Economic Theory

G. B. Richardson

• Publisher: Taylor & Francis
• Year: 2013
• eBook ISBN: 9781136506192
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book introduces economic theory by concentrating on some of the most important matters with which theory deals. Beginning by developing the general criteria of efficiency in the allocation of resources between alternative uses, the book then illustrates how efficient allocation can be promoted directly, by state planning, or indirectly by private enterprise. An analysis of the working of business competition in both its free and restricted forms follows, and analysis of the determination of the general levels of production employment and prices is also included.

1

Introduction

Economics is concerned with the way in which we make use of scarce resources. A resource in this context is taken to mean anything, whether in the form of physical objects or human services, that can be used directly, or through conversion into other things, to satisfy our wants. A resource is said to be scarce when the existing supply of it is insufficient to meet all our requirements.

If resources are scarce we are faced with a problem of how to use or ‘administer’ them. First we have to ensure that scarce resources are all in fact employed, for otherwise wants will be met less fully than they could be. Secondly, it is desirable that resources are employed efficiently, in the sense that they could not be employed, in any alternative way, so as to satisfy wants more fully. This requirement, we say, relates to the proper allocation of resources. If a scarce resource is fully employed, then more of it can be used for one purpose only if less of it is used for another. Choices have therefore to be made between the different ways in which resources can be used. Thus, in the production of, say, food, would it be better to use more of one resource, say labour, and less of another, say land? Should more resources be used to produce food and less to produce clothing? Would some people be better off if they had less food and more clothing, and others if they had less clothing and more food? These, we say, are all problems of resource allocation. If the scarce resources available to a person or to a community would permit wants to be met more fully than they in fact are, then this unnecessary sacrifice is called waste. Waste can result, obviously, from unemployment of resources, and, less obviously, from their inefficient allocation.

The wealth of nations is attributable in great measure to the division of labour. In all but the most primitive societies the work of applying resources to meet needs is divided into very many different functions, in the performance of which different people specialize. By this means each man can make the best use of his particular talents, special skills can be developed and complex processes can be split up into operations for which it is possible to employ labour-saving machines.

The division of labour entails the need for an appropriate organization by which all the specialized functions, undertaken by different people, can be effectively knit together. In the most primitive economies, where each family provides directly for most of its own needs, little co-ordination is required, but economic advance, and the increasing differentiation of function which goes with it, demand the existence within society of a highly sophisticated organization capable of integrating a wide and varied range of individual activities. The forms which such organization can take are various and differ, according to circumstances, from time to time and place to place. In this book I shall discuss two broad classes of economic organization to be distinguished according to whether the ownership of productive resources is vested in public or in private hands.

In economies based on public ownership (or collectivist economies, as they are sometimes called) economic decisions are taken by the central government, or by those to whom it has expressly delegated its authority. The co-ordination of these decisions is generally brought about by means of instructions, issued by the government and based upon its national plan. In some such centrally planned systems the government may endeavour to cover, in its plan, almost all the important decisions which those responsible for production have to take; in others central directions leave more scope for particular issues to be decided, independently, by those directly concerned with them.

In economies based on private ownership the use made of resources generally depends upon decisions taken by private persons and groups owing no responsibility to the government and free to pursue their own interests. Long familiarity with this state of affairs may well blunt our perception of the problem which it poses. The very notion of organization, on the face of it, is difficult to reconcile with the freedom of each man to go his own way. If decisions are taken by a multitude of private persons and private businesses, acting independently and in the furtherance of their own interests, there would seem to be no very obvious reason to expect an orderly administration of the society’s resources ever to result. Yet we know that economies based on private ownership, and free from central direction, can in fact become rich and powerful, and that the allocation of resources which they achieve, even to the superficial observer, exhibits elements of order and rationality scarcely characteristic of a confused welter of unco-ordinated individual strivings. The tasks which are successfully accomplished are of enormous complexity; the production of a motor car, for example, requires the prior undertaking of a bewildering variety of production decisions: iron ore has to be mined, rubber trees have to be planted, electric generating stations built, oil wells sunk and numerous special skills acquired. These manifold activities are not undertaken on the instructions of any single co-ordinating authority, but the fact that they form a related and coherent system of production can scarcely be attributed to accident. The first thing to realize, therefore, is that there is a problem to be solved. We have to ask ourselves what spontaneous forces are at work which, at least to some extent, perform the tasks that might seem to require the existence of a central planning authority.

