CLASSICAL ECONOMICS.docx

**HISTORY OF ECONOMICS** **CLASSICAL ECONOMICS** **NEO-CLASSICAL ECONOMICS** **KEYNESIAN ECONOMICS** **NEO-KEYNESIAN ECONOMICS** **NEOCLASSICAL MICROECONOMICS** ------------------------------------ -------------------------...

**HISTORY OF ECONOMICS** **CLASSICAL ECONOMICS** **NEO-CLASSICAL ECONOMICS** **KEYNESIAN ECONOMICS** **NEO-KEYNESIAN ECONOMICS** **NEOCLASSICAL MICROECONOMICS** ------------------------------------ ------------------------------- ----------------------------------- ---------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Emerged in the late 18^th^ century Emerged in 1800 Emerged in 1930s Emerged during the post-world war period 1950-1970 Emerged in the 1970's Supply-side economics Supply-side economics Demand side economics Focuses on economic growth and stability rather than full employment According to them equilibrium occurs when the quantity supplied is equal to the quantity demanded Introduced by Adam Smith Introduced by Alfred Marshall Introduced by John Maynard Keynes Introduced by John Hicks, Franco Modigliani and Paul Samuelson Introduced by Robert Lucas, Edward Prescott **CLASSICAL ECONOMICS** Adams Smith, David Ricardo, Thomas Malthus, and John Stuart Mill were regarded as the classical fathers of the school of economics thought. The classical economics theory essentially amounts to growth and development and sets out to investigate the nature and causes of the wealth of nations. The distribution of the national product among the factors (means) of production falls within the framework of a growing (teeming) population and resources, and free competition in a private enterprise economy was also emphasized. **CLASSICAL ECONOMICS AND ADAM SMITH** Adam Smith's 1776, in his book titled "The Wealth of Nations" marked the beginning of classical economics. He tells the world that laissez-faire can work meaning a free economy and he also explains a 'kind of natural law of economic behavior', that if the government followed any policy other than "laissez faire", it would be against their natural law i.e. the government should keep away from the working of the economy properly i.e. the government should not interfere in the working of the economy. Adam Smith also emphasized on essential role that trade plays in bringing about the most productive, most efficient uses of the society's resources and the importance of specialization and divisions of labour in an economy. The function of the government should be closely restricted to maintaining law and order, protecting the rights of private property, and regulating the monetary system. "The government should not use the resources of the society for things the people would not want to spend their money on (i.e., say's law; supply creates its demand). As such the government should stay out of it and let the natural forces of the market (demand and supply) direct and control the society\'s productive activities". Another notable scholar Jeremy Bentham published his book (essay) thirteen (13) years later after Adam Smith in 1789 called "Principle of Morals and Legislation". That book was on the welfare of the nation (society) - which was based on how to measure its awareness and how to achieve it. The book also talked about how the wealth of the nation should be shared among the people for the greatest total welfare for the greatest good the society could achieve. Bentham explained the motive of the individual driving force which directs each individual's activities and behaviour. He regarded each person as a self-serving unit in which all individuals are powered by the desire to do things that serve their own best interests (selfish). Bentham also analyzed the motive force where he explained how the market system worked through the force of demand and supply known as "invisible hands". **Thomas Malthus** He was 10 years old when The Wealth of Nations was published. He agreed with the natural laws of economics as presented by Adam Smith in The Wealth of Nations and that the government should follow a policy of laissez-faire to let the natural law operate freely. He published a book called "The Principle of Political Economy" in 1820. He also wrote on population. He said that there was a tendency for the population to expand more rapidly than food supply could expand'. The idea expressed why Malthus was that population expansion would keep the people poor and hungry. This is called "The Malthusian law of Population". In most of the less-developed countries of the world today, population growth is the obstacle (problem) to economic development and improved standard of living for the people. **David Ricardo** **He was a** brilliant economic theorist. He developed a model to show how the market process directs and controls an economy of laissez-faire and competition. Ricardo emphasized the importance of the growth of capital through savings and investment. **The Iron law of wages:** Ricardo agreed that the population would continue to expand and force wages to stay very low below the level of bare subsistence. He also agreed that