HISTORY OF ECONOMIC

THOUGHT
A+ EXAM NOTES
CHAPTER 3
From Ricardo to Mill

Based on: Screpanti & Zamagni, An Outline of the History of Economic Thought (2nd ed., 2005)
Covers: Ricardo vs Malthus (Corn Laws, rent theory, value), Anti-Ricardian reaction (Bailey, Senior),
Cournot/Dupuit/Gossen/von Thünen, German Historical School, J.S. Mill's synthesis, Wages Fund,
English Monetary Debates (Bullionists vs Banking School, Thornton)
A. Topic Overview
What is this chapter about?
This chapter covers the period 1815-1870 (roughly), called the 'Age of Ricardo' followed by the
'Age of Capital.' It is dominated by ONE big argument: David Ricardo vs Thomas Malthus over
the CORN LAWS (tariffs on imported grain). From this debate comes Ricardo's whole theory:
RENT, PROFITS, WAGES, and VALUE.
The chapter has 4 main parts:
1. Ricardo and Malthus — the Corn Laws debate, theory of rent, profits/wages, over-
production debate, theory of value (3.1)
2. The Disintegration of Classical Political Economy — Ricardians vs Anti-Ricardians,
Continental forerunners of neoclassical theory (Cournot, Dupuit, Gossen, von Thünen),
German Historical School (3.2)
3. Theories of Economic Harmony and Mill's Synthesis — J.S. Mill's attempt to unify
everything, wages fund theory (3.3)
4. English Monetary Theories and Debates — Bullionists vs Anti-Bullionists, Currency
School vs Banking School, Henry Thornton (3.4)
Why is this topic important?
• Ricardo's theory of RENT (differential rent / decreasing returns) is one of the MOST
TESTED topics in this entire course — usually with a DIAGRAM question.
• This chapter sets up BOTH later branches of economics: the 'anti-Ricardian reaction'
becomes NEOCLASSICAL economics (Chapters 5-6); Ricardo's labour theory becomes
the basis for MARX (Chapter 4).
• The monetary debates (Currency School vs Banking School, Thornton) are DIRECT
ancestors of the Monetarism vs Keynesianism debate (Chapter 9).
• J.S. Mill is a 'bridge' figure — useful for COMPARISON questions (Mill vs Ricardo, Mill
vs Smith).
Historical Background (the simple story)
5. 1815-1848 ('Age of Restoration'): Europe recovers from the Napoleonic Wars. Politics is
a 3-way fight between landowners (reactionary), bourgeoisie/capitalists (liberal), and
workers (democratic/socialist). This 3-way class conflict shapes the ECONOMIC
debates too.
6. England's Corn Laws (1816): high tariffs on imported corn (grain), protecting
LANDOWNERS' high rents but hurting CAPITALISTS (who wanted cheap food = lower
wage costs).
7. Ricardo (pro-capitalist, anti-Corn-Laws) vs Malthus (pro-landowner, pro-Corn-Laws) had
the BIGGEST economic debate of the era — covering rent, profits, wages, and 'general
gluts' (overproduction).
8. After Ricardo (1815-1848), English economics split into 3 groups: Ricardians (followers),
Ricardian Socialists (used Ricardo's labour theory to attack capitalism — Chapter 4),
and Anti-Ricardians (rejected the labour theory, focused on utility/demand — became
neoclassical economics).
9. On the CONTINENT (France, Germany), economists like Cournot, Dupuit, Gossen, and
von Thünen developed early MARGINALIST ideas — but were largely IGNORED in their
own time.
 10. 1848 Revolutions across Europe → defeated. 1850-1870 = the 'Age of Capital' — a
period of optimism, free trade, and 'harmony of interests' theories. J.S. Mill's Principles
(1848) became the dominant textbook of this era, TRYING to unite Ricardo's macro
theory with the newer micro/utility ideas.
11. Meanwhile, England had ongoing MONETARY debates: after the 1797 Restriction Act
(suspending gold convertibility), economists split into Bullionists (favour gold standard,
blame inflation on excess money) vs Anti-Bullionists (blame external/real factors). This
continued as Currency School vs Banking School after 1825, leading to the 1844 Bank
Charter Act.
Main Idea in Simple Words
Ricardo built his ENTIRE theory around the question: 'What happens to PROFITS as a country
grows?' His answer: as population grows, we must farm WORSE land (decreasing returns) →
rents RISE → wages stay at subsistence (Malthus's population principle) → PROFITS FALL.
Falling profits = slower growth = bad for capitalists. So: ABOLISH the Corn Laws, allow cheap
imported corn, and profits won't be squeezed by rising rents. Malthus disagreed about whether
this would cause 'general gluts' (overproduction). This whole debate split economics into two
streams: the 'Ricardian' stream (focused on production/distribution/labour — leads to Marx) and
the 'Anti-Ricardian' stream (focused on utility/demand/exchange — leads to neoclassical
economics). J.S. Mill tried to combine both streams into one textbook (1848) but ultimately failed
to reconcile them — after Mill, the two streams split PERMANENTLY.

B. Key Definitions
Term Simple Meaning
Corn Laws English tariffs (1816-1846) that kept the price of imported corn
(grain) artificially HIGH, protecting landowners' rents but raising
food costs for workers and capitalists.
Differential Rent Rent that arises because different plots of land have different
fertility (or different distances from market). The MOST fertile
land earns the HIGHEST rent; the LEAST fertile land used
earns NO rent (the 'marginal' land).
Extensive Rent Rent that arises from cultivating land of DIFFERENT QUALITY
(some plots more fertile than others) as production expands
onto worse land.
Intensive Rent Rent that arises from applying MORE capital/labour to the
SAME land — each extra unit of investment produces LESS
extra output (diminishing marginal returns).
Marginal Land The LEAST fertile/productive land currently being farmed. By
definition, it pays NO rent (in the simple model) because it
earns just enough to cover costs.
Law of Decreasing As more of a variable input (e.g., labour/capital) is added to a
(Diminishing) Marginal fixed input (land), each additional unit produces LESS extra
Productivity output than the previous unit.
Falling Rate of Profit Ricardo's prediction: as population grows, farming spreads to
(Ricardo's Law) worse land (or land is farmed more intensively), rents rise,
wages stay at subsistence, so the PROFIT share — and the
profit RATE — must fall over time.
Term Simple Meaning
Embodied Labour vs (Recap Ch.2) Embodied = labour USED to produce a good.
Labour Commanded Commanded = labour the good can BUY. Ricardo preferred
embodied labour as a measure of value because it does NOT
depend on income distribution.
Invariable Measure of Ricardo's (failed) search for a 'perfect' good whose value never
Value changes, so it could be used as a stable 'ruler' to measure the
value of everything else. He never found one — Marx called
this a 'squaring of the circle.'
Absolute Value Ricardo's idea of a value that is 'intrinsic' to a good,
independent of exchange relationships. The book argues this
concept doesn't really make sense — value is always
RELATIVE (a relationship between goods).
Say's Law (recap) Supply creates its own demand. Central to the Ricardo vs
Malthus 'general gluts' debate — Ricardo accepted it, Malthus
questioned it.
General Glut / A situation where the WHOLE economy produces more than it
Overproduction can sell — Say's Law says this is impossible; Malthus argued it
COULD happen if savings aren't fully spent.
Relative Value (Bailey) Samuel Bailey's idea: value is ONLY a relationship/comparison
between two goods being exchanged — there's no 'absolute'
or 'intrinsic' value. Value exists 'in the mind' of the people
exchanging.
Decreasing Marginal The idea that each additional unit of a good gives LESS extra
Utility satisfaction than the previous unit. Discussed by Senior, Lloyd,
and others BEFORE the official 'marginalist revolution' (Ch.5).
Abstinence Theory of Profit is the 'reward' for the SACRIFICE (abstinence) of NOT
Profit (Senior) consuming your capital now, but saving/investing it instead. An
early ancestor of neoclassical theories of capital/interest.
Reaction Curve (Cournot) In duopoly theory, a curve showing how much ONE firm will
produce GIVEN the quantity the OTHER firm produces. Where
the two reaction curves cross = the equilibrium (the 'Nash-
Cournot equilibrium').
Consumer Surplus / The extra benefit consumers get from paying LESS than the
'Relative Utility' (Dupuit) maximum they'd be willing to pay — Dupuit's term was 'relative
utility'; Marshall later renamed it 'consumer rent'/'consumer
surplus.'
Gossen's Laws (1) Marginal utility DECREASES as consumption increases
(until satiety). (2) A rational person allocates spending so that
the LAST unit of money spent on EACH good gives EQUAL
satisfaction (the 'equimarginal principle').
Opportunity Cost (von The idea (implicitly used by von Thünen) that the TRUE cost of
Thünen) using a resource for one purpose is the BENEFIT GIVEN UP
from its NEXT BEST alternative use.
German Historical School A school (Roscher, Hildebrand, Knies, later Schmoller) that
REJECTED the idea of UNIVERSAL economic laws — argued
economics should be based on HISTORICAL/INDUCTIVE
Term Simple Meaning
study of specific countries/periods, not abstract DEDUCTIVE
theory.
Infant-Industry Protection Friedrich List's idea: a developing country's NEW industries
need TEMPORARY tariff protection from foreign competition
until they become strong enough to compete (used to justify
German protectionism against British free trade).
Wages Fund Theory The classical idea that, at any moment, there is a FIXED
amount of capital ('the wages fund') set aside to pay workers.
Total wages = wages fund ÷ number of workers. Unions can't
raise wages above this in the SHORT run.
Stationary State (Mill) J.S. Mill's idea (UNLIKE Ricardo/Smith/Marx, who feared it)
that an economy reaching ZERO growth/zero net investment
could actually be GOOD — wealth would be so abundant that
the 'pain' of saving (abstinence) would disappear, and a kind of
natural 'socialism' (no capitalist profit) would emerge.
Bullionism vs Anti- Bullionists: blamed inflation/depreciation on EXCESS note
Bullionism (1797-1821) issues by the Bank of England; wanted return to gold
convertibility. Anti-Bullionists: blamed REAL/exogenous factors
(war spending, bad harvests); worried convertibility would
cause damaging DEFLATION.
Currency School vs Currency School: money supply should move EXACTLY as if it
Banking School (1825- were 100% gold ('metallic fluctuation') — led to the 1844 Bank
1850s) Charter Act. Banking School: money supply is naturally
ELASTIC/endogenous (driven by 'real bills'/the 'doctrine of
reflux') and CANNOT be tightly controlled by the central bank.
Real Bills Doctrine / The idea that if banks only lend against real trade transactions
Doctrine of Reflux ('real bills'), the money supply automatically adjusts to the
'needs of trade' and can never be 'excessive.'
Lender of Last Resort Henry Thornton's idea: the central bank (Bank of England)
should be ready to lend freely during a financial panic/crisis to
prevent a collapse of the banking system — a core idea in
MODERN central banking.

