Download Major Schools of Economic Theory

Major Schools of Economic
Theory
Adam Smith, father
Of modern economics
Introduction
The word “economics” is derived from the Greek
word oikonmikos which means skilled in
household management.
Although the word is very hold the discipline of
economics is a relatively recent development.
Modern economic thought emerged in the 17th and
18th centuries as the western world transformed
from an agrarian to an industrial society.
Despite the enormous differences between
then and now, the economic problems with
which society struggles remain the same:
• How do we decide what to produce with our limited
resources?
• How do we ensure stable prices and full employment of our
resources?
• How do we provide a rising standard of living both for
ourselves and for future generations?
Mercantilists and Mercantilism
Thomas Paine
•Mercantilism was the economic
philosophy that held a nation’s wealth
came primarily from the accumulation
of gold and silver. Nations without
mines could obtain gold and silver only
by selling more goods than they bought
from abroad.
Physiocrats
•Physiocrats, was a group of 18th century
philosophers, developed the idea of the
the economy as a circular flow of income
and output. They also advocated laissezfaire economics. They opposed the
Mercantilist idea of promoting trade at the
expense of agriculture.
Francois Quesnay
Classical School of Economics
The Wealth of
Nations
by Adam Smith
•In the Wealth of Nations, Adam Smith identified the
three factors of production: land, labor, and
capital.
•Smith believed the “ideal economy was a selfregulating one. That is to say, that it automatically
satisfies the needs of the populace. He called as the
“invisible hand.”
•Smith also supported the idea of laissez-faire
capitalism.
•David Ricardo focused on the
“distribution of wealth” among landowners
on one side and capital on the other. He
believed when population growth and capital
“pressed down” on a fixed supply of land,
that this would push rents up and wages and
profits down.
•Thomas Malthus used the idea of
“diminishing returns” to explain low living
standards. He believed that a rapidly
growing population against a limited amount
of land meant diminishing returns to
labor. He believed this would lead to
chronically low wages, which would limit the
standard of living.
• He also questioned idea of a market
economy that would be able to produce
full employment.
•John Stuart Mill parted company from the other Classical
economists in the area of distribution of income.
•Mill believed that society may be efficient in allocating
resources but not in distributing income. He maintained
that society must get involved.
Marginalist School
• Marginalist economists emphasized that prices also depend
on the level of demand, which in turn depends upon the
amount of consumer satisfaction provided by individual
goods and services.
•They provided modern macroeconomics with basic analytical
tools of demand and supply and consumer utility.
•Finally they pushed the idea that land, labor, and capital
receive returns equal to their contributions to production.
Sometimes this was used to justify existing distribution of
income.
Marxist School
•The Marxist School challenged Classical
theory. Karl Marx saw capitalism as an
“evolutionary” phase in economic
development. He believed capitalism
would eventually destroy itself.
•Marx believed in the labor theory of value which states that
all production belongs to labor because workers produce all
value in society. He also believed that the market system
allows capitalists, (the owners of machinery and factories) to
exploit workers by denying them a fair share of what they
produce.
•He believed workers would eventually rise up and overthrow
this type of capitalism.
Institutionalist School
•Institutionalists believed in government
controls and social reform to bring about
a more equal distribution of income.
•Reacting to the worldwide depression,
John Maynard Keynes broke from the
Classical tradition and wrote
General Theory of Employment,
Interest, and Money.
•In the Classical view, most economists
believed that in a recession, wages and
prices would decline to restore full
employment. Keynes believed that the
direct government intervention was
necessary to increase total spending.
•These theories are the modern
Rationale for the use of government
Spending and taxing to stabilize the
economy (fiscal policy).
Summary
•Monetarism updates the Quantity Theory, the macroeconomic
analysis before Keynes. It reemphasizes the role of monetary
growth.
• Rational Expectations Theory provides a contemporary rationale
for the pre-Keynesian tradition of limited government in the
economy.
•Supply-side Economics recalls the Classical School’s concern
with economic growth as a fundamental prerequisite for improving
society’s material well-being. It emphasizes the need for
incentives to save and invest if the nation’s economy is to grow.