Laissez-faire

9 Pages 2190 Words

will have them, and those who are unemployed voluntarily choose to be so. • The government has a minimal role over the course of the business cycle, and left alone the economy will gravitate toward full employment. In the long run, unemployment is not an important public policy concern as the unemployment present will be voluntary. • Economic analysis should emphasize the study of markets and how they effectively operate. An Early Theory of Value One of the most important questions early classical economists attempted to answer was how the value or price of a good is determined. Smith described how the interaction of supply and demand in the market determined a good's price. Smith needed to go further and explain why two goods with identical demands would have different prices. According to Smith, the prices of goods are determined by what it costs to produce them. Since the majority input used in production during the eighteenth century was labor, Smith developed a labor-based theory of prices. The price of a good reflects the amount of labor used in its creation. One good's price is higher than another's because of the extra labor used in its production. However, in Smith's model the price of a good is independent of the amount produced, resulting in a horizontal supply curve. From this base, Ricardo introduced the idea of diminishing returns in the factors of production. Diminishing returns in labor implies that as additional workers are used in production, the incremental output from each added worker is less than the output gained from hiring the previous worker. The quality of workers does not contribute to diminishing returns; rather, factors outside the individual worker's control yield this result. Ricardo used the example of agriculture. Initially the best, most productive lands were farmed. But as the population grew, marginal lands were harvested, bringing down the yield per acre. As a result, additional labor would be ...