C. Main Ideas — Section by Section

3.1. Ricardo and Malthus
3.1.1. Thirty Years of Crisis
• 1815-1848 = 'Age of Restoration' — politically, old aristocratic powers tried to restore the
pre-revolution order, even as the Industrial Revolution was destroying its economic
foundations.
• THREE social classes = THREE political forces: landlords (reactionary), bourgeoisie
(liberal), proletariat/workers (democratic).
• 1830: July Revolution (France) and Whig victory (England) → constitutional reforms, but
with VERY limited voting rights (just 1% of the population in France could vote!).
 • After 1830, the main conflict shifted from landlords-vs-bourgeoisie to bourgeoisie-vs-
workers (Chartism in England, socialist movements in France).
• 1848 Revolutions: in France, ended in a 'proletarian bloodbath' and bourgeois victory; in
England, ended in 'farce' (a Chartist petition to Parliament). Both countries then entered
a period of social PEACE.
3.1.2. The Corn Laws
ESSENTIAL BACKGROUND for the whole chapter.
• 1816-1846 = 'the Age of Ricardo' in England, named for the Corn Laws debate.
• Napoleonic Wars (1793-1815) cut off food imports → corn prices rose a LOT (more than
manufacturing prices/wages).
• 1816: landowners convinced Parliament to pass tariffs SO HIGH that foreign corn
couldn't enter England at all → kept domestic corn prices (and RENTS) artificially HIGH.
• Who benefited/lost: LANDOWNERS benefited (high rents). CAPITALISTS lost (high food
prices → pressure for higher wages → squeezed profits; also couldn't exploit their
productivity advantage over European rivals).
• The 30-year battle (1816-1846) ended with REPEAL of the Corn Laws — a victory for
the bourgeoisie, made possible by RICARDO'S THEORY.
• KEY TEXTS: Ricardo's Principles of Political Economy and Taxation (1817) vs Malthus's
Principles of Political Economy (1820) — published almost simultaneously, developed
'together' through correspondence, agreeing on METHOD but disagreeing on almost
every POLICY conclusion.
3.1.3. The Theory of Rent
THE MOST IMPORTANT DIAGRAM IN THIS CHAPTER — practice drawing this!
• 1815: FIVE pamphlets published on rent (Malthus x2, West, Torrens, Ricardo) — all
used DIFFERENTIAL RENT theory, though Ricardo credited Malthus (and earlier,
James Anderson, 1777) as the originator.
• SIMPLE MODEL: one good (corn), produced using LAND + LABOUR + seeds. Five
types of land A, B, C, D, E in DECREASING order of fertility, each producing Ga > Gb >
Gc > Gd > Ge (net of seeds), using the SAME amount of labour/seeds per acre.
• EXTENSIVE RENT (cultivating MORE land of different qualities):
11. Start with only land A cultivated → production = Ga.
11. As demand grows, cultivation EXTENDS to B, then C, D, E (in decreasing fertility
order) → total production increases.
11. On the LEAST fertile cultivated land (E, the 'marginal' land), there is NO RENT — the
capitalist there earns profit = (Ge - wr), where wr = real wage.
11. On MORE fertile land (say D), profit WITHOUT rent would be (Gd - wr) > (Ge - wr).
But COMPETITION for the better land lets landlords CHARGE RENT equal to this
DIFFERENCE — so ALL capitalists end up earning the SAME profit rate.
11. RESULT: rent = the EXTRA output of better land OVER the marginal land's output.
Total wages = real wage × total labour. Profits = whatever's left over (residual).
• INTENSIVE RENT (same idea, but applied to MORE INVESTMENT on the SAME land,
not different land qualities): as MORE capital/labour is applied to a FIXED amount of
land, each extra unit of investment produces LESS extra output (diminishing marginal
productivity). The LAST (marginal) unit of investment earns NO rent; earlier
(intramarginal) units earn rent = difference between their productivity and the marginal
unit's productivity.
 • WHY THIS MATTERS: this is literally the 'law of decreasing marginal productivity' — one
of the MOST IMPORTANT and ENDURING concepts in ALL of economics, still used
today!
• Note on criticism: Say criticised Ricardo, claiming the theory implies NO rent is paid on
marginal land (which seemed to contradict reality, since ALL land seems to earn SOME
rent). Ricardo's defence (in a footnote) was unclear — many economists later tried to fix
this with the idea of 'ABSOLUTE RENT.'
3.1.4. Profits and Wages
Ricardo's CHAIN OF REASONING for abolishing the Corn Laws:
12. Corn Laws BLOCK cheap imports → must produce MORE corn DOMESTICALLY →
must farm WORSE land / farm MORE INTENSIVELY (decreasing returns).
13. This INCREASES the RENT share of national income.
14. This DECREASES the PROFIT share.
15. LOWER PROFITS = LESS SAVING = SLOWER CAPITAL ACCUMULATION (since
landlords don't save, and workers can't save at subsistence wages — only capitalists
save).
16. CONCLUSION: the Corn Laws SLOW DOWN economic growth. ABOLISH them!
• RICARDO'S LAW OF THE FALLING RATE OF PROFIT (long-run): even WITHOUT the
Corn Laws, in the VERY LONG RUN, population growth → decreasing returns in
agriculture → falling profit rate. Technical progress could TEMPORARILY raise profits,
but Ricardo believed this would just trigger MORE accumulation/population growth,
which would eventually bring back decreasing returns. (A pessimistic, almost 'doom-
loop' vision!)
• FORMULA (recap from Ch.2, now applied at the MARGIN): p/w = l' + k(1+r'), where l' > l
(productivity FALLS at the margin as cultivation intensifies). GIVEN the real wage (w/p)
and capital coefficient (k), a FALL in productivity (RISE in l') causes a FALL in the profit
rate (r).
• WAGES (Malthusian Population Principle, used by Ricardo via Torrens): if the market
wage > natural (subsistence) wage → population grows faster → labour supply
increases → wages fall back down. If market wage < natural wage → population growth
slows → wages rise back up. RESULT: wages tend toward the 'natural' (subsistence)
level — treated by Ricardo as basically a CONSTANT.
3.1.5. Profits and Over-Production
VERY IMPORTANT for understanding the Say's Law debate.
• Malthus's ARGUMENT (in defence of the Corn Laws): workers and landlords spend ALL
their income on CONSUMPTION (= demand). But profits are mostly SAVED/INVESTED.
If the PROFIT share rises (relative to wages), then WORKERS' wages (the 'wages fund')
aren't enough to buy back everything THEY produced → NOT ENOUGH DEMAND →
'general glut' (overproduction)/economic crisis. UNLESS rent is high enough to make up
the difference (landlords' spending fills the gap) — so, Malthus concluded, the Corn
Laws (which boost RENT) could actually be GOOD, by preventing gluts!
• RICARDO'S REBUTTAL (paraphrased quote): 'I may employ 20 workers to produce
food for 25, then those 25 to produce food for 30...' — i.e., SAVINGS/INVESTMENT
themselves CREATE demand (for more workers, more inputs) — so a higher profit
share does NOT reduce total demand.
• MALTHUS'S BEST COUNTER-ARGUMENT (in a letter to Ricardo, 1814 —
paraphrased): 'having the POWER to purchase doesn't mean having the WILL to
 purchase' — i.e., questioning whether SAVINGS = SPENDING (questioning SAY'S LAW
itself!).
• WHAT HAPPENED: Ricardo recognised the danger of this argument and FIRMLY
rejected it — he assumed savings ALWAYS become investment/spending (= Say's
Law). Malthus, unfortunately, NEVER FULLY DEVELOPED his own insight — his
'Principles' STILL accepted too much of the framework that made his argument hard to
sustain. The 'general gluts' debate was therefore 'won' by Ricardo/Say's Law for the next
100+ years — until KEYNES (Chapter 7) revived Malthus's basic insight!
• IMPORTANT CLARIFICATION: Say's Law (as classical economists used it) did NOT
mean 'always full employment' — it just meant aggregate SUPPLY = aggregate
DEMAND (in VALUE terms), which can happen at ANY employment level. Classical
economists thought permanent UNEMPLOYMENT was prevented mainly by the
MALTHUSIAN POPULATION PRINCIPLE (the unemployed couldn't survive long-term),
NOT directly by Say's Law. NOTE: even Ricardo admitted (in the 'On Machinery'
chapter, added to the 3rd edition of Principles) that NEW MACHINERY could cause
unemployment that persists for a long time (maybe 20 years) before the population
principle 'fixes' it.
3.1.6. Discussions on Value
Technical, but VERY exam-relevant.
• MALTHUS on value: accepted Smith's 'additive' theory (price = wages+profits+rent) and
the LABOUR COMMANDED measure. He argued: since profit exists, the labour
commanded by output is GREATER than the labour commanded by the wages paid →
this 'proves' a demand shortfall (his 'general gluts' argument). PROBLEM: Malthus
CONFUSED 'natural price' (labour commanded, a LONG-RUN concept) with 'market
price' (a SHORT-RUN, demand-driven concept) — this 'mixing up' just added confusion
to his argument.
• RICARDO on value: worked ONLY with NATURAL prices. Rejected Malthus's additive
theory: RENT does NOT enter into price (prices are set at the MARGIN, where no rent is
paid).
• RICARDO'S SEARCH FOR AN 'INVARIABLE MEASURE OF VALUE': Ricardo first
used EMBODIED LABOUR as his measure of value (preferred over labour commanded,
because embodied labour doesn't change just because INCOME DISTRIBUTION
changes). BUT: actual EXCHANGE VALUES of goods DO change with income
distribution (because goods are produced with different TIME PROFILES of labour input
— see formula below) — so embodied labour ALONE isn't a perfect measure either.
• THE TIME-PROFILE FORMULA (two goods produced ONLY by labour, but over
DIFFERENT TIME PERIODS t1, t2):
p1/p2 = (l1/l2) × (1+r)^(t1-t2)
• This shows relative prices depend on (a) the RATIO of labour embodied (l1/l2) AND (b)
the TIME each good's labour is 'tied up' in production (t1 vs t2), via the profit rate r.
• RICARDO'S MISTAKE: he kept searching for an 'ABSOLUTE VALUE' / 'INVARIABLE
MEASURE OF VALUE' — a hypothetical good whose value NEVER changes, which
could be used as a perfect 'ruler.' He KNEW such a good probably doesn't exist in reality
but kept searching anyway. The book (and Sraffa, and Marx) call this a 'CHIMERA' /
'squaring of the circle' — IMPOSSIBLE.

