History of Economic Thought

Module I
Meaning of History of Economic Thought
• It deals with the origin and development of economic ideas and their
interrelations. It is a historical account of economic doctrines.
• Prof. Haney has defined it as “a critical account of the development of economic
ideas, searching into their origin, interrelations and manifestations”.
• According to Prof. Bell, “It is the study of the heritage left by the writers on
economic subjects”.
• Prof. Schumpeter holds that “economic thought is the sum total of all the
opinions and desires concerning economic subjects especially concerning with
public policies of different times and places”. Schumpeter further says that the
history of economic thought traces the historical change of attitudes. It also
speaks about the economic problems and the approaches to those problems.
• The history of economic thought was the philosophy that dealt with different
thinkers and theories in the subject that later became political economy and
economics, from the ancient world to the present day in the 21st Century. This
field encompasses many disparate schools of economic thought.
History of Economic Thought, Economic History,
History of Economics and Economic Ideas
• While History of Economic Thought deals with the development of economic
ideas, Economic History is a study of the economic development of a country. On
the other hand, History of Economics deals with the science of economics.
• Economic ideas are directly and indirectly motivated by the economic conditions
and environment of the country. The History of Economic Ideas surveys topics
that are important for the understanding of contemporary economic issues,
including the ethical foundations of modern economics; ideas regarding property
rights; price theory; money and interest; public finance; the theories of business
cycles and economic growth; international trade; and issues related to population
and resource use.
• Even though Economic History and History of Economic Thought constitute
separate branches of study, they are closely related. Ideas and environment are
equally important and hence close relationship between these concepts.
Evolution of History of Economic Thought
The economic history of the world is a record of the economic activities (i.e. the production,
distribution and consumption of goods and services) of all humans, spanning both recorded history
and evidenced prehistory. The evolution of history of economic thought can be observed fromL
1. Paleolitihic (500,000 – 10,000 BC)
2. Mesolithic
3. Neolithic
4. Antiquity: Bronze and iron ages (early developments in formal money and finance)
5. Antiquity: Classical era (expedition and long distance commerce, external trade with the
Roman empire, the introduction of coinage, developments in economic awareness and
thought)
6. Middle ages
7. Early modern era
8. Proto-industrialization
9. The industrial revolution
10. The twentieth century
11. Twenty-first century and the future
Main periods in the History of Economics
History of the development of economic ideas is broadly studied under
three periods, namely:
• Ancient
• Medieval
• Modern
The History of Economic Thought may be broadly divided into two
parts. The first part deals with the origin and the development of
economic ideas before the development of economics as a science. The
second part deals with the economic ideas after the development of
economics as a science.
Need of Studying History of Economic Thought
• The study of Economic Thought helps us to understand the origin of
economics.
• Economic ideas are instrumental in shaping the economic and political
policies of different countries.
• Economic ideas are conditioned by time, place and circumstances. A study
of Economic Thought provides a broad basis for comparison of different
ideas.
• It enables a person to have a well-balanced and reasonable judgement.
• It helps us to avoid the mistakes committed by earlier economic thinkers.
• It gives an insight into the formulation of important principles and policies
for well-being.
• One cannot possess knowledge of any economic doctrine until one knows
something of its history.
Difficulties in the Study of History of Economic Thought
• History of Economic Thought is selective and interpretative in nature.
• Over-emphasis on some facts and leaving out some important facts
makes the judgement biased. For example, the famous book, “A
History of Economic Doctrines”—written by Gide and Rist leaves out
discussions on ancient economic ideas, medieval economic thought
and the contributions made by Mercantilists.
Various ways to study History of Economic Thought
History of economic thought can be studied and analysed by adopting different approaches:
• Chronological approach: Economic ideas are discussed in order of time. One can find a continuity
in the economic ideas of different economists.
• Conceptual approach: Evolution of different economic concepts (ideas) and their
interdependence. Also called ideological approach.
• Philosophical approach: In the past, economics was considered as a hand maid of ethics.
Philosophical approach was, therefore, adopted by the early writers to discuss the economic
ideas.
• Deductive (or) Classical approach: Universal application of economic laws.
• Inductive approach: Laws of economics are not universal in nature.
• Neo-classical approach: Modification of classical ideas. “Induction and Deduction are necessary
for the science of economics just as the right and left feet are necessary for walking”.
• Welfare approach: Provides the basis for adopting policies which are likely to maximise social
welfare.
• Institutional approach: The institutionalists question the validity of classical ideas and gives
importance to psychological factors
• Keynesian approach: Deals with the problem of economy as a whole. It takes into consideration
the operation of business cycles that affect the entire economic policies. The approach is new and
different from the classical school.
Critical and Positive Ideas of Historical School
1. Critical Ideas of Historical School
• Universality of economic laws
• Crude psychological assumptions
• Use of deductive method
2. Positive Ideas of Historical School
Critical and Positive Ideas…… (contd.)
• Universality of economic laws
- The historians pointed out that economic laws are relative and not absolute
and therefore cannot be applied everywhere and at all times. In order to
make them practically useful, they are to be adapted according to the varying
conditions of time and place.
- As compared to physical law, economic laws are less stable. They are subject
to change both in theory and in practice.
- Economic laws are at once provisional and conditional. They are provisional
because the progress of history brings to light new facts and economic laws
have to be modified accordingly if they are to account for these new facts.
They are conditional in the sense that economic laws are only true so long as
the assumptions on which they are founded are true and other circumstances
do not disturb their operation.
Critical and Positive Ideas…… (contd.)
• Crude psychological assumptions: Man is solely guided by the
consideration of self-interest and is fully absorbed in the gainful
activities.
However,
- Man’s actions are directed by a variety of motives, such as, vanity, love, pity,
glory, pleasure, duty, benevolence, custom, etc.
- The concept of ‘economic man’ – an imaginary human being, devoid of all
motives except self-interest – is abandoned by the modern economists. Now
economics is concerned not with an abstract or economic man, but with a
man of flesh and blood.
 Critical and Positive Ideas…… (contd.)
• Use of deductive method
- Indiscriminate use of the deductive or abstract method for formulating economic
laws.
