History of economic thought

The development of a scientific approach to economics began with the publication of Adam Smith's, The Wealth of Nations in 1776. (Earlier approaches are described in the article on the History of pre-classical economic thought). The nineteenth and twentieth centuries saw major developments in methodology and scope, and the process of development continues.

Nineteenth century economists applied deductive reasoning to axioms considered to be self-evident, and to simplifying assumptions which were thought to capture the essential features of economic activity. That methodology yielded concepts such as elasticity and utility, tools such as marginal analysis, and theorems such as the law of comparative costs. An extension of the relationships governing transactions between consumers and producers was considered to provide all that was necessary to understand the behaviour of the national economy.

The development, in the early 20th century, of systems of economic statistics enabled economists to use inductive reasoning to test theoretical findings against observed economic behaviour, and to develop new theories. Independently of that change, the concept emerged of the national economy as a closed interactive system. Such a system was found to behave in ways that could not be derived by aggregating the behaviour of its components. Analysis of the new concept provided explanations of recessions, unemployment and inflation that were not previously available. The application of empirical data and inductive reasoning to the new concept enabled those theories to be refined, and led to the development of forecasting models that could be used as tools of economic management.

The late 20th and early 21st centuries have seen further theoretical and empirical refinements and significant advances in the techniques of economic management

Classical economy

The "Classical" period of economic thought began in 1776 with the publication of Adam Smith's The Wealth of Nations. It expressed Enlightenment and Newtonian ideas that assumed a world of measurable forces and invariant laws.

Major economists following Smith included Jean-Baptiste Say , Robert Malthus and David Ricardo. Ricardo's model laid the basis for the classical models that became the mainstream in economic theory for the whole of the 19th century.

Malthus

Malthus (1766-1834) is most famous for his "Essay on the Principle of Population" where he formulated the theory that population expanded at a geometric rate (or exponentially) while food production could only increase arithmetically. At a certain point, the population increase would outrun the food supply, and result in general misery. Malthusian models were a major inspirations for Charles Darwin's theory of Natural Selection (1859). Malthusian pessimism regarding depleting resources has become a major themes of the environmental movement.

Ricardo

David Ricardo (1772-1823) set the theoretical fundamentals of the classical model. Ricardo's system depended on the idea of the marginal productivity of land, and was the inventor of the "marginal" concept. His idea was that the value of agricultural products (and hence food) was based on the amount of labour required to produce on the least fertile parcel of land. Hence the "Law of diminishing marginal productivity". Landlords owning land that was more fertile, and who could produce more for a given amount of land, obtained "rents". His conclusion was that the future was in buying land. He, of course, did not predict the tremendous increase in technology and productive capacity brought about by the capitalist system.

Ricardo was also responsible for the idea of comparative advantage in international trade His classic example was between wine and clothing and England and Portugal. Portugal was more efficient than England in producing both cloth and wine, but England had a comparative advantage in cloth production. He showed that it would be advantageous for Portugal to specialize in wine and England to specialize in cloth, and to trade with each other. This resulted in more wine and cloth all around.

Marxism

Karl Marx is the most famous of Ricardo's followers. Writing during the mid-19th century, Karl Marx saw capitalism as an evolutionary phase in economic development. He believed that capitalism was inherently exploitation of the workers, who really produced all wealth, He predicted capitalism would ultimately destroy itself and be succeeded by a socialist system without private property. Marx had little impact on the development of pure economic theory because his theory added little to Ricardo's, though he came to different conclusions. Marx placed little emphasis on the diminishing marginal productivity of land, but more importance on the falling rate of profit. To Marx, capitalist competition would lead to the impoverishment of the "proletariat" or working class and a falling rate of profit. The ultimate resolution would be a communist revolution with the workers seizing power. Soon after the death of Marx, a Marxian school of economics emerged under the leadership of Marx's inner circle of companions and co-writers, notably Friedrich Engels and Karl Kautsky .

Institutional schools

German historicism was represented by Werner Sombart (1863-1941), and historical sociologist Max Weber (1864-1920). In his classic The Protestant Ethic and the Spirit of Capitalism (1905) Weber stressed the importance of Protestant value systems in forming a capitalist mindset and rational outlook toward calculating the future. The most widely read American economist was Thorstein Veblen (1857-1929), a witty commentator on capitalism, the leisure class, and conspicuous consumption. More pedantic but more influential was John R. Commons (1862-1945), who stressed legal frameworks, historical development and practical collection of statistics; he ignored theoretical mathematical models. Commons dominated economics at the University of Wisconsin, where his disciples preached strong government regulation and intervention in the economy, and designed the Social Security pension system that went into effect in 1935. John Kenneth Galbraith was a major spokesman for liberalism and the planned economy, as he poked fun at capitalism and promoted the New Deal Coalition.

The main development of Business Cycle Theory, led by Wesley Clair Mitchell (1874-1948) and sponsored by the National Bureau of Economic Research from the 1920s into the 21st century, used massive amounts of statistical data, but at first avoided macroeconomic theory. Important exponents included two economists who headed the Federal Reserve System, Arthur Burns (1904-1987) and Alan Greenspan (1926- ).

Leonid Vitalyevich Kantorovich (1912-1986), and Wassily Leontief (1906-1999) developed the "input-output" technique; it was used mostly in planned and developing economies for determining the levels of resources necessary to produce according to a given plan.

