that producers are able to extract from the government authorities

Production and exchange

1. Benefits of Specialization: Division of LaborIt is efficient to break down production process into small tasks where each task is being taken by specialized labor. Specialization is so efficient that it emerges between the firms as well as between

countries. Countries specialize by exporting the goods they produce best and importing the goods that others produce better.

2. Mutual gains from exchangeAccording to the ‘Mercantilist view’ the purchase of any good through money will make the buyer poorer while the seller richer so it is always beneficial for an individual or a country to sell a good rather than purchasing it. On the contrary, according to Smith, exchange benefits both the seller and the buyer as the exchange would not occur if either side thought themselves the loser by it. An exchange even benefits both sides, even though each party proposes and accepts the bargain entirely in their own self-interest and not with the other side’s welfare in mind. Also it can be said that the benefits obtained from an exchange is being driven by specialization.

3. Wider Markets can bring bigger gains (Money as a medium of market extension)It is known that the benefits of exchange are driven by specialization and the extent of this specialization depends upon the extent to which exchange is possible.

4. The index of valueWhat determines the rate at which the products are exchanged? In present day context, using the marginal utility theory, it can be stated that this value of marginal utility determines this rate. According to Smith, this value is originally being reflected by the labor put into the item’s transaction. This idea of his has lead to ‘the labor theory of value’.i

Factors of Production

The total costs of production can be divided into the factors land, labor and capital. These factors are owned by different people and thus, they are entitled to the share of earnings produced. Thus, we can classify the earnings based on the various factors as follows:Land ----- Landlord ----- RentLabor ----- Workers ----- WagesCapital or Stock ----- Employers ----- Profits

Production driven by Markets

Definition of an economic system: Land, labor and capital contribute to production thereby making landlord, workers and employers all independent entities. But as it is known that production is intended for exchange as well, these entities are involved in the valuation and distribution of the product as well. Thus, production, valuation and distribution do not exist in isolation but all take place simultaneously as interrelated parts of the functioning of what is known as an economic system.

This economic system drives and directs production. ‘Market Price’ is the price at which producers exchange their goods and the total production cost can be termed as the ‘natural price’. The producers cannot keep the market price less than the natural price persistently and again they cannot keep the market price too high as that would then attract more and more players into the market and thus will increase the competition. As a result of which supply will increase and the market price will come down again. But in case of imperfect competition, regulations may restrict market entry. Again an industry can invent some cheaper production process and can enjoy exorbitant profits.

Wages and Economic Growth

The demand for labor rises when – and only when – national wealth rises. The rise in national income and capital growth increase wages.

Why do wage rates differ?The market price of labor is generally affected by the following: the pecuniary (monetary) rewards are different depending upon the hardness or disagreeability of professions. Some professions are based on trust while others are costly to learn.

Capitals and ProfitsCapital or Stock includes goods reserved for immediate use fixed capital, such as machinery; and circulating capital, including work in progress and goods that have been made but are still on the shelf fixed capital, such as machinery; and circulating capital, including work in progress and goods that have been made but are still on the shelf and depends upon commodity prices and some other random factors. A factor to measure profitability is the interest rate. If people are willing to borrow money even at higher interest rates, it indicates that the economic activity is highly profitable.

Accumulation of CapitalBuilding up of capital is essential for economic progress. The creation of surpluses makes the exchange and specialization possible and this specialization can again help in making further surpluses thus resulting into a virtuous circle. Thus, it can be said that welfare of a nation depends on its production and the amount produced depends upon the division of labor.

Money can only be considered a tool of exchange. Labor can be divided into productive and unproductive labor (similar to the present day settings of manufacturing and service sector). Productive labor is one where the work produces surplus (covering all costs) that is available for reinvestment whereas if the work is consumed immediately, it is known as unproductive labor.

Saving part of our product, instead of consuming it all, allows us to grow our productive capital; which in turn allows us to increase our product in the future. Countries make themselves better off if they do not try to remain self-sufficient or raise trade barriers against others.

Economic Organization, Economic Theory and PolicyEconomic interventionism and absolute advantage: When imports are being restricted in a hope from preventing country’s reserves of gold and silver, it indicates that the domestic consumers are being deprived from a range of foreign products which can be cheaper as well as can be better. This makes the policy of economic interventionism expensive as well as counterproductive. With division of labor according to specialization across countries can thus lead to what is called absolute advantage.

PricesPrices show how much people are willing to sacrifice to get particular goods and services in exchange. They signal where the labor and capital should be steered in order to reap the highest returns.

