History of economic thought: Difference between revisions

From Citizendium
Jump to navigation Jump to search
imported>João Prado Ribeiro Campos
mNo edit summary
 
(454 intermediate revisions by 22 users not shown)
Line 1: Line 1:
'''Economics''' is a social science. It studies the production, distribution, and consumption of goods and services. The word 'economics', originally "rules of the house", comes from the Greek οἶκος (oikos: house) and νόμος (nomos: custom or law). Economics stems from the natural propensity of human beings to barter, to exchange or trade goods. Whilst there are no records of dogs ever having bartered bones, humans have been bartering all sorts of goods since pre-history. Economics as an independent science - and as we understand the word today - begins with the work of [[Adam Smith]],  ''[[The Wealth of Nations]]''. <ref name=WEALTH>[http://www.econlib.org/library/Smith/smWN.html SMITH, Adam. ''An Inquiry into the Nature and Causes of the Wealth of Nations''. Modern Library, 1ª edition, 2000, ISBN 0679783369]</ref>.
{{subpages}}
Before [[Adam Smith|Smith]], Economics was just a chapter in political science, the art of managing a state. This article will focus on economics since it became a science independent from politics. For the history of early economics leading up to the development of ''[[The Wealth of Nations]]'' see the article [[History of Ancient Economics]].
{{col-begin|width=100%}}
{{col-break|50%}}
{|align="center" cellpadding="10" style="background:lightyellow; width:60%; border: 1px solid #aaa; margin:25px; font-size: 98%; font-family: Gill Sans MT;"
|This article is intended to be of interest to students of economics at all levels.<br> It is also intended to be accessible to all who take an informed interest in accounts of economic developments in the media.
<!--|-->
|}
{{col-end}}
<!--{{-}}-->
----
{{TOC|right}}
Modern economic thought is generally considered to have originated in the late eighteenth century with the work of [[David Hume]] and [[Adam Smith]], the founders of classical economics.  The  nineteenth and twentieth centuries saw major developments in the methodology and scope of economic theory; and the early twenty-first century has seen a rethinking of some previously accepted tenets.


===Definition of economics===
Nineteenth- and early twentieth-century economists applied deductive reasoning to axioms considered to be self-evident and simplified 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 advantage]].  An understanding of the relationships governing transactions between consumers and producers was considered to provide all that was necessary to explain the behaviour of the [[economic system]].


Even the definition of economics is subject to controversy. Many economists view economics as the study of how scarce resources are allocated to satisfy alternative competing human wants. This is a ''"neo-classical"'' view first formulated by Lionel Robbins in 1935 and repeated in most economics texts; for example, <ref name=ECONOMICS> SAMUELSON, Paul Anthony e  NORDHAUS, William D.''Economics''. McGraw Hill Professional, 18ª edition, 2004, ISBN 0072872055</ref> [[Paul Samuelson]], who, in his famous book ''Economics - An Introductory Analysis'' <ref name=ECONOMICS> SAMUELSON, Paul Anthony e  NORDHAUS, William D.''Economics''. McGraw Hill Professional, 18ª edição, 2004, ISBN 0072872055</ref>, defines Economics as:
The development, in the latter half of the 20th century, of systems of [[economic statistics]] enabled economists to use [[induction (philosophy)|inductive reasoning]] to test theoretical findings against observed economic behaviour, and to develop new theories. By that time, the concept had emerged of the national economy as a [[complex interactive system]], and analysis of that concept provided explanations of [[recession|recessions]], [[unemployment]] and [[inflation]] that were not previously available. The application of empirical data and inductive reasoning enabled those theories to be refined, and led to the development of forecasting models that could be used as tools of economic management.


::the study of how men and society 'choose', with or without the use of money, to employ 'scarce' productive resources to produce various commodities over time and distribute them for consumption, now an in the future, among various people and groups in society. <ref name=ECONOMICS> SAMUELSON, Paul Anthony e NORDHAUS, William D.''Economics''. McGraw Hill Professional, 18ª edição, 2004, ISBN 0072872055</ref>
The  development of economic thought in the early 21st century has been stimulated by the [[crash of 2008| financial crisis]] and [[Great Recession]], and the  questions that these events raised concerning  the functioning of the global [[financial system]] and the part that it plays in the functioning of the [[economic system]] generally.   


However, a more traditional view is that "Economics is the subject concerned with the material welfare of individuals and groups in society" ([[Asimakopulos]], 1978). or "The economic problem is the study of the process of providing for the material well-being of society". (Heilbroner), or the famous [[Alfred Marshall]] "Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing."
The search for understanding continues.


