An Essay on Economic Theory

Interest is established in the market by lenders and borrowers and the interest rate on a particular loan is determined by the risk of default. A loan is repaid from the income generated from capital investments and the interest paid is equivalent to the profits of fully capitalized enterprises. Small entrepreneurs pay high rates whether they borrow cash or purchase goods to be paid at a later date, based on risk and their propensity to spend beyond their means.Thereby, interest rates on loans are connected with an individual’s time preference. From Part 2: Money and Interest. Narrated by Millian Quinteros.

When the government’s national bank inflates the money supply by increasing the supply of banknotes, it reduces the rate of interest and can increase the price of stocks. This is a corrupt process and when the notes are redeemed, the price of stocks falls and can result in bank runs and economic chaos. This is now known as the business cycle. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

The price of gold and silver and the ratio between them is determined by markets and is also based on their usefulness, cost of production, and transportation costs. When government mints establish a fixed ratio between gold and silver money that is not based on market prices, the overvalued metal will be driven from circulation. This is commonly referred to as “Gresham’s Law” where bad money drives out good money. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

Fractional-reserve banking is a system where the banks lend some of their deposits and earn interest. This increases the amount of money in circulation compared to warehouse or 100% reserve banking. This utility of banking comes at the risk of being unable to withdraw your deposits. The amount that can be lent into circulation depends on the type of bank and the needs of the depositors. There are goldsmith-bankers, the typical banker who issues banknotes, and the national bank. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

National Banks are of little utility and can be the source of economic chaos. The increase in the supply of money that they provide is relatively small and offers the same disadvantages as increases in real money. They are therefore unnecessary and potentially very harmful, as in the cases of the Bank of Venice and the Bank of London. The roles of legal tender laws, fractional reserve banking, and regional trade fairs are described. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

Here the circular-flow economy is extended to international trade. Instead of barter or exchange with money, Cantillon explains how international trade takes place on the basis of bills of exchange. He showsthat a state which accumulates money will enjoy a temporary gain in international trade, but that states where manufacturing industries develop will enjoy a higher standard of living. The only clear exception Cantillon makes to free trade is his famous endorsement of the English Navigation Acts, where domestic shipping is protected, not in its own right, but to provide ships and sailors during wartime. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

There is an expense associated with transporting money based on the distance, risks, and other transaction costs. Bills of Exchange are a type of contract that can reduce this cost by avoiding shipments that are offsetting between two locations. When money must be sent, bankers charge a fee for arranging the shipment and providing their customers with a bill of exchange, or check, that can be drawn or cashed at a correspondent bank where the money is sent. When the exchange rate is above par, it indicates a balance of payments deficit, and when the exchange rate is below par, it indicates a balance of payments surplus. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

Exchange rates are explained as a function of the balance of trade and other factors. A trade deficit can cause your money to exchange below par, while a trade surplus will cause it to exchange above par. In fact, the exchange rate, above and below par, is an indicator of the general balance of trade in a country. An attempt to prohibit the export of gold necessary to pay for deficits only hurts the economy. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

Raising and lowering the nominal value of money is shown not to undermine the theory of the value of money. In contrast, such measures are shown to be methods by which the prince acquires resources by deceiving individuals about the value of money. The process causes chaos in the market. From Part 3: International Trade and Business Cycles. Narrated by Millian Quinteros.

