Economic methodology is the study of methods, usually scientific method, in relation to economics, including principles underlying economic reasoning.[1][2] The term 'methodology' is also commonly, though incorrectly, used as an impressive synonym for method(s). Rather, methodology is the study of method(s).
Many of the general issues that arise in the methodology of the natural sciences also apply to economics. Related or other issues have included:
analysis of theory and practice in contemporary economics.[32]
Economic methodology has gone from periodic reflections of economists on method to a distinct research field in economics since the 1970s. In one direction, it has expanded to the boundaries of philosophy, including the relation of economics to the philosophy of science and to the theory of knowledge.[33][34] In the context of philosophy and economics, additional subjects are treated as well, including decision theory and moral philosophy/ethics.[35][36][37]
Commonly-accepted methods and subjects in economics are described as mainstream economics. Heterodox economics includes other approaches that are in various ways presented as alternatives to or criticisms of mainstream economics.
From the 1970s onwards Friedman's monetarist critique of Keynesian macroeconomics formed the starting point for a number of trends in macroeconomic theory opposed to the idea that government intervention can or should stabilise the economy. Robert Lucas criticized Keynesian thought for its inconsistency with microeconomic theory. Lucas's critique set the stage for a neoclassical school of macroeconomics, New Classical economics based the foundation of classical economics. Lucas also popularized the idea of rational expectations, which was used as the basis for several new classical theories including the Policy Ineffectiveness Proposition.
The standard model for new classical economics is the real business cycle theory, which sought to explain observed fluctuations in output and employment in terms of real variables such as changes in technology and tastes. Assuming competitive markets, real business cycle theory implied that cyclical fluctuations are optimal responses to variability in technology and tastes, and that macroeconomic stabilisation policies must reduce welfare.
Keynesian economic made a comeback among mainstream economists with the advent of New Keynesian macroeconomics. The central theme of new Keynesianism was the provision of a microeconomic foundation for Keynesian macroeconomics, obtained by identifying minimal deviations from the standard microeconomic assumptions which yield Keynesian macroeconomic conclusions, such as the possibility of significant welfare benefits from macroeconomic stabilization. Akerlof’s ‘menu costs’ arguments, showing that, under imperfect competition, small deviations from rationality generate significant (in welfare terms) price stickiness, are good example of this kind of work.
Developments in microeconomics
From the 1970s onwards, microeconomics saw a resurgence of interest in the ideas of game theory, first developed by von Neumann and Morgenstern in 1944. One focus was on exploring and refining the concept of Nash equilibrium.
Financial economics
The efficient-market hypothesis (EMH) formed the core of financial economics for most of the later 20th century. The theory, associated with Eugene Fama, held that the current price of an asset, such as a stock, fully represented all information about the asset. This theory implied that it would be difficult, if not impossible, to consistently beat the typical market return on assets. The theory also dismissed technical analysis, and argued that an asset price followed a random walk—meaning an asset's future price movements were independent of its past movements. Economists used neoclassical rational expectations to support the theory. Instead of trying to pick winning investments, adherents of the EMH focused on modern portfolio theory, which showed how to diversify risks to maximize likely profits. The persistence of financial bubbles has cast doubt on the empirical validity of the EMH, as the market often appears to be driven by irrational exuberance. Recent research in behavioral finance and other fields have disputed the EMH on theoretical grounds, offering alternative models for financiers' behavior.
Behavioral economics
Behavioral economics and behavioral finance are closely related fields that have evolved to be a separate branch of economic and financial analysis, which applies scientific research on human and social, cognitive and emotional factors to better understand economicdecisions by consumers, borrowers, investors, and how they affect market prices, returns and the allocation of resources.
Environmental and ecological economics
By the 20th century, the industrial revolution had led to an exponential increase in the human consumption of resources. The increase in health, wealth and population was perceived as a simple path of progress. However, in the 1930s economists began developing models of non-renewable resource management (see Hotelling's Rule) and the sustainability of welfare in an economy that uses non-renewable resources (Hartwick's Rule).
