Neoclassical economists (1880's), with a narrower focus, deepened our understanding of the first question (Chapter 1, 2), and the emergence of macroeconomics, early in the twentieth century, gave us workable statistical measures to answer that question (Chapter 15).
As for the causes of increases in the wealth of nations, Smith favored the division of labor as the main cause, but other economists have proposed other answers (Ch. 16). Smith's view of the prospects for increasing prosperity was very optimistic. Malthus (1799) opposed Smith's optimism, stressing diminishing returns as a limit on increasing prosperity. This idea of diminishing returns was to play a larger part in later economic thinking, however. Malthus also pointed to unemployment as one of the macroeconomic problems (Ch. 17) that could be barriers to increasing prosperity.
Although Smith understood that a monetary system would be the sine qua non of an economy based on division of labor, he did offer anything very new on the topic. David Ricardo (around 1815) did, in a practical way, when he was called on by the British government to re-engineer their monetary system (Ch. 18).
Ricardo also refined Smith's ideas on the "natural price." Smith had settled (with some dissatisfaction) an the labor theory of value as his answer to the question, "what determines the natural (or normal or average) price of a good or service?" Ricardo put that answer on a very tight logical footing after 1800. Marxist Economics also relied strongly on Ricardo's clarification of the Labor Theory. But by the 1840's, the confidence of economists in the Labor Theory of Value was beginning to shake. There were too many exceptions. John Stuart Mill, among his many other contributions, suggested that some of the exceptions (in international trade, specifically) could be understood in terms of the interaction of supply and demand. By the end of the 1850's, other and lesser economists had extended this insight to make supply and demand the general answer to the question, "what determines the normal price of a good or service?" And so it is today -- the supply and demand theory is the theory of normal price in modern economics (Chapters 3, 4). This also provided the last link in the theory of international trade (Ch. 19). Ricardo had put the long-standing discussion of international trade on a sounder basis with the first clear understanding of why all nations involved can enjoy mutual benefits from trade. However, his reliance on the labor theory had left some questions unanswered that could now be answered.
Thinking of the normal price in terms of supply and demand did not answer all questions, of course. In one sense it just put the questions off to another stage. "What determines supply?" and "What determines demand?" are the questions that now have to be asked. (1870-1900) The answer to "What determines demand?" came sooner in history, but "What determines supply?" is a bit easier for the student to understand. We suppose that supply comes from the decisions of many business firms, and that the business firms want to hire enough labor and produce enough output so that profit will be as large as possible. As a start-up firm expands its labor force and output, it can increase its profits. Will this ever come to a stop? Here, Malthus' principle of "diminishing returns" came back into the picture. As the firm increases its labor force, with its other input resources constant, the productivity of labor would decline, and as a result its costs would rise. To make these ideas more precise and complete, the earliest neoclassical economists had to invent a new approach (new to economics, anyway) called the "marginal" approach. Thus the neoclassical theory of the firm was expressed in terms of maximization of profits, marginal productivity (Ch. 6) and marginal cost (Ch. 7). This also clarified the supply-and-demand analysis of productive resources, especially labor. (Ch. 14)
The marginal approach was helpful in the study of supply, but it was absolutely essential in the study of demand. Early neoclassical economists borrowed from some British philosophers the idea that demand depends on utility. Smith had considered that possibility but rejected it because of a problem he posed but could find no answer to: the paradox of diamonds and water." That paradox had to be resolved. The "marginal utility" approach provided the answer. (Ch. 5) But that was still not enough to clear away the cobwebs, because the philosophical basis of the idea of "utility" seemed unsatisfactory to many economists. A less "far-out" approach was proposed, based on preferences rather than utility. It is a more advanced concept, and we summarize it only very briefly in this book.
This "marginal approach" became the basis of the branch known as "microeconomics." In the study of supply, it was important to make the difference between the long and short run perspectives. After all, it seemed that "diminishing returns" were a short-run thing; in the long run "increasing returns to scale" might prove to be more important. But the long-run perspective also played a role in the study of competition within the industry. (1890's: Ch. 8, 9) This new study led to some remarkable insights about the relationship between price competition and efficient allocation of resources. (1880-1940: Ch. 10)
It also set the stage for new controversies within microeconomics. In many industries, it seemed that there was not a great deal of price competition. Some were, or at least approximated, monopolies, (1890's: Ch. 11) while even in industries that were not monopolized price competition often seemed highly imperfect. (1920-1960: Ch. 12) These were the key controversies in microeconomics in the 1920s, 1930's and 1940's. Other kinds of issues preoccupied a later generation of microeconomists. Supply and demand could only work as long as all the resources used were paid for. What if they were not paid for because they were community property, or for some similar reason? In such a case, many microeconomists reasoned, markets might not lead to efficiency and there might be a role for government in promoting efficiency. (1960-present: Ch. 13)
Whereas microeconomics got started on the basis of an intellectual breakthrough, world events set the stage for macroeconomics to emerge in the 1930's. The world event called the Great Depression needed to be explained, and policies to deal with it needed to be found and understood. This need was answered by Keynesian economics. (Ch. 20, 21, 22, 23) But Keynesian economics never fit well with microeconomics, and remained controversial. Some macroeconomic problems seemed to have more to do with supply than demand, but Keynesian economics had never focused much on supply. New theories of aggregate supply and the price level were proposed. (Roughly 1960-80; Ch 24-25). Monetarist and New Classical economists criticized the whole Keynesian conception, (1970-present) arguing that fiscal policy, or indeed any government attempt to limit unemployment, would be doomed to failure (Ch. 26) and questioning the very concept of unemployment that Keynesian economists had brought forward from Malthus. (Ch. 27) But these initiatives were criticized in turn, and the discussion is ongoing.