The co-ordination of individual economic decisions is normally achieved, in a system based on private ownership, chiefly through exchange. At the most primitive level this may take the form of barter, according to which men specialize and rely on exchanging their own products, of which they have more than they desire, for products, made by others, of which they are in need. Even with this arrangement each man will find himself able to further his own interests by promoting those of others, and there will be some reason to expect that different goods will tend to be made available in such quantities as are required. Advanced economies, in which exchange is faciliated by the use of money, operate on essentially the same principle. A manufacturer, for example, may wish only to obtain the greatest possible profits for his firm, but if he is to succeed in doing so he will have to cater to the particular desires of those to whom he hopes to sell his products. The particular process of manufacture which he adopts will in turn help to determine the kind of raw materials which it will be profitable for other people to produce, as well as the nature of the skills which it will pay workers to acquire. Thus under private ownership the multitudinous activities of producing and consuming, buying and selling, and borrowing and lending are all part of a complex network of relationship and interaction of the kind that we are entitled to call a system. Each man finds the opportunities available to him, for the pursuance of his own interest, closely circumscribed by the interests and actions of very many others; in this way individual economic activity can be made subject to a regulation less personal, but not necessarily less effective, than that exercised by a central planning authority.

Economies of this type, in which the administration of resources is effected through spontaneous organization, based on free exchange, are referred to as market economies, the term market denoting, originally, the place where exchanges were carried out. Alternatively, we may use the term private enterprise, thus stressing that resource administration depends on the initiative of private persons or businesses.

I have chosen to associate state ownership with central planning and private ownership with an unplanned organization based on exchange. This accords with the situation, as we generally find it, at the present time. Centralized direction, while naturally harmonious with public ownership, is difficult to reconcile with the fragmentation of ownership (and normally therefore of control) in many private hands. We shall later have occasion to observe, however, that even under state ownership there may be much reliance upon co-ordination through exchange. Producers, even although agents of the government, may sometimes be instructed to act on the same principles as would a private business man, free from detailed control, in a market economy. Under private enterprise, on the other hand, individuals may sometimes be subject to much centrally imposed regulation. To own resources normally implies the right to decide upon how they are to be used; in some countries, at some times, however, the effective scope of this right has been greatly attenuated by government control. Full private ownership, one can safely say, is incompatible with full central direction, but attenuated private ownership co-exists with some central planning in most of the private enterprise economies of the present day.

Economists may study systems of resource allocation from two distinct points of view. They may endeavour merely to explain how the system in fact operates and how resources come to be allocated as they do; alternatively they may endeavour to develop, and to apply, criteria by which the efficiency of the resource allocation may be judged. Positive economics deals with the former problem; normative or prescriptive economics deals with the latter.

The greater part of positive economics is devoted to a systematic study of the spontaneous organization that arises under a system of private ownership. What will determine, in such a system, the kinds and quantities of goods that are produced? What determines relative amounts of goods that different people enjoy? Why do some goods command a higher price than others? Under what circumstances do men and material resources fail to find employment? Upon what factors will depend the rate of growth of a country’s wealth? It is with questions such as these that positive economics attempts to grapple.

