History of Economic thought.
Adam Smith gave the first definition of value as the exchange price that a consumer gives out to obtain a certain product. The price of any commodity is related to the value. Therefore, the value of labor can be related to the price paid in exchange of the commodity. The price (value) of any item is related to how scarce that item is to obtain. Scarce items have greater value than readily available ones. Adam Smith also defined value in terms of the utility obtained from a product. Utility refers to the satisfaction that a person acquires from consuming a particular commodity. It also refers to the usefulness of a particular product to the consumer.
The nature of the conceptual problem that led Smith to revise his original labor theory of value for an advanced society was the contradiction imposed by the two definitions of value. Under close scrutiny, value has two meanings which are paradoxical the utility (value in use) of an item and the price (value in exchange) of that commodity. The commodities which have the highest value in use have small or no value in exchange. On the other hand, items which have highest value in exchange have small or no value in use. For example, water has the greatest use, but to the contrary, it has little or no exchange value. Gold has scarce value in use, but on the other hand it has the greatest value in exchange.
The second version of defining value of a commodity as postulated by Adam Smith was that the value of any commodity is equivalent to the amount of labor which enables him to buy or command. David Ricardo argued that Smiths second version was unnecessary because the value of any commodity varies with changes in distribution and technology in the labor market. Ricardo accepted the definition that the value of labor was proportional to the exchange value of that commodity.
According to Adam Smith, the term economic growth refers to increase in the total Gross Domestic Product (GDP) of a country. The rate of change in Gross Domestic Product measures economic development in a country. It is used to refer to the amount of goods and services that a country produces and does not include the methods of production used to make the commodities. Alternatively, Gross National Product (GNP) can be used to measure Gross Domestic Product. GDP is used to estimate the purchasing power of currency in a country. GNP compares the per capita incomes of different countries. Inflation adjustment coefficients are used to compensate for inflation that may affect GDP or GNP.
Economic growth is defined in terms of the long term period. It defines the changes in the standards of living of the citizens of a nation over a certain period of time. Econometrics is a field of economics which measures the outcome of the policies made by economists. Other concepts that lie within the definition of economic growth are the rate of unemployment and inflation.
Economic growth can be classified in terms of how positively or negatively it is contributing to the economy of the country. Economic downturn as well as depression defines the negative economic growth. On the other hand, an increase in the Gross Domestic Product is associated with positive economic growth. Smith defines economic development as the change in the methods of producing goods and services. He explains that positive economic development engages introducing new efficient production technologies.
Mercantilism economic theory suggests that the economic growth and development of a country depends on the amount capital resources that it possesses. The theory suggests that the world market of international trade cannot be changed. The bullion held by a country represents the economic capital and that only a positive balance of trade can increase the bullion. Mercantilism also assumes that the capital as well as monetary resources is the same. This theory proposes that the state ought to encourage exports and discourage imports (protectionism) in order to achieve its economic growth and development goals. These goals can be achieved by the use of tariffs and subsidies. The development of mercantilism was seen to encourage several European wars and increased European imperial systems.
Adam Smith criticized mercantilism theory by suggesting that the use of the bullion system should be replaced by the system of measuring economic growth and development according to the productive capacity of a country. He argued that the tariffs discouraged trade although it contributed to a great extent to the income of the country. Adam Smith criticized mercantilism by saying that prices are directly proportional to the amount of money circulating in the country whereas mercantilism did not relate the two aspects clearly. He also said that the wealth of any nation is produced by the human capital and it is not fixed. Mercantilist never recognized the contribution of comparative as well as absolute advantage to trade. Smith never accepted the fact that balance of trade could remain constant for a long period of time as proposed by mercantilists. This is because as countries exchanged bullion, there would be imbalance in supply and demand of the bullion between the state importing and exporting. This would create instability in the balance of trade. Smith suggested that the mercantilists confused wealth and money and that bullion was just like any other commodity and did not require too much emphasis.
Employment of capital (Smith)
Employment of capital is also called capitalism and involves the control of capital by the private sector. This is an economic and social system that allows the trade of labor, goods and capital in markets. Under this system, there is distribution and investing of the profits generated from the capital assets into developing new technology and industries. Capitalism encourages economic growth due to the increase in the GDP that is realized under this system. Under the system of capitalism, there is reduced government control on the market activities.
The history of capitalism can be traced back to the 16th century in Europe. However, during the ancient times, organizations that were similar to capitalism existed. A small amount of capitalism was experienced during the late middle ages. After the massive establishment of capitalism in Europe, it continued to extend all over the world in the 19th and 20th centuries and it is said to have contributed a lot to industrialization.
Composition of capital (Ricardo)
Capital is composed of two elements the variable capital and the constant capital. The variable capital represents the value of labor as a factor of production while the constant capital represents the value of the means of production. The variable capital is adjusted in order to decrease costs and increase profits made by the company. However, the constant capital is incurred by the company despite the amount of profits or losses made by the company.
The theory of capital composition was developed in 1830s. This was invented after economists realized that profits are not only dictated by wages, which was considered the major capital element by that time. As technology changed, the composition of capital continued to change. Economic changes also caused changes in the ratio to which capital components are made of. Adjustments must be made when the economy is favorable while during recession, the composition of capital must be reduced proportionately in order to cater for the changes.
Forces of production (Marx)
According to Karl Marx, the forces of production refer to the combination of means of labor with human labor power. The means of labor refer to the tools, machinery, infrastructure and many others. This concept includes the forces that people apply in the process of production. Karl Marx suggested that labor factors can be considered as forces of production if and only if they applied by the living human beings. Capital is considered as a force of production since it is used to buy labor. Production forces are not similar to means of production. According to Karl Marx, there are three components of production human labor, subject of labor and means of labor. The forces of production include the combination of human labor and the means if labor.