Economics 'schools of thought' School Classical School
The Classical school, which is regarded as the first school of economic thought, is associated with the 18th Century Scottish economist Adam Smith, and those British economists that followed, such as Robert Malthus and Daid Ricardo! The main idea of the Classical school was that mar"ets wor" best when they are left alone, and that there is nothing but the smallest role role for goernment! The a##roach a##roach is firmly one of laisse$%faire laisse$%faire and a strong belief belief in the efficiency of free mar"ets to generate economic development! Mar"ets should be left to wor" because the price mechanism acts as a #owerful &inisible hand& to allocate resources to where they are best em#loyed! 'n terms of e(#laining of #roduction!
value,
the focus of classical thin"ing was that it was determined mainly by scarcity and costs
'n terms of the macro%economy, macro%economy, the Classical economists assumed that the economy would always return to the full-employmentleel of real out#ut through an automatic self%ad)ustment mechanism! 't is widely recognised that the Classical #eriod lasted until 18*+! Neo-classical
The neo-classical school of economic thought is a wide ranging school of ideas from which modern economic theory eoled! The method is clearly scientific, with assum#tions, and hy#othesis and attem#ts to derie general rules or #rinci#les about the the behaiour of firms and consumers! consumers! or e(am#le, neo-classical economics assumes that economic agents are rational in their behaiour, and that consumers loo" to ma(imise utility and firms loo" to ma(imise profits! The contrasting ob)ecties of ma(imising utility and #rofits forms the basis of demand and su##ly theory! Another Another im#ortant contribution of neoclassical economics was a focus on marginal alues, such as marginal cost and marginal utility! utility! Neo-classical economics is associated with the wor" of William Jevons, Carl Menger and -eon Walras! New
classical
.ew classical macro%economics dates from the 1/*+s, and is an attem#t to e(#lain macro%economic #roblems and issues using micro%economic conce#ts li"e rational behaiour, and rational e(#ectations! .ew classical economics is associated with the wor" of Chicago economist, Robert Lucas! Keynesian economics eynesian economists broadly follow the main macro%economic ideas of British economist John Maynard eynes! 0eynes is widely regarded as the most i m#ortant economist of the +th Century, Century, des#ite falling out of faour during the 1/*+s and 1/8+s following the rise of new classical economics!
'n essence, eynesian economists are s"e#tical that, if left alone, free mar"ets will ineitably moe towards a full employmente2uilibrium! KEY POINTS o
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Classical economics focuses on the tendency of mar"ets to moe towards e2uilibrium and on Classical economics ob)ectie theories of alue! As the original form of mainstream economics of the 18th and 1/th centuries, classical economics sered as the basis for many other schools of economic thought, including neoclassical economics!
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Mar(ism focuses on the labor theory of alue and what Mar( considered to be the e(#loitation of labor by ca#ital! 0eynesian economics deries from 3ohn Maynard 0eynes, in #articular his boo", The 4eneral Theory of 5m#loyment, 'nterest and Money 61/79, which ushered in contem#orary macroeconomics as a distinct field! The Chicago School of economics is best "nown for its free mar"et adocacy and monetarist ideas!
mainstream economics
Mainstream economics is a term used to refer to widely%acce#ted economics as it is taught across #rominent uniersities, and in contrast to heterodo( economics! •
School of thought
A school of thought is a collection or grou# of #eo#le who share common characteristics of o#inion or outloo" regarding a #hiloso#hy, disci#line, belief, social moement, cultural moement, or art moement! Throughout the history of economic theory, seeral methods for a##roaching the to#ic are noteworthy enough, and different enough from one another, to be distinguished as #articular &schools of economic thought! & :hile economists do not always fit into #articular schools, es#ecially in modern times, classifying economists into a #articular school of thought is common! Mainstream modern economics can be bro"en down into four schools of economic thought; Classical economics, also called classical #olitical economy, was the original form of mainstream economics in the 18th and 1/th centuries! Classical economics focuses on both the tendency of mar"ets to moe towards e2uilibrium and on ob)ectie theories of alue! .eo% classical economics deries from this school, but differs because it is utilitarian in its alue theory and because it uses marginal theory as the basis of its models and e2uations! Anders Chydenius 61*/<18+79 was the leading classical liberalof .ordic history! A innish #riest and member of #arliament, he #ublished a boo" called The .ational 4ain in 1*=, in which he #ro#osed ideas about the freedom of trade and industry, e(#lored the relationshi# between the economy and society, and laid out the #rinci#les of liberalism! All of this ha##ened eleen years before Adam Smith #ublished a similar and more com#rehensie boo", The :ealth of .ations! According to Chydenius, democracy, e2uality and a res#ect for human rights formed the only #ath towards #rogress and ha##iness for the whole of society! Mar(ian economics descends directly from the wor" of 0arl Mar( and riedrich 5ngels! This school focuses on the labor theory of alue and what Mar( considers to be the e(#loitation of labor by ca#ital! Thus, in this school of economic thought, the labor theory of alue is a method for measuring the degree to which labor is e(#loited in a ca#italist society, rather than sim#ly a method for calculating #rice!