The list of acceptable definitions of economics is endless. Economics can be described as the study of those activities which, with or without money, involve exchange transactions among people. Economics is also the study of wealth.  
==Overview: categories of economic thought==
Historians categorise economic thought into “periods” and “schools”, and tend to attribute each  innovation to one individual.  This categorisation is helpful for the purpose of exposition, but the reality has been a story of interwoven intellectual threads in which advances attributed to particular individuals or schools have often prompted the work of others.  For example, the quantity theory of money, which achieved prominence in the twentieth century and is associated with [[Milton Friedman]], was first formulated at least three centuries earlier. Many of those threads, that have  permeated  the categories referred to as "Classical economics" and "Neoclassical economics", had  earlier origins.  "Classical", in economics, denotes the adoption in the late eighteenth century of an approach that was inspired by the enlightenment and the methodology of the physical sciences, and that had abandoned previous examinations of economics in terms of ethics, religion and politics.  Preoccupation with those threads was overshadowed in the twentieth century by the responses of [[Keynesianism]] and [[monetarism]] to the problems of unemployment and [[inflation]], but the development of neoclassical economics started before that time, and has continued thereafter. The introduction of new tools of exploration has since led to the vigorous development of that, and other, threads, and an expansion in the scope of economics into many new directions.


One can play with definitions, but a favourite remains the one proposed by a Canadian economist, [[Jacob Viner]] <ref name=VINERHET>[http://cepa.newschool.edu/het/profiles/viner.htm Jacob Viner]</ref> (1892-1970)  as "Economics is what economists do".
==Classical Economics==
===David Hume===
The Scottish philosopher [[David Hume]] was an early exponent of what was later known as [[monetary economics]], and was an opponent of "[[mercantilism]]".  Mercanilist policy at the time, regulated trade in ways that subsidised exports so as to promote inflows of gold and silver, and restricted imports in order to discourage outflows.  Hume contested the mercantilist thesis, partly on the grounds that an inflow of money would cause [[inflation]], and partly on the grounds that nations would benefit from the international specialisation that would result from the introduction of free trade.  More generally, Hume argued that all government intervention in commerce tended to obstruct economic progress.<ref>David Hume [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/hume/trade.txt David Hume Essays, Moral and Political, 1742, Vol 2 "Of the Balance of Trade"] (published by Liberty Fund, 1985).</ref>.


==Classical economy==
===Adam Smith===
A major advance in the development of economics occurred with the publication in 1776 of [[Adam Smith]]'s ''An Inquiry into the Nature and Causes of The Wealth of Nations''.<ref name=WEALTH>Adam Smith, [http://www.econlib.org/library/Smith/smWN.html ''The Wealth of the Nations''] (Modern Library, 2000).</ref>.  Smith wrote a comprehensive treatment of the subject,  using deductive logic in a  manner similar to its use in the physical sciences.  His main purpose was to recommend changes of economic policy in the interests of economic growth.  He argued that the division of labour was the main cause of economic growth.  His famous maxim was that the extent of the market is determined by the division of labour.  To thus expand markets, required that they should not be impeded by governmental policies.  He therefore opposed government intervention in commerce (as in mercantilist trade regulation).  But he did not oppose all governmental intervention into the economy.  He advocated government spending upon what are now termed [[public goods]] such as defence, law enforcement, infrastructure, and education of the children of people who could not afford it.  He identified what he considered to be the economic drawbacks of all forms of [[taxation]] (except the [[taxation of land values]]) and of  [[public expenditure]].  He examined the relation of price to value and concluded that the  price of a product tends to equality with its cost of production, which he termed its "natural price". He reasoned that "when the quantity brought to market is just sufficient to supply the effectual demand and no more, the market price naturally comes to be either exactly, or as nearly as can be judged of, the same with the natural price"  - an outcome which he took to be the normal result of  market bargaining.


The ''"[[Classical economy|Classical]]"'' <ref name=CLASSICALHET>[http://cepa.newschool.edu/het/schools/ricardian.htm ''Classical School'']</ref> period of economic thought began in 1776 with the publication of [[Adam Smith|Adam Smith's]] ''[[The Wealth of Nations]]'' <ref name=WEALTH/>. Written during the gentle era of Enlightenment, the ''[[laissez-faire]]'' policies of Adam Smith did not anticipate the economic and social upheavals that the industrial era was about to unleash.  Only 13 years later the French court was bankrupt and the French people took to the streets and beheaded their king; it was the [[French Revolution]].
===Jean-Baptiste Say===
Jean-Baptiste Say<ref name=SAY2>[http://www.econlib.org/library/Enc/bios/Say.html Jean-Baptiste Say]</ref> was an influential advocate of Adam Smith's teaching in French government circles, but his best-known contribution was what came to be known as "Say's Law of Markets."  Later paraphrased as "supply creates its own demand," Say's law stated that, although there could be an imbalance between the supply and the demand for particular products, no such imbalance could exist in the economy as a whole. It was based upon the postulate that money plays no part in the functioning of the economy beyond its role as a medium of exchange. (The claim that money is nothing but a medium of exchange, is another way of saying  that people use money only for buying things (including stocks and bonds). Say  justified that postulate by arguing that it would be foolish to hold money out of circulation because that would mean needlessly going without things (or without dividends or interest).  Say's Law remained part of mainstream classical economics until [[John Maynard Keynes]] drew attention to the [[speculative motive|speculative]] and [[precautionary motive]]s for holding money.