The work of economists Nicholas Georgescu-Roegen and Herman Daly was important in the development of ecological economics. In the Entropy law and the Economic Process (1971), Roegan attempted to demonstrate that the mathematical analysis of production in neoclassical economics is badly flawed because it fails to incorporate the laws of thermodynamics. In his view, an economy must be viewed in thermodynamic terms as a unidirectional flow in which inputs of low entropy matter and energy are used to produce two kinds of outputs, goods and services and high entropy waste and degraded matter.[81] Since neoclassical economic theory in that view, assigns value only to the first output and completely ignores the costs associated with the second, Georgescu-Roegen attempted to refashion this theory to include these costs.[82]Biophysical economics attempts to factor in aspects of energy and environment.[83]Energy economics which relates to biophysical economics also attempts to factor in thermodynamic aspects of energy and environment.[84] One technique for evaluating energy systems is net energy analysis, which seeks to compare the amount of energy delivered to society by a technology to the total energy required to find, extract, process, deliver, and otherwise upgrade that energy to a socially useful form. Energy return on investment (EROEI) is the ratio of energy delivered to energy costs. Biophysical and ecological economists argue that net energy analysis has several advantages over standard economic analysis.
Amartya Sen (born 1933) is a leading development and welfare economist and has expressed considerable skepticism on the validity of neo-classical assumptions. He was highly critical of rational expectations theory, and devoted his work to development and human rights. He won the Nobel Prize in Economics in 1998.
Joseph E. Stiglitz
Joseph Stiglitz (born 1943) Received the Nobel Prize in 2001 for his work in information economics. He has served as chairman of President Clinton's Council of Economic Advisors and as chief economist for the World Bank. Stiglitz has taught at many universities, including Columbia, Stanford, Oxford, Yale, and MIT. In recent years he has become an outspoken critic of global economic institutions. He is a popular and academic author. In Making Globalization Work (2007), he offers an account of his perspectives on issues of international economics.
"The fundamental problem with the neoclassical model and the corresponding model under market socialism is that they fail to take into account a variety of problems that arise from the absence of perfect information and the costs of acquiring information, as well as the absence or imperfections in certain key risk and capital markets. The absence or imperfection can, in turn, to a large extent be explained by problems of information.[80]
Paul Krugman
Paul Krugman (born 1953) is a contemporary economist. His textbook International Economics (2007) appears on many undergraduate reading lists. Well known as a representative of political liberalism, he writes a weekly column on economics, American economic policy, and American politics more generally in the New York Times. He was awarded the Nobel Prize in Economics in 2008 for his work on New Trade Theory and economic geography.
The interventionist monetary and fiscal policies that the orthodox post-war economics recommended came under attack in particular by a group of theorists working at the University of Chicago, which came to be known as the Chicago School. This more conservative strand of thought reasserted a "libertarian" view of market activity, that people are best left to themselves, free to choose how to conduct their own affairs. More academics who have worked at the University of Chicago have been awarded the Nobel Prize in Economics than those from any other university.
Ronald Coase
Ronald Coase (born 1910) is the most prominent economic analyst of law and the 1991 Nobel Prize winner. His first major article, The Nature of the Firm (1937), argued that the reason for the existence of firms (companies, partnerships, etc.) is the existence of transaction costs. Rational individuals trade through bilateral contracts on open markets until the costs of transactions mean that using corporations to produce things is more cost-effective. His second major article, The Problem of Social Cost (1960), argued that if we lived in a world without transaction costs, people would bargain with one another to create the same allocation of resources, regardless of the way a court might rule in property disputes. Coase used the example of an old legal case about nuisance named Sturges v Bridgman, where a noisy sweetmaker and a quiet doctor were neighbours and went to court to see who should have to move.[74] Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain about who moves house that reaches the same outcome of resource distribution. Only the existence of transaction costs may prevent this.[75] So the law ought to pre-empt what would happen, and be guided by the most efficient solution. The idea is that law and regulation are not as important or effective at helping people as lawyers and government planners believe.[76] Coase and others like him wanted a change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analysing the costs of action.[77]