2. SUMMARY OF JOAN ROBINSON’S “HISTORY vs. EQUILIBRIUM”

3. SUMMARYOF RONALD COASE’S “THE NATURE OF THE FIRM (1937)”

Economic system as defined by Arthur Salter “a normal economic system works itself, and it is under no central control. Supply is adjusted to demand, and production to consumption, by a process that is automatic, elastic and responsive. According to Hayek, an economic system is being coordinated by price mechanism. However, this does not mean that there should not be any economic planning.The above definition gives an incomplete picture of economic system and thus, ignores the role of economic planning in an economic system. This led Marshall to introduce ‘organization’ as the fourth factor of production and also led to the development of the idea of co-ordination through management. The presence of price mechanism as a coordinating factor leads to another question of the need of organizations. Outside the firm, production is being directed by price mechanisms through a series of transactions in the market whereas within a firm the production is being directed by the entrepreneur or the manager acting as a coordinator.

How one firm is different from another?The distinguishing factor between firms is the degree of supersession of the price-mechanism by a firm.

Why a firm emerges in an exchange economyii?Two common but not so important reasons could be (a) individuals’ preference to work under some persons by accepting less and (b) purchasers’ preference to purchase the commodities produced by firms rather than produced in a different mannerHowever, the two reasons mentioned above are of negligible importance.The main reason why it is profitable to establish a firm is related to the cost associated with the price mechanism. The costs include the costs of negotiation and concluding a contract for each exchange transaction. However, in case of a firm a factor of production does not make a series of contracts with the other coordinating factors within a firm as it would have been in case of price- mechanism. Again within a firm, the contracts should be such so as to limit the powers of the entrepreneur to direct the factors of production.The other reason for the existence of firms is related to long term contracts. Owing to the uncertainty associated in forecasting demand, the long term contracts help the supplier to be indifferent towards the several courses of actions taken by him and also making the purchaser ignorant about the courses of actions making it less desirable for the buyer to specify what the other contracting party is supposed to do. Keeping this in mind the definition of a firm can be provided as “when the direction of resources (within the limits of contract) becomes dependent

on the buyer in the above mentioned manner, the relationship which is termed as a firm can be obtained. Thus, a firm emerges when a short term contract proves to be unsatisfactory.In short, certain marketing costs are saved by forming an organization and allowing some authority to direct the resources.The third reason is being driven by the fact, the way the transactions within a firm and in a market are treated by the government itself with regulatory powers. Taxes, quotas and methods of price control are only applicable to market transactions and not on the transactions organized within a firm.

Diminishing Returns to Management and limit to the size of a firmIt can be said that firms grow with the increasing number of transactions by the entrepreneur the size reduces when the entrepreneur abandons the transactions. The next question that arises is that, what limits the entrepreneur to carry out one extra transaction? Had there been no such limits, there might have been only one giant sized firm in which all the activities are concentrated.

4. SUMMARY OF GABSEWICZ’S TEXT BOOK

INTRODUCTION

Conditions for a Perfectly Competitive Market Large number of buyers and sellers Absence of entry barriers to potential buyers and sellers Good should be perfectly homogeneous All agents should have full information

FROM PERFECT COMPETITION TO IMPERFECT COMPETITION

5. USING PRICES FOR COORDINATION AND MOTIVATION (ECONOMICS, ORGANIZATION AND MANAGEMENT- MILGROM AND ROBERTS)

Price and CoordinationHow markets can achieve coordination without central planning?

The needs of consumers can be satisfied in multiple numbers of ways, similarly the economy’s resources can be put to multiple uses. This makes the allocation of resources complex in an efficient way.

A price system can solve the coordination problem in the following ways:

1. Each productive unit is aware of the prices and own individual production and tries to maximize profits at the given prices.

2. Each consumer is aware of the prices and own individual preferences and tries to maximize the utility at the given prices.

3. The prices are such that the market clearing condition is established i.e. at that price the total supply should equal demand.

Competitive Equilibrium: The condition of existence of a price vector p having all non negative components, a consumption plan (Bn, Sn) for each consumer n and a production plan (Ij, Oj) for each firm j satisfying the conditions: (i) each consumer’s consumption plan must maximize his utility, (ii) each firm’s production plan must maximize its profit and (iii) at the given prices the quantity demanded of each item must equal its supply.

Fundamental Theorem of Welfare Economics: In case of competitive equilibrium, the resulting allocation of resources is efficient.

i According to this the values of commodities are related to the labor needed to produce them.ii In an exchange economy the distribution of resources is organized by price mechanism.