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Schools of economic thought

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 David Ricardo.

The main idea of the Classical school was that markets work best when they are left alone, and that there is

nothing but the smallest role for government. The approach is firmly one of laissez-faire and a strong belief in

the efficiency of free markets to generateeconomic development.Markets should be left to work because

theprice mechanismacts as a powerful 'invisible hand' to allocate resources to where they are best employed.

In terms of explaining value, the focus of classical thinking was that it was determined mainly by scarcity and

costs of production.

In terms of the macro-economy, the Classical economists assumed that the economy would alwaysreturn to

full-employmentlevel of real output through an automatical self-adjustment mechanism.

It is widely recognised that the Classical period lasted until 1870.

Neo-classical

The neo-classical school of economic thought is a wide ranging school of ideas from which modern economic

theory evolved. The method is clearlyscientific,with assumptions, and hypothesis and attempts to derived

general rules or principles about the behaviour of firms and consumers.

For example, neo-classical economics assumes that economic agents are rational in their behaviour, and that

consumers look to maximiseutilityand firms look to maximiseprofits.The contrasting objectives of

maximising utility and profits forms the basis of demand and supply theory. Another important contribution of

neo-classical economics was a focus on marginal values, such as marginal cost and marginal utility.

Neo-classical economics is associated with the work ofWilliam Jevons,CarlMengerand LeonWalras.

New classical

New classical macro-economics dates from the 1970s, and is an attempt to explain macro-economic problems

and issues using micro-economic concepts like rational behaviour, and rational expectations. New classicaleconomics is associated with the work of Chicago economist,Robert Lucas.

Keynesian economics

Keynesian economists broadly follow the main macro-economic ideas of British economistJohn Maynard

Keynes.Keynes is widely regarded as the most important economist of the 20th Century, despite falling out of

favour during the 1970s and 1980s following the rise of new classical economics.

In essence, Keynesian economists are sceptical that, if left alone, free markets will inevitably move towards

afull employmentequilibrium.

They Keynesian approach is interventionist, coming from a belief that the self interest which governs micro-

economic behaviour does not always lead to long run macro-economic development or short run macro-

economic stability. Keynesian economics is essentially a theory of aggregate demand, and how best best to

manipulate it through macro-economic policy.

classical economics

A school of economic thought, exemplified by Adam Smith's writings in the 18th century, that states

that a change in supply will eventually be matched by a change in demand - so that the economy is

always moving towards equilibrium.

Overtaken first by neo-classical economics in the early 20th century, it was then overtaken by

Keynesian thought in the 1920s and 1930s. The re-emergence in the late 20th century of policies

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aimed at minimising government intervention in the economy, including efforts towards free trade,

was backed to some extent by principles related to classical economics. [1]

The term classical economics was first used by Karl Marx (18181883) to describe early economists

like Adam Smith (17231790), David Ricardo (17721823), John Stuart Mill (18061873) and

Thomas Robert Malthus (17661834). Most important is Smiths work An Inquiry into the Nature

and Causes of the Wealth of Nations (1776) because it marks the starting point of economics as a

science.

Still today, Smiths concept of the invisible hand shapes our understanding of the market economy.

It is interpreted as the work of the price mechanism bringing together supply and demand in a

market. The result is that the market economy simultaneously maximises the benefits for consumers

and firms.

Furthermore, his promotion of the laissez-faire concept where economic performance is

optimised when there is limited government interferenceopened the door for free trade and aproper role for governments. In terms of trade, the concept means no protectionism. In terms of the

role of the government, the laissez-faire approach advocates setting up and enforcing a legal

system that protects free markets and competition.

Example

David Ricardos concept of comparative advantage between countries in international trade, for

example, is one theory from classical economics that is still applied today. It states that a country

should produce for export goods and services whose production costs are lower than that of other

goods.

Ricardo makes his famous example of England and Portugal both producing wine and cloth, but at

lower costs in Portugal than in England. Consequently, Portugal has an absolute advantage in trade.

However, it makes sense for both countries to trade.

England should focus on the production of cloth and Portugal on wine, because these are the

products where both countries have a comparative advantage. That is, Portugals production cost for

wine is lower than for cloth and in England it is the other way around. For example, with the wine

produced, Portugal can buy more cloth through trade than if it used its resources to produce the

cloth. The same is true for England . It will get more wine in exchange for cloth, compared to a

situation in which it produces its own wine

Keynesian economics

Relating to the ideas of John Maynard Keynes, who believed that, in a recession, the economy can

be made to grow and unemployment reduced by increasing government spending and making

reductions in interest rates. [1]

Theory based on the ideas of economist John Maynard Keynes that optimum economic performance

could be achieved by influencing aggregate demand through government fiscal (public spending and

taxation) policy, not through the free market philosophy characterised by the classical and neo-

classical schools.

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neo-classical economics

School of economic thought that gained prominence at Cambridge University in the late 19th

Century. It gave analytical depth to the ideas of the classical economists, developing the theories of

equilibrium, elasticity and monopoly. Supplanted by Keynesian economics after the Second World

War but came back into fashion with the monetarism of the late 20th Century.