3.2. The Disintegration of Classical Political Economy in the Age of

Ricardo
3.2.1. The Ricardians, Ricardianism, and the Classical Tradition
• THREE groups of English economists (1815-1848):
16. RICARDIANS — true followers (James Mill, McCulloch, De Quincey, Whewell, and
Robert Torrens — though Torrens disagreed on VALUE, arguing value = capital
advanced/cost of production, not pure labour).
16. RICARDIAN SOCIALISTS — used Ricardo's labour theory to argue capitalism
EXPLOITS workers (covered in Chapter 4).
16. ANTI-RICARDIANS — rejected the labour theory, focused on UTILITY/DEMAND
(covered in 3.2.2 below) — became forerunners of NEOCLASSICAL economics.
• KEY CONTRAST: in ENGLAND, Ricardo's MACRO/surplus tradition dominated, so the
anti-Ricardians had to stage a 'REVOLT' to develop micro/utility ideas. On the
CONTINENT (France/Germany), Say's MICRO/individualist tradition ALREADY
dominated, so forerunners like Cournot, Dupuit, von Thünen, and Gossen did NOT need
a 'revolution' — but, ironically, they were almost completely IGNORED by their
contemporaries anyway (too far ahead of their time)!
3.2.2. The Anti-Ricardian Reaction
• Motivation: Ricardo's labour theory of value had become a DANGEROUS political
weapon for SOCIALISTS (it seemed to 'prove' workers were exploited, since profit = a
'residual' after wages). Anti-Ricardians wanted to REJECT this conclusion.
• Samuel Bailey: attacked the very idea of 'ABSOLUTE VALUE' — said value is only
RELATIVE (a relationship between two goods in exchange), and exists only 'in the mind'
of the people exchanging. This OPENED THE DOOR to fully SUBJECTIVE theories of
value.
• Nassau Senior: value depends on BOTH supply (scarcity) AND demand (utility) — came
close to DECREASING MARGINAL UTILITY (paraphrased: 'pleasure from a good
diminishes rapidly... two units rarely give twice the pleasure of one').
• William Forster Lloyd (1834): perhaps the FIRST to clearly state the principle of
MARGINAL UTILITY — value depends on 'a feeling of the mind... at the margin of
separation between satisfied and unsatisfied wants' (paraphrased).
• WHY REJECT THE LABOUR THEORY? Samuel Read and George Poulett Scrope
were EXPLICIT: rejecting the OBJECTIVE (labour) theory of value was really about
rejecting the RESIDUAL theory of PROFIT (i.e., the idea that profit = 'leftover' after
wages, which implies EXPLOITATION).
• Senior's ABSTINENCE THEORY OF PROFIT: labour and land are the 'original' factors;
CAPITAL is a THIRD factor, created through ABSTINENCE (sacrifice of postponing
consumption/saving). Profit = the REWARD for this sacrifice — NOT a 'residual' or
'exploitation.'
• Longfield: developed a more TECHNOLOGICAL version — profit rewards capital's
CONTRIBUTION to making labour more productive (via machines), i.e., based on the
EFFICIENCY of capital, not just the SACRIFICE of saving. (It took until the marginalist
revolution to fully INTEGRATE the psychological [Senior] and technological [Longfield]
explanations of capital.)
3.2.3. Cournot and Dupuit
Important for later neoclassical/micro theory (Chapters 5-6).
• Augustin Cournot (Recherches sur les principes mathématiques de la théorie des
richesses, 1838): rejected ALL theories of value (even utility-based ones, due to
measurement problems) — but gave HUGE importance to DEMAND in price
determination.
 • Cournot's MONOPOLY theory: demand function D = f(p). Total revenue R = pf(p).
Marginal revenue R' = f(p) + pf'(p). PROFIT-MAXIMISING RULE: marginal revenue =
marginal cost (STILL the textbook rule today!).
• Cournot's DUOPOLY theory: introduced 'REACTION CURVES' — each firm's best
output choice GIVEN the other firm's output. The two reaction curves cross at a
UNIQUE, STABLE equilibrium — now called the 'NASH-COURNOT EQUILIBRIUM' (one
of the EARLIEST examples of game theory, ~100 years before Nash!).
• Jules Dupuit (De l'utilité et de sa mesure, 1844): studied PUBLIC GOODS (canals,
bridges) — built an early DEMAND CURVE interpreted via UTILITY. Defined
MARGINAL utility vs TOTAL utility. His 'RELATIVE UTILITY' = (total utility) - (marginal
utility × quantity) = the SOCIAL BENEFIT from a price decrease. Marshall LATER
renamed this 'CONSUMER RENT' (today: CONSUMER SURPLUS).
• Dupuit ALSO defined 'PRODUCER SURPLUS' (revenue minus marginal costs). TOTAL
social benefit = consumer surplus + producer surplus — Dupuit is credited as the
INVENTOR of COST-BENEFIT ANALYSIS.
3.2.4. Gossen and Von Thünen
• Hermann Heinrich Gossen (1854): SOLVED the 'positive value vs comparative value'
puzzle that had bothered German economists (Soden, Lotz — Chapter 2) by saying
'ABSOLUTE VALUE' doesn't exist — value is a RELATIONSHIP between a SUBJECT
(person) and an OBJECT (good), based on UTILITY.
• GOSSEN'S TWO LAWS (still core to modern microeconomics!):
16. FIRST LAW (diminishing marginal utility): pleasure from a good DECREASES as the
amount consumed increases, until satiety (zero extra pleasure).
16. SECOND LAW (equimarginal principle): a rational person will allocate their spending
so that the LAST unit of money spent on EACH different good gives EQUAL
satisfaction — i.e., 'the values of the LAST units possessed of each good become
equal.'
• Gossen also introduced the ROBINSON CRUSOE metaphor (an isolated individual
making rational choices) — this became a STANDARD teaching tool in neoclassical
economics.
• Johann Heinrich von Thünen (Der Isolierte Staat, Part I 1826, Part II 1850):
◦ Part I: theory of LOCATION of production, implicitly using 'OPPORTUNITY COST';
ALSO developed differential rent theory (price = cost of the MOST
DISADVANTAGED producer; surplus of more efficient producers = rent).
◦ Part II: extended this to LABOUR and CAPITAL — FIRST COMPLETE theory of
distribution based on MARGINAL PRODUCTIVITY of factors (capital and labour are
paid according to their marginal product, found by differentiating an income function
and setting the derivative = 0).
◦ Von Thünen's famous 'NATURAL WAGE' formula: w* = √(a × p) (geometric average
of subsistence needs 'a' and labour productivity 'p'). He was SO proud of this formula
he wanted it ENGRAVED ON HIS TOMBSTONE! It's a NORMATIVE ('just') wage —
the wage that makes a worker INDIFFERENT between staying a wage-earner or
becoming an independent capitalist-farmer.
3.2.5. The Romantics and the German Historical School
• MOST AMBITIOUS attack on classical political economy — NOT from the 'pre-
neoclassical heretics' above, but from the GERMAN HISTORICAL SCHOOL, which
attacked the very IDEA that economics could be a 'science' with universal laws.
 • Philosophical roots: German ROMANTICISM (irrationalist, organicist worldview) —
REJECTED individualism and rationalism (the foundations of classical economics).
• Friedrich List (Das nationale System der politischen Oekonomie, 1841): accepted MUCH
of classical theory's ANALYSIS, but REJECTED free trade — proposed 'INFANT-
INDUSTRY PROTECTION' (temporary tariffs to help new industries grow) — used to
justify GERMAN protectionism vs British free trade. List was a 'bridge' figure — pro-
capitalism, but pro-NATIONAL interest over individual interest.
• German Historical School proper: founded by Wilhelm Roscher (1843), developed
further by Hildebrand and Knies ('Old Historical School'; Schmoller led the later 'Young
Historical School' — Chapter 4).
• CORE CRITICISM: economic 'laws' are NOT like natural laws (not universal, not
independent of history/geography). Only the INDUCTIVE method (gathering
historical/empirical data, then generalising) is valid — NOT the DEDUCTIVE method
(starting from abstract assumptions, like 'rational self-interest').
• PHILOSOPHICAL DISAGREEMENT: Historical School had an ORGANIC view of
society (individuals are NOT just self-interested 'atoms'; social action has MULTIPLE,
INTERCONNECTED dimensions — economics should NOT be separated from
history/sociology/politics).
• LASTING IMPACT: this debate became the famous 'METHODENSTREIT' (methodology
dispute) at the end of the 19th century — relevant to BOTH classical AND neoclassical
economics, and still echoes in debates about mathematical/abstract vs
historical/institutional approaches to economics TODAY.

