Economics (McConnell) AP Edition, 19th Edition

Chapter 2: The Market System and the Circular Flow

Origin of the Idea

	2.1 Laissez-faire
	2.2 Self-interest
	2.3 Specialization/division of labor
	2.4 Circular Flow Diagram

2.1 "Laissez-faire"

While Classical economists such as Adam Smith are famous for their economic philosophy of laissez-faire, the term originated with a group of French economists known as Physiocrats. The full phrase, "laissez-faire, laissez-passer," is credited to Vincent de Gournay, and in modern translation means "let people do as they please without government interference." More literally translated from the French, "laissez-faire" means "to allow to do" or "non-interference," while laissez-passer means "to permit." ⁽¹⁾

The laissez-faire principle of freedom in economic affairs became part of Classical economics as a result of Adam Smith's study of the Physiocrats and his close association with the Physiocrats Francois Quesnay (1694-1774) and Anne Robert Jacques Turgot (1727-1781).

Classical economist John Stuart Mill (1806-1873) defends the concept in his "On the Influence of Government." He states,

In all the more advanced communities, the great majority of things are worse done by the intervention of government, than the individuals most interested in the matter would do them, or cause them to be done, if left to themselves. The grounds of this truth are expressed with tolerable exactness in the popular dictum, that people understand their own business and their own interests better, and care for them more, than the government does, or can be expected to do so. ⁽²⁾

Born in London, England, on May 20, 1806, John was the eldest of nine children of James Mill, a prominent philosopher, statesman, and political economist. James Mill believed that all people are born with equal ability, so he carefully supervised his son's education. John's intense education included Greek, Latin, philosophy, history, mathematics, and political economy, and he was writing and publishing works by his mid-teens. When he was twenty he suffered from what some would consider a well-deserved nervous breakdown.

John Stuart Mill influenced economics students for decades. In 1848 he published Principles of Political Economy, the leading textbook in the discipline for over forty years. Trained in Classical economic thought, but with the humanitarian influence he credited to his wife, Harriet Taylor, John Stuart Mill represents a transitional point between Classical economics and the more familiar schools of economic thought that would follow.

Cassell's French Dictionary (London: Cassell & Company Ltd., 1962), 444
John Stuart Mill, Principles of Political Economy, 7th ed. (London: Longmans, Green, 1896), 571 [Originally published in 1848]

Photograph courtesy of: (c)Hulton-Deutsch/Corbis;

2.2 Self-interest

According to Adam Smith, specialization and economic growth are motivated by self-interest. At the same time, pursuit of self-interest by individuals promotes the well being of the rest of the community. "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to the their own interest"⁽¹⁾ Smith's logic here is simple and effective. Society benefits by having goods provided. People don't provide those goods for us because they like us, but because it is a way for them to generate income to satisfy their own wants. If, to earn that income, the butcher, brewer, and baker must compete with others in their industry to sell their products, it encourages the production and sale of quality goods at lower prices.

Adam Smith (1723-1790) is perhaps the most famous of all economists. At the very least he is the best-known classical economist and his contributions have played a significant role in shaping modern economic thought.

Born in Kirkcaldy, Scotland, Smith attended Glasgow College at age 14, and later studied moral and political science and languages at Balliol College, Oxford. After serving as a lecturer on rhetoric and literature in Edinburgh, Glasgow College, in 1751, elected Smith to be professor of logic and, a year later, the chair of moral philosophy.

Smith left Glasgow College 12 years later to serve as a private tutor. In the course of his travels as a tutor, Smith spent time in France, where he befriended Francois Quesnay and Anne Turgot. The two physiocrate economists helped shape Smith's thinking, as evidenced by his use of the French term, laissez-faire.

Before focusing his attention on political economy (the old term for economics), Smith published The Theory of Moral Sentiments in 1759. This work concentrated primarily on philosophy and ethics, and in particular the moral forces which guide behavior. Smith's best known work, the work that clearly defines Smith as an economist, was An Inquiry into the Nature and Causes of the Wealth of Nations (often referred to simply as Wealth of Nations), published in 1776. The 900 pages of Wealth of Nations contain not only the articulation of many time-tested concepts in economics, but also a refutation of the economic philosophy known as mercantilism. Mercantilists believed that nations should enact trade barriers with other countries so as to reduce imports and achieve a trade surplus. Their belief was that the wealth of a nation was in the gold and silver (bullion) it possessed, and that trade surpluses were a primary means to accumulating bullion. Smith argued that the wealth of a nation was the real goods it produced, not the money it possessed.

Smith, Wealth of Nations, 27.

Photograph courtesy of: (c)Bettman/Corbis

Photograph courtesy of: (c)Nance Trueworthy

2.3 Specialization: Division of Labor

The wealth of a nation could be increased, according to Smith, by specialization, also known as "division of labor". Smith illustrated the concept by describing the workings of a pin factory.

To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business (which the division of labour had rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certain could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed,

and where some of them consequently performed two or three distinct operations. But though they were poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins might be considered as making four thousand eight hundred pins a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day.⁽¹⁾

Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, (New York: G.P. Putnam's Sons, 1877), 19. [Originally published in 1776.]

Photograph courtesy of: (c)Corbis #BUS2079;

2.4 Circular Flow Diagram

Origins of the circular flow diagram can be traced to Francois Quesnay (1694-1774). Quesnay belonged to a group of economists known as the Physiocrats, so named because Quesnay was himself the court physician for Louis XIV in France. As a physician, Quesnay likened economic activity to the functioning of the human body. Money and goods were to the economy what blood was to the body.

The original circular flow diagram was Quesnay's Tableau Economique, drawn for the king in 1758 and revised in 1766. It demonstrated how inputs, revenue and goods were exchanged between farmers, landlords and merchants.

The circular flow diagram appearing in the text traces most directly back to economist Francis Knight and his "wheel of wealth" that he constructed in the 1930s.

McConnell Economics Nineteenth Edition Large Cover Image

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