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HistoryofEconomicThought
Throughouthistory,wehavehadmanyexplana>onsofhowtheeconomy
works.Whypeoplebuythings,howthingsarevalued,whogenerates
wealthintheeconomy,howthiswealthshouldbedistributedandwhat
thegovernmentshoulddotoimprovethestandardoflivingforeveryone.
In1848,KarlMarxandFriedrichEngelspublished“TheCommunist
Manefesto”whichincorrectlyarguedthatthevalueofsomethingwas
whatwasputintoit;andthatlabourcontrolledthemeansofproduc>on.
Weknowthatitistheintersec>onofdemandandsupplythat
determinesthevalue(orprice)ofsomethingandthatiswhy
entrepreneurscanmakealoss.Alsoweknowthatenterpriseisthefactor
ofproduc>onthatcombinestheotherthreetoproducegoodsand
services.Itisforthisreasonthatwesaythatenterprisecontrolsthe
meansofproduc>on.ThetheoryofCommunismhassincebeen
disproved,evens>lltherearecountries,likeVenezuela,thattrytoadopt
thisfailedideology.
BeforeWorldWarII,Keynesianeconomicsbecameverypopular,tothe
pointwherealaterAmericanPresident,RichardNixon,said“Weareall
Keynesiansnow.”Keynesarguedforhugegovernmentexpenditure
during>mesofrecessioninordertos>mulatetheprivatesectorinto
growth.Almosteverygovernmentaroundtheworldinthe70’sadopted
thisstrategy.
Aswemovedintothe80’s,theideathatAdamSmithtalkedabout“The
InvisibleHandoftheFreeMarket”cameverymuchintofashion.This
calledforasliZlegovernmentaspossibleandjustallowtheprivate
interac>onsofconsumersandsellerstooccur;anditbelievedthatthis
wouldincreasethestandardoflivingofthepopulacemorethan
Keynesian,interven>onalistpolicies.TheAmericanPresident,Ronald
Reagan,triedtoreducedthelevelofgovernmentinvolvementinthe
economy(howeverheincreasedgovernmentexpenditurebutremoved
manyregula>onswhicharetherulesthatgoverncertainsectorsofthe
economylikethebankingsector).ThisledtogreatprosperityinAmerica
inthe80’sandwasseenasthewayforward.
The2000’sinAmericawasadifferentstorywitheconomicstagna>onand
hugeunemployment,andeconomistslikeJosephS>glitz,proposedthat
theeconomicrecessionoflate2001wastheresultofthelackof
regula>oninthe80’sand90’sandgeneraleconomica`tudestartedto
moveawayfromFreeMarketprinciples.
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TheprinciplesofFreeMarketCapitalismhavebeenblamedfortherecent
financialcrisisastheyhadcomebackintofashioninthelate1990’sand
early2000’sinthiscountry.
Wewillnowtakealookatthedevelopmentofeconomicthought
throughouthistoryandthemainpeoplethatwereassociatedwiththem.
TheMercan5lists(1500-1780)
1) TheMercan>listsbelievedthatwealthconsistedofpreciousmetals
likegoldandsilver.
2) Theybelievedthatcountriesshouldtrytoachieveafavourable
balanceoftrade(exportmoregoodsthantheyimported)by
increasingexportsandloweringimports.
3) TheythoughtthatEuropeancountriesshouldacquirecoloniesand
stealnaturalresources(goldandsilver)fromthesecolonies,exportit
andachieveamorefavourablebalanceoftrade.
4) Theythoughtthatcountriesshouldtrytobecomeselfsufficient(not
relyontheimportsofothercountries).Theythoughtthatcountries
shouldachievethisbypursuingprotec>onistpolicies.
5) Theyfeltthatthegovernmentshouldintervenetotrytoachievea
favourablebalanceoftrade.
Physiocrats(1750-1800)
1) Theyfeltthatagriculturewasthemainsourceofacountry’sincome
(wealth).
2) Theyfeltthatstateinterferencemadetheeconomyworseoffandas
suchwantedtokeepstateinterferencetoaminimum.Theypromoted
laissez-fairepolicies.
3) Theyfeltthatindividualpropertyrightswasexcep>onallyimportant
toachieveeconomicgrowth.
ClassicalSchool(1780-1800)
1) TheClassicalschoolisthebirthofrealmoderndayeconomics,which
s>lllaststodayandisbeingmoreandmorepromotedrecently.
2) Theybelievedthatlaissez-faireeconomicpolicieswerethekeyto
economicgrowthandassuchwantedgovernmentinvolvementkept
toaminimum.
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3) TheycontributedtotheideaofwhatisknownastheLabourTheoryof
value.Theincorrectassump>onthatthevalueofacommidityisthe
valueofthelabour(hourlywageX>metakentoproducethegood)
thatwasputintoit.