if wages were less than subsistence, the population and the labour force would get smaller. How? Many people would die of malnutrition and old or sick people would not survive as long. Young people would delay marriage and have fewer children. The population would fall and the workforce would also reduce. Ricardo, made an important contribution to the development of our present understanding of economics, as most of his work focused on a problem which today is very real and very serious. **Jean Baptist says**: He was nine years old in 1776 when the "Wealth of Nations appeared, that is, published a book on political economy in the early 1800's. His essay contained how the market process works. J.S. Say is best known for his "Law of the Market", the idea that supply creates its demand. The more a producer takes to the market (supply), the more he can get in trade (buy) and take home with him (demand). Say's law does not always work out exactly right in the real world. But, the tendency is there, and sometimes it's helpful to know about it. **John Stuart Mill** John Stuart Mill was born in 1806. He published a book on political economy in 1848. Mill's textbook was orthodox classical economics which integrated much of what had been done by various writers from Adam Smith to David Ricardo. Mill's book is against classical economics specifically the Ricardian model on the "Laws of Distribution". Mill also concluded that the natural market forces should decide how much each person is going to get to eat. **Questions** 1. Compare and contrast the theories of David Ricardo and Thomas Malthus. Can you find any current real-world e.g. either of these theories? 2. State and Explain "Say's law of market". Give examples of how Say's law works in the economy today. 3. Explain how, according to Adam Smith's Wealth of Nations, laissez-faire and competition would automatically solve society's three basic economic questions. 4. Explain the contribution of Jeremy Bentham to the development of classical economics. **Assignment** 1\. Discuss the contribution of 5 neo-classical and the differences between the classical and neo-classical. 2\. Write a short note on the contributions of the following to the development of economics as a discipline. a\) Adam Smith b) John Maynard Keynes c) David Richardo d) Thomas Malthus e) Milton Freeman- a vanity of money 3\. Discuss the origin, features, contributions, and importance as well as criticism of the Physiocrat\'s economic doctrine. **KEYNESIAN SCHOOL OF ECONOMICS THOUGHT** They are the modern economics school of thought from the Great Depression that occurred in Britain in 1936. The Keynesian ideas arose out of the neoclassical or Marginalist school, with Keynes himself being steeped in the Marshallian tradition. Although, Keynes sharply criticized certain aspects of neoclassical economics, which he lumped together (Joined together) with the Richardian doctrines under the heading of "Classical economics". Keynes himself used many of the postulates theories and methods of neoclassicism and his system was based on a subjective, psychological which was permeated with Marginalist concepts including static equilibrium analysis. Where he disassociated himself from any attacks on the neoclassical theory of value and distribution. John Maynard Keynes (1883-1946) was the son of an eminent intellectual scholar (parents who survived him). His father was John Neville Keynes, who was an outstanding logical and political economist. His mother was interested in public affairs and social work. She was a justice of peace, alderman, and a Mayer of Cambridge. Among the Keynes's teachers were the Marshall and A.C Pigou. Both of whom recognized his brilliance. At 28 years of age, Keynes became an editor of the economic journal and he also managed the investment of its publisher. John Maynard Keynes was an important figure both in the world of practical affairs and in academic life. He was the chairman of the Board of Life Insurance where he served as a director of the company and also as a Governing Board in the Bank of Industry. In addition to being a financier, he was a high government official, a scholar writing many theoretical works, a journalist, and also a college teacher at Cambridge. **THE SOCIAL BACKGROUND OF THE KEYNESIAN SCHOOL OF THOUGHT** Keynes's idea grew out of the fearful depression of the 1930 which was the worst that the Western World had ever known or experienced in modern times. (The Great Depression of 1936) The major Keynesian economists are: 1. The Keynesian assumes that there is a high correlation between national income and the level of employment. The immediate determinants of income and employment are consumption and investment spending i.e. every naira spent on the final goods and services either for consumption or investment purposes becomes income -- Y= C+I (by Keynes). If we designate where C = Consumption, I = Investment, Y = Income then Y = C+I. Savings is the difference between income and consumption -- S = Y -- C then, we also consider taxation. As such, saving will equal disposable