- These laws do not take into account the numerous motives actually operative in the
economic world. True theory is that which explains the multiplicity of economic
phenomena and such a theory can be constructed only by induction from observed
facts about the complex economic life.
In a science like economics, which deals with complex economic phenomena
and where experiments are not possible, abstraction and analysis provide
the only means of scientific investigation. It is through this method that we
can examine the effect of a particular motive on economic action and escape
from all other complex influences. Today, the controversy regarding the
relative merit of the deductive and inductive methods is over. The
economists are of the view that both the methods are necessary for the
proper development of the economic science.

The main difference between inductive and deductive reasoning is that inductive reasoning aims at
developing a theory while deductive reasoning aims at testing an existing theory. Inductive reasoning moves
from specific observations to broad generalizations, and deductive reasoning the other way around.
Critical and Positive Ideas…… (contd.)
2. Positive Ideas of Historical School
In their positive contribution to economic thought, the historical economists presented an entirely different view
of the aim and scope of economics.
Mechanic point of view (Classical thinkers) for example, price fluctuations, interest rate, wages and rent. These
are explained by the mechanical interplay of free individuals guided by their self-interests and competing with
each other for individual gains. But such mechanical principles tell us nothing about the extremely varied and
constantly changing aspects of economic life. In nut-shell, the mechanical conception leaves the actual periods of
history unexplained and it is here that the organic approach claims superiority. The mechanical viewpoint
considers man’s activity but ignores his environment.

Organic point of view (Historians) analysed man’s economic activity in relation to his environment. The nature of
man’s actions and their effects differ according to the physical, social, religious and political conditions in which he
lives. Geographical conditions, natural resources, efficiency of labour, entrepreneurial skill, level of technology, all
these factors which influence the economic institutions and determine the stage of economic development vary
from nation to nation and from time to time.

Hildebrand has remarked, “Man as a social being is essentially a child of civilisation and a product of history”.
The historical school became instrumental in driving home the importance of the truth that there has to be a
proper balance between facts and logic. The two must supplement each other. Theory has no meaning unless it
can be substantiated by facts and a collection of facts is useless without our being able to derive certain
conclusions from them.
Positive economics: The ‘value free’ approach, where the economist’s
opinions make no difference to the argument or to the evidence which
is presented to support or oppose the argument.
Normative economics: There is disagreement among the economists
 Lack of agreement in Economic Thought
Celebrated playwright, George Bernard Shaw, once famously quipped:
"If all economists were laid end to end, they would not reach a
conclusion.” So, how is it that two experienced, knowledgeable
economists study and analyze the same data and each comes up with a
different forecast for the nation's economy? Why do these experts so
often disagree with one another?
Economists live in the real world and not in the land of dreams. Hence
they disagree with each other and occasionally with their own
previously expressed opinions. This disagreement is a virtue.
Criticism of untruths or partial truths is necessary, for it is only by
rigorous criticism that the subject will progress.
 Lack of agreement in Economic Thought (contd.)
Reasons for disagreement:
• Economists disagree because they are ignorant. This statement applies to scholars of all disciplines. Until ultimate
truth is known, if it ever is, people will make false statements which reflect their ignorance.
• Economists face particular difficulties as they focus on human being. Human behaviour changes over time because
they learn from their experiences. This makes it very difficult, perhaps even impossible, to derive any general laws of
human behaviour. An ’economic ‘law’ which seems to operate in one country, or at one period of time, may prove to
be quite inadequate elsewhere or at other times. Human beings are complex creatures, so economists who try to
derive laws which will predict their action often prove to be wrong.
• The principal disagreement among economists is a matter of economic philosophy. There are two competing schools
of economic thought: Keynesian economics and free-market, or laissez-faire economics. Keynesian economists,
named after John Maynard Keynes, believe that the government should play a role in markets whereas free-market
economists believe that the government should be hands-off and let the market regulate itself.
• Most of the predictions in economies depend on the assumption of ceteris paribus – that other things remain equal.
In real life, however, other things do not remain equal. A prediction that was previously successful may not be so at
another time or in another place.
• The only way to test economic theories is to match them against the evidence. This may seen obvious, but in practice
evidence cannot prove a theory to be true. That is because; facts do not speak for themselves, but have to be
interpreted. Which facts should be used? Difference of opinion emerges.
• When forecasting, economists weigh the importance of certain economic factors differently, such as gross domestic
product (GDP), inflation, unemployment, and interest rates.
• Although economics deals with numerical data and well-established formulas that work to solve various problems
and provide insight into economic activity, it is not completely empirical science. Often unforeseen influences such as
natural disasters, wars, and pandemics, can throw a kink into economic forecasts, derailing economic theories.
Lack of agreement …… (contd.)
• When forecasting the future of the economy- short-term, mid-term, and long-term- economists may study
some or all the economic indicators. Most economists have a personal opinion about these indicators for
forecasting the future.
• Interpreting economic data is both an art and a science, resulting in a different viewpoint of the many
economic factors that impact one another.
• Much of the data economists look at is from the past as opposed to current as it takes time to gather data
and sort it. This results in economists not always having a clear picture of current economic conditions.
• Some economists may over-emphasize the importance of leading economic indicators while discounting the
significance of inflation or the risk of inflation in a vigorously growing economy.
• Some economists may misinterpret the data, and others may give too much or not enough weight to certain
factors. Still, other economists have a favorite formula for predicting the economic future that may exclude
certain items of data that, if considered, would project a different picture of future conditions.
• Because they have not analyzed a comprehensive mix of economic data, their judgments may be at variance
with economists who have taken all the significant data into account.
• Some economists build an element of the unexpected into their forecasting while others either leave it out
completely or do not give it enough weight in their equations. Therefore, disagreements always occur.
• Economists may be employed in a variety of different jobs. They may work for the government, for business,
or in the banking, brokerage, or financial industries. They may hold positions on Wall Street or in academia,
or work as journalists. Each of these employers may have objectives or agendas that color the opinions of
their economists and the differing philosophical views of all economists provide fodder for honest
disagreement.
Homer and Hesoid
• Hesiod
– Works and Days
Poems, c. 700 BC
• Homer
– The Iliad and the Odyssey
Tales from a long oral tradition, finally written down
c. 750-725 BC
• Earliest written record in Europe
• Both the poets shared the idea that security is bound up with land.