4) TheybelievedthatinterestratesseZledwhensavingsequals
investment.Thisiss>lltrueintheLongRunbutJohnMaynardKeynes
provedituntrueintheShortRun.
5) Theybelievedthatfreetrade(Notraderestric>onsliketariffs,quotas
orembargoes)ensuredahigherlevelofNa>onalIncome.
6) Thebelievedinthefreemarket.Theideathatthegovernmentshould
notinterfereineconomicpolicies.Letthepricemechanismbringthe
marketintoequilibrium.
Marxists
1) Theybelievedthattherewasastrugglebetweenclassesonewhich
theworkerswouldeventuallywin.
2) Theybelievedthatlabourwasthemeansofproduc>on,that
producedandexcessvaluewhichwastakenbythecapitalists(the
ownersofcapitalwhoweretheownersofthecompany).Thisexcess
valuewaswhatcapitalistscalledprofits.
3) Theybelievedthatsocialismandlatercommunismwouldeventually
replacecapitalismaroundtheworld.
Neo-ClassicalSchool
1) Thecontributedtothe“U>lityTheoryofValue”.Thevalueof
somethingintheshortrunisdeterminedbyitu>lityintheshortrun
anditscostsofproduc>oninthelongrun.
2) Theythoughtthatgovernmentcouldtakeposi>veeconomicac>onby
preven>ngthegrowthofmonopolies.Remember,monopoliesarea
formofmarketfailure.
3) Theyintroducedtheideaofelas>city.
4) TheypromotedtheMRPofWagestheory
5) Theirmaininterestwasonthehouseholdandthefirmandassuch
thestudyofmicroeconomicsbegan
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KeynesianSchool
1) Hesuggestedthatna>onalincomecouldbeinequilibrium(Aggregate
DemandequalsAggregateSupply)withoutfullemployment
2) HeopposedtheClassicalSchoolideathatinarecession,wageswould
fall,thedemandforlabourwouldthenriseandarecoverywould
follow.Keynessaidthatifwagesfell,consump>onwouldfall(asreal
incomefell)whichwouldleadtoaworserecession.
3) Keynesfavouredgovernmentinterven>onintheformoffiscal
s>mulus(loweringtaxesandincreasegovernmentspending)inorder
totrytos>mulatedemand.Thisbecameknownas“spendingyour
wayoutofarecession”.
4) HewastheonethatintroducedtheideaoftheMul>plier.
5) HeopposedtheClassicalSchooltheoryofinterestratedetermina>on
intheshortrun(LoanableFundsTheory)andcameupwithhisown
theoryofinterestratedetermina>onintheShortRun.Liquidity
PreferenceTheory.Thisstatesthatinterestratesintheshortrunare
determinedbythedesireofpeopletoholdtheirwealthincashform.
6) Keynesproposedthatthelevelofinvestmentwasinfluencedmoreby
theexpecta>onsofbusinesspeoplethantherateofinterest.
Monetarists
1) MonetaryPolicy:shouldbethemaininstrumentusedbythe
governmenttomanagetheeconomyandnotfiscalpolicy.Increased
governmentexpenditurewouldonlyleadtohigherpricesandnot
increasedoutputandemploymentasadvocatedbyKeynes.
2) ControlofMoneySupply:Monetaristssuggeststrictcontrolofthe
moneysupplysoastocontrolinfla>on.Limi>ngcreditavailability,
keepinginterestrateshighwouldcontrolconsumerborrowing.
3) Infla5on:Reduc>onininfla>onincreasescompe>>venesswhichmay
leadtorela>velycheaperexports,increasedexportsandjobcrea>on
inthelongrun.Companiesshouldkeepwageincreasestoaminimum
inordertoavoidcost-pushinfla>on.
4) LaissezFairePrinciples:Monetaristsfavourareturntolaissezfaire
principles:minimumstateinterven>on;de-regula>onofmarkets;
priva>sa>onofstatebodies.
5) SupplySidePolicies:Monetaristsfavouredanypolicieswhichimprove
marketefficiency/boostsupply/reducetheabilityoftradeunionsto
interferewiththelabourmarket.
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SupplySiders
1) TheyagreedwithSay’sLaw(wewilllookatthislater),whichsaidthat
supplycreatesitsowndemand.Therefore,theyadvocatedan
expansionofsupplyandnotofdemandasasolu>ontoeconomic
problems.Remember,itisthequan>tyandquality(orvalue)ofwhat
isproducedinaneconomythatdefinesthewealthofana>on.
2) Theyadvocatedlowtaxesastheywouldencourageproduc>on(orat
leastremoveadisincen>vetoproducegoodsandservices)which
wouldcreateemployment.