Among the economists who tried to understand the new phenomena three were outstanding: [[Jean-Baptiste Say]]<ref name=SAY2>[http://cepa.newschool.edu/het/profiles/say.htm Jean-Baptiste Say]</ref> , [[Thomas Robert Malthus]]<ref name=MALTHUSHET>[http://cepa.newschool.edu/het/profiles/malthus.htm Thomas Robert Malthus]</ref> and [[David Ricardo]]<ref name=RICARODHET>[http://cepa.newschool.edu/het/profiles/ricardo.htm '''David Ricardo''']</ref>. They all had different visions for political economy after Smith. Of those, Ricardo was the most succesful and influential and laid the basis for the ''[[Classical economy|Classical Economy]]'' <ref name=CLASSICALHET>[http://cepa.newschool.edu/het/schools/ricardian.htm Classical Economy]</ref> that would become the mainstream economy thought for the whole of the XIX century
===Thomas Malthus===
In his influential ''Essay on the Principle of Population'', [[Thomas Malthus]] postulated that the population would grow at a geometric rate (2, 4, 8, 16...) while food production could only increase arithmetically (1, 2, 3, 4 ....) and concluded that the food supply would eventually be insufficient to support the population.<ref>Thomas Malthus, ''[http://www.econlib.org/Library/Malthus/malPlong.html Essay on the Principle of Population]''.</ref>  This theory led him to oppose the introduction of the UK's [[Poor Law]], and to advocate the protection of agriculture. In other respects, he followed Adam Smith in opposing government intervention in commerce. Evidence in support of his postulates was lacking at the time, and they have since been found to be mistaken<ref>[http://www.nytimes.com/1999/09/19/weekinreview/why-malthus-was-mistaken.html, Nicolas Wade ''Why Malthus Was Mistaken'', New York Times, September 19, 1999]</ref>, mainly  because they took no account of the benefits of technical change.


[[Thomas Robert Malthus]]<ref name=MALTHUSHET>[http://cepa.newschool.edu/het/profiles/malthus.htm Thomas Robert Malthus]</ref> (1766-1834) is most famous for his ''"[[Essay on the Principle of Population]]"'' <ref name=MALTHUS1>[http://www.ac.wwu.edu/~stephan/malthus/malthus.0.html ''"Essay on the Principle of Population"'']</ref> where he formulated the theory that population [[exponential growth|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. Malthus was one of the major inspirations for Darwin’s theory of Natural Selection, and his echoes can be found in today’s environmental literature that warn of depleting resources.
===David Ricardo===
With minor reservations, [[David Ricardo]] accepted and extended Adam Smith’s economics. In his major work,''The Principles of Political Economy and Taxation'', he accepted the concept of a value-determined “natural price”, although he considered value to be determined by labour value added, rather than cost.<ref>David Ricardo, ''[http://www.econlib.org/library/Ricardo/ricP.html The Principles of Political Economy and Taxation]'' (John Murray, 1821).</ref> Following Adam Smith’s lead, he also developed the [[Wage-fund theory|wage fund]] concept that the amount available for the payment of wages is fixed at any particular level of capital investment, so that an increase in the supply of labour would lead to a reduction in wage rates.  He pioneered a definition of [[rent]] as the difference between the produce of a unit of labour on the land in question, and its produce on the least productive land in use. In a further extension to Adam Smith’s work, he explored the incidence of taxation on wages, profits, houses, and rent, identifying in each case (but with the exception of rent) its harm to the economy. Probably his most influential contribution, however, was his development of his "Law of [[Comparative advantage]]" that challenged the belief that the trading of a product is possible only with those with a lesser ability to produce it.  Ricardo produced a logical demonstration that there can be mutually  beneficial trade between two countries, one of which is better able than the other to produce all of the commodities that are traded.


[[David Ricardo]] <ref name=RICARODHET>[http://cepa.newschool.edu/het/profiles/ricardo.htm '''David Ricardo''']</ref> (1772-1823) was perhaps the most important of the XIXth century political economists. He combined Smith's labour theory of value with Malthus's population dynamics in a system which showed that capitalist economies would eventually result in a steady state of universal misery. On his ''On the Principles of Political Economy and Taxation'' <ref name=RICARDOPRINC>[http://www.econlib.org/library/Ricardo/ricP.html RICARDO, David. ''On the Principles of Political Economy and Taxation'']</ref> Ricardo set the theoretical fundaments of the [[Classical economy|Classical Economy]].
===Karl Marx===
[[Karl Marx]]<ref name=MARXHET>[http://www.econlib.org/library/Enc/bios/Marx.html Karl Marx]</ref> adapted Ricardo's concept of labour value and put it to an entirely different use. In his analysis, as in Ricardo's, labour consumption determines value. This, Marx termed ''exchange value''. But Marx regarded each labourer as a product, whose exchange value is determined by the labour inputs required to feed, clothe, and train him. He reasoned that what the employer receives is the labourer's ''use value'', which is determined by the utility of his products.  Marx noted that a labourer's use value normally exceeds his exchange value, and he termed the difference ''surplus value'', which was the employer's profit.  Like Adam Smith and his classical predecessors, Marx was preoccupied with the subject of economic growth but, unlike them, he saw technical progress as a major contributor.