William Petty set off the search for a par value between land and labor. Cantillon provides a theoretical answer (referenced in Adam Smith’s 'Wealth of Nations') that property owners must provide their labor with the production of at least twice the land necessary to sustain the worker in order that enough children are raised to maintain the workforce over time. The amount of land will actually vary from job to job, person to person, and among different countries and societies. Therefore, the practical circumstances of the world dictate that there is no such “par” value between land and labor, only money — a “most certain measure” — can be used for income measurements and comparisons. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Cantillon develops a circular-flow model of the economy that shows the distribution of farm production between property owners, farmers, and workers. Farm production is exchanged for the goods and services produced in the cities by entrepreneurs and artisans. While the property owners are “independent,” the model demonstrates the mutual interdependence between all the classes of people that Adam Smith dubbed the “invisible hand” in 'The Theory of Moral Sentiments' (1759). From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Cantillon constructs a model of the isolated estate or closed economy where the choices of property owners determine outputs and prices, regardless if they manage the isolated estate or lease it to farmers. Mistakes of the farmers or changes in demand by the property owners cause changes in prices, profits and losses, which drive the economy back to equilibrium. The result is that the price system directs resources to the same outcome as that provided by the direct management of the estate owner, ala Adam Smith’s use of the “invisible hand” in the Wealth of Nations. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Cantillon uses his price-specie flow mechanism to analyze some of the effects of inflation. Increasing the supply of money by mining hurtssome people and benefits others because certain prices and incomes rise faster than others. However, if the new money is accumulated and saved by those who successfully export goods, either because of superior quality or more efficient transportation, it will lead to higher standards of living. From Part 2: Money and Interest. Narrated by Millian Quinteros.

Increases in the supply of money from a balance of trade eventually causes prices to rise. This in turn puts pressure on domestic producers and increases imports. The result is that the balance of trade is reduced and eventually is negative. This is Cantillon’s price specie-flow mechanism which demonstrates the reasons for the tendency for equilibrium in international monetary flows. The balance of trade can result in economic power, but this also causes the economy to lapse into luxury and decline. From Part 2: Money and Interest. Narrated by Millian Quinteros.

The interest rate is determined by the supply and demand for loanable funds, not the supply of money. Savings and frugality decrease the interest rate while lavish spending increases it. War increases the interest rate, peace decreases it. Paying off the national debt decreases the interest rate. A positive balance of trade decreases the interest rate, but the government cannot effectively lower the interest by a usury law. The interest rate is a critical factor in the valuation of assets such as land. From Part 2: Money and Interest. Narrated by Millian Quinteros.

Population is based on the tastes and choices of property owners. Early versions of the Malthusian approach to population growth — that it follows some mathematical formula — are criticized. This chapter also shows that the opulence and lavish spending of the prince and absentee landlords living far from their lands was responsible for the poverty and declining population of France, which ultimately led to the French Revolution. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Farm production produces three rents, one of which sustains the farm workers, while the other two can be sold at wholesale to entrepreneurs who in turn provide property owners and farmers with goods and merchandise. This is the circular flow model of the economy. Money facilitates the flow and timing of rent payments (i.e., “velocity”) and the rate of the monetary flow determines the ratio between the quantity of money and the value of annual production. This model is then used to explain the implications of international trade. From Part 2: Money and Interest. Narrated by Millian Quinteros.

Large transactions can be accomplished with the use of bills of exchange or barter, which reduces the demand for money. Ordinary transactions by people require actual coin money in circulation. A variety of factors, therefore, affect the flow of money in circulation and this in turn affects the amount of money in circulation. From Part 2: Money and Interest. Narrated by Millian Quinteros.

Rural France was impoverished because commodities had to be sent to the capital and major cities to pay taxes to the state and rents to the property owners living there. It is argued here that if factories were permitted in rural areas, basic commodities could be turned into goods, which could then be sent to the cities at a much lower transport cost. This would save resources in transportation and benefit both rural populations and property owners. From Part 2: Money and Interest. Narrated by Millian Quinteros.

When there is an increase in the quantity of money, prices will increase depending on how the new money holders decide to spend their money. The price changes will also be affected by such things as regulations on trade and the perishability of the products that are traded. In other words the simple quantity theory of money is naïve in proposing that a doubling of the quantity of money would double all prices equally. Changes in the quantity of money will change relative prices and have real effects on the economy, a phenomenon now known as the Cantillon Effects. From Part 2: Money and Interest. Narrated by Millian Quinteros.