Milton Friedman
Milton Friedman (1912-2006) stands as one of the most influential economists of the late twentieth century. He won the Nobel Prize in Economics in 1976, among other things, for A Monetary History of the United States (1963). Friedman argued that the Great Depression had been caused by the Federal Reserve's policies through the 1920s, and worsened in the 1930s. Friedman argues laissez-faire government policy is more desirable than government intervention in the economy. Governments should aim for a neutral monetary policy oriented toward long-run economic growth, by gradual expansion of the money supply. He advocates the quantity theory of money, that general prices are determined by money. Therefore active monetary (e.g. easy credit) or fiscal (e.g. tax and spend) policy can have unintended negative effects. In Capitalism and Freedom (1967) Friedman wrote:
"There is likely to be a lag between the need for action and government recognition of the need; a further lag between recognition of the need for action and the taking of action; and a still further lag between the action and its effects.[78]
Friedman was also known for his work on the consumption function, the permanent income hypothesis (1957), which Friedman himself referred to as his best scientific work.[79] This work contended that rational consumers would spend a proportional amount of what they perceived to be their permanent income. Windfall gains would mostly be saved. Tax reductions likewise, as rational consumers would predict that taxes would have to rise later to balance public finances. Other important contributions include his critique of the Phillips curve and the concept of the natural rate of unemployment (1968). This critique associated his name with the insight that a government that brings about higher inflation cannot permanently reduce unemployment by doing so. Unemployment may be temporarily lower, if the inflation is a surprise, but in the long run unemployment will be determined by the frictions and imperfections in the labour market.
This sparked widespread discussion over how to interpret the different conditions of the theorem and what implications it had for democracy and voting. Most controversial of his four (1963) or five (1950/1951) conditions is the independence of irrelevant alternatives.
In the 1950s, Arrow and Gerard Debreu developed the Arrow-Debreu model of general equilibria. In 1971 Arrow with Frank Hahn co-authored General Competitive Analysis (1971), which reasserted a theory of general equilibrium of prices through the economy. In 1969 the Swedish Central Bank began awarding a prize in economics, as an analogy to the Nobel prizes awarded in Chemistry, Physics, Medicine as well as Literature and Peace (though Alfred Nobel never endorsed this in his will). With John Hicks, Arrow won the Bank of Sweden prize in 1972, the youngest recipient ever. The year before, US President Richard Nixon's had declared that "We are all Keynesians now".[73] The irony was that this was the beginning of a new revolution in economic thought.
After the war, John Kenneth Galbraith (1908-2006) became one of the standard bearers for pro-active government and liberal-democrat politics. In The Affluent Society (1958), Galbraith argued voters reaching a certain material wealth begin to vote against the common good. He argued that the "conventional wisdom" of the conservative consensus was not enough to solve the problems of social inequality.[70] In an age of big business, he argued, it is unrealistic to think of markets of the classical kind. They set prices and use advertising to create artificial demand for their own products, distorting people's real preferences. Consumer preferences actually come to reflect those of corporations—a "dependence effect"—and the economy as a whole is geared to irrational goals.[71] In The New Industrial State Galbraith argued that economic decisions are planned by a private-bureaucracy, a technostructure of experts who manipulate marketing and public relations channels. This hierarchy is self serving, profits are no longer the prime motivator, and even managers are not in control. Because they are the new planners, corporations detest risk, require steady economic and stable markets. They recruit governments to serve their interests with fiscal and monetary policy, for instance adhering to monetarist policies which enrich money-lenders in the City through increases in interest rates. While the goals of an affluent society and complicit government serve the irrational technostructure, public space is simultaneously impoverished. Galbraith paints the picture of stepping from penthouse villas onto unpaved streets, from landscaped gardens to unkempt public parks. In Economics and the Public Purpose (1973) Galbraith advocates a "new socialism" as the solution, nationalising military production and public services such as health care, introducing disciplined salary and price controls to reduce inequality.