0eynesian economics deries from 3ohn Maynard 0eynes, and in #articular his boo", The 4eneral Theory of 5m#loyment, 'nterest and Money 61/79, which ushered in contem#orary macroeconomics as a distinct field! The boo" analy$ed the determinants of national income, in the short run, during a #eriod of time when #rices are relatiely infle(ible! 0eynes attem#ted to e(#lain, in broad theoretical detail, why high labor%mar"et unem#loyment might not be self%correcting due to low >effectie demand,> and why neither #rice fle(ibility
nor monetary #olicy could be counted on to remedy the situation! Because of its im#act on economic analysis, this boo" is often called >reolutionary?!
A final school of economic thought, the Chicago School of economics, is best "nown for its free mar"et adocacy and monetarist ideas! According to Milton riedman and monetarists, mar"et economies are inherently stable so long as the money su##ly does not greatly e(#and or contract! Ben Bernan"e, current Chairman of the ederal Resere, is among the significant #ublic economists today that generally acce#ts riedman&s analysis of the causes of the 4reat De#ression!
Differences Between Classical @ 0eynesian 5conomics by smond ite$
5conomics is the 2uantitatie and 2ualitatie study on the allocation, distribution and #roduction of economic resources! 5conomics often studies the monetary #olicy of a goernment and other information using mathematical or statistical calculations! ualitatie analysis is made by ma"ing )udgments and inferences from fiscal information! Two economic schools of thought are classical and 0eynesian! 5ach school ta"es a different a##roach to the economic study of monetary #olicy, consumer behaior and goernment s#ending! A few basic distinctions se#arate these two schools!
Basic Theory Classical economic theory is rooted in the conce#t of a laisse$%faire economic mar"et! A laisse$%faire%%also "nown as free%%mar"et re2uires little to no goernment interention! 't also allows indiiduals to act according to their own self interest regarding economic decisions! This ensures economic resources are allocated according to the desires of indiiduals and businesses in the mar"et#lace! Classical economics uses the alue theory to determine #rices in the economic mar"et! An item@am#rs2uos alue is determined based on #roduction out#ut, technology and wages #aid to #roduce the item! 0eynesian economic theory relies on s#ending and aggregate demand to define the economic mar"et#lace! 0eynesian economists beliee the aggregate demand is often influenced by #ublic and #riate decisions! Eublic decisions re#resent goernment agencies and munici#alities! Eriate decisions include indiiduals and businesses in the economic mar"et#lace! 0eynesian economic theory relies heaily on the fact that a nation@am#rs2uos monetary #olicy can affect a com#any@am#rs2uos economy!
Government Spending 4oernment s#ending is not a ma)or force in a classical economic theory! Classical economists beliee that consumer s#ending and business inestment re#resents the more im#ortant #arts of a nation@am#rs2uos economic growth! Too much goernment s#ending ta"es away aluable economic resources needed by indiiduals and businesses! To classical economists, goernment s#ending and inolement can retard a nation@am#rs2uos economic growth by increasing the #ublic sector and decreasing the #riate sector! 0eynesian economics relies on goernment s#ending to )um#start a nation@am#rs2uos economic growth during sluggish economic downturns! Similar to classical economists, 0eynesians beliee the nation@am#rs2uos economy is made u# of consumer s#ending, business inestment and goernment s#ending! Foweer, 0eynesian theory dictates that goernment s#ending can i m#roe or ta"e the #lace of economic growth in the absence of consumer s#ending or business inestment!
Short Vs. Long-term Afects
Classical economics focuses on creating long%term solutions for economic #roblems! The effects of inflation, goernment regulation and ta(es can all #lay an im#ortant #art in deelo#ing classical economic theories! Classical economists also ta"e into account the effects of other current #olicies and how new economic theory will im#roe or distort the free mar"et enironment! 0eynesian economics often focuses on immediate results in economic theories! Eolicies focus on the short%term needs and how economic #olicies can ma"e instant corrections to a nation@am#rs2uos economy! This is why goernment s#ending is such a "ey cog of 0eynesian economics! During economic recessions and de#ressions, indiiduals and businesses do not usually hae the resources for creating immediate results through consumer s#ending or business inestment! The goernment is seen as the only force to end these downturns through monetary or fiscal #olicies #roiding instant economic results!
