Part II

Classical economics proceeded from the assumption of scarcity of resources. Dating from the 1870s, Neo-Classicist economists shifted emphasis from limitations on supply to interpretations of consumer choice. Neo-Classicists explained market prices according to the intensity of consumer preference for one more unit of a commodity. The British economist Alfred Marshall explained demand by the principle of marginal utility, and supply by the rule of marginal productivity (the cost of producing the last item of a given quantity). In competitive markets, consumer preferences for low prices of goods and seller preferences for high prices settle on a mutually agreeable level. This same reconciliation between supply and demand occurs in markets for money and human labour. For example, in competitive labour markets, actual wages represent to the employer the value of the output, and to the employee the acceptable compensation for the work.

During the Great Depression of the 1930s, accepted strategies for reversing the depression failed, and fresh policies were urgently required. The British economist John Maynard Keynes supplied them. In his work The General Theory of Employment, Interest, and Money (1936), he asserted that (1) neither high prices nor high wages explain persistent depression and mass unemployment, and (2) the explanation of these phenomena should be focused on aggregate demand-that is, the total spending of consumers, business investors, and governmental bodies. When aggregate demand is low, sales and jobs suffer; when it is high, all is well and prosperous. These ideas form the basis of contemporary macroeconomics. The national economy depends not on the actions of consumers, who are limited in the amounts that they can spend by the size of their incomes, but on business investors and governments, who invest in the economy. In a recession or depression, the proper thing to do is either to enlarge private investment or create public substitutes. This is done through easy credit or low interest rates, or more drastically by incurring deliberate budget deficits through public projects or subsidies to afflicted groups.

Economic Systems

The two major economic systems are the free-enterprise system and the Communist system. The major differences between these concern ownership of factories, farms, and other enterprises, and contrasting principles of pricing and income distribution. In free-enterprise societies, much of the gross national product (GNP) is directly generated by profit-making business enterprises, farm­ers, and private institutions. Prices are determined by markets, and income is not firmly established. In Communist economies, the state plans much of the price setting, and there is public ownership of factories, farms, and large retail estab­lishments. However, all organized economic systems mix market activity and government intervention to some degree.

Falling somewhere between societies that emphasize either central planning or free enterprise are those that formally practise social democracy, or liberal socialism. For example, Sweden organizes the bulk of productive activity under private ownership but regulates this activity closely, intervenes to protect the jobs of workers, and redistributes substantial portions of profits and large individual incomes to low-income groups.

1. How did the British economist Alfred Marshall explain demand and supply?

2. What do actual wages represent to the employer and the employee in competitive labour markets?

3. What were the two main items in John Maynard Keynes’s The General Theory of Employment, Interest, and Money?

4. What does the national economy depend on?

5. What are the major differences between the free-enterprise system and the Communist system?