3.3. The Theories of Economic Harmony and Mill's Synthesis

3.3.1. The 'Age of Capital' and the Theories of Economic Harmony
• 1850-1870 = Hobsbawm's 'Age of Capital' — after 1848 revolutions were defeated, the
workers' movement went quiet for ~20 years, and capitalism expanded rapidly (Britain =
'workshop of the world,' Crystal Palace Exhibition 1851; growth also in Belgium,
Sweden, Germany, USA).
• Social reforms DURING this period of capitalist confidence: 10-hour working day
(England, 1850); right to strike (France, 1864); serfdom abolished (Russia, 1861);
slavery abolished (USA, 1862).
• 'THEORIES OF ECONOMIC HARMONY': economists (Bastiat, Carey, Ferrara, Cairnes,
Fawcett) argued there is HARMONY (not conflict) between social classes, BEST
achieved through PERFECT COMPETITION — strongly pro-free-trade, anti-State, anti-
socialist. Made limited THEORETICAL progress but were POLITICALLY influential.
• Francesco Ferrara: developed a 'REPRODUCTION COST' / SUBSTITUTION theory of
value — value of a good depends on COMPARISON with its SUBSTITUTES (an early
'substitution' idea). Pareto called Ferrara 'the best of Italian economists' and saw him as
a LINK between Galiani (Ch.2) and Pareto's own theory of 'OFELIMITY' (Ch.6).
3.3.2. John Stuart Mill
'BRIDGE' FIGURE — great for COMPARISON exam questions.
• Mill's Principles of Political Economy (1848) tried to UNIFY: (1) Ricardo's MACRO theory
of surplus AND (2) the emerging MICRO theory of individualistic competitive equilibrium.
He called his own work an effort to 'construct bridges and clear roads' between earlier
theories (paraphrased, from his Autobiography, 1861).
 • RESULT: after the 1870s, these TWO approaches split PERMANENTLY — Ricardo's
branch → Marxist economics; the anti-Ricardian branch → neoclassical economics. Mill,
who tried to hold both together, was accused of 'eclecticism' by BOTH sides and largely
FORGOTTEN — but the book argues he does NOT deserve this.
• Mill's philosophy: raised as a strict Benthamite utilitarian, but later TEMPERED by
Romantic influences (Coleridge). In Utilitarianism (1863), Mill REJECTED two of
Bentham's core assumptions:
16. That ALL human action reduces to SELFISH pleasure-seeking — Mill said pleasure
can ALSO come from CARING about others' happiness (altruism/solidarity CAN be
'utilitarian' too).
16. That the INDIVIDUAL is always the BEST judge of their own interest — this justified
SOME State intervention (education, working hours, poor relief) where the State
'knows better' (an early hint of the modern 'MERIT GOODS' idea).
• Mill on PRIVATE PROPERTY: used Locke's argument (labour → ownership — Chapter
1) to JUSTIFY property, but CRITICISED the resulting INEQUALITY as a matter of
HISTORY/INSTITUTIONS (not 'natural law') — proposed e.g. PROGRESSIVE DEATH
DUTIES (inheritance tax).
• Mill's KEY DISTINCTION: the LAWS OF PRODUCTION are 'natural' (fixed, like
Ricardo/Smith said) — BUT the LAWS OF DISTRIBUTION are NOT natural (can be
changed by policy/institutions). This let Mill support FREE MARKETS for production
WHILE supporting REDISTRIBUTIVE policies (profit-sharing, co-operatives, small
farms) — a very 'progressive liberal' position.
• Mill considered himself a friend of the working class and thought history was moving
toward 'socialism' — but did NOT call himself a socialist, and actively argued AGAINST
contemporary socialist theories using economic analysis.
3.3.3. Wages and the Wages Fund
Practice the DIAGRAM (Fig. 5 in the book)!
• PROBLEM with Ricardo's 'natural wage' (subsistence) idea: (1) the 'subsistence wage'
isn't PURELY biological — it depends on SOCIAL HABITS/CUSTOMS too; (2) if
habits/customs CHANGE with income, the 'natural' wage ITSELF can change — so it's
NOT a stable 'anchor.' Also, the adjustment via the population principle takes
GENERATIONS — too slow to be useful for short-run analysis.
• THE WAGES FUND MODEL: McCulloch and followers (Torrens, Cairnes)
ABANDONED the 'natural wage' idea — kept subsistence ONLY as a MINIMUM
FLOOR. Define: W̄ = wages fund (a FIXED amount, set by past profits, capitalists'
saving rate, and technology). Real wage wr = W̄ / L (wages fund ÷ number of workers).
• DIAGRAM LOGIC (Fig. 5): wr = W̄ /L is a DOWNWARD-SLOPING curve (more workers
L → lower wage wr, for a FIXED wages fund). There's also a LABOUR SUPPLY curve L̄
(vertical, at full employment). ONLY ONE wage level (we) makes the wages-fund curve
cross EXACTLY at full employment.
• THE LOGICAL PROBLEM: if technology (K/L ratio) and the wages fund (W̄ ) are BOTH
FIXED, then employment AND wages are BOTH automatically determined —
INDEPENDENT of labour SUPPLY! If actual labour supply ≠ this 'determined' level, the
resulting wage (wd) is NOT really a 'market-clearing' wage either — the system can't
reach 'we' because capital (K) is fixed by W̄ and the K/L ratio.
• MILL'S USE OF THE THEORY: in the SHORT RUN, unions CANNOT raise wages
(fixed wages fund ÷ fixed labour = fixed wage; raising wages above this →
unemployment, then competition pushes wages back down). In the LONG RUN, wages
CAN rise if the wages fund (W̄ ) grows FASTER than the labour force (L̄ ) — i.e., Mill told
unions: 'less revolution, more contraception' (paraphrased — control population growth!).
 • MILL'S LATER 'RECANTATION' (1869, responding to W.T. Thornton's criticism):
admitted the DISTRIBUTION of income and capitalists' SAVING RATE are NOT fixed —
so wages COULD rise if profit-share/luxury consumption FALL. BUT there's still a LIMIT:
if wages rise too much, it could cause capitalist BANKRUPTCIES.
3.3.4. Capital and the Wages Fund
• Mill's BIGGEST theoretical break from Ricardo: in Principles, Mill argued workers do
NOT have a right to the WHOLE product, because CAPITAL (via 'ABSTINENCE,'
borrowing Senior's term) is ALSO a 'requisite' of production, alongside LABOUR.
• Mill's quote (paraphrased): the product must be enough to pay not just for labour, but
also to REMUNERATE the ABSTINENCE of those who advanced the wages — and
THIS remuneration is PROFIT.
• Mill's profit = 3 parts: (1) management salary, (2) risk premium, (3) remuneration for
ABSTINENCE (= INTEREST). Mill could STILL say profit (net of these 3 components) is
a 'residual' — sounding Ricardian — but he ALSO claimed INTEREST rewards a
PRODUCTIVE contribution — something Ricardo would NEVER have accepted!
• WHAT STOPPED MILL going FULLY 'Austrian' (i.e., toward the full
neoclassical/Austrian capital theory)? He was MISSING TWO ideas: (1) labour and
capital can be combined in DIFFERENT PROPORTIONS (variable K/L ratios); (2) the
productive CONTRIBUTION of capital DECREASES as the 'period of investment'
increases. (These ideas come later — Austrian School, Chapter 6.)
• MILL'S THEORY OF THE FALLING RATE OF PROFIT — OPTIMISTIC twist: like
Smith/Ricardo/Marx, Mill believed profit rates fall in the very long run. BUT Mill was
OPTIMISTIC about this 'STATIONARY STATE': as society gets WEALTHIER, the 'pain'
of saving (abstinence) DECREASES, so the 'reward' (interest/profit) needed also
DECREASES — eventually reaching ZERO. At THIS point, NOBODY earns more than
the product of their OWN labour — Mill saw this as the PEACEFUL, NATURAL arrival of
something like SOCIALISM, achieved WITHOUT abolishing private property!
• Mill's quote on the stationary state (paraphrased): he did NOT view it with the 'unaffected
aversion' of older economists — he thought it could be 'a very considerable
IMPROVEMENT' on the present condition.
• LEGACY: Mill is sometimes called a father of 'FABIAN' (gradual, evolutionary) socialism
— change happens 'naturally,' over time, NOT through revolution.