Paul Samuelson
In contrast to Galbraith's linguistic style, the post-war economics profession began to synthesise much of Keynes' work with a mathematical representations. Introductory university economics courses began to present economic theory as a unified whole in what is referred to as the neoclassical synthesis. "Positive economics" became the term created to describe certain trends and "laws" of economics that be objectively observed and described in a value free way, separate from "normative economic" evaluations and judgments. The best selling textbook writer of this generation was Paul Samuelson. His Ph.D. was an attempt to show on how mathematical methods could represent a core of testable economic theory. It was published as Foundations of Economic Analysis in 1947. Samuelson started with two assumptions. First, people and firms will act to maximise their self interested goals. Second, markets tend towards an equilibrium of prices, where demand matches supply. He extended the mathematics to describe equilibrating behaviour of economic systems, including that of the then new macroeconomic theory of John Maynard Keynes. Whilst Richard Cantillon had imitated Isaac Newton's mechanical physics of inertia and gravity in competition and the market,[20] the physiocrats had copied the body's blood system into circular flow of income models, William Jevons had found growth cycles to match the periodicity of sunspots, Samuelson adapted thermodynamics formulae to economic theory. Reasserting economics as a hard science was being done in the United Kingdom also, and one celebrated "discovery", of A. W. Phillips, was of a correlative relationship between inflation and unemployment. The workable policy conclusion that securing full employment could be traded-off against higher inflation. Samuelson incorporated the idea of the Phillips curve into his work. His introductory textbook Economics was influential and widely adopted. It became the most successful economics text ever. Paul Samuelson was awarded the new Nobel Prize in Economics in 1970 for his merging of mathematics and political economy.
After World War II, the United States had become the pre-eminent global economic power. Europe and the Soviet Union lay in ruins and the British Empire was at its end. Until then, American economists had played a minor role. The institutional economists had been largely critical of the "American Way" of life, especially regarding conspicuous consumption of the Roaring Twenties before the Wall Street Crash of 1929. After the war, however, a more orthodox body of thought took root, reacting against the lucid debating style of Keynes, and re-mathematizing the profession. The orthodox centre was also challenged by a more radical group of scholars based at the University of Chicago. They advocated "liberty" and "freedom", looking back to 19th century-style non-interventionist governments.
Institutionalism
Thorsten Veblen (1857-1929), who came from rural mid-western America and worked at the University of Chicago, is one of the best known early critics of the "American Way". In The Theory of the Leisure Class (1899) he scorned materialistic culture and wealthy people who conspicuously consumed their riches as a way of demonstrating success and in The Theory of Business Enterprise (1904) Veblen distinguished production for people to use things and production for pure profit, arguing that the former is often hindered because businesses pursue the latter. Output and technological advance are restricted by business practices and the creation of monopolies. Businesses protect their existing capital investments and employ excessive credit, leading to depressions and increasing military expenditure and war through business control of political power. These two books, focusing on criticism first of consumerism, and second of profiteering, did not advocate change. However, in 1911, Veblen joined the faculty of the University of Missouri, where he had support from Herbert Davenport, the head of the economics department. Veblen remained at Columbia, Missouri through 1918. In that year, he moved to New York to begin work as an editor of a magazine called The Dial, and then in 1919, along with Charles Beard, James Harvey Robinson and John Dewey, helped found the New School for Social Research (known today as The New School). He was also part of the Technical Alliance,[67] created in 1918-19 by Howard Scott, which would later become Technocracy Incorporated. From 1919 through 1926 Veblen continued to write and to be involved in various activities at The New School. During this period he wrote The Engineers and the Price System (1921)[68].
John R. Commons (1862-1945) also came from mid-Western America. Underlying his ideas, consolidated in Institutional Economics (1934) was the concept that the economy is a web of relationships between people with diverging interests. There are monopolies, large corporations, labour disputes and fluctuating business cycles. They do however have an interest in resolving these disputes. Government, thought Commons, ought to be the mediator between the conflicting groups. Commons himself devoted much of his time to advisory and mediation work on government boards and industrial commissions.