0eynesian s Classical models and #olicies
irstly, for AS economics, a "nowledge of 0eynesian and classical iews is not essential 6at least for the e(am boards ' "now9! Foweer, you should get credit if you use it for ealuation! 't is definitely good to "now for A leel economics! 'Gll start with easiest differences! !" #hape of long run aggregate supply"
The most basic distinction between the 0eynesian and classical iew of macroeconomics, can be illustrated loo"ing at the long run aggregate su##ly! The Classical iew is that -ong Run Aggregate Su##ly 6-RAS9 is inelastic! Classical vie$ of Long Run %ggregate #upply
This has im#ortant im#lications! The classical iew suggests that Real 4DE is determined by su##ly side factors < the leel of inestment, the leel of ca#ital and the #roductiity of labour e!t!c! Classical economists suggest that in the long%term an increase in aggregate demand 6faster than growth in -RAS9 will )ust cause inflation!
eynesian vie$ of Long Run %ggregate #upply
The 0eynesian iew of long run aggregate su##ly is different! They argue that the economy can be below full ca#acity in the long term! Therefore, a 0eynesian #lays greater em#hasis on the role of aggregate demand in causing and oercoming a recession! &" emand deficient (nemployment
Because of the different o#inions about the sha#e of the aggregate su##ly and the role of aggregate demand in influencing economic growth, there are different iews about the cause of unem#loyment •
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Classical economists argue that unem#loyment is caused by su##ly side factors < real wage unem#loyment, frictional unem#loyment and structural factors! They down#lay the role of demand deficient unem#loyment! 0eynesians #lace a greater em#hasis on demand deficient unem#loyment! or e(am#le the current situation in 5uro#e 6+1H9, a 0eynesian would say that this unem#loyment is #artly due to insufficient economic growth and low growth of aggregate demand 6AD9
)" *hillips Curve trade off
A classical iew would re)ect the long run trade off between unem#loyment, suggested by the Ehilli#s Cure!
Classical economists say that in the short term, you might be able to reduce unem#loyment below the natural rate by increasing AD! But, in the long%term, when wages ad)ust, unem#loyment will return to the natural rate, and there will be higher inflation! Therefore, there is no trade off in the long%run 0eynesians su##ort the idea that there can be a trade off between unem#loyment and inflation! See; Ehilli#s cure
+" ,leibility of prices and $ages
'n the classical model, there is an assum#tion that #rices and wages are fle(ible, and in the long%term mar"ets will be efficient and clear! or e(am#le, su##ose there was a fall in aggregate demand, in the classical model, this fall in demand for labour would cause a fall in wages! This decline in wages would ensure that full em#loyment was maintained and mar"ets IclearG!
A fall in demand for labour would cause wages to fall from :1 to : Foweer, 0eynesians argue that in the real world, wages are often infle(ible! 'n #articular, wages are Istic"y downwardsG! :or"ers resist nominal wage cuts! or e(am#le, if there was a fall in demand for labour, trade unions would re)ect nominal wage cuts, therefore, in the 0eynesian model it is easier for labour mar"ets to hae dise2uilibrium!:ages would stay at :1, and unem#loyment would result! A 0eynesian would argue in this situation, the best solution is to increase aggregate demand! 'n a recession, if the goernment did force lower wages, this might be counter%#roductie because lower wages would lead to lower s#ending and a further fall in aggregate demand! ." Rationality and confidence
Another difference behind the theories is different beliees about the rationality of #eo#le •
Classical economics assumes that #eo#le are rational and not sub)ect to large swings in confidence!
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0eynesian economics suggests that in difficult times, the confidence of businessmen and consumers can colla#se < causing a much larger fall in demand and inestment! This fall in confidence can cause a ra#id rise in saing and fall in inestment and it can last a long time < without some change in #olicy!
Difference in #olicy recommendations !" /overnment spending •
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The classical model is often termed Ilaisse$ faireG because there is little need for the goernment to interene in managing the economy! The 0eynesian model ma"es a case for greater leels of goernment interention, es#ecially in a recession when there is a need for goernment s#ending to offset the fall in #riate sector inestment! 60eynesian economics is a )ustification for the I.ew DealG #rogrammes of the 1/7+s!9
&" ,iscal *olicy •
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Classical economics #laces little em#hasis on the use of fiscal #olicy to manage aggregate demand! Classical theory is the basis for Monetarism, which only concentrates on managing money su##ly, through monetary #olicy! 0eynesian economics suggests goernments need to use fiscal #olicy, es#ecially in a recession! 6This is an argument to re)ect austerity #olicies of ++8%17 recession!
)" /overnment borro$ing" •
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A classical iew will stress the im#ortance of reducing goernment borrowing and balancing the budget, because there is no benefit from higher goernment s#ending! -ower ta(es will increase economic efficiency! 6e!g! at the start of the 1/7+s, the I Treasury iewI argued the J0 needed to balance its budget by cutting unem#loyment benefits! The 0eynesian iew suggests that goernment borrowing may be necessary because it hel#s to increase oerall aggregate demand!
+" #upply side policies •
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The classical iew suggests the most im#ortant thing is enabling the free mar"et to o#erate! This may inole reducing the #ower of trade unions to #reent wage infle(ibility! Classical economics is the #arent of Isu##ly side economicsI < which em#hasises the role of su##ly side #olicies in #romoting long term economic growth! 0eynesian donGt re)ect su##ly side #olicies! They )ust say they may not always be enough! e!g! in a dee# recession, su##ly side #olicies canGt deal with the fundamental #roblem of a lac" of demand!