Hesoid (Ancient Greek Economist)
... Through work men grow rich in flocks and substance ...
— Hesiod
• In the opinion of the Austrian School of Economics, the first economist is thought to be Hesoid. He wrote the earliest known work
concerning the basic origins of economic thought, contemporary with Homer.
• "Erga" presents a synthetic picture of economic conditions. Economic life is, in many respects, primitive. In agriculture, family
tenure of land was displaced by private tenure. The land was held in severalty, and, at the death of the owner, was divided among
his heirs. Farms were freely bought and sold.
• One of the recognized causes of early Greek colonization was the burden of the family system of land tenure, and private
ownership of land probably first arose among the colonists.
• The "lords of the district" are wealthy and powerful. They hold large tracts of the best land, and are a source of bitter oppression to
the peasant farmers.
• The oppressed were in danger of losing land. The Boeotian farmer is still largely autonomous. He makes his own tools on the
homestead, for the most part.
• Some farmers were turning to trade to supplement their living. Consequently a term for the life of trader was developed. Partial
dependency on sea commerce was increasing and also the demand for products other than home products to satisfy needs.
• Commerce was accepted as a means of escape from debts and from hard economic condition.
• Sea trade, was becoming a regular means of gaining livelihood or even a competence.
• Iron has taken the place of bronze as the metal for all practical purpose
• Pandora’s box (unexpected troubles, misery, sickness, death and many other unspecified evils) – unforeseen problems

It is out of such developing conditions in obscure Ascra that Hesiod's epic comes as the first-known voice raised in Greece in behalf of
the common man.
Hesiod describes himself as a farmer, and says that his father was forced to emigrate owing to poverty.

Works and Days is a poem within the tradition of oriental wisdom literature, moving seamlessly between advice that would nowadays
be seen as ritualistic or astrological and practical advice on agriculture and on when to set sail in order to avoid being lost at sea.
Hesoid’s economic contribution
• The basic economic problem is one of scarce resources.
• Poverty brings shame, while wealth brings confidence.
• Work is considered to be a hard necessity of the evil iron age. Through it, men become
wealthy and beloved by gods and men.
• Lazy men are despised by all. They are stingless drones that devour the work of the bees,
and they ever wrestle with curse.
• Agriculture is the means of gaining competence.
• The poet’s emphasis is on agricultural labor, which was generally held in higher repute
among the Greeks than the mechanical labor of the industrial and commercial world.
However, he has no prejudice against the skilled artisan, and even farm labor was
"banausic" to thinkers like Plato and Aristotle.
• Hesiod, places sea trade by the side of agriculture.

•
• Hesiod realized that the basic economic problem is one of doing one’s best with scarce
resources.
- The reason men have to work is that ‘the gods keep men’s food concealed: otherwise you
would easily work even in a day enough to provide you for the whole year without working’.
Hesiod regards morality and pleasing Zeus as the main challenges that men have to deal
with.
- There is in Hesiod an intuitive understanding of the need to be inventive.
- Choices have to be made between work (which leads to wealth) and leisure.
- Hesiod even suggests that competition can stimulate production, for it will cause craftsmen
to emulate each other.
- But these ideas are not explicitly stated; one has to infer them.
- In Hesiod, the virtues that lead to prosperity are hard work, honesty and peace.
- His ideal is agricultural self-sufficiency, without war to destroy the farmer’s produce. This is
far from the aristocratic disparagement of work and support for martial virtues that can be
found in Homer.
Reflections from Hesoid’s work
• There was little division of labor in his art, either as to materials or kinds of
work.
• The precious metals and ornaments receive little mention.
• No mention of money, implies that barter was the regular mode of exchange
in Boetia.
• In the Boeotian country, slaves were merely domestic, serving in the house or
on the farm, as in the Homeric age. The owner still worked with them.
• There were also free hired servants of both sexes.

Hesoid’s contribution to economic thought is at least in his relevancy to the practice of economical
activity in the depositing and lending of grain, as his writings are "... the chief resource for details as to
Grecian agriculture ..." and that according to Loudon (1825) he provided " ... directions for the whole
business of family economy in the country".
Hesiod offers his readers much advice about coping with life under these conditions.
Homer
The economic and social life at the time was recognized to be undeveloped and naive. Colonization and the
economic revolution were well under way, and the Greek world was entering upon a new era of individualism,
personal reflection, and bitter social and political strife.

In the two poems, Illiad and Odyssey , the society at that time was described as follows:
• Describes the Mycenaean (Bronze Age) world of Troy around 1400–1100 BC .
• The society was ordered and hierarchical.
• This society was not based on market transactions.
• Wealth was acquired through gifts, theft, prizes for winning competitions, plunder received in war, and
tribute paid by defeated cities to their conquerors.
• Trade was viewed as a secondary, and inferior, way of acquiring wealth.
• Most economic activity took place in the household, understood as the landowner, his family, and all his
slaves
• Prosperity comes from efficient management of the household.
• Gifts were governed by a strict code of reciprocity, in which it was important that, when gifts were
exchanged, those involved should hold the same rank after the exchange as before.
• Hosts were obliged to provide hospitality and gifts for their guests, who in turn had an obligation to provide
gifts, perhaps to the hosts’ families, at a later date in return.
 Homer’s economic contribution
• Homer was the first Greek poet (and first intellectual) to clearly express the economic
problem of choosing the best option between several alternatives given a certain set of
restrictions.
• Specifically in the Odyssey, Homer discussed the problem of minimum cost choice and
understood that human beings must often weigh different options given certain
constraints.
• Because the problem of minimum cost choice is at the heart of neoclassical economics,
Homer is considered as a forerunner of this school of thought and the rational choice
theory.
• The basis for this economy was the household, understood as the landowner, his family
and all the slaves working on an estate.
• Owners and slaves work alongside each other.
• Prosperity was seen by Homer as the result of being in a well-ordered, rich household.
• On the other hand, there was suspicion of excessive wealth – households should be rich,
but not too rich.
• Both the poets, Hesoid and Homer, share the idea that security is bound up with land.
