Chapter 2d

Mill's Assumptions


We keep the first Classical postulate that Wage is equal to the marginal product of labour.

Real wages and the volume of output (and hence of employment) are uniquely correlated.

Employment can only increase through a decline in the rate of real wages.

Industry is subject to decreasing returns in the short period, while capital is constant.

The real wage earned by a unit of labour has a unique inverse correlation with the volume of employment.

  • If employment increases in a short time, the reward per unit of labour in terms of wage-goods declines and profits increase. *
  • The marginal product in the wage-good industries (which governs real wages) necessarily diminishes as employment is increased.

n men are employed. The nth man adds 1 bushel a day to the harvest. Wages have a buying power of 1 bushel a day. The n + 1th man, however, would only add .9 bushel a day. In this case, employment cannot rise to n + 1 men unless the price of wheat rises relatively to wages until all daily wages have a buying power of .9 bushel [to match the previous 0.9]. Aggregate wages would then amount to 0.9 (n + 1) bushels as compared with n bushels previously. Thus, the employment of an additional man will involve a transfer of income from those previously in work to the entrepreneurs [This is wrong. The extra man will still be paid the same 1 bushel. It will be a loss to the entrepreneur].

As long as this proposition holds, increased employment also reduces:

  • the marginal product and
  • the wages measured in terms of this product.

But we deleted the second postulate which says that a decline in employment is due to workers demanding more wage-goods.

Reducing money-wages is not necessarily a remedy for unemployment.

From the time of Say and Ricardo, the classical economists have taught that supply creates its own demand.

  • All the costs of production must necessarily be spent in the aggregate on buying the product.

J. S. Mill’s Principles of Political Economy explains this doctrine:

The means of payment for commodities is simply commodities. Each person pays for the productions of other people with his own. All sellers are inevitably buyers. If we could suddenly double the country's productivity, we would double the supply of commodities in every market. We would also double the purchasing power. Everybody would bring a double demand as well as supply. Everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange. Principles of Political Economy, Book 3, Chapter 14

Any individual act of abstaining from consumption causes the labour and commodities to be diverted from supplying consumption into the investment in the production of capital wealth.

Marshall’s Pure Theory of Domestic Values[9] illustrates the traditional approach:

The whole of a man’s income is expended in the purchase of services and of commodities. A man spends some portion of his income and saves another. But it is a familiar economic axiom that a man purchases labour and commodities with that portion of his income which he saves just as much as he does with that he is said to spend. He spends when he seeks to obtain present enjoyment from the services and commodities which he purchases. He saves when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future.

It is not easy to compare Marshall’s later work[10] with Edgeworth or Pigou.

The doctrine is never stated today in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it.

Contemporary economists accept Mill’s conclusions which require Mill’s doctrine as their premise.

Pigou believes:

  • that money makes no real difference except frictionally and
  • that the theory of production and employment can be worked out (like Mill’s) as being based on ‘real’ exchanges with money introduced perfunctorily in a later chapter, is the modern version of the classical tradition.

Contemporary thought is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another.[11] Post-war economists seldom succeed in maintaining this standpoint consistently*.

*Superphysics Note: This is due to growth in the doctrine of profit maximization which did not exist during the time of Mill or Ricardo

The Classical conclusion is that the costs of output are always covered in the aggregate by the sale-proceeds resulting from demand.

Another Classical idea is that income derived in the aggregate by all the elements in society concerned in a productive activity necessarily has a value exactly equal to the value of the output.

The first conclusion has great plausibility because it is difficult to distinguish it from the latter idea.

Similarly, it is natural to suppose that a man who enriches himself, without taking anything from anyone else, must also enrich the community as a whole. In this way, an act of individual saving inevitably leads to a parallel act of investment*.

*Superphysics Note: Yes, because there is no profit maximization to hinder investments at low profits

The assumptions of classical theory are:

  1. The real wage is equal to the marginal disutility of the existing employment [workers not working]

  2. There is no such thing as involuntary unemployment

  3. Supply creates its own demand in the sense that the aggregate demand price is equal to the aggregate supply price for all levels of output and employment

These stand and fall together*.

*Superphysics Note: Yes they fall if you convert real value (based on goods) into nominal value (based on cash and money). That would then lead to a gambling or speculative economy which is totally arbitrary.


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