The Great Depression was a time of significant upheaval in the States. One of the most original contributions to understanding what had gone wrong came from a Harvard Universitylawyer, named Adolf Berle (1895-1971), who like John Maynard Keynes had resigned from his diplomatic job at the Paris Peace Conference, 1919 and was deeply disillusioned by the Versailles Treaty. In his book with Gardiner C. Means, The Modern Corporation and Private Property (1932), he detailed the evolution in the contemporary economy of big business, and argued that those who controlled big firms should be better held to account. Directors of companies are held to account to the shareholders of companies, or not, by the rules found in company law statutes. This might include rights to elect and fire the management, require for regular general meetings, accounting standards, and so on. In 1930s America, the typical company laws (e.g. in Delaware) did not clearly mandate such rights. Berle argued that the unaccountable directors of companies were therefore apt to funnel the fruits of enterprise profits into their own pockets, as well as manage in their own interests. The ability to do this was supported by the fact that the majority of shareholders in big public companies were single individuals, with scant means of communication, in short, divided and conquered. Berle served in President Franklin Delano Roosevelt's administration through the depression, and was a key member of the so called "Brain trust" developing many of the New Deal policies. In 1967, Berle and Means issued a revised edition of their work, in which the preface added a new dimension. It was not only the separation of controllers of companies from the owners as shareholders at stake. They posed the question of what the corporate structure was really meant to achieve.
“Stockholders toil not, neither do they spin, to earn [dividends and share price increases]. They are beneficiaries by position only. Justification for their inheritance... can be founded only upon social grounds... that justification turns on the distribution as well as the existence of wealth. Its force exists only in direct ratio to the number of individuals who hold such wealth. Justification for the stockholder's existence thus depends on increasing distribution within the American population. Ideally the stockholder's position will be impregnable only when every American family has its fragment of that position and of the wealth by which the opportunity to develop individuality becomes fully actualized.”[69]
John Maynard Keynes (1883-1946) was born in Cambridge, educated at Eton and supervised by both A. C. Pigou and Alfred Marshall at Cambridge University. He began his career as a lecturer, before working in the British government during the Great War, and rose to be the British government's financial representative at the Versailles conference. His observations were laid out in his book The Economic Consequences of the Peace.[64] In his Theory of Money, Keynes said that savings and investment were independently determined. The amount saved had little to do with variations in interest rates which in turn had little to do with how much was invested. Keynes thought that changes in saving depended on the changes in the predisposition to consume which resulted from marginal, incremental changes to income. Therefore, investment was determined by the relationship between expected rates of return on investment and the rate of interest.
During the Great Depression, Keynes had published his most important work, The General Theory of Employment, Interest, and Money (1936). He argued that there exists a continuum of equilibria, the full employment equilibrium position being just one of them. One innovation in his core argument is to stop taking prices and wages as perfectly flexible, arguing instead for a certain degree of stickiness. Thanks to stickiness, it is established that the interaction of "aggregate demand" and "aggregate supply" may lead to stable unemployment equilibria. To combat unemployment Keynes advocated low interest rates and easy credit. However, Keynes also argued that low interest rates were not the only necessary condition to restore economic activity. If investers' expectations are pessimistic (they forecast that effective demand will not grow) they will not invest. So lasting unemployment was entirely possible, and there would be no automatic self correction without external intervention by government. Keynes advocated that state spending be financed by a budgetary deficit.
The book was an enormous success, and though it was criticised for false predictions by a number of people.[65] As a UK representative he helped formulate the plans for the International Monetary Fund, the World Bank and an International Trade Organisation[66] at the Bretton Woods conference, a package designed to stabilise world economy fluctuations and create a level trading field across the globe.
While the end of the nineteenth century and the beginning of the twentieth were dominated increasingly by mathematical analysis, the followers of Carl Menger, in the tradition of Eugen von Böhm-Bawerk, followed a different route, advocating the use of deductive logic instead. This group became known as the AustrianSchool, reflecting the Austrian origin of many of the early adherents. Thorstein Veblen in 1900, in his Preconceptions of Economic Science, contrasted neoclassical marginalists in the tradition of Alfred Marshall from the philosophies of the Austrian school.[59][60]
Joseph Alois Schumpeter (1883 – 1950) was an Austrian economist and political scientist mostly known for his works on business cycles and innovation. He insisted on the role of the entrepreneurs in an economy. In Business Cycles: A theoretical, historical and statistical analysis of the Capitalist process, Schumpeter made a synthesis of the theories about business cycles. He suggested that those cycles could explain the economic situations. According to Schumpeter, capitalism necessarily goes through long-term cycles, because it is entirely based upon on scientific inventions and innovations. A phase of expansion is made possible by innovations, because they bring productivity gains and encourage entrepreneurs to invest. However, when investors have no more opportunities to invest, the economy goes into recession, several firms collapse, closures and bankruptcy occur. This phase lasts until new innovations bring a creative destruction process, i.e. they destroy old products, reduce the employment, but they allow the economy to start a new phase of growth, based upon new products and new factors of production.[61]
Ludwig von Mises (1881 – 1973) was an Austrian economist who contributed the idea of Praxeology, "The science of human action". Praxeology views economics as a series of voluntary trades that increase the satisfaction of the involved parties. Mises also argued that socialism suffers from an unsolvable economic calculation problem, which according to him, could only be solved through free marketprice mechanisms.