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 "[[Rent|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.
Marx was probably the first economist to make a systematic attempt to explain the fluctuations in economic activity known as the [[business cycle]]. He considered that if technical progress were to slow down,  the only way to maintain growth would be to invest more and more in machinery and buildings, as a result of which the rate of profit on new investment would fall, leading to a further reduction in growth. Also, in his view, any departure from the conditions necessary for steady growth would lead to the accumulation of unwanted stocks of goods, producing a downturn in economic activity - until price-cutting, in order to get rid of surpluses, put the process into reverse.  


Ricardo was also responsible for the idea of [[comparative advantage in international trade]] <ref name=RICARODHET>[http://cepa.newschool.edu/het/profiles/ricardo.htm '''David Ricardo''']</ref>. 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.
In his major work, ''Das Kapital''<ref>Karl Marx, ''[http://archive.workersliberty.org/wlmags/capital/ruhle2.htm Das Kapital]'' (abridged).</ref> Marx puts his findings in an historical, concludes that economic conditions shape history, and forecasts a breakdown of the capitalist system and its replacement by [[socialism]].


[[Karl Marx]]<ref name=MARXHET>[http://cepa.newschool.edu/het/profiles/marx.htm Karl Marx]</ref> is the most famous of [[David Ricardo|Ricardo's]] followers. In [[Samuelson|Samuelson's]] words, he was a "minor Ricardian" - and had little impact on the development of pure economic theory. His economics differed little from Ricardo's, but had different conclusions. He 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 [[Karl Marx]] <ref name=MARXHET>[http://cepa.newschool.edu/het/profiles/marx.htm Karl Marx]</ref>, a [[Marxist Socialism|Marxian school of economics]] <ref>[http://cepa.newschool.edu/het/index.htm Marxian school of economics]]</ref>  emerged under the leadership of Marx's inner circle of companions and co-writers, notably  [[Friedrich Engels]]<ref name=ENGELSHET>[http://cepa.newschool.edu/het/profiles/engels.htm Friedrich Engels] </ref> and [[Karl Kautsky]] <ref name=KAUTSKYHET>[http://cepa.newschool.edu/het/profiles/kautsky.htm Karl Kautsky]</ref> , both of whom were German.
===Other contributors===
{{main|Classical economy}}
Among the many lesser contributors to classical economic theory, the best-known was [[John Stuart Mill]]. His ''Principles of Political Economy''<ref>John Stuart Mill, ''[http://www.econlib.org/library/Mill/mlP.html Principles of Political Economy]'', (Longmans Green, 1926.</ref>, although intended by the author merely to bring together the works of others, offered some fresh insights into [[scale economies|increasing returns to scale]] and their consequences for the development of monopolies, and anticipated (though not in these terms) the neoclassical concepts of [[elasticity]] and the determination of price by the interaction of [[supply and demand]].  
{{main|Marxist Socialism}}


==The marginalist revolution==
Written during the classical period, but without recognition at the time, was the [[Theory of the Firm]] by the French economist and mathematician Antoine Augustin Cournot.  Cournot used differential calculus to demonstrate the profit-maximising requirement of equality between marginal cost and marginal revenue, thus anticipating some of the more important developments of neoclassical economics.


The German economist [[Hermann Heinrich Gossen]] <ref name=GOSSEN>[http://cepa.newschool.edu/het/profiles/gossen.htm Hermann Heinrich Gossen]</ref> (1810-1859) was the first one to formulate in 1854, in an obscure German book <ref name=GOSSEN1>[http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=8361 GOSSEN, Hermann Heinrich. ''The Laws of Human Relations and the Rules of Human Action Derived Therefrom''.<small>Translated by Rudolph C. Blitz; introduction by Nicholas Georgescu-Roegen. Cambridge, MA: MIT Press, 1983.] ISBN 0262070901</small></ref>, "The First Gossen Law'", which was actually the first "marginalist law"; but Gossen's work remained completely unknown. In the 1870's, three economists became responsible for what is called the ''"[[Marginalist Revolution]]"'' <ref name=MARGREVHET>[http://cepa.newschool.edu/het/essays/margrev/margrev.htm The Marginalist Revolution]</ref> - [[William Stanley Jevons]] <ref name=JEVONSHET>[http://cepa.newschool.edu/het/profiles/jevons.htm William Stanley JEVONS, 1835-1882]</ref> , [[Carl Menger]] <ref name=MENGERHET>[http://cepa.newschool.edu/het/profiles/menger.htm Carl MENGER, 1841-1921]</ref> and [[Léon Walras]] <ref name=WALRASHET>[http://cepa.newschool.edu/het/profiles/walras.htm Marie Esprit Léon WALRAS (1834-1910)]</ref> . They, independently of each other, developed a new theory of value based on utility. The three are responsible for the concept of [[marginal utility]] <ref name=MARGUTILGRAPH>[http://www.chass.utoronto.ca/~reak/eco100/utility5.swf '''Marginal Utility''' <small>Animated graph</small>]</ref> , and the derivation of a downward sloping [[Supply and demand|demand curve]] <ref
==Neoclassical Economics==
name=DEMANDCURVE>[http://pdfdownload.bofd.net/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/demand98.pdf ''Demand Functions and Demand Curves'']</ref>. The ''[[Marginalist Revolution]]'' put an end to the ''[[Classical economy|The Classical Scholl]]'' <ref name=CLASSICALHET>[http://cepa.newschool.edu/het/schools/ricardian.htm ''Classical School'']</ref> and the era of the ''[[Neoclassical|Neoclassical School]]'' <ref name=NEOCLASSICALHET>[http://cepa.newschool.edu/het/thought.htm#neoclassical ''Neoclassical School'']</ref>, which lasts to today, began. This made possible the logical analysis of the ''"[[Producers's Decision]]"'' <ref name=PRODURCERSHET>[http://cepa.newschool.edu/het/essays/product/decision.htm ''"Producers's Decision"'']</ref> or how and why ''"producer"'' transforms factors of production into finished goods.  
===The neoclassical approach===
The term "neoclassical" is commonly applied to all of  the continuing developments in economic thinking that followed the replacement of value-based concepts by the concept of [[market (economics)|market]]s that are  governed by the interaction of [[supply and demand]]. In that sense, the term denotes a period rather than a consistent approach - although it is a period that overlaps the competing approaches of [[Keynesianism]] and [[monetarism]]. It is nevertheless a period in which most economists have deduced their findings from  the same hypothetical postulates - including the assumption of competitive markets in which consumers  maximise [[utility]] and producers maximise profits. Within that framework of postulates, neoclassical economists have explored a variety of aspects of economic activity in a variety of different ways.


