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Main article: Classical economics The publication of Adam Smith's The Wealth of Nations in 1776 is considered to be the first formalisation of economic thought.The publication of Adam Smith's The Wealth of Nations in 1776, has been described as "the effective birth of economics as a separate discipline."[113] The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth, as distinct from the Physiocratic idea that only agriculture was productive. Smith discusses potential benefits of specialization by division of labour, including increased labour productivity and gains from trade, whether between town and country or across countries.[114] His "theorem" that "the division of labor is limited by the extent of the market" has been described as the "core of a theory of the functions of firm and industry" and a "fundamental principle of economic organization."[115] To Smith has also been ascribed "the most important substantive proposition in all of economics" and foundation of resource-allocation theory – that, under competition, resource owners (of labour, land, and capital) seek their most profitable uses, resulting in an equal rate of return for all uses in equilibrium (adjusted for apparent differences arising from such factors as training and unemployment).[116] In an argument that includes "one of the most famous passages in all economics,"[117] Smith represents every individual as trying to employ any capital they might command for their own advantage, not that of the society,[118] and for the sake of profit, which is necessary at some level for employing capital in domestic industry, and positively related to the value of produce.[119] In this: He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.[120] Economists have linked Smith's invisible-hand concept to his concern for the common man and woman through economic growth and development,[121] enabling higher levels of consumption, which Smith describes as "the sole end and purpose of all production."[122][123] He embeds the "invisible hand" in a framework that includes limiting restrictions on competition and foreign trade by government and industry in the same chapter[124] and elsewhere regulation of banking and the interest rate,[125] provision of a "natural system of liberty" — national defence, an egalitarian justice and legal system, and certain institutions and public works with general benefits to the whole society that might otherwise be unprofitable to produce, such as education[126] and roads, canals, and the like.[127][128] An influential introductory textbook includes parallel discussion and this assessment: "Above all, it is Adam Smith's vision of a self-regulating invisible hand that is his enduring contribution to modern economics."[129] The Rev. Thomas Robert Malthus (1798) used the idea of diminishing returns to explain low living standards. Human population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labour. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.[130] Economist Julian Lincoln Simon has criticised Malthus's conclusions.[131] While Adam Smith emphasized the production of income, David Ricardo (1817) focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent conflict between landowners on the one hand and labour and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits. Ricardo was the first to state and prove the principle of comparative advantage, according to which each country should specialize in producing and exporting goods in that it has a lower relative cost of production, rather relying only on its own production.[132] It has been termed a "fundamental analytical explanation" for gains from trade.[133] Coming at the end of the Classical tradition, John Stuart Mill (1848) parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market's two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene.[134] Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity.[135] Other classical economists presented variations on Smith, termed the 'labour theory of value'. Classical economics focused on the tendency of markets to move to long-run equilibrium. MarxismMain article: Marxian economics The Marxist school of economic thought comes from the work of German economist Karl Marx.Marxist (later, Marxian) economics descends from classical economics. It derives from the work of Karl Marx. The first volume of Marx's major work, Das Kapital, was published in German in 1867. In it, Marx focused on the labour theory of value and the theory of surplus value which, he believed, explained the exploitation of labour by capital.[136] The labour theory of value held that the value of an exchanged commodity was determined by the labour that went into its production and the theory of surplus value demonstrated how the workers only got paid a proportion of the value their work had created.[137] The U.S. Export-Import Bank defines a Marxist-Lenninist state as having a centrally planned economy.[137] They are now rare, examples can still be seen in Cuba, North Korea and Laos.[138][needs update] Neoclassical economicsMain article: Neoclassical economics A body of theory later termed "neoclassical economics" or "marginalism" formed from about 1870 to 1910. The term "economics" was popularized by such neoclassical economists as Alfred Marshall as a concise synonym for 'economic science' and a substitute for the earlier "political economy".[8] This corresponded to the influence on the subject of mathematical methods used in the natural sciences.[139] Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with the labour theory of value inherited from classical economics in favor of a marginal utility theory of value on the demand side and a more general theory of costs on the supply side.[140] In the 20th century, neoclassical theorists moved away from an earlier notion suggesting that total utility for a society could be measured in favor of ordinal utility, which hypothesizes merely behavior-based relations across persons.[43][141] In microeconomics, neoclassical economics represents incentives and costs as playing a pervasive role in shaping decision making. An immediate example of this is the consumer theory of individual demand, which isolates how prices (as costs) and income affect quantity demanded.[43] In macroeconomics it is reflected in an early and lasting neoclassical synthesis with Keynesian macroeconomics.[72][142] Neoclassical economics is occasionally referred as orthodox economics whether by its critics or sympathizers. Modern mainstream economics builds on neoclassical economics but with many refinements that either supplement or generalize earlier analysis, such as econometrics, game theory, analysis of market failure and imperfect competition, and the neoclassical model of economic growth for analyzing long-run variables affecting national income. Keynesian economicsMain articles: Keynesian economics and Post-Keynesian economics John Maynard Keynes (right), was a key theorist in economics.Keynesian economics derives from John Maynard Keynes, in particular his book The General Theory of Employment, Interest and Money (1936), which ushered in contemporary macroeconomics as a distinct field.[143] The book focused on determinants of national income in the short run when prices are relatively inflexible. Keynes attempted to explain in broad theoretical detail why high labour-market unemployment might not be self-correcting due to low "effective demand" and why even price flexibility and monetary policy might be unavailing. The term "revolutionary" has been applied to the book in its impact on economic analysis.[144] Keynesian economics has two successors. Post-Keynesian economics also concentrates on macroeconomic rigidities and adjustment processes. Research on micro foundations for their models is represented as based on real-life practices rather than simple optimizing models. It is generally associated with the University of Cambridge and the work of Joan Robinson.[145] New-Keynesian economics is also associated with developments in the Keynesian fashion. Within this group researchers tend to share with other economists the emphasis on models employing micro foundations and optimizing behavior but with a narrower focus on standard Keynesian themes such as price and wage rigidity. These are usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style ones. Chicago school of economicsMain article: Chicago school (economics) The Chicago School of economics is best known for its free market advocacy and monetarist ideas. According to Milton Friedman and monetarists, market economies are inherently stable if the money supply does not greatly expand or contract. Ben Bernanke, current Chairman of the Federal Reserve, is among the economists today generally accepting Friedman's analysis of the causes of the Great Depression.[146] Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the classical economists and modernized them. One example of this is his article in the September 1970 issue of The New York Times Magazine, where he claims that the social responsibility of business should be "to use its resources and engage in activities designed to increase its profits ... (through) open and free competition without deception or fraud."[147] Other schools and approachesMain article: Schools of economics Other well-known schools or trends of thought referring to a particular style of economics practiced at and disseminated from well-defined groups of academicians that have become known worldwide, include the Austrian School, the Freiburg School, the School of Lausanne, post-Keynesian economics and the Stockholm school. Contemporary mainstream economics is sometimes separated into the Saltwater approach of those universities along the Eastern and Western coasts of the US, and the Freshwater, or Chicago-school approach. Within macroeconomics there is, in general order of their appearance in the literature; classical economics, Keynesian economics, the neoclassical synthesis, post-Keynesian economics, monetarism, new classical economics, and supply-side economics. Alternative developments include ecological economics, constitutional economics, institutional economics, evolutionary economics, dependency theory, structuralist economics, world systems theory, econophysics, feminist economics and biophysical economics.[148] |
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