The marginalist revolution

The German Hermann Heinrich Gossen (1810-1859) was the first to formulate in 1854, "the law of diminishing marginal utility"; but Gossen's work was unknown until 1878.

In the 1870s, three economists became responsible for what is called the "Marginalist Revolution" - William Stanley Jevons , Carl Menger and Léon Walras . They, independently of each other, developed a new theory of value based on utility. The three are responsible for the concept of marginal utility , and the derivation of a downward sloping demand curve . The Marginalist Revolution would eventually put an end to the The Classical Scholl and the era of the Neoclassical School , which lasts to today, began. This made possible the logical analysis of the "Producers's Decision" or how and why "producer" transforms factors of production into finished goods.

The Italians contributed much for the construction of the Marginalist Revolution. The bulk of the Lausanne School came from Italy -- Vilfredo Pareto, Enrico Barone, Giovanni Antonelli, Pasquale Boninsegni, etc. Some economists, such as Henry Schultz, preferred to call it simply the "Italian School". The Neoclassical economist Maffeo Pantaleoni, the Italian "Marshallian", can be considered part of this group.

Alfred Marshall (1900-1920) was responsible for the combination of "demand" and "supply" ,where demand was based on "marginal utility". He was responsible for developing numerous concepts still used in economics, including: demand and supply curves or schedules and their equilibrium, "elasticity of demand" , consumer surplus, the distinction between short- and long-period, etc.

Marshall's work was only the beginning. His work was refined and further developed, and continues to be extended to this day. Neoclassical economists have built a truly astounding logical edifice into a "Production Function" that rival Newtonian mechanics in completeness and rigour. The basis of neo-classical economics is maximisation under constraint, and this constantly involves the "marginal concept" . The tools developed by economists are even now beginning to be used by other social sciences such as anthropology, sociology and even psychology.

International trade theory

Bertil Ohlin, (1899-1979), professor of economics at the Stockholm School of Economics (1929-65) and longtime leader of the Swedish Liberal party shared the 1977 Nobel Prize for economics with British theorist James E. Meade (1907-1995) for their "pathbreaking contribution to the theory of international trade and international capital movements."

The Keynesian revolution

Keynesianism, introduced by Cambridge (England) economist John Maynard Keynes in 1936, and revised by John Hicks, dominated mainstream economic thought from 1936 to the early 1970s. Keynes' ideas on the causes of unemployment revolutionalized macroeconomic theory and profoundly altered government's involvement in the economy. Instead of micromanagement of prices and factories, the Keynesian model told governments to regulate the overall supply and demand, through taxation and budget deficits or surpluses. In the 1970s economists became increasingly critical of Keynesian ideas, because it could not handle stagflation (the real-life combination of high unemplyment and high inflation), and because because of problems with the micro-foundations regardiung issues such as the "consumption function." The leading British Keynesians were Sir John Hicks (1904-1989) and Richard Stone (1913-1991) The leading American Keynesians were Alvin Hansen (1887-1975), Paul Samuleson (1915- )and Franco Modigliani (1918 ) at MIT, and James Tobin (1918-2005) at Yale. Milton Friedman was the leading critic of Keynesianism, though his own alternative theory of monetarism was found wanting in practice.

The monetarist "counterrevolution"

While the Keynesian-Neoclassical synthesis took over the profession, an unregenerate rearguard of neo-classical economists centred at the University of Chicago continued to exist. See Chicago School of Economics They never accepted the idea of involuntary unemployment or government intervention to ensure full employment, and strongly believed in the virtues of markets and laissez-faire. The most famous economist of the Chicago School is Milton Friedman. He was mainly responsible for what is known as the Monetarist counterrevolution of the 1970s.

With the perceived failure of Keynesian models to explain or resolve the "stagflation" of the 1970s, (which combined high unemployment and high inflation), the free market prescriptions of monetarism became much more popular, and were eventually espoused by many governments in the 1980's (Reagan, Thatcher, Mulroney), and, perhaps more importantly, by the central banks of most industrialized countries.

The Chicago School of Microeconomics

The Chicago School of Economics not only challenged established theories in macroeconomics, they pioneered the expansion of microeconomics to include antitrust and many unexpected topics, such as marriage and divorce, criminal behavior, and slavery. The main tool was price theory as developed by Ronald Coase (1910- ), George Stigler (1911-1991) and Gary Becker (1930 - ).

Thematic schools

Thematic Schools are specialty areas especially: Business Cycle Theory, Demography, Econometrics, Imperfect Competition, Economic Development, Uncertainty and Information, Game Theory and Finance Theory.

Economics subdisciplines

Modern economic theory is divided in two main branches: Microeconomics which is concerned with the actions of "individual economic agents" and Macroeconomics which studies the aggregate economy.

External links

• Economics 100 Online. Department of Economics at the University of Toronto; a primer to understanding the basic principles of Economics
• The History of Economic Thought Website

• Backhouse, Roger E. A History of Modern Economic Analysis. 1985, full text

• World Wide Web Resources in Economics. Center for Innovative Education, Helsinki School of Economics;links to the various Economics subdisciplines)

See also

• Classical economy
• History of pre-classical economic thought
• Keynesians
• Keynesian Revival
• Macroeconomics
• Microeconomics
• Neoclassical Schools (1871-today)

Bibliography

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