Xenophon (c. 430 – 354 BC)
• The influence of Babylonian and Persian thought on Greek administrative
economics is present in the work of Greek historian Xenophon.
• Discussion of economic principles are especially present in his works:
Oikonomikos, Cyropaedia, Hiero and Ways and Means.
• Hiero is a minor work which includes discussion of leaders stimulating private
production and technology through various means including public recognition
and prizes.
• Ways and Means is a short treatise on economic development, and show an
understanding of the importance of taking advantage of economies of scale and
advocated laws promoting foreign merchants.
• The Oikonomikos discusses the administration of agricultural land. Subjective
personal value of goods is analyzed and compared with exchange value.
Xenophon uses the example of a horse, which may be of no use to a person who
does not know how to handle it, but still has exchange value.
• In Cyropaedia, Xenophon presents what in hindsight can be seen as the
foundation for a theory of fair exchange in the market. There is mutual advantage
from exchange.
 Xenophon (c. 430 – 354 BC)
• Oikonomikos is the origin of the words ‘economist’ and ‘economics’.
- It is, however, better translated as The Estate Manager or Estate Management.
- Taken literally it means Household Management, ‘oikos’ being the Greek word for ‘household’, but by
extension the word was used to refer to an estate
• Xenophon’s Oikonomikos is in fact a treatise on managing an agricultural estate. It
is a dialogue principally about household management and agriculture.
• Familiar Socratic themes such as an emphasis on self-discipline and training
people to wield authority are found in the book, but its main theme is efficient
organization.
• Good organization could double productivity.
• Given the Greeks’ emphasis on the human element in production (perhaps a
feature of a slave society), efficient management translated into effective
leadership.
• Effective leadership require knowledge of the production technology and an
understanding of the importance of order and organization.
• Xenophon extended these notions to the administration of a state. The emphasis
was on top-down administration, and not on decentralized markets.
• Without defence the fruits of agriculture would be lost; and without
enough agricultural output the country could not be defended.
• Though officials were given the right incentives, it was still necessary that
the ruler took an interest in all the affairs of the state – agriculture as well
as defence.
• Administrative authority, not the market mechanism, is important by which
resources would be efficiently allocated and productivity maximized.
• Productive efficiency involves managing the use of natural resources so as
to get the most from them.
• He assumed a static world in which it is taken for granted that nature is
known and understood.
Given the development of trade and commerce in Athens by this time,
agricultural estates are still central to Xenophon’s view of economic activity
as they were for Homer’s.
Xenophon: division of labor
• Xenophon is important for two crucial insights:
1. Division of labor leads to higher productivity, and
2. The extent of division of labor is determined by the extent of the market
• Xenophon saw that in a small town the same workman may have to make
chairs, doors, ploughs and tables, but he cannot be skilled in all these
activities.
• In large cities, however, demand is so large that men can specialize in each
of these tasks, becoming more efficient.
• Turning back to the household, Xenophon argues that division of labour
can be practiced in the kitchen. Food prepared in a large kitchen will be
superior to food prepared in a smaller kitchen where one person has to
perform all tasks.
Xenophon: division of labor
• But in Xenophon’s writings, trade and markets are peripheral.
• He does not connect division of labor to the market mechanism.
• He takes the extent of the market as given, and not as something that
can be expanded through the expansion of trade.
Plato (Ancient Greek) (429-347 BC) -
• Greek philosopher and mathematician
• He belongs to city-state of ATHENS.
• Wrote first political science book – ‘The Republic – Ideal society and government’.
- It described the ideal city-state, run by philosopher-kings, and contained references to
specialization of labour and production.
- As far as a state is concerned, Plato gives ideas about how to build an Ideal commonwealth,
who should be the rulers of the Ideal state and how to achieve justice in the Ideal state. Plato
finds the state as the more suitable to discuss about the morality than an individual, because
everything is easier to see in the large than in the small.
- For Plato, the optimum state is a rigid, static, ideal construct from which any deviation
whatsoever is considered to be regressive.
- Every state has three parts: Producer class, Military class and Ruling class.
- The state is to be formed with the skills (techne) of individuals supporting economic
sustainability.
- With respect to the identification of skill, Plato's writing in the Republic also deals with the
specialization of skills as the concept of division of labour.
Plato’s Ideal State
The background to Plato’s Republic, which attempts to provide a blueprint for the ideal state, is the
political turmoil that engulfed Athens and the other Greek city states in the fifth and fourth
centuries bc.
Experience had taught Plato that neither democracy nor tyranny could provide a stable society.
Leaders in a democracy would not do what was just, but would use their office to gain support.
Tyrants, on the other hand, would use their power to further their own interests, not those of the state as a
whole.
But without any leadership there would be chaos.
Plato’s solution to this dilemma was to create a class of philosopher-kings – the ‘guardians’ – who
would rule the state in the interests of the whole society.
These would be self-appointed, for they would be the only ones capable of understanding how
society should be organized.
In the ideal state their whole upbringing and way of life would be designed to train them for their
role and to ensure that they fulfilled it properly.
To ensure that the guardians would not become corrupt, pursuing their own interests, they would
be forbidden to own property or even to handle gold and silver.
They would receive what they needed to live as a wage from the rest of the community.
Unlike tyrants, they would have to put the interests of the state first.
• Plato’s vision was concerned with the efficient organization of society –
with a just society organized on rational principles.
• Left behind great number of writings that record ideas on wide variety of
topics, from nature of truth to ideal form of government.
• His main achievement was
• Division of labour.
• He also gives the plan of ideal social structure.
• State rise out of the need of mankind.
• He conclude that city arise because of division of labour, which emerge
because of natural inequalities among human beings.
• The things are produced in plenty. When one does which is natural to him.
• For 2000 years later Adam Smith used the same concept.
There is significant difference between Plato’s division of labour and
Smith’s division of labour.
1) Plato division of labour is the basis of social organization but Smith,
division of labour for those who practice it.
2) Plato, inequalities in human being lead specialization but Smith
stress the specialization for the point of view of productivity.
3) Plato used this concept for the structure of the society, Smith used
this concept for an idealization of caste system.
