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The Evolution of Markets and Institutions: 

The Evolution of Markets and Institutions Principles of Macroeconomics Professor Dalton ECON 201 Boise State University


Economics Economists study. . . …how people make decisions. …how people interact with each other. …the forces and trends that affect the economy as a whole.

How People Make Decisions: 

How People Make Decisions 1. People face tradeoffs. To get one thing, we usually have to give up another thing. 2. The cost of something is what you give up to get it. Decisions require comparing costs and benefits of alternatives. Opportunity Cost is the value of the alternative foregone in a choice or action.

How People Make Decisions: 

How People Make Decisions 3. People think at the margin. Marginal changes are incremental adjustments to an existing plan. Compare marginal benefit vs. marginal cost of a choice. 4. People respond to incentives. Changes in marginal costs or benefits motivate people to respond. Decision to choose one good over another occurs when MB > MC.

How People Interact: 

How People Interact 5. Trade makes everyone better off. Individuals gain from trade with others. Markets allow people to specialize in what they do best. 6. Markets are a good way to organize economic activity. In a Market Economy, households and business firms determine what and how much to produce, how to produce, and for whom to produce. The coordination problems are solved by voluntary social cooperation.

Growth in the Past Two Millennia: 

Growth in the Past Two Millennia

Markets and Growth: 

Markets and Growth The growth in per capita income in the past 500 years has been astonishing. Already claimed that this is due largely to the introduction and spread of markets. Have also noted that proper institutions are necessary to facilitate markets, specialization and trade, and consequent economic growth. Two questions arise…

Institutions and Markets: 

Institutions and Markets What are the “proper” institutions necessary to facilitate markets, specialization and trade, and consequent economic growth? A question of political economy How did the institutional framework of a market economy arise? A question of economic history

Institutions of a Market Economy: 

Institutions of a Market Economy A market economy is characterized by voluntary social cooperation to solve the coordinating problems that arise due to scarcity. In order to cooperate, individuals must feel secure in the outcomes of cooperation.

Institutions of a Market Economy: 

Institutions of a Market Economy Security of outcomes requires that there must be a recognition and enforcement of private property rights and contracts. Private property right – claim of ownership and control over an asset or action by an individual or voluntary group of individuals Contract - an agreement between two or more parties that creates in each party a duty to do or not do something

Institutions of a Market Economy: 

Institutions of a Market Economy The recognition and enforcement of private property rights and contracts requires a system of law and enforcement mechanisms. The functions of law and enforcement have historically been provided by both private and collective entities, though government has been historically the most prominent.

Institutions of a Market Economy: 

Institutions of a Market Economy Security of outcomes and, more importantly, specialization and trade also depend upon the existence of a stable monetary unit. Historically, a stable monetary unit arose on the market through private action, though in recent history, governments have taken on this function.

Institutions of a Market Economy: 

Institutions of a Market Economy The central institutions of a market economy are private property rights, contracts, a system of law with associated enforcement mechanisms, and a stable monetary unit.

The Political Economy of Markets: 

The Political Economy of Markets The normative defense of the pure market economy (limited to the central institutions) is known by several names: Laissez-faire Classical Liberalism Market Liberalism government provision of law Anarcho-capitalism market provision of law

Institutions and Markets: 

Institutions and Markets We have briefly answered the question: What are the “proper” institutions necessary to facilitate markets, specialization and trade, and consequent economic growth? Now turn to the other question of the relationship between institutions and markets: How did the institutional framework of modern market economies arise?

Evolution of Economic Systems: 

Evolution of Economic Systems Economies in the common era have evolved from traditional or slave societies to feudalism, to mercantilism, to capitalism. Socialism and welfare capitalism arose as reactions to capitalism.

The Ancient World: 

The Ancient World The great ancient societies Mesopotamia, China, India, Egypt, Greece, and Rome. The ancient societies of China and India had little influence on the development of western economic systems, except through trade. Economies of Greece and Rome most important to the development of western economies.

Ancient Greece: 

Ancient Greece Early Greek economy agricultural based by 700 BCE numerous Greek colonies dot shores of the Mediterranean. sea-going Greek merchant traders compete with Phoenicians. manufacture by independent handicraftsmen Merchants generally denied citizenship; citizenship based on ownership of land. First coined money appears circa 700 BCE

Ancient Greece: 

Ancient Greece First philosophical defense (Aristotle) and critique (Plato) of private property circa 350 BCE. Critique of interest by Aristotle. Stoic philosophers advance notion of natural law. Slavery taken for granted and plays reasonably large role in agricultural and small handicrafts.

The Hebrew Bible: 

The Hebrew Bible Judaism, as a foundation for Christianity, plays a significant role in later western economic development. Economy of Galilee-Judea heavily agricultural, small crafts, trade with Mediterranean cultures. Hebrew scriptures encourage private property within context of stewardship; discourage interest in relations with poor, but allow in relations with Gentiles; wealth largely treated as result of righteousness.