Mises' outspoken criticisms of socialism had a large influence on the economic thinking of Friedrich von Hayek (1899-1992), who, while initially sympathetic to socialism, became one of the leading academic critics of collectivism in the 20th century.[62] In echoes of Smith's "system of natural liberty", Hayek argued that the market is a "spontaneous order" and actively disparaged the concept of "social justice".[63] Hayek believed that all forms of collectivism (even those theoretically based on voluntary cooperation) could only be maintained by a central authority. In his book, The Road to Serfdom (1944) and in subsequent works, Hayek claimed that socialism required central economic planning and that such planning in turn would lead towards totalitarianism. Hayek attributed the birth of civilization to private property in his book The Fatal Conceit (1988). According to him, price signals are the only means of enabling each economic decision maker to communicate tacit knowledge or dispersed knowledge to each other, in order to solve the economic calculation problem. Along with his contemporary Gunnar Myrdal, Hayek was awarded the Nobel Prize in 1974.
Vilfredo Pareto (1848-1923) was an Italian economist, best known for developing the concept of the circumstance under which nobody need be made worse off, and nobody better off through wealth redistribution. When this situation exists, the economy is said to be "Pareto efficient". Pareto devised mathematical representations for this optimal resource allocation, which when represented on a graph would yield a curve. Different points along the curve represent different allocations, but each would be optimally efficient. Rather than using the persuasive language of classical economists like Mill, the Pareto efficient curve could be represented with a precise mathematical formula:
Alfred Marshall is also credited with an attempt to put economics on a more mathematical footing. He was the first Professor of Economics at the University of Cambridge and his work, Principles of Economics[57] coincided with the transition of the subject from "political economy" to his favoured term, "economics". He viewed maths as a way to simplify economic reasoning, though had reservations, revealed in a letter to his student Arthur Cecil Pigou.
"(1) Use mathematics as shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This I do often."[58]
Coming after the marginal revolution, Marshall concentrated on reconciling the classical labour theory of value, which had concentrated on the supply side of the market, with the new marginalist theory that concentrated on the consumer demand side. Marshall's graphical representation is the famous supply and demand graph, the "Marshallian cross". He insisted it is the intersection of both supply and demand that produce an equilibrium of price in a competitive market. Over the long run, argued Marshall, the costs of production and the price of goods and services tend towards the lowest point consistent with continued production. Arthur Cecil Pigou in Wealth and Welfare (1920), insisted on the existence of market failures. Markets are inefficient in case of economic externalities, and the State must interfere. However, Pigou retained free-market beliefs, and in 1933, in the face of the economic crisis, he explained in The Theory of Unemployment that the excessive intervention of the state in the labor market was the real cause of massive unemployment, because the governments had established a minimal wage, which prevented the wages from adjusting automatically. This was to be the focus of attack from Keynes.
Carl Menger (1840-1921), an Austrian economist stated the basic principle of marginal utility in Grundsätze der Volkswirtschaftslehre[55] (1871, Principles of Economics). Consumers act rationally by seeking to maximise satisfaction of all their preferences. People allocate their spending so that the last unit of a commodity bought creates no more than a last unit bought of something else. Stanley Jevons (1835-1882) was his English counterpart, and worked as tutor and later professor at Owens College, Manchester and University College, London. He emphasised in the Theory of Political Economy (1871) that at the margin, the satisfaction of goods and services decreases. An example of the theory of diminishing returns is that for every orange one eats, the less pleasure one gets from the last orange (until one stops eating). Then Leon Walras (1834-1910), again working independently, generalised marginal theory across the economy in Elements of Pure Economics (1874). Small changes in people's preferences, for instance shifting from beef to mushrooms, would lead to a mushroom price rise, and beef price fall. This stimulates producers to shift production, increasing mushrooming investment, which would increase market supply and a new price equilibrium between the products - e.g. lowering the price of mushrooms to a level between the two first levels. For many products across the economy the same would go, if one assumes markets are competitive, people choose on self interest and no cost in shifting production.
