On “effectual demand” and the “extent of the market” in Adam Smith and David Ricardo

Abstract

This paper revisits the question of demand in the works of Adam Smith and David Ricardo by adopting a novel approach: the joint examination of the concepts of “effectual demand” and the “extent of the market.” The discussion on “effectual demand” highlights its social nature and finds that in a multi-commodity framework, the vector of commodity supplies adapts to the vector of effectual demands. Subsequently, the “extent of the market” is seen to play a distinct role in determining economic growth as a demand-side determinant alongside the supply-side determinants of net saving and technological progress. The connections between the “extent of the market” and “effectual demand” are also explored in this paper. The findings point to a more important analytical role for demand in both Smith and Ricardo than has hitherto been highlighted.

Keywords:

• Effectual demand
• classical economics
• extent of the market
• social tastes
• economic growth

JEL CLASSIFICATIONS:

• B12
• B31
• B50

Acknowledgements

I am indebted to the discussant and audience at the 2018 annual conferences of both the European Society of the History of Economic Thought (ESHET) and the History of Economic Thought Society of Australia (HETSA), and particularly to Tony Aspromourgos and the two anonymous referees for valuable comments and criticism, without implicating any of them in the final product.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 In Richard Cantillon’s Essai (1755 [1931]), an embryonic version of “effectual demand” can be found (see Thomas, 2018b, 19). The phrase “effectual demand” is already present in James Steuart’s work but not as an analytical component of his value theory (1767 [1966], I, 117).

2 Skinner advances a marginalist interpretation when he writes: “…in dealing with the problem of price, Smith was implicitly using the analytical device of a static system, and working in terms of a given (stable) stock of factors together with a given (stable) level of aggregate demand for them” (Skinner, 1996, 150).

3 Throughout the article, Ricardo’s On the Principles of Political Economy and Taxation (Sraffa 1951a) is cited as Ricardo I and his Notes on Malthus’s Principles of Political Economy (Sraffa 1951b) as Ricardo II.

4 The role of “habit” is underscored in Ricardo’s definition of the “natural price of labour” (cf. Stirati, 1994, 147):

The power of the labourer to support himself, and the family which may be necessary to keep up the number of labourers, does not depend on the quantity of money which he may receive for wages, but on the quantity of food, necessaries, and conveniences become essential to him from habit, which that money will purchase. (Ricardo I, 93)

Also see Ricardo I, 96–7 where he argues that the “natural price of labour … essentially depends on the habits and customs of the people.” It is therefore not surprising when King notes that Wesley Mitchell found similarities between Ricardo’s political economy and institutional economics because of the role ascribed to habits in his theory (King, 2013, 175).

5 This sentence, while present in the first edition of Principles, is not found in the third edition (see the editorial note at Ricardo I, 100, n. 1).

6 More precisely, “effectual demand” and the quantity actually brought to the market are “single quantities” (Palumbo, 2015, 105).

7 References to emulation are also found in Cantillon (1755 [1931], 63; cf. Thomas, 2018b, 25) and Steuart (1767 [1966], 151; cf. Thomas, 2015, 64–6).

8 Hence, Garegnani writes: “…unlike most modern theorists, classical authors considered the analysis of the ‘content’ of preferences to be an important part of economics” (Garegnani, 1990, 129–130).

9 Note that Smith is talking about the “average produce” and not the “actual produce” which is adapting to the “effectual demand.” This is consistent with the method of the classical economists which studies “natural prices” (owing to its more permanent nature) as opposed to “market prices” (which are more temporary in nature).

10 But outside what Ricardo considers to be the special case, he rightly does not see any tension between reduced consumption and the ability to accumulate: “There are two ways in which capital may be accumulated: it may be saved either in consequence of increased revenue, or of diminished consumption” (Ricardo I, 131).

