History Of Economic Thought Lecture PDF

7 HISTORY OF ECONOMIC THOUGHT Prepared by: MARIA FRANCESCA TOMALIWAN De La Salle University  HISTORY OF ECONOMIC THOUGHT OVERVIEW i. Mercantilism (1500-1700s) ii. Classical School (1700s- 1850s) iii. Neoclassical School (1860s- present) iv. Keynesian School (1880s- present)...

7 HISTORY OF ECONOMIC THOUGHT Prepared by: MARIA FRANCESCA TOMALIWAN De La Salle University  HISTORY OF ECONOMIC THOUGHT OVERVIEW i. Mercantilism (1500-1700s) ii. Classical School (1700s- 1850s) iii. Neoclassical School (1860s- present) iv. Keynesian School (1880s- present) 3 Why study the history of economic thought?  Political economy or economics as a social science  The cumulative view of evolution: a progressive movement towards a more perfect of understanding  The competitive view: different conceptual foundations about similar economic realities  The contextual view: economic theories determined by the historical, national and international background 4 MERCANTALISM  Mercantilism, 16th-18th centuries  The first dominant school, in a period of capitalist emergence  The State or the sovereign should accumulate wealth, especially money (precious metals)  The balance of trade should be kept positive  The state should use legislation and protective policy to augment the country’s wealth 5 THE CLASSICAL SCHOOL  Period of the extension of the Industrial Revolution  Well- known economists: Adam Smith (1723-1790) David Ricardo (1772-1823) Thomas Robert Malthus (1766-1834) John Stuart Mill (1806-1873) 6 THE CLASSICAL SCHOOL Adam Smith Wrote « The Wealth of Nations » (1776) Famous concept: the invisible hand Known as «father of modern economics » Individual self-interest as the main motivation: « It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. » About the economic agent: « 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. » A criticism of state intervention: « Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently 7 promotes that of the society more effectually than when he really intends to promote it. » THE CLASSICAL SCHOOL David Ricardo Wrote « On the principles of political economy and taxation» (1817) Famous concept: Comparative Advantage Countries gain from trade by trading goods in which they have a comparative advantage. « Comparative advantage refers to the ability of a party to produce a particular good or service at a lower opportunity cost over another. Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies”. 8 THE CLASSICAL SCHOOL Thomas Robert Malthus Wrote « An Essay on the Principle of Population» (1798) Famous concept: Malthusian population trap On booming population: « The power of population is so superior to the power of the earth to produce subsistence for man, that premature death must in some shape or other visit the human race…” Vice, war and epidemics will probably control population, but “Should success be still incomplete, gigantic inevitable famine stalks in the rear, and with one mighty blow levels the population with the food of the world.” » 9 THE CLASSICAL SCHOOL John Stuart Mill Wrote ”Utilitarianism” 1863 Famous concept: Utilitarianism, happiness Definition: the ethical doctrine that the moral worth of an action is solely determined by its contribution to overall utility, defined as happiness, and not on religious basis. "The sole end for which mankind are warranted, individually or collectively, in interfering with the liberty of action of any of their number, is self- protection. That the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others. He cannot rightfully be compelled to do or forbear because it will be better for him to do so, because it will make him happier, because, in the opinion of others, to do so would be wise, or even right...The only part of the conduct of anyone, for 10 which he is amenable to society, is that which concerns others. In the part which merely concerns himself, his independence is, of right, absolute. Over himself, over his own body and mind, the individual is sovereign.” NEO-CLASSICAL SCHOOL  Well- known economists:  Alfred Marshall (1842-1924)  « Neoclassical » : a critical term introduced by Veblen (1900) to stress the disputable continuities with the classics, but a questionable label, taking into account the important breaks with the classics 11 NEO-CLASSICAL SCHOOL Alfred Marshall Wrote « Principles of economics” (1890) Famous concepts: Supply and demand, Marshallian Cross and Marginalism 12 NEO-CLASSICAL SCHOOL Marshallian Economics  The « partial equilibrium » method: isolating an agent or industry, analyzing its behavior under the ceteris paribus clause, and allowing gradually fixed elements of the environment to change  Supply and demand curves : the marshallian cross, determination of equilibrium price and quantity  Increasing or decreasing returns to scale  A defense of free entreprise, but admission of a limited state intervention for promoting social welfare 13 NEO-CLASSICAL SCHOOL Marshallian cross 14 THE KEYNESIAN SCHOOL John Maynard Keynes Known greatly for his explanation for the Great Depression Economist Worked at the Treasury during WWI. Great works include “General Theory of Employment, Interest and Money” and “Treatise on Money” Prior to the Great Depression Classical economists believed that markets would adjust quickly and direct the economy toward full employment. The huge decline in output, prolonged unemployment, and lengthy duration of the Great Depression undermined the classical view and provided 15 the foundation for Keynesian economics.  THE KEYNESIAN SCHOOL John Maynard Keynes Microeconomics and macroeconomics do not operate on the same basis. One cannot assume that what is true for the economic agent at the level of the individual consumer or firm is true in aggregate. This amounts to the fallacy of composition. “In microeconomics, relative price effects dominate. This is not true in macroeconomics. In macroeconomics, income effects dominate, making income more important in determining aggregate economic behavior.” Keynesian economics does not believe that price adjustments are possible easily and so the self-correcting market mechanism based on flexible prices also obviously doesn't. The Keynesian theorists believe that government intervention in the form of monetary and fiscal policies is an absolute must to keep the economy running smoothly. 16  THE KEYNESIAN SCHOOL John Maynard Keynes Aggregate demand is key to the Keynesian macroeconomic model. Keynes believed that weak aggregate demand was the cause of the Great Depression. "Long run is a misleading guide to current affairs. In the long run we are all dead.“ Classical economists believed in the long run and aimed to provide long run solutions at short run losses. Keynes was completely opposed to this, and believed that it is the short run that should be targeted first. He stressed on the fact that government intervention is absolutely necessary to ensure growth and economic stability in form of measures like government spending, tax breaks and hikes, etc. for the best functioning of the economy. 17 THE KEYNESIAN SCHOOL Alvin Hansen Known greatly for being the « American Keynes » Worked as economic adviser in Federal Board Wrote a paper pointing out a math error in Keynes’ Treatise on Money; not enthusiastic about the General Theory at first. Wrote “Fiscal Policy and Business Cycles” which extended Keynes’ Policy Recommendations and supported Keynes’ analysis of the 1930s Hicks (1939) had pointed out problems with Keynes’ theory, utilizing his own IS-LM apparatus. Hicks and Hansen worked out the 18 indeterminacy of the interest rate and other problems. THE KEYNESIAN SCHOOL  Hicks and Hansen Synthesis (IS-LM) r LM r* IS y* y 19