3.4. English Monetary Theories and Debates in the Age of Classical

Economics
These debates are DIRECT ANCESTORS of Monetarism vs Keynesianism (Chapter 9) —
VERY GOOD for comparison/'trace the origins' essay questions.
3.4.1. The Restriction Act
• 1797: Britain SUSPENDED gold convertibility of the pound (the 'Restriction Act') due to a
financial crisis — created a system in CONFLICT with orthodox (gold standard)
monetary theory.
• 1810 'Bullion Committee' investigated why sterling had DEPRECIATED. Dominated by
BULLIONISTS (Henry Thornton, David Ricardo were the two MOST IMPORTANT
bullionists).
• BULLIONIST ARGUMENT: a persistent GOLD PREMIUM (market price of gold > official
mint price) = evidence of CURRENCY DEPRECIATION caused by EXCESS note issues
(made possible BECAUSE convertibility was suspended). Based DIRECTLY on Hume's
 price-specie-flow mechanism (Ch.1/2): excess money → higher prices → depreciation
→ (normally) gold flows out to correct it — but THIS couldn't happen with
INCONVERTIBLE currency.
• BULLIONIST POLICY VIEW: the Restriction Act was illegitimate government
interference — the Bank of England (though semi-private) should be run like a normal
bank, with convertibility forcing it to behave responsibly.
• ANTI-BULLIONIST ARGUMENT (Pitt, Bosanquet, Torrens [at this stage], Malthus [at
this stage]): the exchange-rate problems were due to EXOGENOUS REAL FACTORS
— financing allies in the Napoleonic Wars, military spending abroad, falling exports,
expensive imports, BAD HARVESTS — NOT excess money. Returning to convertibility
NOW would force painful DEFLATION (falling money supply → falling
prices/output/employment) — was this a luxury Britain could afford during war?
• ANTI-BULLIONIST MONETARY VIEW (anti-monetarist!): causation runs from PRICES
to MONEY SUPPLY (not the other way round) — i.e., the MONEY SUPPLY is
ENDOGENOUS, adjusting PASSIVELY to the 'needs of trade.' Supported by the 'REAL
BILLS DOCTRINE' (already suggested by Adam Smith!): if banks only lend against
REAL trade transactions ('real bills'), money creation simply reflects REAL economic
activity and can't be 'excessive' — when the bill is repaid, the money is automatically
withdrawn from circulation.
3.4.2. The Bank Charter Act
• Post-war STAGNATION: alternating brief 'speculative euphoria' booms and sharp crises
(falling output/prices/employment).
• 1819-21: drastic cuts to Bank of England note issues to PREPARE for the return to
convertibility (achieved 1821) → contributed to the 1825 CRISIS. Ricardo's critics
blamed HIS monetary theory; Ricardo blamed the SPEED of the Bank's actions (even
though he himself had earlier said the return to gold should be RAPID — a bit
hypocritical!).
• 1825-1840s DEBATE: CURRENCY SCHOOL (Joplin, Lord Overstone, Torrens —
Torrens SWITCHED SIDES from anti-bullionist to currency school!) vs BANKING
SCHOOL (Tooke, Fullarton, Gilbart, and — somewhat ambiguously — J.S. Mill).
• CURRENCY SCHOOL principle: 'METALLIC FLUCTUATION' — the amount of
banknotes in circulation should change EXACTLY as if it were 100% backed by gold
(banknotes should rise/fall ONE-FOR-ONE with gold reserves). They believed
DISCRETIONARY Bank policy caused BOOM-BUST cycles: in booms, the Bank let
credit expand too easily (fuelling speculation); in busts, the Bank then had to slam the
brakes (deepening the crisis).
• CURRENCY SCHOOL's TWO PROPOSALS (both implemented in the 1844 BANK
CHARTER ACT, a.k.a. the 'PEEL ACT'):
16. Split the Bank of England into TWO departments: an 'ISSUE department' (notes
ONLY, backed by gold + a fixed £14 million in bills) and a 'BANKING department'
(normal credit/lending activities).
16. This was meant to ensure 'metallic fluctuation' — note issues would automatically
track gold reserves, removing DISCRETION.
• BANKING SCHOOL response: agreed gold standard > inconvertible paper, BUT
disagreed on almost everything else. Defined 'MONEY' more broadly (currency +
DEPOSITS + bills of exchange — much closer to MODERN definitions!). Argued the
money supply is ENDOGENOUS and CANNOT be effectively controlled by the Bank —
even the circulation of BANKNOTES is largely outside the Bank's control. Used the OLD
'real bills' doctrine, now renamed the 'DOCTRINE OF REFLUX.'
 • BANKING SCHOOL's NEW WEAPONS (compared to the earlier anti-bullionists): (1)
convertibility had been RESTORED (so 'excess' notes would just flow back to the Bank
for gold, self-correcting); (2) the 5% usury-law CAP on the discount rate had been
ABOLISHED in 1833 — so the Bank could now use the INTEREST RATE as a tool to
control speculative credit demand.
• WHO WAS RIGHT? Largely the BANKING SCHOOL — the money supply WAS very
elastic and outside the Bank's full control; the Bank Charter Act had to be SUSPENDED
during crises (1847, 1857, partly 1866). HOWEVER, Britain DID maintain external
balance for ~70 years DESPITE a permanent trade deficit — but NOT via the 'automatic,
neutral' gold standard mechanism the theory described; rather, via DELIBERATE
discount-rate policy that effectively pushed adjustment costs onto LESS-DEVELOPED,
raw-material-exporting countries.
• CREDIT MULTIPLIER: this debate produced an important (if not fully appreciated at the
time) insight — Torrens described the CREDIT MULTIPLIER fairly precisely (fractional-
reserve banking AMPLIFIES monetary impulses). But most currency-school economists
thought this only 'amplified' policy without UNDERMINING the Bank's overall CONTROL
— the role of VARIABLE bank reserve ratios in limiting central bank control was NOT yet
well understood.
3.4.3. Henry Thornton
Direct ancestor of Keynesian monetary theory — VERY important name to remember!
• Henry Thornton (An Enquiry into the Nature and Effects of the Paper Credit of Great
Britain, 1802) — a PRACTICAL banker/MP (not an academic), helped draft the 1810
Bullion Report. The book calls his work 'the greatest work on monetary theory of the 19th
century.'
• Thornton was a BULLIONIST in the LONG RUN (believed in Hume's price-specie-flow
mechanism, AND was an early believer that MONETARY POLICY IS INEFFECTIVE in
the LONG RUN — sounds like MODERN MONETARISM!), BUT he saw IMPORTANT
REAL EFFECTS in the SHORT RUN — UNLIKE strict Ricardo.
• THORNTON'S ADDITION to Hume's theory: deflation to correct a balance-of-payments
deficit affects NOT JUST PRICES, but ALSO INCOME/OUTPUT levels — and therefore
DEMAND for imports directly (an early 'income effect' on the balance of payments).
• Thornton was NOT a 'committed deflationist' like Ricardo — agreed with anti-bullionists
that EXOGENOUS/TEMPORARY shocks (bad harvest, panic, war transfers) could
ALSO cause a gold premium/depreciation — in THESE cases, CUTTING note issues
would make things WORSE, not better.
• LIQUIDITY PREFERENCE (early version!): people hold money NOT just for
transactions, but as a STORE OF VALUE/precaution — the AMOUNT they want to hold
depends on CONFIDENCE. In a CRISIS (low confidence), people HOARD money (e.g.
hoard gold coins/'guineas') — so the VELOCITY of money FALLS during crises.
CONCLUSION: cutting note issues DURING a crisis (to 'fix' a drain) would be a
SERIOUS POLICY ERROR — it would make the crisis WORSE.
• LENDER OF LAST RESORT: Thornton argued the Bank of England, as a PUBLIC
institution, should act as 'LENDER OF LAST RESORT' during crises — lend FREELY to
stop panics from spiralling. THIS IDEA IS STILL THE CORE JOB OF CENTRAL BANKS
TODAY.
• INTEREST RATE THEORY: Thornton showed that USURY LAWS (capping interest at
5%) FORCED the Bank to expand credit WITHOUT LIMIT whenever the PROFIT rate
exceeded 5% — creating CUMULATIVE INFLATION (anticipating WICKSELL's
'cumulative process,' Chapter 6!). Also: a 5% NOMINAL rate with 3% inflation = only 2%
REAL rate — so usury laws (capping NOMINAL rates) prevent the Bank from using the
 INTEREST RATE as an EFFECTIVE policy tool. Policy implication: ABOLISH usury laws
so the central bank CAN use interest rates for monetary policy.

D. Economist Profiles
Each profile follows: Who / Nationality / Period / School / Contributions / Theories / Books / Key
Concepts / Exam Questions / Easy Example / Modern Application / Memory Trick.

David Ricardo (1772-1823)

Category Details
Who was he? A British stockbroker turned economist and Member of Parliament —
the dominant figure of English economics 1815-1848.
Nationality British
Period Late 18th - early 19th century (1772-1823)
School of Thought Classical Political Economy (founder of 'Ricardianism')
Main Contributions Developed the theory of differential rent; the theory of the falling rate of
profit; an embodied-labour theory of value (with the time-profile
correction); led the campaign against the Corn Laws; major bullionist in
monetary debates.
Important Theories Theory of differential rent (extensive & intensive); falling rate of profit
(decreasing returns + Malthusian population principle); labour theory of
value (embodied labour + time of investment); price-specie-flow
mechanism (monetary theory).
Important Books On the Principles of Political Economy and Taxation (1817, multiple
editions); The High Price of Bullion (1810); Notes on Malthus (1820,
published 1928)
Key Concepts Differential rent; marginal land; falling rate of profit; embodied labour vs
labour commanded; invariable measure of value; Say's Law
(accepted); price-specie-flow mechanism
Theory (short) As population grows, farming spreads to worse land (decreasing
returns), raising rents and squeezing profits. Abolish the Corn Laws to
slow this process. Value is best measured by embodied labour
(adjusted for time).
Contribution Created the THEORETICAL FRAMEWORK that dominated English
economics for decades; the theory of decreasing marginal productivity
(via rent theory) is still core to economics today; his labour theory
directly inspired Marx.
Criticism Never found his 'invariable measure of value' (a 'chimera,' per Marx/the
book). His pessimistic 'falling rate of profit' theory assumed technology
could NEVER permanently overcome decreasing returns — too
pessimistic (technology DID keep up). His theory of value couldn't fully
separate the effects of income distribution from 'pure' value changes.
Application The CORE LOGIC of differential rent — that scarce, high-quality
resources earn a 'premium' (rent) over marginal resources — applies to
land, but ALSO to scarce skills, urban property, even spectrum licences
Category Details
today.
Real-life Example / Imagine 5 farms of different quality. The WORST farm currently used
Easy Example earns just enough to break even (no rent). The BEST farm produces
much more with the SAME labour/seed cost — the EXTRA output
becomes RENT paid to the landlord, not extra profit for the farmer
(competition for the good land bids the rent up).
Modern Application Differential rent = the modern concept of 'ECONOMIC RENT' (any
payment to a factor above what's needed to keep it in its current use)
— used in discussions of land taxes, natural resource royalties, and
even 'rents' from monopoly power.
What Exams 'Explain Ricardo's theory of differential rent (extensive and intensive)
Usually Ask with a diagram.' / 'Explain Ricardo's chain of reasoning for abolishing
the Corn Laws.' / 'What is the "invariable measure of value" and why
did Ricardo fail to find it?' / 'Explain the Ricardo vs Malthus debate over
general gluts.'
Exam Shortcut / RICARDO = 'Rent Increases as Cultivation Advances,
Memory Trick Reducing/Decreasing prOfits' — R.I.C.A.R.D.O. Remember: WORSE
land = NO rent; BETTER land = rent = the difference.