Ancient Rome: 

Ancient Rome Economy of early Roman Republic agricultural citizens primarily free land-owning farmers state ownership of all mines manufactures (weapons and textiles) other manufactures are independent craftsmen trade dominated by Greeks and Orientals finance/banking associated with upper aristocracy

Ancient Rome: 

Ancient Rome Wars of conquest against Greece and Carthage Influx of slaves displaces peasants and free workers Influx of slave-grown grain depress grain prices Growth of latifundia displaces yeoman farmers Peasants and yeoman farmers trade toil for free games, cheap government grain, and selling votes Rome becomes society resting upon external plunder and internal slavery Cicero advances notions of Natural Law

Imperial Rome: 

Imperial Rome Imperial Rome (44 BCE - 476 ) Progressive debasement of coinage “barbarian” invasions and plague end expansion heavy taxation and first wage and price controls (Diocletian in 301) Constantine gives support to Christianity (313-325) Theodosius makes Christianity official religion (380) 476: End of Western Empire; Odovocar takes control of Italy

Early Christianity: 

Early Christianity Belief in Imminence of Second Coming Early Church Fathers - detachment form worldly possessions Asceticism Condemnation of wealth and market activity Tertullian and St. Jerome Delay in Second Coming Wealth and trade as means not ends Clement of Alexandria and St. Augustine Prohibition on interest-taking

Fall of Rome and Rise of Feudalism: 

Fall of Rome and Rise of Feudalism Fall of Rome disintegration of cities inability of central government to provide defense against marauding barbarians Invasion and Defense invasion by horsemen Moors, Vikings, Magyars - 8th & 9th Centuries system of local defense provided by armored horsemen (Knights)

Fall of Rome and Rise of Feudalism: 

Fall of Rome and Rise of Feudalism Frankish Kingdoms under Charlemagne develop Feudalism grants of lands in exchange for military service land grants entail administration of local order and justice Feudalism dominates Western world from 8th to the 15th century. Manorialism is the economic system


Manorialism Manorialism - the economic structure Roman latifundia become self-sufficient estates and feudalism introduces warriors into ruling class division of land into lord’s demesne, peasant lands, and commons demesne worked by peasants as service to lord Peasant status up to 10th/11th, conditions become increasingly servile from 12th century on, a progressive relaxation towns and merchants few


Feudalism The First Logistic (9th-11th Centuries) Agricultural Innovation and Population Growth increased agricultural productivity via three-crop rotation, heavy wheeled plow and adoption of horses for fieldwork Geographic expansion and land reclamation The Crusades (1095-1291) Response to Seljuk Turk expansion into Holy Lands ends with Egyptian Malmuks in control of Holy Land Centralizes Power and Wealth in Church Weakens Islamic Power and Christian Faith Expansion of Trade and Commerce

The Decline of Feudalism: 

The Decline of Feudalism Commercial Revolution (11th-13th Centuries) Rise of Cities, Markets, the Merchant Class and Communes Fairs of Champagne and rise of Law Merchant Manufactures Intensified Rivalry between Manors and Towns From Serfdom to Wage Labor Population/urban growth expands hired labor as wage rates fall Private landholdings increase relative to commons Rental payments replace service requirements for serfs

The Decline of Feudalism: 

The Decline of Feudalism Consequences of Crusades and Commercial Revolution Expansion of Universities Loss of Papal authority influx of Islamic science, commercial ideas Rediscovery of Aristotle through Arabic translations rediscovery of Stoic and Epicurean themes of natural law theory and republican equality Development of “Two forums” doctrine Roman Law in external world (jus fori) and Canon Law in confessional (jus poli) -mitigates interest prohibition

The End of Feudalism: 

The End of Feudalism Famine, Plague, War, and Statism The Great Famine (1315-1317) Rise of Nation State (France and England) taxation and plunder of the Church and the Fairs The Black Death (1348-1352) Hundred Years War (1338-1453) From Serfdom to Wage Labor Disasters of 14th Century increase wages landlord competition for labor dissolves feudal ties wage controls and peasant revolts

The Transition to Nations: 

The Transition to Nations Europe’s Second Logistic (15th-17th Centuries) Renewed Growth and Development Maritime Trading Centers, Era of Discovery and Expansion Breakdown of Trading and Guild Monopolies The Price Revolution (Gold and Silver Inflows) The Great Nation States England, France, Spain, Sweden, The Netherlands, Portugal, Russia Decline of Mediterranean and prosperity of northern Europe Loss of international language of science and philosophy

Rise of Mercantilism: 

Rise of Mercantilism Common Problems in the new Nation States revenue source problem expansion of trade and colonization Central governments become an active influence on economic decision making. encourage growth by legitimizing and financing a variety of activities limit growth by forming and protecting monopolies


Mercantilism Mercantilism is an economic system in which government determines the what, how, and for whom decisions by distributing rights to undertake certain economic activities and controlling trade opportunities domestically and internationally.