Cities form at sites where large property owners have decided to live. Specialization of labor expands to meet the demands of the wealthy. Cities grow even larger when manufacturing industries produce for export, and whose workers are essentially supported by the production of foreign lands. Cantillon placed a great deal of emphasis on transportation costs. He found that property owners who lived far from their lands would experience a reduction in income proportional to the cost of transporting their production to market. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Here Cantillon introduces, for the first time, the theory of entrepreneurship. Entrepreneurs are the prime directors of resources. Their occupations come with risks due to uncertainty, especially from competition and changing tastes. As a result, their income can be very large, but they also face the prospect of bankruptcy. The property owner is independent in having a large income (rent) from the land, and the capitalist, or large money owner, also can live independently on interest. Everyone else is ultimately dependent on the expenditures of property owners for their livelihoods. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

The wealth of a nation depends on putting the labor force to work. Those who are unnecessary for farming can be employed in making higher quality products and manufactured goods, particularly durable goods made from metal. Saving is the key determinant of wealth and gold is a particularly useful form of savings because it can purchase all things, even in time of war. The prince and property owners determine how people will be employed by their consumption choices, while the Catholic Church reduces the resources available to materially sustain the people. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Gold and silver were highly valued before they were used as money. They hold many advantages over other goods such as durability, divisibility, transportability, and homogeneity. These are the reasons which led gold, silver, and copper to be chosen as money, not “fancy” or common consent. When princes debase money or issue imaginary money, they hurt the economy. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Market prices are determined by the bargaining between suppliers and demanders. Price determination by supply and demand is illustrated with a thought experiment that uses a fixed quantity of a perishable product (e.g., green peas) and known maximum valuations of consumers. From Part 2: Money and Interest. Narrated by Millian Quinteros.

All human societies are based on a system of property rights. The distribution of rights will necessarily be unequal, and the use to which property is put will be dependent on the tastes of the owners. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Entrepreneurs establish markets in centrally located villages which provide the necessary conditions under which prices are established between supply and demand. The size of the market town depends on the size of the economy it serves. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

The opportunity cost of becoming a skilled worker includes both the direct expenses as well as the foregone labor during the training period or apprenticeship. As a result, skilled workers must be paid higher wages than unskilled workers. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Intrinsic value can be measured by the quantity of land and laborers, taking into account the quality of land and labor. Some goods are produced almost entirely with land, others solely from labor. In the garden example, intrinsic value is both the direct expenses of the garden and the foregone value of land. Intrinsic value of a choice never changes, but market prices vary according to demand. Cantillon’s construction of “intrinsic value” should therefore be understood as the concept of opportunity cost, not the essential nature of a thing. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Because the opportunity cost of a good cannot be fixed, it is impossible to know the proper exchange ratios for barter. This problem is overcome in the market by using commodities that have marketable characteristics, such as transportability, durability, and a recognized economic value, to serve as a medium of exchange. Prices of goods do not strictly follow the quantity theory of money. From Part 2: Money and Interest. Narrated by Millian Quinteros.

Introduction to Richard Cantillon's 'An Essay on Economic Theory'. Cantillon deals with a wide variety of fundamental and philosophical issues such as the nature of property, the distribution of income, the origin of money, and the role of government. Narrated by Millian Quinteros.

In this first of four chapters on economic geography and location theory, Cantillon explains that settlements are based on the requirements of production, especially the quantity of labor, and the extent of the specialization and division of labor. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Wherever a government establishes its capital, the city will grow in size because the additional spending attracts labor and businesses to service the government and its employees and thus, it becomes a commercial center for the nation as well. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

In addition to training and the forces of supply and demand, workers with higher quality skills, risky jobs, or jobs which require trustworthy employees will receive higher wages. This is now known as the theory of compensating differentials that is often attributed to Adam Smith. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

The supply of workers adjusts itself to the demand for labor, across all professions, via wage rates, migration, and changes in population. Prosperity cannot be created by subsidizing job training. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.

Foreword to Richard Cantillon's 'An Essay on Economic Theory'. Mark Thornton and Chantal Saucier have accomplished the arduous task of bringing forth a new and improved translation of Cantillon’s famous work. Narrated by Millian Quinteros.

Cantillon defines wealth as the consumption goods produced by land and labor. This contrasted with the Mercantilists who thought money was wealth. From Part 1: Production, Distribution, and Consumption. Narrated by Millian Quinteros.