Plato (Ancient Greek) (429-347 BC) -
• Greek philosopher and mathematician
• He belongs to city-state of ATHENS.
• Wrote first political science book – ‘The Republic – Ideal society and government’.
- It described the ideal city-state, run by philosopher-kings, and contained references to
specialization of labour and production.
- As far as a state is concerned, Plato gives ideas about how to build an Ideal commonwealth,
who should be the rulers of the Ideal state and how to achieve justice in the Ideal state. Plato
finds the state as the more suitable to discuss about the morality than an individual, because
everything is easier to see in the large than in the small.
- For Plato, the optimum state is a rigid, static, ideal construct from which any deviation
whatsoever is considered to be regressive.
- Every state has three parts: Producer class, Military class and Ruling class.
- The state is to be formed with the skills (techne) of individuals supporting economic
sustainability.
- With respect to the identification of skill, Plato's writing in the Republic also deals with the
specialization of skills as the concept of division of labour.
Plato’s Ideal State
The background to Plato’s Republic, which attempts to provide a blueprint for the ideal state, is the
political turmoil that engulfed Athens and the other Greek city states in the fifth and fourth
centuries bc.
Experience had taught Plato that neither democracy nor tyranny could provide a stable society.
Leaders in a democracy would not do what was just, but would use their office to gain support.
Tyrants, on the other hand, would use their power to further their own interests, not those of the state as a
whole.
But without any leadership there would be chaos.
Plato’s solution to this dilemma was to create a class of philosopher-kings – the ‘guardians’ – who
would rule the state in the interests of the whole society.
These would be self-appointed, for they would be the only ones capable of understanding how
society should be organized.
In the ideal state their whole upbringing and way of life would be designed to train them for their
role and to ensure that they fulfilled it properly.
To ensure that the guardians would not become corrupt, pursuing their own interests, they would
be forbidden to own property or even to handle gold and silver.
They would receive what they needed to live as a wage from the rest of the community.
Unlike tyrants, they would have to put the interests of the state first.
• Plato’s vision was concerned with the efficient organization of society –
with a just society organized on rational principles.
• Left behind great number of writings that record ideas on wide variety of
topics, from nature of truth to ideal form of government.
• His main achievement was
• Division of labour.
• He also gives the plan of ideal social structure.
• State rise out of the need of mankind.
• He conclude that city arise because of division of labour, which emerge
because of natural inequalities among human beings.
• The things are produced in plenty. When one does which is natural to him.
• For 2000 years later Adam Smith used the same concept.
There is significant difference between Plato’s division of labour and
Smith’s division of labour.
1) Plato division of labour is the basis of social organization but Smith,
division of labour for those who practice it.
2) Plato, inequalities in human being lead specialization but Smith
stress the specialization for the point of view of productivity.
3) Plato used this concept for the structure of the society, Smith used
this concept for an idealization of caste system.
 Plato's definition of economics
“Economics is the science which deals with the satisfaction of human
wants through exchange, seeking so to regulate the industries of the
state as to make its citizens good and happy, and so to promote the
highest well-being of the whole.”
 Theory of division of labor
• First observed in a copy of the Republic (Politeia),
• cooperation among any number of persons is more productive than
the individual efforts of the same persons in isolation from one
another.
• The economic incentives springing from the division of labour explain
the origin and nature of human societies
Three reasons for division of labour:
1. there are natural productive differences between the individuals, which
make one person a better tailor, while another one might be a better
farmer, and so on;
2. the daily exercise resulting from specialization improves the
workmanship;
3. many jobs need to be done at the right moment in time and therefore
require permanent availability of some person charged with this task.

The overall result of the division of labor is therefore to increase the physical
productivity of individual human effort, to facilitate this effort, and to make it
more beautiful.
Economic Ideas of Plato
• Plato starts off by identifying the better satisfaction of human needs as the root cause of
association.
• In book II of the Republic, Plato follows a macro approach to the analysis of justice.
• Plato's first principle in his discourse on justice is that specialization and division of labor establish
efficiency and productivity.
• Like other Greek writers, he saw efficiency as involving the human element in production.
• Men should specialize in those activities for which they were naturally suited, and should be
trained accordingly.
• Indeed, the origins of cities (states) lay in specialization and the dependence of people on one
another.
• He took the physical endowment of resources and technology for granted.
• Goods and services are distributed through a marketplace, with money as a token' of exchange.
But in typically Greek fashion, he did not consider the marketplace capable of self-regulation. The
marketplace, like the state, requires administrative control.
• In order to get merchandise from strangers, one needs to pay them with merchandise that is in
short supply in their place. Therefore it is necessary for our citizens to produce in excess of their
own needs.
• His was a static world, in which everyone had a fixed place, maintained by efficient administration
undertaken by disinterested rulers.
• Exchange is a driving force of consumption
• Consumer goods might be bought and sold, but property was to be allocated
appropriately (on mathematical principles) between citizens.
• There would be no profits or payment of interest.
• This view of the state presumed that cities would remain small.
• In a later work, Plato argued that the optimum number of households in a city
was 5040. The reason for this number was that it was divisible by the first ten
integers, and so allowed division into an optimal number of administrative units.
• The idea that cities should remain small was consistent with the experience of
Greek cities, constrained by the availability of agricultural land and resources.
When populations rose, a city would organize an expedition to found a colony.
This colony would become a new city in which the Greek way of life would be
maintained. Such colonies, which often became independent of the cities.
• Plato was the first to advocate the Credit Theory of Money, that money
originated as a unit of account for debt.
Government Role

Only limited to have a check on the exchanges and maintaining

property rights
Opulent Cities
• To move towards luxury
• To move towards expansion
• When a limit is reached, then a need to go on other land arises and
thus wages war
• For war making men are chosen very carefully
• Having a dog nature ( they not attacking own people but strangers)
• Thus conversion into opulent forces war
Aristotle (384-322 BC)
• Aristotle (384–322 bc) was a son of a physician and a student of Plato.
• He joined the Academy at the age of seventeen, and remained there
till Plato’s death twenty years later.
• His writing encompassed philosophy, politics, ethics, natural science,
medicine and virtually all other fields of inquiry
• His writings dominated Western thought in most areas for nearly
2,000 years.