Mercantilism Common Aspects of Mercantilist Policy “bullionism;” an attempt to accumulate gold and silver and prohibit their export support of agriculture and prohibition of foodstuff exports encouragement of domestic manufacture through monopoly, subsidy, and high tariffs large merchant navies and navigation laws encouragement of fisheries through monopoly colonies as economic subordinates in imports and exports

Reaction against Mercantilism: 

Reaction against Mercantilism Natural Law ideas of Grotius, Hobbes and Locke assault notion of central authority Reaction to English mercantilism Locke, North Reaction to French mercantilism (Colbertism) Boisguilbert, Cantillon, Gournay, Turgot and the Physiocrats Laissez-faire - the economic policy of leaving coordination of individuals’ actions to the market (voluntary social cooperation).

From Mercantilism to the Market Society : 

From Mercantilism to the Market Society Industrial revolution – Beginning about 1750, technology and machines rapidly modernized industrial production and mass-produced goods replaced handmade goods. New industrial wealth and merchants become supporters of laissez-faire and democratic-republican ideas A.R.J. Turgot attempts French reforms Adam Smith and the Wealth of Nations

The Industrial Revolution: 

The Industrial Revolution During the 19th century, technological advances accelerated, mass-production increased, democratic-republican institutions became dominant, and markets and wealth expanded. Wealth produced increasing concerns about social and working conditions poverty, slavery “Capitalism is marked by long workdays, low wages, child labor, and dangerous working conditions” Laissez-faire never completely victorious

The Anti-Market Reaction: Carlyle, Ruskin and Dickens: 

The Anti-Market Reaction: Carlyle, Ruskin and Dickens During the mid-19th century, the greatest opponents of the market society were the English literary figures Thomas Carlyle, John Ruskin and Charles Dickens idealized Feudalism and demonized the Market Society feudalism assigned each man his task and allowed him to flourish in that activity in the market system, no task is assigned and man is “forced” to pursue consumption and accumulation to survive rather than an emphasis upon activity, the emphasis is upon gain and acquisition in the market system

The Anti-Market Reaction: Carlyle, Ruskin and Dickens: 

The Anti-Market Reaction: Carlyle, Ruskin and Dickens Idealization of feudalism turned in Carlyle’s “Occasional Discourse on the Negro Question” to a defense of slavery blacks are subhuman (“two-legged cattle”) blacks can only contribute to society if put to the “beneficent whip” Dickens dedicates Hard Times (1854) to Carlyle savage attack on markets and market economies five years after “Occasional Discourse on the Negro Question” one year after Carlyle’s enlarged and revised pamphlet Occasional Discourse on the Nigger Question

The Socialist Reaction: Marx’s Analysis: 

The Socialist Reaction: Marx’s Analysis Karl Marx and socialists filled ideological niche formed by Victorian literary figures Marx first to use word “capitalism” to describe the laissez-faire, market society Marx argued that workers would revolt and that capitalism would be replaced by socialism

Marx on Socialism and Capitalism: 

Marx on Socialism and Capitalism Socialism – an economic system based upon the collective ownership of the means of production. Capitalism – an economic system based upon the private ownership of the means of production. Marx argued that ownership of the means of production resides with a ever smaller group of “capitalists.”

Marx on Socialism and Capitalism: 

Marx on Socialism and Capitalism Who decides answers to the coordination problems (what and how much to produce, how to produce, for whom to produce) if means of production are collectively owned? Vague notion that individuals’ goodwill toward others, not self-interest, will guide collectively determined answers to questions. Notion that economy will be organized as one big family, where everyone contributes what they can and get what they need.

The Rise of State Socialism: 

The Rise of State Socialism Capitalism did not evolve into socialism as Marx predicted. Socialism took root instead in feudalist Russia. Russian socialists created state socialism. State socialism – an economic system in which government central planning agencies coordinate economic activities.

Central Planning: 

Central Planning Collective ownership of the means of production requires administrative control or central planning to solve the coordination problems. Ludwig von Mises (1920) “Economic Calculation In The Socialist Commonwealth” argued that socialism could not be as efficient as a market society in satisfying consumer wants. Collective ownership means no markets and no prices for capital and land. Incentive, calculation and knowledge problems.

State Socialism: 

State Socialism Since the late 1980s, state socialism has virtually disappeared. Workers lacked incentives to work. Production was inefficient. Technology lagged. Consumer goods were either unavailable or of poor quality. High officials exploited their positions.

The Rise of Welfare Capitalism : 

The Rise of Welfare Capitalism Instead of socialism, the market societies of the 19th century were transformed into welfare capitalism. Welfare capitalism is an economic system in which markets are the basic means of solving coordination problems, but government regulation of markets and government redistribution of income is significant.

The Regulated Market Society: 

The Regulated Market Society Major regulatory changes were adopted throughout the latter half of the 19th century and first half of the 20th century. By the 1960s, western nations had all, to one degree or another, adopted welfare capitalism or the regulated market society. Since the 1990s, the focus has shifted from alternative economic systems to alternative institutions.

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