Prescriptive economics is concerned not with how things are but with how things ought to be. But this must not be taken to imply, as might at first appear, that economists are so arrogant as to lay down the aims that members of a community, either individually or as a body, ought to pursue. On the contrary, the reasoning of prescriptive economics can be applied only when the ends desired, and the means available, are both known. The first stage in resource allocation must be the framing of objectives, in the form of a system of priorities, and the assessment of the range of opportunities which the existing endowment of resources, taken in conjunction with the known technological possibilities, makes available. Only after these questions are settled does it become possible to isolate the purely logical problem, associated with the choice of the most efficient course of action, upon which the principles of prescriptive economics can be brought to bear. Frequently the first stage in the process may represent much more than half the battle; the problem of choice that then remains may have an intuitively obvious solution. Thus a housewife will be concerned mainly with judging her family’s needs and with ascertaining the quality and prices of the goods that are on sale; in finally choosing the best way in which to spend her income she will follow no very elaborate chain of conscious reasoning. But the problems of resource allocation that confront a large business concern, or, above all, a state planning authority, will rarely be thus capable of intuitive solution; a special logical framework, such as prescriptive economics seeks to provide, may then be necessary. The principles of prescriptive economics, to which the reader will presently be introduced, may therefore be said to represent a logic of choice, specially devised for use in the problems posed by resource allocation.¹

A problem of resource allocation will assume, characteristically, either of two forms. In the first form the available resources are fixed whereas the objective desired is capable of different degrees of fulfilment; our aim is then to decide which particular way of employing resources would ensure the maximum fulfilment of the objective. Given, for example, a fixed amount of money capital, and various opportunities for its investment, how can it be made to yield the highest rate of return? Or, given a fixed income, and a range of goods with particular prices, what pattern of expenditure would provide the maximum satisfaction? In its second form the problem presupposes that a precise objective, which does not admit of different degrees of fulfilment, has to be attained; we have then to determine how to attain it with the minimum use of resources. In order to illustrate the nature of this way of posing the problem the examples which have just been quoted need merely to be reformulated. Given the desire to obtain a certain rate of return, what particular investment policy—on the basis of the opportunities available—would require the minimum amount of money capital? Or given the desire for a certain level of satisfaction, what pattern of consumption expenditure would procure it at lowest cost? The relationship between these two alternative formulations is clear; in the former case the means are fixed and the maximum fulfilment of the end is desired; in the other the end is fixed and the use of means is to be minimized. In either case the aim, succinctly stated, is to reduce waste in terms of an unnecessary sacrifice either of means or of ends. Prescriptive economics, in other words, is to do with economizing, for this word, in its proper sense, denotes not the deliberate forgoing of desired objectives but the avoidance of waste in attaining them. When we apply an economic criterion, or judge an activity from an economic point of view, our aim is to decide whether there has been any unnecessary sacrifice in terms either of objectives desired or of means used for their attainment. In saying that a particular policy is uneconomic we mean that the expenditure of resources contemplated is not justified by the objective to be secured; we imply, in other words, that there are alternative policies which would achieve the same end with less resources, or which would permit the same amount of resources to obtain a more valued objective. Thus, in this sense, for example, it would be uneconomic for Britain to produce all her food at home, in that some of the men and materials required to do this, if used instead to produce manufactured goods for export, could indirectly enable us to import a greater quantity of food than they could produce directly within these islands.

It is evident, therefore, that allocative problems may exhibit both similarities of form and differences of content and of scope. Thus we may endeavour to set up principles with which to judge the efficiency of the choices made by an individual, whether as consumer or investor or manager of a firm; alternatively, we may seek criteria with which to judge the efficiency with which resources are allocated within the community as a whole. Welfare economics is the name given to that part of our subject which has this latter aim in view. As the term implies, it seeks to identify criteria for the efficiency of resource allocation where the relevant objective is—in some carefully defined sense—the welfare of the general public.

Welfare economics will, in effect, form the essential subject matter of the following two chapters. In order to facilitate the exposition of its fundamental principles I shall consider a hypothetical economy based on state ownership in which all allocative decisions are taken by a Central Planning Authority. By first supposing that the Authority has unlimited knowledge and unlimited administrative capacity, we shall be free to concentrate exclusively on the pure logic of the problems of choice that will confront it. In chapter 4, while still confining the discussion to an economy based on public ownership, I shall recognize that inevitable limitation in the knowledge and administrative capacity of any Central Planning Authority will oblige it to delegate some authority and decentralize some decisions. At this stage, that is to say, our interest will extend beyond the criteria of efficient allocation (the pure logic of choice) to the ways and means by which efficient allocation might be secured in practice.