• His thoughts on economic issues are found in
– Book V of the Nichomachean Ethics, which was on justice, and in
– Book I of the Politics, which was about the household, the state, and wealth acquisition
• In Book V of the Nichomachean Ethics, Aristotle dealt with cases of
isolated exchange (in which individual buyers and sellers negotiate
with each other about specific goods).
• He was not dealing with exchange in organized, competitive markets.
It is likely that, though trade was well developed in Athens by the
fourth century bc, competitive markets were few and far between.
• There is much evidence that prices of standard commodities were
regulated.
• The quality of manufactured goods was probably sufficiently variable
that the price of each item would have had to be negotiated
individually, as in isolated exchange.
Aristotle: Economic justice
• In organized, modern markets, the scope for disputes between buyers and
sellers is limited
• However, in Aristotle’s days, markets were not widespread, and products
were not standardized.
• This led to legal disputes between buyers and sellers.
• Aristotle sought to set out the principles for the settlement of such
disputes
• Aristotle considered three concepts of justice
- Distributive justice: how should the spoils of war be shared
- Rectificatory justice: how should one be compensated for past injustice
- Reciprocal justice: when is an economic exchange between a buyer and a seller just
Aristotle: Distributive justice
The common problem in Aristotle’s day, for much was distributed by the state – booty from
war, silver from the mines at Laurium, and many other goods. How should, say, the spoils
of war be shared?
• Aristotle felt that the sharing must be done according to each person’s ‘merit’. This
requires that goods (or honours, or whatever is being distributed) are distributed to
people in proportion to their merit.
Aristotle’s concept of distributive justice was a very elastic notion, for merit can be defined
in different ways in different settings.
• After a battle, merit might be measured by the contribution of soldiers to the victory.
• Within a partnership, justice would require that goods be distributed in proportion to the
capital that each person had invested.
• Furthermore, different criteria may be used to assess merit: in a democacy it might be
assumed that all citizens should receive an equal share, whereas in an oligarchy the
oligarchs would be thought to merit larger shares than other citizens.
Aristotle: Rectificatory justice
This implies putting right previous injustices by compensating those
who had lost out.
• Rectificatory justice restores equality
Aristotle: reciprocal justice
• Also known as commutative justice, or justice in exchange.
If two people exchange goods, how do we assess whether the transaction is just?
• One idea, commonly understood in ancient Greece, is that if an exchange is
voluntary it must be just.
- Xenophon cited the example of two boys – one tall and with a short tunic, the other short and with a
long tunic – who exchanged tunics. The conventional view was that this was a just exchange, for both
boys gained from it.
• Aristotle recognized, however, that voluntary exchange does not determine a
unique price, but merely a range of possible prices in between the lowest price
the seller is prepared to accept and the highest price the buyer is prepared to
pay.
• Within this range, what is the just price?
• Aristotle’s answer was the harmonic mean of the two extreme prices.
• Suppose
- the lowest price the seller would accept is $5.00, and
- The highest price the buyer would pay is $8.00
• According to Aristotle, the just price for this exchange is the harmonic
mean of 5 and 8.
• This is 2/((1/5)+(1/8)) = $6.15
• This price is 23.08% higher than $5.00 and 23.08% lower than $8.00
• This general property of the harmonic mean makes it the just solution,
according to Aristotle.
• Here, justice involved finding a mean between extremes, neither if which is
just.
• The principle that justice involves finding a suitable mean also applies to the two
other forms of justice.
• Distributive justice involves proportionality, or geometric proportion, and is
associated with the geo- metric mean. (The geometric mean of two quantities is
found by multiplying them together and taking the square root of the result.)
• Rectificatory justice involves arithmetic proportion (compensation should equal
what has been lost).
In essence, Aristotle has related the three types of justice to the three types of
mean that were known to him: the geometric, arithmetic and harmonic means.
Aristotle, like Plato, was strongly influenced by the Pythagoreans, who worked out
the mathematical relationship between musical notes. It was believed that similar
harmonies and ratios could explain other phenomena, and it is therefore not
surprising that there were close parallels between Aristotle’s theory of justice and
the mathematics of ratios and harmonies.
The influence of Pythagorean mathematics on Aristotle’s account of
exchange extends even further.
• By Aristotle’s time it was widely accepted that all things were built up from
common units (atomism).
• Geometry was based on points, arithmetic on the number ‘1’, and so on to
the physical world.
• It was believed that different phenomena were commensurable in the
sense that they could similarly be expressed as ratios of whole numbers.
• Discovery of irrational numbers like 𝜋 or √2 that could not be expressed as
ratios.
Aristotle (384-322 BC)
• Aristotle (384–322 bc) was a son of a physician and a student of Plato.
• He joined the Academy at the age of seventeen, and remained there
till Plato’s death twenty years later.
• His writing encompassed philosophy, politics, ethics, natural science,
medicine and virtually all other fields of inquiry
• His writings dominated Western thought in most areas for nearly
2,000 years.
• His thoughts on economic issues are found in
– Book V of the Nichomachean Ethics, which was on justice, and in
– Book I of the Politics, which was about the household, the state, and wealth acquisition
• In Book V of the Nichomachean Ethics, Aristotle dealt with cases of
isolated exchange (in which individual buyers and sellers negotiate
with each other about specific goods).
• He was not dealing with exchange in organized, competitive markets.
It is likely that, though trade was well developed in Athens by the
fourth century bc, competitive markets were few and far between.
• There is much evidence that prices of standard commodities were
regulated.
• The quality of manufactured goods was probably sufficiently variable
that the price of each item would have had to be negotiated
individually, as in isolated exchange.
Aristotle: Economic justice
• In organized, modern markets, the scope for disputes between buyers and
sellers is limited
• However, in Aristotle’s days, markets were not widespread, and products
were not standardized.
• This led to legal disputes between buyers and sellers.
• Aristotle sought to set out the principles for the settlement of such
disputes
• Aristotle considered three concepts of justice
- Distributive justice: how should the spoils of war be shared
- Rectificatory justice: how should one be compensated for past injustice
- Reciprocal justice: when is an economic exchange between a buyer and a seller just
Aristotle: Distributive justice
The common problem in Aristotle’s day, for much was distributed by the state – booty from
war, silver from the mines at Laurium, and many other goods. How should, say, the spoils
of war be shared?