Early attempts to explain away the periodical crises of which Marx had spoken were not initially as successful. After finding a statistical correlation of sunspots and business fluctuations and following the common belief at the time that sunspots had a direct effect on weather and hence agricultural output, Stanley Jevons wrote,
"when we know that there is a cause, the variation of the solar activity, which is just of the nature to affect the produce of agriculture, and which does vary in the same period, it becomes almost certain that the two series of phenomena— credit cycles and solar variations—are connected as effect and cause.[56]
Just as the term "mercantilism" had been coined and popularised by its critics, like Adam Smith, so was the term "capitalism" or Kapitalismus used by its dissidents, primarily Karl Marx. Karl Marx (1818-1883) was, and in many ways still remains the pre-eminent socialist economist. His combination of political theory represented in the Communist Manifesto and the dialectic theory of history inspired by Friedrich Hegel provided a revolutionary critique of capitalism as he saw it in the nineteenth century. The socialist movement that he joined had emerged in response to the conditions of people in the new industrial era and the classical economics which accompanied it. He wrote his magnum opus Das Kapital at the British Museum's library.
Context
Robert Owen (1771-1858) was one industrialist who determined to improve the conditions of his workers. He bought textile mills in New Lanark, Scotland where he forbade children under ten to work, set the workday from 6 a.m. to 7 p.m. and provided evening schools for children when they finished. Such meagre measures were still substantial improvements and his business remained solvent through higher productivity, though his pay rates were lower than the national average.[50] He published his vision in The New View of Society (1816) during the passage of the Factory Acts, but his attempt from 1824 to begin a new utopian community in New Harmony, Indiana ended in failure. One of Marx's own influences was the French philosopher Pierre Proudhon. While deeply critical of capitalism, he also objected to those contemporary socialists who idolized association. In his book The Philosophy of Poverty Proudhon made a political economic attack on the classical subsistence theory of wages.(1846)[51] In his book What is Property? (1840) he argue that property is theft, a different view than the classical Mill, who had written that "partial taxation is a mild form of robbery".[52] However, towards the end of his life, Proudhon modified some of his earlier views. In the posthumously published Theory of Property, he argued that "property is the only power that can act as a counterweight to the State."[53]Friedrich Engels, a published radical author, released a book titled The Condition of the Working Class in England in 1844[54] describing people's positions as "the most unconcealed pinnacle of social misery in our day." After Marx died, it was Engels that completed the second volume of Das Kapital from Marx's notes.
After Marx
The first volume of Das Kapital was the only one Marx alone published. The second and third volumes were done with the help of Friedrich Engels and Karl Kautsky, who had become a friend of Engels, saw through the publication of volume four.
In the 1860s, a revolution took place in economics. The new ideas were that of the Marginalist school. Writing simultaneously and independently, a Frenchman (Leon Walras), an Austrian (Carl Menger) and an Englishman (Stanley Jevons) were developing the theory, which had some antecedents. Instead of the price of a good or service reflecting the labor that has produced it, it reflects the marginal usefulness (utility) of the last purchase. This meant that in equilibrium, people's preferences determined prices, including, indirectly the price of labor.
This current of thought was not united, and there were three main schools working independently. The Lausanne school, whose two main representants were Walras and Vilfredo Pareto, developed the theories of general equilibrium and optimality. The main written work of this school was Walras' Elements of Pure Economics. The Cambridge school appeared with Jevons' Theory of Political Economy in 1871. This English school has developed the theories of the partial equilibrium and has insisted on markets' failures. The main representatives were Alfred Marshall, Stanley Jevons and Arthur Pigou. The Vienna school was made up of Austrian economists Menger, Eugen von Böhm-Bawerk and Friedrich von Wieser. They developed the theory of capital and has tried to explain the presence of economic crises. It appeared in 1871 with Menger's Principles of Economics.