Thomas Robert Malthus (1766-1834)

Category Details
Who was he? An English clergyman and economist, Ricardo's great 'friendly rival' in
debate; defender of the landowners' position.
Nationality English
Period Late 18th - early 19th century (1766-1834)
School of Thought Classical Political Economy (Anti-Ricardian on policy, though
methodologically close to Ricardo)
Main Contributions The 'Population Principle' (Essay on the Principle of Population, 1798);
a theory of 'general gluts' (underconsumption) challenging Say's Law;
one of the originators of differential rent theory (alongside West,
Torrens, Ricardo, and earlier Anderson).
Important Theories Population Principle: population grows GEOMETRICALLY, food supply
grows ARITHMETICALLY, so poverty is 'natural' unless checked.
'General glut' theory: if profits/savings rise relative to wages, demand
may fall short of supply (questioning Say's Law).
Important Books An Essay on the Principle of Population (1798); Principles of Political
Economy (1820)
Key Concepts Population principle (geometric vs arithmetic growth); general
gluts/underconsumption; defence of the Corn Laws (via rent's role in
demand)
Theory (short) Population grows faster than food supply, so poverty/starvation is a
'natural' check (unless people practise 'moral restraint'). Separately: if
profits (saved) rise relative to wages/rent (spent), total demand might
fall short of total supply — a 'general glut.'
Category Details
Contribution The Population Principle became CENTRAL to Ricardo's theory of
wages (used to justify the 'subsistence wage' as an equilibrium). His
'general glut' argument was a CENTURY AHEAD of its time — Keynes
(Ch.7) later REVIVED very similar reasoning about the gap between
saving and spending.
Criticism His political conclusion (don't help the poor, since it just causes more
population growth/suffering) was widely criticised as cruel and was
used to justify harsh Poor Law reforms. His 'general glut' argument was
NOT fully developed — he never explicitly REJECTED Say's Law,
which weakened his own case against Ricardo.
Application The Population Principle is still referenced in debates about resource
scarcity, food security, and environmental limits to growth (though
modern data shows technology has massively outpaced Malthus's
prediction so far).
Real-life Example / Imagine a population of 100 doubling every 25 years
Easy Example (100→200→400→800...) while food production only ADDS a fixed
amount each 25 years (say +100 each time: 100→200→300→400...).
After just 75 years: population = 800, food = only enough for 400 —
Malthus's 'crisis.'
Modern Application Modern 'neo-Malthusian' arguments appear in environmental
economics (limits to growth, resource depletion) — though most
economists note Malthus underestimated TECHNOLOGICAL progress.
What Exams 'Explain Malthus's Population Principle and its role in Ricardo's wage
Usually Ask theory.' / 'Explain Malthus's "general glut" argument and Ricardo's
rebuttal.' / 'Why did Malthus support the Corn Laws?'
Exam Shortcut / MALTHUS = 'More Adults, Less Total Has Usable Sustenance' —
Memory Trick population GEOMETRIC, food ARITHMETIC. And: 'Malthus worried
about a Mismatch — too much Saving, not enough Spending' (general
glut).

John Stuart Mill (1806-1873)

Category Details
Who was he? An English philosopher, politician, and economist — son of James Mill
(a Ricardian) — tried to create a grand 'synthesis' of classical
economics.
Nationality English
Period 19th century (1806-1873)
School of Thought Classical Political Economy / Smithian-Ricardian synthesis (transitional
figure to neoclassical economics)
Main Contributions Wrote Principles of Political Economy (1848), the dominant economics
textbook for ~40 years; developed the wages-fund/abstinence theory of
capital; the 'stationary state' theory; reformed utilitarianism; supported
progressive redistribution within a market framework.
Important Theories Wages fund theory (W̄ = wrL); abstinence theory of profit/interest
(capital = result of sacrifice); 'natural' laws of production vs 'non-natural'
Category Details
(changeable) laws of distribution; the optimistic 'stationary state.'
Important Books Essays on Some Unsettled Questions in Political Economy (1844);
Principles of Political Economy (1848, revised 1849); Utilitarianism
(1863); Autobiography (1861)
Key Concepts Wages fund; abstinence (= remuneration for capital/interest);
production vs distribution (natural vs institutional); stationary state;
reformed utilitarianism (altruism counts too)
Theory (short) Production follows 'natural' (Ricardian) laws, but DISTRIBUTION is
shaped by HISTORY/INSTITUTIONS and CAN be reformed
(progressive taxes, co-operatives) without abandoning markets. In the
very long run, a 'stationary state' (zero growth) could be a GOOD
outcome — a kind of peaceful, voluntary socialism.
Contribution Tried (ultimately unsuccessfully) to UNITE the macro
(Ricardian/surplus) and micro (utility/equilibrium) traditions into one
coherent system — his FAILURE to do so explains why economics
SPLIT into Marxist and neoclassical branches after the 1870s.
Criticism Accused of 'eclecticism' by BOTH later Marxists and neoclassicals —
his wages-fund theory had the SAME logical problems as the original
Ricardian version (over-determination if K/L and W̄ are both fixed). His
optimistic 'stationary state' view was NOT shared by Smith, Ricardo, or
Marx.
Application Mill's distinction between 'natural' production laws and 'changeable'
distribution laws is STILL the basic justification for modern 'market
economy + redistribution' (welfare-state capitalism) policies.
Real-life Example / Mill argued: the LAW that says 'capital + labour produce output' is
Easy Example FIXED (natural) — but the LAW that decides HOW MUCH of that
output goes to capitalists vs workers is a matter of SOCIAL CHOICE
(e.g., taxes, unions, inheritance laws) — and CAN be changed.
Modern Application The modern 'mixed economy' (markets for production + government
redistribution) reflects Mill's production/distribution distinction. His
progressive death duties idea is the ancestor of modern
inheritance/estate taxes.
What Exams 'Explain Mill's attempted synthesis of classical economics — what were
Usually Ask the two traditions he tried to combine, and why did it fail?' / 'Explain the
wages fund theory and its logical problems.' / 'Explain Mill's "stationary
state" and how it differs from Ricardo's view of the falling rate of
profit.' / 'How did Mill's utilitarianism differ from Bentham's?'
Exam Shortcut / MILL = 'Merging Ideas: Labour theory + Limits of distribution' — Mill
Memory Trick tried to MILL together (combine) Ricardo + utility theory, but it didn't
quite WORK ('Mill grinds slowly').

Augustin Cournot (1801-1877)

Category Details
Who was he? A French mathematician, philosopher, and economist — pioneer of
using MATHEMATICS in economics.
Category Details
Nationality French
Period 19th century (1801-1877)
School of Thought Forerunner of Neoclassical Economics (Continental tradition)
Main Contributions First rigorous mathematical theory of monopoly (marginal revenue =
marginal cost); first theory of duopoly using 'reaction curves' (ancestor
of game theory / Nash equilibrium).
Important Theories Monopoly profit-maximisation (MR=MC); duopoly 'reaction curve'
model (Cournot/Nash-Cournot equilibrium).
Important Books Recherches sur les principes mathématiques de la théorie des
richesses (1838)
Key Concepts Demand function (loi du débit); marginal revenue; reaction curve;
Nash-Cournot equilibrium; stability of equilibrium
Theory (short) A monopolist maximises profit where marginal revenue equals marginal
cost. In a duopoly, each firm picks its output based on what it
EXPECTS the other firm to produce — the two firms' 'reaction curves'
intersect at a stable equilibrium.
Contribution His work received almost NO attention for decades (he even gave up
economics!) but is now seen as FOUNDATIONAL — the MR=MC rule
and the Cournot duopoly model are STILL taught in every
microeconomics course.
Criticism His duopoly model assumed ZERO costs (to guarantee a 'nice'
equilibrium) — a simplification that limits its generality. He rejected
utility theories of value due to measurement problems — which meant
he couldn't connect his demand-side analysis to a full theory of VALUE.
Application The MR=MC rule is used by EVERY firm with market power (from
airlines setting ticket prices to pharmaceutical companies pricing drugs)
to maximise profit.
Real-life Example / Two gas stations on the same road (duopoly) each decide how much
Easy Example fuel to stock based on what they EXPECT the other to do. If station A
expects B to under-supply, A might over-supply — but over time, both
adjust until neither wants to change (= Cournot/Nash equilibrium).
Modern Application Modern game theory (Nash equilibrium, used in everything from
auctions to international trade negotiations) traces its ROOTS to
Cournot's duopoly model — nearly 100 years before John Nash
formalised it.
What Exams 'Explain Cournot's monopoly model and the MR=MC rule.' / 'Explain
Usually Ask Cournot's duopoly model using reaction curves.' / 'Why is the "Nash-
Cournot equilibrium" named after both Cournot and Nash?'
Exam Shortcut / COURNOT = 'Calculating Output Using Reaction curves, Numerically
Memory Trick Optimal Trade-off (MR=MC)'. C for Cournot = C for Curves (reaction
curves).