• Aristotle felt that the sharing must be done according to each person’s ‘merit’. This
requires that goods (or honours, or whatever is being distributed) are distributed to
people in proportion to their merit.
Aristotle’s concept of distributive justice was a very elastic notion, for merit can be defined
in different ways in different settings.
• After a battle, merit might be measured by the contribution of soldiers to the victory.
• Within a partnership, justice would require that goods be distributed in proportion to the
capital that each person had invested.
• Furthermore, different criteria may be used to assess merit: in a democacy it might be
assumed that all citizens should receive an equal share, whereas in an oligarchy the
oligarchs would be thought to merit larger shares than other citizens.
Aristotle: Rectificatory justice
This implies putting right previous injustices by compensating those
who had lost out.
• Rectificatory justice restores equality
Aristotle: reciprocal justice
• Also known as commutative justice, or justice in exchange.
If two people exchange goods, how do we assess whether the transaction is just?
• One idea, commonly understood in ancient Greece, is that if an exchange is
voluntary it must be just.
- Xenophon cited the example of two boys – one tall and with a short tunic, the other short and with a
long tunic – who exchanged tunics. The conventional view was that this was a just exchange, for both
boys gained from it.
• Aristotle recognized, however, that voluntary exchange does not determine a
unique price, but merely a range of possible prices in between the lowest price
the seller is prepared to accept and the highest price the buyer is prepared to
pay.
• Within this range, what is the just price?
• Aristotle’s answer was the harmonic mean of the two extreme prices.
• Suppose
- the lowest price the seller would accept is $5.00, and
- The highest price the buyer would pay is $8.00
• According to Aristotle, the just price for this exchange is the harmonic
mean of 5 and 8.
• This is 2/((1/5)+(1/8)) = $6.15
• This price is 23.08% higher than $5.00 and 23.08% lower than $8.00
• This general property of the harmonic mean makes it the just solution,
according to Aristotle.
• Here, justice involved finding a mean between extremes, neither if which is
just.
• The principle that justice involves finding a suitable mean also applies to the two
other forms of justice.
• Distributive justice involves proportionality, or geometric proportion, and is
associated with the geo- metric mean. (The geometric mean of two quantities is
found by multiplying them together and taking the square root of the result.)
• Rectificatory justice involves arithmetic proportion (compensation should equal
what has been lost).
In essence, Aristotle has related the three types of justice to the three types of
mean that were known to him: the geometric, arithmetic and harmonic means.
Aristotle, like Plato, was strongly influenced by the Pythagoreans, who worked out
the mathematical relationship between musical notes. It was believed that similar
harmonies and ratios could explain other phenomena, and it is therefore not
surprising that there were close parallels between Aristotle’s theory of justice and
the mathematics of ratios and harmonies.
The influence of Pythagorean mathematics on Aristotle’s account of
exchange extends even further.
• By Aristotle’s time it was widely accepted that all things were built up from
common units (atomism).
• Geometry was based on points, arithmetic on the number ‘1’, and so on to
the physical world.
• It was believed that different phenomena were commensurable in the
sense that they could similarly be expressed as ratios of whole numbers.
• Discovery of irrational numbers like 𝜋 or √2 that could not be expressed as
ratios.
 Aristotle: Acquisition of wealth
Two different ways of wealth-getting:
• Getting wealth through profitable productive activity
• Getting wealth through exchange
1. Getting wealth through profitable productive activity
• Getting rich by identifying and pursuing a profitable productive
activity was fine.
• Trading to obtain goods that could not be produced at home and
exchanging one’s surplus produce for something of which one had
greater need are perfectly natural.
• There is a limit to the natural acquisition of wealth.
• There is a socially acceptable level of consumption. Anything in excess
was frowned upon.
2. Getting wealth through exchange
• Getting wealth through exchange is unnatural and unacceptable. For this involves making a
gain at someone else’s expense.
• Unnatural ways to acquire wealth included commerce and usury (lending money at
interest).
• Commerce and usury enabled people to make huge amounts of money, without doing any
hard work and far in excess of normal needs.
• Typically, merchants are not citizens, so raising money in this way meant going outside the
polis (independent city).
• Goods are not being used for their proper purpose.
Goods can be either used or exchanged. Of these, the former is a proper, natural
procedure, as is exchange between people who need goods different from what they
currently possess. The essence of natural acquisition of property is that it enables
men to live a good life in the polis.
• Getting wealth through exchange implies that money is being made simply for the sake of
making money, and not for the needs of the good life.
Aristotle on money
• Money had three basic functions
- Means of exchange
- Measure of value (unit of account)
- Store of value
• As the metallic content of money is a convention determined by the
state, the ruler was entitled to profit by reducing the metal content of
money
 Fan Li (Ancient China)
• Born in 517 BC. Also known as Tao Zhu Gong.
• Chinese businessman, politician and strategist.
• Fan Li was born into a poor family. He was engaged in agriculture for living. Due to
brilliant management, he soon became wealthy in the neighbourhood.
• An advisor in the state of Yue in the Spring and Autumn period.
• After achieving a victory for Yue over the state of Wu, he resigned and renamed
himself Tao Zhu Gong.
• A businessman in his later years and became legendary for his success. He became
well-known for his wealth. He was widely known as the Civil God of Wealth or the
Sage of Commerce.
• He discovered seasonality’s effect on the market demand and supply and their
implications on prices. This motivated him to stock up during times of low demand
supplies at heavy discount on prices and sell at times of high demand at a premium.
• He was generous and interested in various public welfare projects, which
earned him a good reputation. He was also regarded as a model of business in
Chinese history.
• He believed that one who understood money and wealth would be willing to
abandon it if it became a burden.
• He reduced the social cost of drought and famine.
• It is commonly believed that Fan Li invented the weighing scale widely used
today.
• His golden rules on business success are far-reaching:
"The rarer it is, the more it is worth. One should have his own views and
tastes on investment. Hoarding rare goods will corner the market. Success in
business is a matter of knowing when to take a risk.”