income minus consumption i.e. S = Yd -- C. When the consumption and investment spending is inadequate to maintain full employment, the government should be ready to add to the income stream through spending finance by the deficit. The ultimate determinants of consumption and investment spending are: i. the size of consumption which is the function of income: C = F (Y) income, ii. the marginal efficiency of capital, iii. the rate of interest. Keynes assumed that consumption is a variable factor determined by the size of income, that is, consumption spending is a stable proportion of income at each level of income, and this proportion falls as income increases. The consumption function is based on the psychological propensity to consume which means that at any income level, people tend to spend a certain fixed proportion of income on consumption. Also, the investment spending is determined by the rate of interest and the marginal efficiency of capital which means the expected rate of return over cost on new investment i.e. MEC = 1/ (1+r)^n^. 2. The second determinant of investment is marginal efficiency of capital (MEC). The Marginal Efficiency of Capital depends on the expectation of future profits and the supply price of the capital asset. Keynes defined Marginal Efficiency of Capital as being equal to that rate of discount which would make the present values of streams or series of the expected return to equal to the supply price of the capital asset. 3. The third idea of the Keynesian school of economic thought is that Laissez faire is absolute and that the government should only intervene to promote full employment. Keynesian school relied on a large role for the government to stabilize the economy at a full employment level. One of the thing that the government should do, is to stimulate private investment during depression by forcing (reducing) down the rate of interest. This could be done through the Central Bank Nigeria Bank policy. The important point is that instead of the government allowing Laissez faire condition to determine interest rate, the government should take action to force them downward in order to overcome inadequacy in investment. **THE INSTITUTIONAL SCHOOL OF ECONOMICS THOUGHT** This school of thought represents an outstanding American contribution to economic thought which began in 1900. The founder is Thorstein Veblen who published his first essay (book) and many articles. This school of thought may be said to have ended in 1936 due to the emergence of John Maynard Keynes when creating a more elegant theoretical system (Laissez-faire economy). There were three great figures (important personalities) in the institutional school of economics thought: Thorstein Veblen critically dissected orthodox thinking and provided a theoretical approach to the institutional economy Wesley C. Mitchell stimulated inductive and deductive approaches in its statistical studies and John R. Commons helped persuade the nation of the need for reform through government legislation and also through government legislation and who also helped to write new laws. **AN OVERVIEW OF THE INSTITUTIONAL SCHOOL OF ECONOMIC THOUGHT** **The Social Background of the School** Between the Civil War and the First World War, the achievements of American capitalism were impressive, rapid growth made, and the biggest as well as the most powerful industrial system in the world. The rise in the levels (standard) of living of the lowest income earners stated did not keep pace with the rise in the national income. The improvement in the living conditions of most wage-earners fell far -- short (less than) of their aspiration and other possibilities. The hours of labour were very long, housing was inadequate, security in sickness, unemployment, and old-age were negligible, higher education was inaccessible for most workers' children, job security was virtually non-existent, (except working with the government), health and safety regulations were inadequate frequently, the employers organized company towns and dominated the workers even in their personal lives, large immigration tended to undermine wage rates, taxation was regressive, usury (interest) was widespread and recurring depression were devastating to those who lost their jobs. In economics theory and analysis, there was increasing dissatisfaction with orthodox marginalist doctrine -- a neo-classical school of thought headed by Alfred Marshall. Besides the socialists, there were a few respectable or semi-respectable academic economists who disagreed with the postulates, (what they disagreed) analyses, and conclusions of the dominant school. The assumptions of the marginalists were unrealistic, as such, the defense of laissez-faire and the status quo has been producing the best of all possible worlds seemed untenable. There was increasing concern about monopoly, poverty, depression, and waste. The operation of modern capitalism was not conforming to the expectations based on traditional economic theory which led to the movement to social control and reform which was gathering momentum. There