Economic Dating and Surplus

PRE-KEYNESIAN ECONOMICS

Classical is defined to mean all of those economists from Smith to the present who argue that capitalism does not cause recessions and, rather, that it recovers automatically when an outside shock causes a recession. (These views were defined as Classical by Keynes, whose opposing views are discussed in the next chapter.)

The key points discussed are:

* Classical economic defenses of "Say's Law"

Classical view of the flow of money and goods. Classical view of how investment demand by borrowing and money supplied by saving help bring about a recovery from any recession;

* Classical view of how the operation of supply and demand in the market for labor automatically tends to return to equilibrium with full employment after any disturbance:

the Classical arguments against government intervention.

TWO VIEWS OF MACROECONOMICS

Most contemporary Classical economists claim to reject Say's Law, yet their basic policy conclusions on the macro economy have remained the same as those of J. B. Say. As noted above, classical economists believe that all downturns are caused by forces outside the capitalist economic relations.

The classical view states that the capitalist economic system always tends towards full employment with an equilibrium of supply and demand in the economy as a whole.

This equilibrium of supply and demand tends to maintain itself. If an outside shock of some kind, such as a natural disaster, pushes the economy under full employment, the economy gets back to equilibrium at full employment because businesses and investors will invest where there is opportunity and hire the recently unemployed. Since the economy automatically corrects the problem of unemployment, no government action is needed. The traditional, Classical view is explained in detail in this chapter.

THE FLOW OF MONEY AND PRODUCTS

The Classical argument for Say's Law can be clarified in a simple picture of the entire economy, shown in Figure 3.1. It shows how goods and services circulate in one direction, while money circulates in the other direction.

The box on the left side of figure 3.1 is called "households" to show that all people are located there. What does the box on the right side called "business" mean? It includes all of an economy's businesses, whether they are owned by single individuals, or they are partnerships (two or more partners), or whether they are corporations.

Corporations range from very small to giant ones that have revenues larger than many small countries. A corporation is a business owned by those who have bought its stock. Each piece of stock is evidence of ownership of part of the corporation and shows a right to part of its profits.

An individual business or a partnership may borrow money, but its owners are personally liable for its debts. The owner of corporate stock, however, is NOT liable for the debts of a corporation. If a corporation goes bankrupt, the owner of its stock finds that his or her stock is worthless. However, he or she cannot be pursued by creditors for the unpaid debts of the corporation. This is a nice deal. It means that if a giant bank went bankrupt, its chief executive officer loses wealth from the stocks he or she owned. Nevertheless, the stock owner retains all of the previous hundreds of millions of dollars paid in previous years as salary or dividends.

In Figure 3.1, the top line in the picture reveals that money goes from households to businesses. If you have ever bought a package of gum at the drugstore, you know that this is true. Households buy all kinds of consumer goods and services from business.

The second line down in the picture shows that business provides goods and services to households in return for money. When the economy is functioning well, the demand for goods and services measured in dollars equals the value of all goods and services offered by business at present prices. Say's Law and classical economics claim that this equality of supply and demand in the economy as a whole will always tend to hold, though there may be minor disturbances and short-term interruptions.

The third line down shows goods and services flowing from households to business. What goods and services flow in that direction? What services do households give to business?

The main thing that households provide to business is labor services. If you go to work for a seemingly endless eight hour day, you know what a labor service is. Aggregate labor in the whole economy includes many kinds. There is manual labor for an hourly wage. There is a wage paid per piece that is produced. There is skilled manual labor, such as that of a plumber or electrician, who gets a much higher income than a maid or hotel porter or U.S. postal worker. There is professional labor by nurses, doctors, teachers, and lawyers.

There is also managerial labor, including the low-paid labor of a manager in a small store in a small town. Yet managerial labor also includes the salary of the top corporate executive officer of the Bank of America. That executive officer may be paid more than a hundred million dollars, all said to be for managerial labor.

In the classical view, owners of businesses, whether individual businesses or corporations, also contribute to the business. They contribute their money, though they may also be paid for managerial labor. The money they contribute to the business allows the business to buy equipment, buildings, and inventories of goods to be used in the business or sold.

Thus, the third line of the picture shows that all kinds of labor services are provided to business. There are also other resources that households provide to businesses. Land and natural resources go from their owners to business. In addition to land and labor, businesses obtain money from households in order to purchase capital equipment.

Some of that money that is used by business is borrowed, some is obtained by the issuance of stock, while some comes from the owners of an individual business. This includes the amount of investment in their own businesses by individual owners as well as profits retained by corporations and re-invested.

Economists often refer to the goods and services that households provide to businesses as "factors of production". Using that vocabulary, land, labor and capital are factors of production.

The fourth line at the bottom of the picture shows money going from business to households. What might that be? The most common flow is the payment of wage