• Fan Li made great contributions to the establishment of economic
study at the time.
The Twelve Golden Rules of Business Success
• Ability to know people's character. You must perceive evidence of
characteristics from experience.
• Ability to handle people. Never prejudge a prospect.
• Ability to stay focused on the business. Have a definite focus in life
and business and avoid jumping around.
• Ability to be organized. A disorganized presentation is
unappealing.
• Ability to be adaptable. Make sure you are organized enough to
respond quickly.
• Ability to control credit. Do not allow non-payment. Make sure
you collect what is owed.
• Ability to use and deploy people. Use employees in ways which
bring out their potential(s).
• Ability to articulate and market. You must be able to educate
customers on the value of goods.
• Ability to excel in purchasing. Use your best judgement in
acquiring stock.
• Ability to analyze market opportunities and threats. Know what is
selling according to areas and trends.
• Ability to lead by example. Have definite rules and standards.
Make sure they are followed to ensure good relations.
• Ability to have business foresight. Know market trends and
cycles.
The Twelve Golden Safeguards
• Don't be stingy. Never confuse efficiency with inhumanity.
• Don't be wishy-washy. Be confident in pursuing opportunities. Time is
of the essence.
• Don't be ostentatious. Do not overspend in order to make an
impression.
• Don't be dishonest. Truth is the only basis for business. Without it
someone will get hurt.
• Don't be slow in debt collection. Without collections, liquidity is
affected.
• Don't slash prices arbitrarily. This will only trigger a price war in which
everyone will lose.
• Don't give in to herd instinct. Make sure the opportunities are real and not
part of a craze.
• Don't work against the business cycle. When things fall in price, they will
then rise and vice versa.
• Don't be a stick-in-the-mud. Keep up with things and make progress.
Examine new things objectively.
• Don't overbuy on credit. Credit is not license to spend wildly.
• Don't under-save (keep reserve funds strong). When business is slow, one
with money can expand while others close.
• Don't blindly endorse a product. Make sure your vendors are still following
standard operating procedure.
 Abu Yusuf (731 – 798 BC): Medieval Islamic World
• Abu Yusuf Yaqub ibn Ibrahim al-Ansari was among the earliest muslim economic thinkers, a
student of Abu Hanifah, extended the influence of the Hanafi school of Islamic law through
his writings and the government positions he held. He was appointed Qadi (judge) in
Baghdad, Iraq, and later became chief justice (qadi al-qudat) under Abbasid Caliph Harun al-
Rashid, on whose request he authored Kitab al-Kharaj (the Book on Taxation). It is one of the
earliest works on the Islamic system of taxation and fiscal problems.
• Kitab al-Kharaj outlined his ideas on taxation, public finance and agricultural production.
• He discussed proportional tax on produce instead of fixed taxes on property as being superior
as incentive to bring more land into cultivation. In his opinion, if the amount of tax is fixed,
then it will overburden tax-payers in the event of ‘a shortfall in production’; while it will mean
a loss of potential revenue to the state if the production is considerable’
• He also advocated forgiving tax policies which favor the producer and a centralized tax
administration to reduce corruption.
• Abu Yusuf favored the use of tax revenues for socioeconomic infrastructure.
• Abu Yusuf also discussed expenditures & distribution of revenue, taxation (kharaj -
tax on land, zakat (including ‘ushr - tax on crops) and other taxes such as jizyah,
customs duties (‘ushur), sales tax, death tax, import tariffs; public administration, law
& order; other issues relating to leasing of land, public goods, prices, supply & value.
• Economic development needs availability of infrastructure. In view of the importance
of agriculture and trade in his time, Abu Yusuf emphasizes provision of irrigation and
transportation facilities.

Kharaj is a tax on conquered land, a system of rent, and was originally levied by Umar
(r.a.) on the unit of land area (misahah) as a fixed tax (kharaj al-wazifah)
Yusuf’s ideas on public finance
• Public revenue: Tax rate should be according to the ‘ability of tax payer’ and
‘land condition’. The principle of economy should be observed in collection
of taxes, so in no case the cost of collection should exceed the amount
collected. With low tax rate, incentive to work is not killed and payment of
taxes is made happily.
• Public expenditure: According to Abu Yusuf development projects whose
benefit is general should be financed by public treasury, but such projects
whose benefit is confined to a particular group, should be financed by that
group. He made detailed suggestions on how to meet developmental
expenditures on building bridges, dams and irrigation works.
• Public borrowing and deficit financing: Abu Yusuf was silent on the aspect of
public borrowing and deficit financing since the central bank did not exist,
and in any case not necessary given the prosperity and surplus funds in
public treasury (bayt al-mal) of their period. Hence no income tax to repay
any national debt.
• Price control: He rejected the policy measures such as price control,
reaffirming that prices should be determined by market forces. On
prices he observed: “Low prices are not caused by a surplus of crops
nor high prices by the scarcity of them, but are from Allah. Sometimes
there may be a surplus of crops and the price high, and sometimes
there may be a scarcity and the price low”. This does not necessarily
contradict the price mechanism, if one considers value in exchange,
where prices are a function of two ratios (the demand & supply of
goods and the demand & supply of money).
• Abu Yusuf appears to have suggested application of cost and benefit
analysis for carrying out a project when he says: ‘the authorities must
cancel the project of digging any canal whose damage is greater than
its benefit.
• With his ideas, Abu Yusuf not only brought radical changes in people's faith and
rituals but also in their economic practices and institutions. Control over lending,
reform of corrupt market practices and a systematic transfer of funds in favour of the
poor.
• Justice causes development of the country and increases the income. Divine favour is
linked with justice and disappears with injustice.
• According to Yusuf, “The ruler is responsible for the welfare of the people and must
do everything that he considers good for them”. He quotes ‘The best of men in
authority are those under whom people prosper and worst are those under whom
people encounter hardship’.
• Abu Yusuf believes ‘God fearing and personal character of the ruler leads a nation to
correct direction and abandonment of which demolishes the very foundation of the
state’.
• Every effort of development will be sabotaged if the country lacks peace and security.
• Abu Yusuf said: “Take care of what Allah has assigned to you and fulfil the obligation
of authority entrusted to you”.