Unit 2- The Age of Reason: - Homo Economicus

Homo Economicus & Market Forces

• Homo Economicus (Rational Choice Theory) – Assumes individuals maximize their well-being while exerting the least effort, acting in self-interest. However, they cannot harm others in the process.

• Adam Smith – The founder of modern economics, who introduced the concept of the Invisible Hand, where individuals pursuing self-interest drive the economy through supply and demand.

• Smithian Growth – Economic expansion occurs when more goods are consumed. This leads to increased specialization, as businesses reinvest their wealth into hiring specialized workers (e.g., companies hiring more marketers to expand their market).

Classical vs. Neoclassical Economics

• Classical Economics – Focuses on factors of production such as capital and labor.

• Neoclassical Economics – Emphasizes marginal utility, where consumers' willingness to pay for goods is based on the pleasure derived from consumption.

Value & Marginal Utility

• Marginal Utility – The amount of pleasure gained from consuming a product.

• Diamond-Water Paradox – Diamonds are more valuable than water because they are scarce, and people are willing to give up more for them, even though water is essential for life.

Taxes & Government Policy

• Anne-Robert-Jacques Turgot – Argued that taxes interfere with the free market and should be simplified. He believed powerful groups, especially those who contribute nothing to the economy, should pay taxes. He advocated for a single tax on a country's net product (total goods and services value minus depreciation).

Population & Economic Limits

• Thomas Malthus – Predicted that population growth would outpace food supply, leading to widespread famine and decline. However, the Industrial Revolution disproved this by increasing agricultural productivity through technological advancements.

Say’s Law & Market Equilibrium

• Jean-Baptiste Say – Developed Say’s Law, which states that supply creates its own demand, making overproduction in a market nearly impossible.

  • Since human wants exceed our ability to produce, supply will always be met with demand.

  • Overproduction can happen when firms miscalculate demand, but they will shift to a different market to recover their losses.

  • Competition drives prices down, as consumers naturally choose lower-cost options.

Supply-Side vs. Demand-Side Economics

• Classical Economists – Believed that the supply side (production and availability of goods) is the key driver of economic growth.

• Keynesian Economists – Argued that growth is driven by demand, since people might hold onto their money (e.g., paying off debt), reducing economic activity.

Comparative & Absolute Advantage in Trade

• David Ricardo –

  • Ricardian Equivalence – Government borrowing leads to future taxation. Rational taxpayers should save money now to prepare for future taxes. However, most people ignore this, as higher taxes often come after their lifetime.

  • Opposed Protectionism – Opposed Corn Laws, which restricted foreign wheat imports. He argued that protectionist policies limit a country’s ability to grow wealth.

  • Absolute Advantage – A country should produce goods it makes most efficiently.

  • Comparative Advantage – Even if one country is better at making two products than another, both benefit by specializing in what they produce best relative to other goods. For example:

    • Country A produces hats and shoes better than Country B.

    • Instead of making both, Country A focuses on hats while Country B produces shoes.

    • This allows Country A to maximize hat production while still obtaining shoes through trade.

Labor Markets & Trade Effects

• New Classical Economists – Believe labor markets set wages based on supply (workers available) and demand (jobs available), meaning unemployment is voluntary.

• Capital-Rich Countries & Trade – Wealthy nations may suffer job losses in industries where labor-abundant countries can produce goods more cheaply (e.g., shoes).

Government Regulation & Economic Crises

• Jean-Charles Sismondi – Believed government intervention is necessary to regulate wealth accumulation and prevent economic crises.