B.A. LL.B. (Five Years) Sem 2 Economics I (old course) 2012 Jan Question Paper with Solutions

3. Scarcity: Lionel Robbins (1932) made it the science of choice between "scarce means which have alternative uses".
4. Growth: Paul Samuelson added choice over time and growth.

The question asks about the first of these, the classical theory. The Kannada line of the question speaks of the theory of the classical school.

2. Who were the classical economists?

The classical school began with Adam Smith, whose An Inquiry into the Nature and Causes of the Wealth of Nations appeared in 1776. Its main members were David Ricardo and J. B. Say. Ricardo wrote Principles of Political Economy and Taxation (1817), and Say wrote the Treatise on Political Economy (1803). J. S. Mill completed the school with his Principles of Political Economy (1848).

J. M. Keynes, in his General Theory (1936), used the word "classical" more widely. He included the followers of Ricardo, such as Marshall and Pigou. He called Pigou's Theory of Unemployment "the only detailed account of the classical theory of employment which exists".

3. Laissez-faire. Since markets work well on their own, the State should do little: keep order, enforce contracts, provide defence and some public works. It should not control prices or trade.

4. Value. The classical writers separated value in use from value in exchange. Smith's example: "Nothing is more useful than water; but it will purchase scarce any thing", while a diamond "has scarce any value in use" yet commands much in exchange. Ricardo traced value mainly to the labour needed to produce a good.

5. Rent. Ricardo defined rent as "that portion of the produce of the earth, which is paid to the landlord for the use of the original and indestructible powers of the soil". He argued that "Corn is not high because a rent is paid, but a rent is paid because corn is high". Rent arises from the law of diminishing returns on land.

6. Distribution. National output is divided into rent for land, wages for labour and profit for capital. The classical writers studied how these shares change as an economy grows.

7. Say's law. Say wrote that "a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value". Supply creates its own demand, so there can be no general overproduction.

4. Its case for markets and free trade still guides policy in many countries, including India's reforms since 1991.
5. It treated wealth as a yearly flow, the root of the idea of national income.

6. Criticisms

1. Keynes's attack on full employment. The Great Depression of the 1930s brought years of mass unemployment. Keynes showed that employment depends on effective demand, which can settle below full employment. Wages and prices do not fall quickly enough to clear the labour market. He wrote that Say's law "is equivalent to the proposition that there is no obstacle to full employment", and rejected it.

2. Saving may not be invested. Income saved may be held as money rather than spent on investment, so total demand can fall short of supply.

3. Too narrow a view of wealth. Only material goods counted, so services were left out. Carlyle called economics "the dismal science" in 1849, and Ruskin replied that "THERE IS NO WEALTH BUT LIFE".

4. Unreal economic man. People act from many motives, not only self-interest.

Conclusion. Economics is the study of how scarce resources are used to satisfy wants, and its definition has moved from wealth to welfare, scarcity and growth. The classical theory, from Smith (1776) to Mill (1848), treated economics as the science of wealth. Its doctrines were division of labour, the invisible hand and laissez-faire, together with theories of value, rent and distribution. Say's law, full employment through flexible wages and interest, free trade and economic man completed it. It founded economics as a science, but Keynes showed after the Great Depression that its belief in automatic full employment was wrong.