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ILRLE344 - Final_StudyGuide

ILRLE344 - Final_StudyGuide - LE 344 Final Exam Study Guide...

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LE 344 Final Exam Study Guide I. OVERLAP FROM MIDTERM: ADAM SMITH Adam Smith – Wealth of Nations (4 Points): 1. Law of Markets: Notion of the invisible hand. Through competition, markets produce quantities, prices, and wages of the market: Perfect Competition 2. Division of Labor: Key to increasing productivity is the division of labor, both within a factory, but also within entire industries . Reasons it works: A. Increased dexterity: become process expert B. Save time from shifting to different tasks C. Develop innovation through process familiarity Absolute Advantage: Smith believed that it was always best to buy what was cheaper domestically, domestically, and go abroad for what was cheaper there. Definition of Wealth: Divides population into productive and unproductive labor. Productive labor produces tangible objects (like physiocrats, but including manufactures). Unproductive was essentially the service sector (Lawyers, teachers, etc.). Wealth was defined as the value of goods produced by productive labor. 3. Theory of Value: Diamond-Water Paradox: The use-value of water is much higher than its market value, where diamonds commands high market value but low use-value . Smith focuses on value of a commodity as it relates to its exchange value. Natural value is determined by its cost of production (just as Aquinas defined it). In the short run, a single supply meets with the market demand to produce the price of the good. While sometimes high or low, this price will tend toward the natural value of the product. 4. Theory of Distribution: Smith classified people into three groups: landlords earned rent, capitalists receive profit, and workers receive wages. Wage Fund Theory: Wages determined by available variable capital, divided by the labor force. This equation explained the short run wage rate. The long run wage rate tended toward a subsistence wage. Economic growth leads to increase in the wage fund, which leads to population growth, leads to larger labor supply, lowering wages. Believes that higher wages lead to higher productivity.
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Profit: defined as rate of return on invested capital. Over time in a growing economy, these levels will inevitably fall. The most profitable investments are pursued first, because of invisible hand. Interest Rates are indicative of profits. Smith believes that b/c all investment comes out of profits, we should focus on maximizing profits. Rent: Price paid to landlord for the use of the land. Rent is revenue from the land-profit. Smith believed that landlords were getting wealthier and wealthier as other two classes would get poorer and poorer. Smith, Book 1 Chapter 10 Part one: Variance in wages across occupations (5 reasons) 1. Some jobs more disagreeable, resulting in higher wages 2.
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