[[Alfred Marshall]] <ref name=MARSHALL2>[http://cepa.newschool.edu/het/profiles/marshall.htm Alfred Marshall]</ref> (1900-1920) was responsible for the combination of ''"[[Supply and demand|demand]]"'' <ref
===Marginal analysis===
name=DEMANDCURVE>[http://pdfdownload.bofd.net/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/demand98.pdf ''Demand Functions and Demand Curves'']</ref> and ''"[[Supply and demand|supply]]"'' <ref name=SUPPLYCURVE>[http://pdfdownload.04340.com/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/supply98.pdf ''Supply Functions and Supply Curve'']</ref>,where demand was based on ''"[[marginal utility]]"''<ref name=MARGINALUTILITY>[http://pdfdownload.bofd.net/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/utilmax498.pdf ''Marginal Utility and Optimization]</ref>. He was responsible for developing numerous concepts still used in economics, including: [[Supply and demand|demand]] <ref
The neoclassical period is also marked by an expansion in the number of people applying their minds to the problems of economics, as a result of which there have frequently been similar contributions from a number of different thinkers. That was true of the innovative concepts of marginal analysis, that are attributable to the contributions of  William Stanley Jevons <ref name=JEVONSHET>[http://www.econlib.org/library/Enc/bios/Jevons.html William Stanley Jevons, 1835-1882]</ref> , Carl Menger <ref name=MENGERHET>[http://www.econlib.org/library/Enc/bios/Menger.html Carl Menger, 1841-1921]</ref> and Léon Walras <ref name=WALRASHET>[http://www.econlib.org/library/Enc/bios/Walras.html Marie Esprit Léon Walras (1834-1910)]</ref>. Their contributions have been brought together by Alfred Marshall in his ''Principles of Economics'' <ref> Alfred Marshall ''Principles of Economics'' Macmillan 1890</ref>, which provides the reader with an accessible and  readable (and non-mathematical) account of those and other contributions. The concept of [[utility]],  was given more prominence, and it was demonstrated logically (and mathematically) that a rational consumer would continue to buy additional units of a product until its  marginal utility (the increase in utility obtainable from one additional unit of the product) became level with to its price; and that a rational supplier would continue to offer additional units of a product until its [[marginal cost]] became level with the  [[marginal revenue]] that he would get from selling it. The American economist, John Bates Clark, subsequently applied the concept to a market in which a rational employer would continue to hire labour until its [[marginal product]] became level with the prevailing wage rate.
name=DEMANDCURVE>[http://pdfdownload.bofd.net/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/demand98.pdf ''Demand Functions and Demand Curves'']</ref> and [[Supply and demand|supply]] <ref name=SUPPLYCURVE>[http://pdfdownload.04340.com/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/supply98.pdf ''Supply Functions and Supply Curve'']</ref> curves or schedules and their equilibrium, ''"[[Elasticity of demand|elasticity of demand]]"'' <ref name=ELASTICITY1>[http://pdfdownload.bofd.net/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/elas98.pdf ''"Elasticity of demand"'']</ref>, consumer surplus, the distinction between short- and long-period, etc. Modern [[microeconomics]]] <ref name=MICRO_EXERCISES>[http://www.msu.edu/course/ec/201/brown/pim/ '''''MICROECONOMICS: Most important concepts explained in detail'''''. Text and workable problems. <small>'''WARNING: Internet Explorer will not work!''' Get "Firefox" or "Netscape" for free. Requires "Adobe Acrobat Reader" as a helper to your web browser. You will need "Excel 97" or higher running on your computer to use the spreadsheets.</small>]</ref> <ref name=MICROECONOMICS>[http://arielrubinstein.tau.ac.il/Rubinstein-revision.pdf RUBINSTEIN, Ariel. ''Lecture notes in microeconomic theory : the economic agent''. Princeton: Princeton University Press, 2006.]</ref>, the study of individual economic agents and individual markets, is a continuation and elaboration of his work.
{{main|Microeconomics}}
Marshall's work was only the beginning. His work was refined and further developed, and continues to be extended to this day. [[neoclassical|Neoclassical economists]] have built a truly astounding logical edifice into a ''"[[Production Function]]"'' <ref name=PROFUNCTION>[http://cepa.newschool.edu/het/essays/product/prodfunc.htm#function ''"Production Function"'']</ref> 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]]"'' <ref name=MARGINALUTILITY>[http://pdfdownload.bofd.net/pdf2html.php?url=http://www.msu.edu/course/ec/201/brown/pim/pdffiles98/utilmax498.pdf ''Marginal Utility and Optimization]</ref>. The tools developed by economists are even now beginning to be used by other social sciences such as anthropology, sociology and even psychology.
{{main|Marginalist Revolution}}