were two major alternative methods for achieving social change: i. The first was to reorganize the society along the socialist lines, which raised the possibility of sharpening class struggle, militant unionism, and a revolutionary orientation towards existing society. ii. The second method was to achieve social change achievement through social reform. This means ameliorating conditions through government intervention in the economy. The essence of this was to save capitalism and not to overthrow it by improving the condition of the masses. Although, Veblen kept aloof from socialist movements and was critical of them. It favoured a radical reconstruction of society. Nevertheless, the institutionalism school that he founded preferred the reformist approach, that is, the changes brought by the New Deal in the 1930's were in essence the epitome of institutionalism. **THE IDEAS OF THE INSTITUTIONAL SCHOOL OF THOUGHT** Eight key ideas are basic to this type of economic thinking. 1. The economy as a whole (in totality) must be studied rather than examining small parts separately and in isolation from the whole. 2. The school also emphasized the role of institution in the economic life where an institution is defined as not merely an organization or establishment for the promotion of a particular objective like a school, a prison yard, a union or a central bank. It's also an organized pattern of group behaviour, that is, well established and accepted as a fundamental of a culture which includes customs, norms, belief system social habit, laws, mode of thinking and ways of living. Others are believed in laissez faire or unionism or a government social security system. 3. Maladjustment in economy life are not departure from normal equilibrium level, but are themselves normal. The outstanding maladjustment in business slump, collecting control through government and necessary to continually correct and overcome these rearing maladjustments. 4. The Darwinian evolutionary approach should be used because the society and its institutions are constantly changing instead of equilibrium, there is no motion. The institution disagree with the static equilibrium analysis that sought to discover eternal economic truths without regards to their differences of time and place without concern for charges that were occurring constantly. 5. The institutional school thought promote liberal democratic reforms for more equitable distribution of income and wealth, which invariably condemned laissez faire and favoured large role of government in economic and social affairs. 6. The institutional school of thought school of thought favoured rather than the inductive approach instead of the deductive approach which put a call went forth for more fact- finding, more statistical studies, a closer examination of the actual workings of the system. 7. The institutional school of thought repudiated the pleasure pain psychology where they reached out instead for a better psychology and some of them incorporated feudal and the behavioristic idea into their thinking. 8. Instead of the harmony of interest that most of their contemporaries and predecessors deduced from their theories, the institutional of school of thought recognized serious clashes of interest. There is however a clash of interest between the groups such as: big business against small business, consumer against producers, farmers against city people e.t.c. 1. The under -- consumption argument 2. The instability in investment 1. **UNDER- CONSUMPTION PRINCIPLE:** The major attack on the say's law of the supply creates its own demand is the under-consumption theories of Thomas Malthus, Foster and Catching and Hobson. Thomas Malthus point out at the inequality in income distribution and its resultant effect on consumer purchasing power. He posits that the wealthy class consumes less proportion of their earned income and does more savings, while the poor or low-income earners may not be able to purchase most of the goods produced. The under-consumption, since final consumer goods are a long time forthcoming, prices will rise as money income increases. Once the production process is completed, the output of consumer goods overrides the consumer's purchasing power. Price fall and profit margin created by an excess of demand over supply will be wiped out. Thus, a general depression will follow when the consumer goods industries curtail- output. 2. **INSTABILITY OF INVESTMENT PRINCIPLE**: Investment according to the business cycle theorists is highly unstable, it could be the problem of under-investment at one time and over-investment problem at another time. Thus, this fluctuation depends on the changes in technology, the development of new industries, interest rates, final demand, inventory psychology, and all kinds of unpredictable and highly volatile factors. Thus, an increase in consumer demand calls for more investment, but, if consumer demand is static no new investment is needed. **Assignment** 1. Write short notes on (a) Veblen (b) Mitchel (c) Commons and their contribution to the history of economics.