In chapters 5 to 9 I shall be concerned with the explanation, and the appraisal, of the working of private enterprise. Can the full and efficient employment of resources be promoted automatically, through spontaneous organization based on free exchanges? And, if it cannot, in what ways, and to what extent, must spontaneous co-ordination be supplemented by planned co-ordination, whether by the government or by the concerted action of several firms?

Such, then, is the general shape of the argument that I shall present. The reader will not expect to derive from this very short volume an acquaintance with all the major issues with which economists interest themselves. My aim has been to take up certain central questions, and, by discussing them in terms of a connected argument, to endeavour to impart an understanding of the structure of the subject as a whole. Although I have striven, at the cost of much time and effort, to write as clearly and simply as a complex subject and a limited space would permit, it has not proved possible to spare the reader from exertion. A command of economic analysis implies not so much the knowledge of facts as the ability to apply certain specialized techniques of thought; inevitably, therefore, its acquisition demands more than passive attention.

One limitation in the scope of this volume is so important as to require explicit mention. I shall be concerned with the analysis of a closed economy, with an economy, that is to say, without commercial links with the rest of the world. In fact, of course, and not least for the United Kingdom, these links are of vital importance; rarely, whether in the explanation of events or the formulation of policy, can they be ignored. My omission of international trade is not therefore to be taken as indicating its relative unimportance. Given the limited space available, some topics had perforce to be excluded, and international economics proved one of those most readily severable. Let it be said in extenuation that the study of a closed economy leads us to formulate principles which also apply, with appropriate modification, to economies linked by external trade. An introduction to the theory of a closed economy is therefore also an introduction to economic theory as a whole.

Finally it should be emphasized that this is an introduction to economic theory rather than to economics as a whole. It is designed not to set down facts about this or that economy, past or present, but to provide a set of ideas without which economic facts cannot be fruitfully organized and interpreted. It was observed by the great economist Alfred Marshall that the part played by theory in the production of knowledge resembles that which machinery plays in the production of goods. As part of the process of manufacture, it may be necessary to perform certain routine operations over and over again; whenever this is the case it is usually possible to devise a machine which will do the work. Similarly, within the field of intellectual enquiry, we frequently have to attend to very much the same kind of problems in very much the same way, so that great advantage can be obtained from the construction of an engine of thought—in the form of an appropriate method of selecting and presenting the relevant facts—expressly designed to deal with them. Anyone who sets out to explain, for example, changes in the price of typewriters will have to gather a good deal of factual information; he will not, however, need to learn every known fact about the history, manufacture, current use, etc., of these articles; it will be necessary to select those aspects of the situation which are relevant to the problem in hand and to devise some way of organizing or presenting them which will enable a solution to be found. Investigations into the prices of shoes, or eggs, or steel, would have to be conducted in a similar manner, and it would be found that very much the same general ideas and principles of presentation were common to them all. This would make it possible to set out a generalized account of the determination of the prices of goods which could be used to guide the investigation of particular instances. Such an account would consist of certain relevant ideas, such as that of demand and cost, and of the relationship between them. Different problems, of course, require the constructi...

Table of contents

• Cover
• Routledge Library Editions — Economics
• Title Page
• Copyright Page
• Contents
• Preface
• 1 Introduction
• 2 The logic of choice
• 3 Capital, technology and time
• 4 The decentralization of decisions
• 5 Private ownership: the system in outline
• 6 The long-run adjustment of supply to demand
• 7 The short-run adjustment of supply to demand
• 8 The general level of employment, output and prices
• 9 The role of money
• 10 Conclusion
• Index