Henry Thornton (1760-1815)

Category Details
Who was he? A British banker, philanthropist, and Member of Parliament — NOT an
academic, but the most important monetary theorist of his era.
Nationality British
Period Late 18th - early 19th century (1760-1815)
School of Thought Bullionist (long-run) but with important short-run/Keynesian-style
insights
Main Contributions Developed an early version of LIQUIDITY PREFERENCE theory;
argued for the central bank as 'LENDER OF LAST RESORT'; refined
Hume's price-specie-flow mechanism with income/output effects;
analysed the relationship between usury laws, interest rates, and
cumulative inflation (anticipating Wicksell).
Important Theories Liquidity preference (money demand depends on confidence); lender of
last resort doctrine; the relationship between nominal interest rate caps
(usury laws) and cumulative inflation.
Important Books An Enquiry into the Nature and Effects of the Paper Credit of Great
Britain (1802)
Key Concepts Liquidity preference; lender of last resort; velocity of circulation; usury
laws and the cumulative inflation process; bullionism with short-run real
effects
Theory (short) Money is held not just for transactions but as a PRECAUTION — how
much people hold depends on CONFIDENCE. In a panic, people hoard
money (velocity falls), so CUTTING the money supply during a crisis
makes things WORSE — the central bank should LEND FREELY in a
crisis instead.
Contribution His 'lender of last resort' idea is the FOUNDATION of modern central
banking (e.g., central banks providing emergency liquidity during
financial crises like 2008). His liquidity preference ideas pre-figure
Keynes by over 100 years.
Criticism His ideas were largely OVERSHADOWED at the time by the simpler,
more rigid Ricardian bullionist view — it took until Keynes (and the
2008 financial crisis) for his insights to be FULLY appreciated.
Application Every time a central bank announces 'emergency lending facilities'
during a financial panic (e.g., 2008, 2020), it is implementing
Thornton's 'lender of last resort' idea.
Real-life Example / During a banking panic, people rush to hold CASH (hoarding) instead
Easy Example of spending/lending it — if the central bank then ALSO shrinks the
money supply (to 'fight inflation'), the economy could collapse even
further. Thornton said: in THIS situation, the central bank should
INCREASE lending, not decrease it.
Modern Application Central banks' crisis responses (2008 financial crisis, 2020 pandemic)
— providing massive emergency liquidity to prevent bank collapses —
directly implement Thornton's 'lender of last resort' principle.
What Exams 'Explain Thornton's liquidity preference theory and its modern
Usually Ask relevance.' / 'What is the "lender of last resort" doctrine and why is it
important?' / 'How did Thornton's views differ from Ricardo's on the
Category Details
SHORT-RUN effects of monetary policy?'
Exam Shortcut / THORNTON = 'The Hoarding Of Reserves Needs Timely action:
Memory Trick Lender Of last resort'. T.H.O.R.N.T.O.N — think of Thornton as the
'THORN' that pricked the simple bullionist view by pointing out SHORT-
RUN real effects.
Chapter 3 Cheat Sheet (One Page Summary)
Most Important Economists
• David Ricardo — differential rent, falling rate of profit, labour theory of value, anti-Corn-
Laws, bullionist
• Thomas Malthus — Population Principle, general gluts theory, pro-Corn-Laws
• Samuel Bailey, Nassau Senior, W.F. Lloyd — anti-Ricardian reaction (relative value,
abstinence, marginal utility hints)
• Cournot, Dupuit, Gossen, von Thünen — Continental forerunners of
neoclassical/marginalist theory
• Friedrich List, German Historical School (Roscher, Hildebrand, Knies) — anti-universal-
laws, infant-industry protection
• John Stuart Mill — wages fund, abstinence theory, stationary state, attempted synthesis
• Henry Thornton — liquidity preference, lender of last resort (vs Bullionists/Currency
School)
Most Important Theories / Concepts
• Differential rent (extensive & intensive) — DECREASING MARGINAL PRODUCTIVITY
• Falling rate of profit (Ricardo's pessimistic version vs Mill's optimistic 'stationary state')
• Ricardo's invariable measure of value (the 'chimera')
• Say's Law and the 'general gluts' debate (Ricardo vs Malthus)
• Marginal utility hints (Senior, Lloyd, Gossen's Two Laws, Dupuit's consumer/producer
surplus)
• Cournot's MR=MC and reaction curves (duopoly)
• Wages fund theory and its logical problems
• Bullionists/Currency School vs Anti-Bullionists/Banking School — ancestor of
Monetarism vs Keynesianism
Most Important Dates
• 1797: Restriction Act (suspends gold convertibility)
• 1815: 5 pamphlets on rent (Malthus x2, West, Torrens, Ricardo)
• 1816: Corn Laws passed
• 1817: Ricardo's Principles of Political Economy and Taxation
• 1820: Malthus's Principles of Political Economy
• 1821: Gold convertibility restored
• 1825: Financial crisis (blamed on Ricardian monetary policy)
• 1838: Cournot's Recherches (monopoly/duopoly theory)
• 1841: List's Das nationale System der politischen Oekonomie
• 1843: Roscher founds the German Historical School
• 1844: Dupuit's De l'utilité et de sa mesure; Bank Charter Act ('Peel Act')
• 1846: Corn Laws repealed
• 1848: J.S. Mill's Principles of Political Economy; 1848 Revolutions across Europe
• 1850-1870: 'Age of Capital'
• 1854: Gossen's Entwicklung der Gesetze...
Most Important Debates
 • Ricardo vs Malthus: Corn Laws — do they help (landlords' rent → demand) or hurt
(squeeze profits → slow growth) the economy?
• Ricardo vs Malthus: 'general gluts' — can the economy have a general lack of demand
(questioning Say's Law)?
• Ricardians vs Anti-Ricardians: is value OBJECTIVE (labour, cost of production) or
SUBJECTIVE (utility, demand)?
• Classical economics vs German Historical School: are there UNIVERSAL economic
laws, or only HISTORICALLY-SPECIFIC patterns?
• Currency School vs Banking School: can/should the central bank tightly CONTROL the
money supply?
Most Likely Exam Questions (Chapter 3)
17. Explain Ricardo's theory of differential rent (extensive and intensive) with a diagram.
18. Explain Ricardo's argument for abolishing the Corn Laws (the full chain of reasoning).
19. Explain the Ricardo vs Malthus debate on 'general gluts' and its relevance to later
(Keynesian) economics.
20. Explain the wages fund theory and its logical problems, with reference to Fig. 5.
21. Compare the Currency School and Banking School views on monetary policy.
22. Explain Cournot's contributions to monopoly and duopoly theory.
23. Explain Gossen's Two Laws and their importance for neoclassical economics.
24. How did J.S. Mill try to synthesise classical economics, and why did this synthesis
ultimately fail?
Quick Memory Tricks
• RENT THEORY = 'WORSE land gets NO rent; BETTER land's EXTRA output IS the
rent'
• RICARDO'S CHAIN = 'Corn Laws → worse land → higher rent → lower profit → less
saving → slower growth'
• MALTHUS vs RICARDO on gluts = 'Malthus: saving ≠ spending (maybe); Ricardo:
saving = spending (Say's Law)'
• GOSSEN'S 2 LAWS = '(1) Less of MORE = less extra joy; (2) Spread your money so the
LAST cent of EACH good feels the SAME'
• CURRENCY SCHOOL = 'paper money should move like GOLD (metallic fluctuation)';
BANKING SCHOOL = 'money supply is FLEXIBLE/endogenous (real bills/reflux)'
• THORNTON = 'lend MORE in a crisis, not less' (lender of last resort)

Memory Notes
1-Minute Revision
The Corn Laws debate (Ricardo vs Malthus) is the heart of this chapter. Ricardo's theory of
DIFFERENTIAL RENT says: as population grows, we farm WORSE land (or farm more
intensively) → diminishing returns → rents RISE, profits FALL (the marginal/worst land earns
NO rent; better land's EXTRA output IS the rent). Ricardo wanted to abolish the Corn Laws to
slow this profit squeeze. Malthus defended the Corn Laws using a 'general glut'
(underconsumption) argument — questioning whether SAVING always becomes SPENDING
(questioning Say's Law) — an idea Keynes revived ~100 years later. After Ricardo, economics
split: ANTI-RICARDIANS (Bailey, Senior, Lloyd) rejected the labour theory and developed early
MARGINAL UTILITY ideas (also Cournot's MR=MC, Dupuit's consumer surplus, Gossen's Two
Laws, von Thünen's marginal productivity) — these became NEOCLASSICAL economics. The
German Historical School rejected 'universal laws' entirely. J.S. Mill (1848) tried to UNIFY
everything (wages fund theory, abstinence theory of profit, the 'stationary state') but ultimately
FAILED — leading to the permanent split between Marxist and neoclassical economics.
Meanwhile, English MONETARY debates (Bullionists/Currency School vs
Anti-Bullionists/Banking School, and Henry Thornton's liquidity preference/lender-of-last-resort
ideas) are direct ancestors of Monetarism vs Keynesianism.

