Unit 1 – The Capitalist Revolution: Comprehensive Notes

Historical Backdrop: A Once-Flat World

• Fourteenth century: Modest material differences between regions; striking contrasts within societies (rich vs. poor).

• Seven centuries later: Vast international income gaps (e.g., Singapore's richest 10% vs. Liberia's poorest 10%), creating a “skyscraper and flatlands” picture.

Measuring Income and Living Standards

• GDP (Gross Domestic Product): Market value of final goods/services produced in a country over a period.

• GDP per capita:
  \dfrac{\text{GDP}}{\text{Population}}
  — proxy for average income.

• Disposable income: Income after taxes plus transfers; maximum spending without borrowing. Excludes non-market benefits.

• Nominal vs. Real GDP:

  • Nominal: Uses current prices (\sum_i p_i q_i).

  • Real: Holds prices fixed at a base year to isolate quantity changes (\sum_i p_{\text{base}} q_{t}).

• Growth rate formula: g=\dfrac{y_{t+1}-y_t}{y_t}.

• Purchasing-Power Parity (PPP): Uses international price set for comparing real buying power (e.g., Indonesian GDP per capita is 21% of Sweden's at PPP vs. 6% at market exchange rates).

History’s “Hockey-Stick” Curves

• For most of history, GDP per capita was stagnant.

• Around 1700–1850, Britain, then NW Europe, US, and Japan, experienced sharp upward growth.

• On a ratio scale, constant percentage growth appears as a straight line.

Inequality: Two Dimensions

1. Within countries: Rich/Poor (90/10) ratio varies significantly (e.g., Singapore ~18, Norway 5.4, Botswana 145).

2. Between countries: Large average income disparities (e.g., Norway's average income is 19x Nigeria's; Norway's poorest 10% earn almost twice Nigeria's richest 10%).

GDP’s Blind Spots and Ethical Debates

• GDP fails to measure what makes life worthwhile (health, education, etc.).

• Counts negative activities (cigarette advertising, pollution) as positives.

• Modern “quality-of-life” dashboards try to address these omissions.

From Nominal to Real and International Comparisons

1. Deflating over time: Choose a base year; price all quantities at those prices.

2. PPP across space: Equalize the cost of a basket of goods, accounting for price differences (e.g., cappuccino example).

The Permanent Technological Revolution

• Industrial Revolution (≈1760 on): Innovations like steam power, textiles, iron, railways.

• Technology in economics: A process transforming inputs into outputs (a “recipe”).

• Lighting example (Nordhaus): Massive increase in light yielded per labour-hour over two centuries (a hockey-stick curve).

Information, Connectivity and Speed

• Historical progression from slow news transmission (e.g., 1 mph for Rome→Egypt) to near-light speed in the digital era, enabling global collaboration.

Environment: The Other Hockey Stick

• CO₂ concentration: Rose from 275 ppm (pre-industrial) to >410 ppm.

• Fossil-fuel emissions: Exploded post-1800.

• Global temperatures: Modern warming >0.8 °C above 1961–90 mean.

• Local impacts (urban pollution); global impacts (melting ice caps, sea-level rise).

Defining Capitalism

Economic system combining three institutions:

1. Private property: Secure, transferable ownership of assets.

2. Markets: Voluntary, reciprocated, competitive exchanges.

3. Firms: Privately owned organizations hiring labour, purchasing inputs, directing production, and selling for profit.

• Usage of the term “capitalism” spiked in crises and remained high after the 1980s.

• Illustrations: William Pitt on private property; Facebook vs. eBay (only eBay is a market due to reciprocated/priced exchanges).

Firms, Labour Markets and Specialisation

• Labour market: Owners (demand) offer wages to workers (supply).

• Hierarchy + cooperation: Centralised power within firms (managers direct workers) balanced by decentralised power from inter-firm competition (threatening failure).

• Adam Smith’s pin factory: Demonstrated increased productivity through specialisation (e.g., ten workers producing 50,000 pins/day).

Why Specialise?

1. Learning by doing.

2. Differences in ability or environment.

3. Economies of scale.

Comparative-Advantage Parable (Greta & Carlos)

• Even if one person has an absolute advantage in all goods, both can gain from trade by specialising in their comparative advantage (producing goods where they have a relatively lower opportunity cost).

• Example: Greta (better at both apples and wheat) and Carlos (worse at both). If Carlos specialises in apples (his comparative advantage) and Greta in wheat, both consume more of both goods through trade.

Capitalism, Causation and Natural Experiments

• Proving cause is difficult; economists use natural experiments (exogenous institutional change).

• East vs. West Germany (1949–1989): Shared culture, pre-war income, but divergent institutions led to West Germany's GDP per capita being >2x East's by 1989. This suggests market-oriented institutions foster growth.

Varieties of Capitalism & Government’s Role

• South Korea: Transformed from Nigerian income level to >7x Nigeria's by 2020 through a developmental state steering export-oriented growth.

• Botswana vs. Nigeria: Botswana's stronger rule of law led to faster catch-up despite similar resource endowments (diamonds vs. oil).

• Former Soviet Union: Modest growth under planning, then collapse in the 1990s transition.

When is Capitalism Dynamic?

Economic prerequisites:

1. Secure private property.

2. Competitive markets (no entrenched monopoly).

3. Merit-based firm control.

Political prerequisites:

1. Rule of law and contract enforcement.

2. Policies curbing monopolies, bail-outs, and rent-seeking.

3. Provision of public goods (infrastructure, education, research, environmental safeguards).

A stable society and sustainable biosphere are also crucial.

Political Systems and Capitalism

• Capitalism coexists with diverse political systems: pre-1900 Britain (capitalist, not fully democratic), post-1945 Japan/South Korea (democratic capitalist), contemporary China (capitalist under one-party state), Scandinavian democracies (high taxes, transfers).

The Economy Inside Society and Nature

• Households: Supply labour, consume, raise next generation.

• Firms: Combine labour and capital to produce goods/services.

• Both draw from the biosphere (energy, materials) and emit waste. Environmental degradation can undermine future production, highlighting the importance of sustainability.

Key Concepts Recap

• Industrial Revolution: Sustained, innovation-driven growth beginning ~1760.

• Technology: The recipe linking inputs to outputs.

• Capitalist revolution: Spread of private property, markets, and firms, fueling growth and inequality.

• Democracy: Political system where government is selected by broad electorate.

• Natural experiment: Real-world institutional variation mimicking controlled experiments (e.g., the two Germanies).

Take-Home Messages

1. Human history mostly stagnant; capitalism and technology broke this pattern.

2. GDP per capital is useful but incomplete; disposable income, inequality, leisure, and environment also matter.

3. Capitalism's success relies on incentives (private property), information/discipline (competitive markets), and coordinated production (firms).

4. Specialisation and trade (via markets) boost productivity through comparative advantage.

5. Institutions and policies determine whether capitalism is dynamic, stagnant, inclusive, or exclusionary.

6. Economic activity is embedded in society and nature; growth brings prosperity but also environmental risks.