==The [[Great Depression]] and [[Keynesians|Keynesianism]]==
===Equilibrium and the Price Mechanism===
The concept of "market equilibrium" is central to the neoclassical model. Léon Walras<ref>[http://www.cooperativeindividualism.org/walrasbio.html Léon Walras]</ref> thought of it as the achievement of an imaginary auctioneer who adjusts a notional opening price in response to a succession of bids by buyers and sellers, and permits transactions to take place  only when a price is reached at which buyers are willing to buy all that is offered for sale. That is the process of price determination by [[supply and demand]] which marks the abandonment of the concept of value-determined price, and which is examined in detail in [[Alfred Marshall]]'s ''Economics'' and in [[Milton Friedman]]'s ''Price Theory''<ref>Milton Friedman: ''Price Theory'', Transaction Publishers, 2007 </ref>. Walras, and subsequently the Italian economist [[Vilfredo Pareto]] <ref>[http://www.econlib.org/library/Enc/bios/Pareto.html Vilfredo Pareto]</ref>, later developed the concept of a [[general equilibrium]] in which supply is equal to demand in every market in a closed economy. The normal assumption of neoclassical economics is that of a stable equilibrium to which the economy will automatically return after a disturbance. In such an economy, [[unemployment]] does not persist  because any excess in the supply of labour, relative to its demand, is corrected by a reduction in wages.


However, the edifice of [[Neoclassical|Neoclassical]] economics suffered a severe blow with the [[Great Depression]] of the 1930's. According to the [[Neoclassical]] economists unemployment is not supposed to occur in competitive markets. For them it can only occur if monopolistic forces prevent the demand and supply of labour from reaching its natural equilibrium. This was clearly not what was happening during the 1930's.
===Welfare and Efficiency===
The most politically influential of the contributions of the neoclassical economists was probably their development of the concept of [[welfare (economics)|welfare]]. In accordance with the precepts of [[representative government]],  they assumed the criterion for the success of an economic system to be the welfare of the individual, and they introduced the concept of [[economic efficiency]] as a measure of that success. Vilfredo Pareto took the lead in defining efficiency as a state in which no-one could be made better off without making someone worse off. The three types of efficiency were identified as [[Economics#Productive efficiency|productive efficiency]] (the production of good at minimum cost), [[Economics#Allocative efficiency|allocative efficiency]] (the provision of the mix of goods that consumers want) and [[Economics#Distributive efficiency|distributive efficiency]] (the distribution of the goods in such a way as to maximise individual welfare). That work laid the foundations for the subsequent development of the theory of [[welfare economics]] by Sir John Hicks  and others. (The subject of economic welfare is discussed extensively in Arthur Pigou's ''Economics of Welfare'' <ref>[http://www.econlib.org/Library/NPDBooks/Pigou/pgEW.html Arthur C Pigou ''The Economics of Welfare'' Macmillan 1920],</ref>, and the theorems of [[welfare economics]] are summarised in
William Baumol's ''Economic Theory and Operations Analysis'' <ref>[http://www.questia.com/PM.qst?a=o&d=59217071 William Baumol ''Economic Theory and Operations Analysis'' Chapter 13, Prentice-Hall 1961]</ref>)


Marshall's most famous disciple and pupil, [[John Maynard Keynes]], attacked the [[neoclassical]] system with the publication of the ''General Theory of Employment, Interest and Money'' <ref name=KEYNES1>[http://cepa.newschool.edu/het/texts/keynes/gtcont.htm KEYNES, John Maynard. ''The General Theory of Employment, Interest and Money''. London: Macmillan Press; New York: St. Martin's Press,; 1936]</ref> in 1936. Keynes showed that the depression was due to insufficient aggregate demand and advocated the need for government intervention to restore full employment. In the process, he created macro-economics.
===Competition===
The theorems of welfare economics establish a presumption that allocative [[efficiency]] - that is to say that resources will be optimally allocated as between the production of  alternative products - will be achieved  under the hypothetical conditions of perfect [[competition]]. (Those conditions include the requirement that for each product there is no supplier large enough to influence prices, that all producers supply identical products, and that all consumers are well informed and behave rationally.) Despite the unreasonableness of those requirements, most  economists advocate a presumption that restrictions upon competition will result in a reduction in efficiency . Those theoretical developments were the foundation for [[antitrust]] and other forms of [[competition policy]], the economics and politics of which have been developed by George Stigler .