3) Theypromotedthederegula>onofmarkets(theremovaloflegal
restric>onsonhowcompaniesareallowedtoact)andthe
priva>sa>onofstatecompanies.
Economist
MainIdeas
ThomusMun
EncouragedTradeSurplusandSelf
Sufficiency
JamesStuart
GovernmentInterven>on
Agricultureisthesourceofwealth
FrançoisQuesnay
JacquesTurgot
TableauÉconomique-Similartothe
CircularFlowofIncome
LawofDiminishingMarginalReturnsas
appliedtoagriculture
AgainstGovernmentInterference
DivisionofLabour(Specialisa>on)
AdamSmith
LabourTheoryofValue
AgainstGovernmentInterference
CanonsofTaxa>on
ThomasRobertMalthus
Popula>ongrowsfasterthanfoodsupply
IronLawofWages
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Economist
DavidRicardo
JohnBap>steSay
JohnStuartMill
MainIdeas
LawofCompara>veAdvantage
(Interna>onalTrade)
TheoryofRent(Rewardtotheownersof
land)
Produc>oncreateditsowndemandand
thereforeeconomiccrisescouldnotexist
Iden>fiedEnterpriseasthe4thFactorof
Produc>on
WagesFundTheory
AdvocatedFreeTrade
MRP
U>lityTheoryofValue
AlfredMarshall
QuasiRent
Elas>city,ConsumerSurplus,Longand
ShortRun
JohnBatesClark
MRPTheoryofWages
TheAcceleratorPrinciple
Favouredgovernmentinterven>onin
economicaffairsbywayoffiscalpolicy
JohnMaynardKeynes
LiquidityPreferenceTheory
Na>onalIncomecouldbeatequilibriumat
lessthenfullemployment
Mul>plier
AdvocatedtheuseofMonetaryPolicy
MiltonFriedman
ControlofMoneySupply
Priceswillstabiliseleadingtoan
environmentofeconomicgrowth.
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DavidRicardo
1) LawofCompara5veCosts:Ricardosupportedtheideaoffreetrade
anddevelopedthelawofcompara>vecostswhichstatesthata
countryshouldspecialiseintheproduc>onofthosecommodi>esin
whichitisrela>velymostefficientandtradefortheremainderofits
requirements.
2) TheoryofEconomicRent:Ifpopula>onincreaseditwasnecessaryto
useinferior/moreremoteland.Foruseofthislandrentwaspaid.As
aresultthepriceoffoodrose.Costofproducingonthebestlandwas
lowerthereforefoodproducedonthislandearnedasurplusoverthat
producedoninferiorland.Thissurplusledtoanincreaseinrent
payablefortheuseofgoodland.
3) AcceptedtheSubsistenceWagesTheory:Hebelievedthatany
increaseinwagesabovethesubsistencelevelwouldcauseanincrease
inpopula>onwhichwouldinturncausewagelevelstofall.
AdamSmith
1) ThePursuitofSelfInterest:Thisbestbenefitedtheindividualand
hencebestbenefitedsociety.
2) DivisionofLabour:Increasedproduc>vityandacountry’swealth.His
example-themanufactureofpinsillustratedthebenefitsofthe
divisionoflabour.
3) LabourTheoryofValue:Thevalueofanitemwasequaltothe
amountoflabourthatwentintoproducingtheproduct.
4) StateProtec5onofPropertyRights:Encouragestheaccumula>onof
personalwealth.
5) InvisibleHandofCompe55on:Allowsaselfregula>ngmarketto
operatethusensuringeconomicprogressisachieved.
6) PerfectCompe55on:Freeentryintomarkets;profitssufficientto
rewardentrepreneurs;inefficiencypenalisedandpricewouldbe
basedonthecostofproduc>on.Monopolieswouldnotpersist.
7) Laissez-Faire:Nojus>fica>onforgovernmentinterven>oninthe
economyexceptfordefence/jus>ce.
8) CanonsofTaxa5on:Tofundthestate’sdefence/jus>cesystems
taxa>onwasnecessaryandhedevisedthefourprinciplesofafairtax
system:equity,economy,certaintyandconvenience.
9) ParadoxofValue:Hedis>nguishedbetween‘valueinuse’and‘value
inexchange’.Someitemshadavastu>lity(air,water)butarenot
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exchanged,whileothers(diamonds)possessedliZleu>litybutcould
commandagreatvalueinexchange.
10)FreeTrade:Headvocatedinterna>onalfreetradeunhinderedbythe
imposi>onoftariffssothatmarketscouldoperateeffec>velyand
allowthegainsfromtradetobespreadbetweenna>ons.
AlfredMarshall
1) TheoryofValue:Thevalueofacommoditywasdeterminedinthe
short-runbyitsu>lityanddemandandinthelong-runwas
determinedbyitscostofproduc>on.