10-Minute Revision
• 3.1 Ricardo vs Malthus: Corn Laws (1816-1846) — high tariffs on corn, pro-landlord.
Differential rent theory (5 pamphlets, 1815) — extensive rent (different land qualities)
and intensive rent (diminishing returns from extra investment on same land) — marginal
land earns NO rent. Ricardo's chain: Corn Laws → worse land → higher rent → lower
profits → less accumulation → slower growth (+ falling rate of profit in the very long run
via population growth). 'General gluts' debate: Malthus said high profit share could mean
insufficient demand (questioning Say's Law); Ricardo rejected this (saving = spending).
Value debate: Ricardo preferred embodied labour (adjusted for TIME via the formula
p1/p2 = (l1/l2)(1+r)^(t1-t2)) but never found his 'invariable measure of value' (a
'chimera').
• 3.2 Disintegration: 3 English groups (Ricardians, Ricardian Socialists [→Ch.4], Anti-
Ricardians [→neoclassical]). Anti-Ricardians (Bailey's relative value, Senior's abstinence
theory, Lloyd's marginal utility) rejected the labour theory to avoid 'exploitation'
conclusions. Continental forerunners (Cournot's MR=MC and reaction curves/duopoly;
Dupuit's consumer/producer surplus and cost-benefit analysis; Gossen's Two Laws —
diminishing marginal utility + equimarginal principle; von Thünen's marginal productivity
theory of distribution and 'natural wage' formula) were largely IGNORED in their time.
German Historical School (Roscher, Hildebrand, Knies; List's infant-industry protection)
rejected universal economic laws — only historical/inductive analysis is valid (sets up the
later 'Methodenstreit').
• 3.3 Mill's Synthesis: 'Age of Capital' (1850-1870) — optimism, free trade, 'theories of
economic harmony' (Bastiat, Ferrara, Carey). J.S. Mill (1848) tried to combine Ricardo's
macro/surplus theory with emerging micro/utility theory — modified Bentham's
utilitarianism (altruism counts; state can override individual judgment for 'merit goods');
distinguished 'natural' production laws from 'changeable' distribution laws (justifying
redistribution); wages fund theory (W̄ =wrL, has logical problems — over-determination);
abstinence theory of profit/interest (capital = sacrifice of consumption); optimistic
'stationary state' (zero growth = peaceful 'socialism' without abolishing property).
• 3.4 Monetary Debates: 1797 Restriction Act (suspends convertibility) → Bullionists
(Thornton, Ricardo: excess money causes depreciation, price-specie-flow) vs Anti-
Bullionists (Pitt, Malthus, Torrens: exogenous real factors, money supply endogenous
via 'real bills doctrine'). After 1821 convertibility restored → 1825 crisis → Currency
School (metallic fluctuation, leads to 1844 Bank Charter Act splitting the Bank into
issue/banking departments) vs Banking School (broader definition of money,
endogenous money supply, 'doctrine of reflux'). Henry Thornton: liquidity preference
(confidence-dependent money demand), lender of last resort, usury laws + cumulative
inflation (anticipates Wicksell).
• BIG PICTURE: this chapter is the 'FORK IN THE ROAD' — Ricardo's macro/labour
tradition → Marx (Ch.4); the anti-Ricardian/utility tradition → neoclassical economics
(Chs.5-6); the monetary debates → Monetarism vs Keynesianism (Ch.9).

Night-Before-Exam Revision
 25. Memorise the rent diagram: 5 lands A-E (decreasing fertility), marginal land E earns NO
rent, better lands' EXTRA output = rent.
26. Memorise Ricardo's chain: Corn Laws → worse land → ↑rent → ↓profit → ↓saving →
↓growth (+ long-run falling profit rate via population growth).
27. Memorise the 'general gluts' debate: Malthus questions Say's Law (saving ≠ spending?);
Ricardo defends Say's Law (saving = investment = demand).
28. Memorise the time-profile value formula: p1/p2 = (l1/l2)(1+r)^(t1-t2) — and that Ricardo's
'invariable measure of value' was a 'chimera' (impossible).
29. Memorise Gossen's Two Laws: (1) diminishing marginal utility, (2) equimarginal principle
(equalise marginal utility per dollar across goods).
30. Memorise Cournot's MR=MC (monopoly) and reaction curves (duopoly = Nash-Cournot
equilibrium).
31. Memorise the wages fund formula wr=W̄ /L and its 'over-determination' problem; Mill's
'less revolution, more contraception' quip.
32. Memorise Currency School (metallic fluctuation, 1844 Bank Charter Act) vs Banking
School (endogenous money, doctrine of reflux) — and Thornton's liquidity preference +
lender of last resort.

Morning-Before-Exam Revision
• Six names to write fast if you freeze: RICARDO (rent, falling profit, value), MALTHUS
(population principle, general gluts), MILL (wages fund, abstinence, stationary state),
COURNOT (MR=MC, duopoly), GOSSEN (2 laws), THORNTON (liquidity preference,
lender of last resort).
• One sentence per name:
◦ Ricardo: worse land → no rent; better land's surplus = rent; abolish Corn Laws to
protect profits.
◦ Malthus: population grows faster than food; questioned whether savings always =
spending (general gluts).
◦ Mill: tried to combine Ricardo's macro theory with utility-based micro theory; wages
fund + abstinence theory; 'stationary state' = good thing.
◦ Cournot: monopolist sets MR=MC; duopolists reach equilibrium via reaction curves.
◦ Gossen: marginal utility diminishes; spend so the LAST unit of each good gives
EQUAL satisfaction.
◦ Thornton: money demand depends on confidence (liquidity preference); central bank
should lend freely in a crisis (lender of last resort).

Visual Learning
Diagram 1: Ricardo's Theory of Differential Rent (Fig. 3 in the book)
This is the MOST IMPORTANT diagram in Chapter 3. Practice it until you can draw it from
memory!
How to draw it (EXTENSIVE rent version):
33. Draw a histogram (bar chart): horizontal axis = total land cultivated (label sections A, B,
C, D, E from LEFT to RIGHT). Vertical axis = output per unit of land (G).
34. Draw FIVE bars, DECREASING in height from left to right: Ga (tallest, land A = most
fertile) down to Ge (shortest, land E = least fertile).
 35. Draw a HORIZONTAL line across the chart at height 'wr' (the real wage) — this
represents the cost of labour per plot.
36. SHADE the area ABOVE the wr line and BELOW each bar's height — this shaded area
= RENT for that plot of land.
37. For land E (the shortest bar, = wr or just above it): NO shaded area (or very little) = NO
RENT. The capitalist here earns profit = (Ge - wr) only.
38. For land A (the tallest bar): the LARGEST shaded area = HIGHEST rent.
39. Label: 'Total wages = area below wr line' / 'Total rent = shaded areas above wr' / 'Total
profit = area between wr and p (uniform profit rate across all lands, due to competition).'
INTENSIVE rent version (same diagram, different labels):
• Horizontal axis now = LEVEL OF EMPLOYMENT (not land area). All land is the SAME
quality, but MORE labour/capital is applied.
• Bars Ga, Gb, Gc... now represent the OUTPUT of the 1st, 2nd, 3rd... 'unit' of investment
— each SMALLER than the last (diminishing marginal productivity).
• The LAST unit of investment (shortest bar) earns NO rent; EARLIER units earn rent =
difference between THEIR productivity and the LAST unit's productivity.
What each part means:
•
Bars (Ga, Gb, Gc, Gd, Ge) = output levels of different land qualities (extensive) OR
different units of investment (intensive)
• wr line = the real wage (cost of labour, assumed FIXED/given)
• Shaded areas = RENT (the surplus above wages that flows to landlords)
• Unshaded area between wr and the bar tops = PROFIT (uniform rate due to competition)
Common mistakes:
• Don't forget: the MARGINAL (worst/last) land/unit earns ZERO rent — this is the KEY
insight examiners look for.
• Don't confuse EXTENSIVE rent (different land QUALITIES) with INTENSIVE rent (same
land, MORE investment, diminishing returns) — both produce the SAME kind of
diagram, but the horizontal axis means something DIFFERENT.
• Remember: this is essentially the 'LAW OF DECREASING MARGINAL
PRODUCTIVITY' — ONE OF THE MOST IMPORTANT IDEAS IN ALL OF
ECONOMICS. Examiners may ask you to CONNECT this to modern marginal
productivity theory.
Simple text sketch of the diagram:
G (output)
| [rent]
| [rent] [rent]
| [rent] [rent] [rent]
| [rent] [rent] [rent] [rent]
wr|--[profit][profit][profit][profit][profit=Ge-wr]
|__A______B______C______D______E___________ Land (or investment level)
(A=most fertile/first unit, biggest rent ... E=marginal/least fertile, ZERO rent)

Diagram 2: Cournot's Duopoly Reaction Curves (Fig. 4 in the book)

How to draw it:
40. Draw axes: horizontal = quantity supplied by firm A (Sa); vertical = quantity supplied by
firm B (Sb).
41. Draw firm A's reaction curve (Qa-Q'a): shows how much A will supply for EACH possible
quantity that B supplies.
42. Draw firm B's reaction curve (Qb-Q'b): shows how much B will supply for EACH possible
quantity that A supplies.
43. Mark the point where the TWO curves CROSS = point C = the Nash-Cournot
EQUILIBRIUM.
44. To show the ADJUSTMENT PROCESS: start at some quantity H for A → B reacts with
K → A reacts with H' → B reacts with K' → ... the process SPIRALS INWARD toward
point C (stable equilibrium).
Common mistakes:
• Don't forget: Cournot ASSUMED ZERO COSTS to guarantee the reaction curves are
SYMMETRICAL and cross in the POSITIVE quadrant — mention this assumption if
asked about LIMITATIONS.
• Remember: at the equilibrium (point C), EACH firm's EXPECTATION about the OTHER
firm's output is CORRECT — this is WHY it's called an 'equilibrium' (no firm wants to
change its decision).

END OF CHAPTER 3 NOTES. Continuing to Chapter 4: Socialist Economic Thought and

Marx.