[[Microeconomics]] <ref name=MICRO_EXERCISES>[http://www.msu.edu/course/ec/201/brown/pim/ '''''MICROECONOMICS: Most important concepts explained in detail'''''. Text and workable problems. <small>'''WARNING: Internet Explorer will not work!''' Get "Firefox" or "Netscape" for free. Requires "Adobe Acrobat Reader" as a helper to your web browser. You will need "Excel 97" or higher running on your computer to use the spreadsheets.</small>]</ref> <ref name=MICROECONOMICS>[http://arielrubinstein.tau.ac.il/Rubinstein-revision.pdf RUBINSTEIN, Ariel. ''Lecture notes in microeconomic theory : the economic agent''. Princeton: Princeton University Press, 2006.]</ref> is a continuation and elaboration of the work of the early neo-classicals. It deals with the behaviour of individuals and firms, and with individual markets. Other 1930's economists, [[Joan Robinson]] at Cambridge and [[Edwin Chamberlin]] in the U.S. developed the theory of imperfect competition. Joan Robinson was responsible for the idea that profit maximization involve the equation of marginal cost and marginal revenue, while Chamberlin was responsible for the idea of monopolistic competition and product differentiation.
===The theory of the firm===
The tools of welfare economics were also used to develop the [[theory of the firm]] by Nicholas Kaldor of the London School of Economics  in his ''Equilibrium of the Firm'' <ref> Nicholas Kaldor ''The Equilibrium of the Firm'' the Economic Journal 1934 </ref> and Ronald Coase  in his "The Nature of the Firm <ref>[http://courses.essex.ac.uk/ec/ec262/lecture_notes/CoaseNatureofthefirmj.1468-0335.1937.tb00002.x.pdf Ronald Coase: ''The Nature of the Firm'', Economica, November 1937 ]</ref>. (Those theoretical developments have been summarised in William Baumol's ''Economic Theory and Operations Analysis'' <ref> William Baumol ''Economic Theory and Operations Analysis'' Chapters 9 and 10, Prentice-Hall 1961</ref>. An empirical study of the way firms actually behave is provided by Cyert and March's ''Behavioral Theory of the Firm'' <ref>[http://www.questia.com/read/89106593 Richard Cyert and James G March ''The Behavioral Theory of the Firm'' Prentice-Hall 1963]</ref>)


Keynesianism became the orthodoxy in economics until well into the 1970's. In order not to abandon all the neo-classical economics that had been built up, the dominant economic ideology became the Keynesian-neo-classical synthesis. The basic idea was to let the government ensure full employment, and then neo-classical economics could be used to ensure the best allocations of resources. The Keynesian-neo-classical synthesis is generally associated with [[Paul Samuelson]], who wrote the most influential ever textbook in economics. Most economics texts today are clones of [[Paul Samuelson|Samuelson's]] text, generally following the same general outline. The 1950's and 60's were the heyday of Keynesian economics, when most economists believed that the judicious application of government intervention could smooth out the business cycle and ensure full employment without inflation.
===Economic growth===
There has been succession of attempts to create [[model (theory)| models]] of economic growth that identify the contributions of such factors as investment, productivity, innovation and institutional environment; and that explain the differences in growth experienced by different regions of the world. In the simple model proposed by Malthus in 1850, growth could not exceed population growth, but it was not long before it became evident that it was doing so. The ''Harrod-Domar  model'' <ref>  Roy Harrod ''An essay in dynamic theory'' Economic Journal March 1939</ref>, and its successors, assume that there would be sufficient economic growth to enable some to go into growth-enhancing  investments. In a later development, the 1956 ''Solow model'' <ref> Robert Solow ''A Contribution to the Theory of Economic Growth''  Quarterly Journal of Economics 70 1956</ref> introduced the influence of the substitution of [[capital (economics)|capital]] for labour that results from  investment in improved capital equipment. Solow also pioneered the technique of ''growth accounting'' , which he used to estimate relative  contributions to historical growth in the United States; and he identified an unexplained residual which he termed ''total factor productivity'', the growth of which he attributed to technological change. Technological change was [[exogenous]] to the Solow model, in that it was not the consequence of factors that were represented in the model. As a result of  subsequent research, notably that  of Paul Romer <ref> Paul Romer ''Endogenous Technological Change'' Journal of Political Economy October 1986</ref> and Robert Lucas <ref> Robert Lucas Jr  ''On the Mechanics of Economic Development''  Journal of Monetary Economics July 1988</ref>,  some of the factors believed to influence technological change, such as expenditure on R&D and training, have since been  embodied in the growth models, which are termed ''[[endogenous growth]] models''. The most recent work on the subject has sought to identify the contributions to economic growth of institutional factors such as quality of governance, trust, and ethic diversity; and to explore its links with geographical factors and globalisation.