11 Marshall’s attempt to interpret Ricardo as a precursor to marginalism is visible in the following excerpt: “Again, in a profound, though very incomplete, discussion of the difference between ‘Value and Riches’ he seems to be feeling his way towards the distinction between marginal and total utility” (Marshall, 1890 [2013], 670). Of course, nothing could be farther from the truth. In the preface to the Japanese edition of The General Theory, Keynes correctly notes that Marshall’s “work largely consisted in grafting the marginal principles and the principles of substitution on to the Ricardian tradition” (Keynes, 1936 [2013], xx; also see the discussion in King, 2013, 194–5). Like Marshall, Samuelson (1978) and Hollander (1979) view Smith’s and Ricardo’s political economy through a marginalist lens. In fact, Samuelson goes as far as stating that “within every classical economist there is to be discerned a modern economist trying to be born” (Samuelson, 1978, 1415). Although Morishima (1989) advances a similar interpretation of Ricardo as Hollander (1979), Morishima offers a harsh assessment of Samuelson’s interpretation: “It is nothing but Samuelson in the garb of Ricardo” (Morishima, 1989, 122).

12 It is owing to this analytical separation in Ricardo’s political economy that Garegnani (1978, 340n) writes: “Ricardian theory of distribution … is not incompatible with effects of … demand on aggregate output or the speed of accumulation.”

13 There is a problem here because Smith does not offer any reconciliation of the supply-side and demand-side factors (on this issue, see Aspromourgos, 2009, 192–6).

14 However, Elmslie (1998, 506) thinks that the “historians of economic thought have made more of the vent for surplus doctrine than Smith ever intended.”

15 In this article, I do not explore in detail the consequences of foreign trade on activity levels and economic growth via the “cheapness of commodities” channel.

16 Therefore, since “value” was unchanged, as Winch notes, Ricardo “denied that the general level of profits could permanently be affected by new markets for goods or outlets for capital” (Winch, 1963, 394). Ricardo also discusses the case when “value” decreases and “riches” increases (Ricardo I, 274) and in this case the profit rate would be affected.

17 By “distribution,” Malthus referred to the matching of commodities with that of the society’s “wants and tastes” (Ricardo II, 420). This process is nothing but the adapting of commodity supplies with their effectual demands (see Section 2.2).

18 Due to Ricardo’s special assumption, Hagemann states that “demand does not constitute a decisive barrier to economic growth” (Hagemann, 2015, 160). Also, see Davis, 2005, 162–182 who argues that Ricardo’s position on the question of demand in theory and policy are inconsistent (or, see Davis, 2001).

19 Of course, in Ricardo’s discussion of economic growth, the diminishing returns associated with land is significant, and consequently, the need for “technological improvements” to counteract the diminishing returns (cf. Kurz, 2010, 1194–6, 1198).

20 The dominant interpretation is that Smith assumes planned saving to be one and the same as planned investment (Smith, II.iii.18; cf. Aspromourgos, 2009, 192–3).

21 However, for Morishima, Ricardo’s analysis “was carried out within a framework constructed with the spirit of general equilibrium analysis” (Morishima, 1989, 18). Furthermore, he argues that “Ricardo’s economy is not a simple macro-model; it is a decentralized economy…” (Morishima 1989, 103). This interpretation of Ricardo is different from the one advanced in this paper wherein it is argued that Ricardo was emphatic about the distinction between “value” and “riches” and consequently of the analytical separation of the price and quantity system. For the same reasons, Hollander’s arguments that “final expenditure matters” for distribution and that Ricardo uses the “standard demand-supply analysis” stand exposed (Hollander, 2001, 10–11).

22 But, for Morishima, Ricardo assumed the full employment of labour and capital (Morishima, 1989, 106) despite explicit textual evidence to the contrary (especially, see Ricardo I, 89 for the presence of spare capacity in Ricardo and the chapter on machinery in the third edition of the Principles). Winch also asserts the presence of full employment in Ricardo; he points out that it is owing to this assumption that Ricardo argued that “the opening of new markets” only influenced the composition of output and did not add to aggregate output (Winch, 1963, 394).