2) Distribu5onofWealth:Thereturntoeachofthefactorsof
produc>onwasdeterminedbytheirmarginalproduc>vity.
3) Compe55onRegulatedEconomicAc5vity:Governmentinterven>on
andinter-businessco-opera>oncouldregulateeconomicac>vityand
enhanceeconomicfreedom.
4) GrowthofMonopoliescouldbePrevented:Regula>onby
government;consumerinforma>on;increasednumberofsmall
investors/moreaccountability.
5) QuasiRent:Theeconomicrentearnedbyfactorsofproduc>oninthe
shortrunwhendemandexceededsupply.
6) Developedconceptsofprice-elas5cityofdemand/consumer
surplus/howmarketsadjustedtochangesinD&Sover5me:
quan>fyingbuyers’sensi>vitytoprice;thesurplusvalueoru>litya
consumerenjoys;Marketperiod,shortperiodandlongperiod.
JohnMaynardKeynes
1) Na5onalIncomeatLessthanFullEmployment:Keynesobservedthat
na>onalincomecouldreachequilibriumwithoutreachingfull
employmentandhencehesuggestedgovernmentinterven>onto
helpcreatejobswhenrequired.
2) OutputisDemandDetermined:Thesizeofna>onalincomedepends
onexpenditurei.e.C=I+G+X−M
3) FavouredGovernmentInterven5onintheEconomy:Thejobofthe
governmentistomanagetheeconomy.Thegovernmentcanusefiscal
policytocreatefullemployment.
4) InvestmentDecisionsbyEntrepreneurs:Hestatedthatinvestmentby
entrepreneursdependedmoreonbusinessmen’sexpecta>onsthan
ontherateofinterest.
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5) InvestmentcouldbelessthanSavings:Thiscouldresultinaleakage
inspendingwhichdecreasesna>onalincomeandemployment.
6) NewEconomicConcepts–TheMul5plier:Hedevelopednewtoolsto
explainhistheoriesincludingthemul>plier:Anyini>alincreasein
spendingwillcauseagreatermuchgreaterincreaseinGNPduetothe
factthatoneperson’sexpenditureisanotherperson’sincome.He
developedconceptssuchas:-MPC,MPM,etc.
7) LiquidityPreferenceTheory:Peoplemayprefertoholdtheirwealth
inmoneyformforthreereasons:transac>onary;precau>onaryand
specula>vereasons.
8) ManagedsystemofExchangeRates:Hefavouredasystemofforeign
exchangerateswhichcouldbe‘managed’bythestateratherthanthe
goldstandard.
MiltonFriedman
1) MonetaryPolicy:Shouldbethemaininstrumentusedbythe
governmenttomanagetheeconomy.
2) ControlofMoneySupply:Monetaristssuggeststrictcontrolofthe
moneysupplysoastocontrolinfla>on.
3) ReduceInfla5on:Thisincreasescompe>>venesswhichmayleadto
increasedexportsandjobcrea>oninthelogrun..
4) LaissezFairePrinciples:Hefavouredareturntolaissezfaireprinciples
-withminimumstateinterven>on;de-regula>onofmarkets;
priva>sa>onofstatebodies.
5) SupplySidePolicies:Hefavouredanypolicieswhichimprovedmarket
efficiency/boostedsupply:de-regula>onofmarkets;reducingthe
abilityoftradeunionstointerferewiththelabourmarket.
KarlMarx
1) Marxarguedthatworkerswerepaidsubsistence/minimumwages
bytheiremployers.
2) Thevalueofthegoodsproducedbyaworkerwasmorethanthe
wagespaidtotheworker.(Thedifferencebetweenthetwohecalled
the‘surplusvalue’orprofittotheemployer).Thisillustratedthat
workerswereexploitedandin>mewouldbereplacedbycapital
resul>ngintheirunemployment.
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ThomasRobertMalthus
1) Malthusstatedthatpopula>onincreasesinageometricprogression
(i.e.2,4,8,16etc)whilefoodsupplyincreasesinanarithme>c
progression(i.e.2,3,4,5etc).
2) Popula>onwouldoutgrowthemeansofsubsistence.Theoutcome
wouldbefamine,diseaseetc.
No
Histheoryisnotrelevanttoday
POPULATION
1) Extensivepopula>oncontrolmeasuresareinplaceworldwidewhich
arehelpingcontrolpopula>ongrowth.
2) Somecountriesimposestrictpopula>oncontrolse.g.China’s‘One
ChildPolicy’.
FOODPRODUCTION
1) Becauseofthedevelopmentofhighyieldingcrops/Gene>c
modifica>onmeansthatfoodproduc>onisbeingincreased.
2) Theavailabilityofcheaperimportsfromdevelopedna>ons(EU;
NorthAmerica)ishelpingthedistribu>onoffoodworldwide.
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