==The monetarist "counterrevolution"==
==Keynesian macroeconomics==
===The contribution of John Maynard Keynes===
The most important contribution to economic thought by [[John Maynard Keynes]] was his examination of the factors determining the levels of national income and employment, and the causes of economic fluctuations. His major (and hard to read) work, the ''General Theory of Employment, Interest and Money'', contains a sustained attack on much of the thinking of classical economics - mainly on the grounds that their postulates were unrealistic. His first target was Say's law of markets with its denial of the possibility of a general deficiency of demand. He challenged its implicit assumption that  money is no more than a medium of exchange by drawing  attention to the [[speculative motive]]  for holding money. Secondly, he attacked the classical economists' contention that it was the [[interest rate]] that reconciled savings plans with investment plans, claiming that the level of savings was largely determined by the level of national income. Thirdly, he rejected the classical economists' assumption that any tendency for unemployment to rise would be corrected by a reduction in the general level of wages, substituting the contention that "wages are sticky downward". Having substituted his assumptions for those of his predecessors, he advanced the thesis that a deficiency of demand could occur if there was an excess of planned savings over planned investment, because such an  excess could be removed only by a reduction in national income. The implication of that thesis was that the economy could settle down into a condition of high unemployment, lacking the self-righting mechanism envisaged by the classical economists.


While the [[Keynesians|Keynesian]]-[[Neoclassical]] synthesis took over the profession, an unregenerate rearguard of neo-classical economists centred at the University of Chicago continued to exist. 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 1970's. Not only did they succeed in bringing the Keynesian theory down, but they considerably extended the scope of [[microeconomics]] <ref name=MICRO_EXERCISES>[http://www.msu.edu/course/ec/201/brown/pim/ '''''MICROECONOMICS: Most important concepts explained in detail'''''. Text and workable problems. <small>'''WARNING: Internet Explorer will not work!''' Get "Firefox" or "Netscape" for free. Requires "Adobe Acrobat Reader" as a helper to your web browser. You will need "Excel 97" or higher running on your computer to use the spreadsheets.</small>]</ref>  to include even education and family formation.
===Neo-Keynesianism===
Shortly after the publication of Keynes' ''General Theory'',  John Hicks published an article entitled "''Mr Keynes and the Classics''"<ref>[https://webspace.utexas.edu/hcleaver/www/368/368hicksonkeynes.html John Hicks ''Mr Keynes and the Classics''(Econometrica, April 1937)]</ref>,  in which he  produced a synthesis between the Keynesian and neoclassical models. Its main feature is  the ''[[IS/LM]] diagram'' with its intersecting curves, one of which (Investment/Savings) relates the demand for savings to the interest rate,  and the other (Liquidity/Money Supply) relates the demand for money to the interest rate - and in which the  point of intersection of the two curves represents an equilibrium level of demand.  (The IS/LM diagram subsequently  came to be known as the ''Hicks-Hansen diagram'' in recognition of prior work by the American economist Alvin Hansen . The important feature of the synthesised model is that it can be made to depict behaviour in accordance with either the Keynesian model or the neoclassical model, depending upon what is assumed concerning the slopes of the two curves. In doing so it introduced a fundamental departure in the methodology of economics - a change from an exclusive reliance upon logical deduction from ''a priori'' postulates, to the increasing use of the [[induction (philosophy|inductive]] process of testing hypotheses against empirical evidence, that was made possible at the time by the comparatively recent practice of systematically collecting [[economic statistics]]. The work of a large body of economists was subsequently devoted to testing such hypotheses, using the mathematical technique known as "''[[econometrics]]''". That work does not appear to have resolved the controversy concerning the usefulness of the two models (except that some economists now acknowledge that one or the other seems to have worked better from time to time and in some countries' economies)


With the perceived failure of [[Keynesians|Keynesian]] economics to explain and correct the ''"[[stagflation]]"'' of the 1970's, the free market prescriptions of [[monetarism]] became much more popular, and were eventually espoused by many right wing governments in the 1980's (Reagan, Thatcher, Mulroney), and, perhaps more importantly, by the central banks of most industrialized countries.
===Policy Implications===
A Keynesian consensus dominated the economic policies of the developed countries for two or three decades following the second world war. Keynesian stabilisation policy required governments to counter downturns in demand by cutting taxes or increasing [[public expenditure]]. Since it takes some years for such actions to take effect, their timing had to be based upon forecasts using computerised [[economic forecasting models]], but  forecasting errors and misguided attempts to stimulate growth often had destabilising consequences. Measures that unwittingly stimulated demand at a time when an economy was operating at its full capacity, frequently gave rise to rising inflation - for which the only remedy appeared to be wage restraint - and the situation was sometimes exacerbated by the operation of [[Foreign Exchange|foreign exchange]] policies. Opposition to those policy actions came from economists of the [[Austrian School]], and from economists of the [[Chicago School]] whose thinking is described below.


==Economics today and the [[Keynesians|Keynesian revival]]==
==Monetarism and the Chicago School==
===The Chicago School===
The University of Chicago School of Economics  
<ref>[http://economics.uchicago.edu/ The University of Chicago Department of Economics]</ref>  has enjoyed a reputation for economic excellence since its foundation in 1892  However, the term ''Chicago School'' is usually taken to refer to the outlook and methodology of its economists during the period that started in the 1960s - including  Milton Friedman, George Stigler, Ronald Coase, Robert Lucas, Cary Becker, Harry Johnson and Merton Miller, and to some like-minded economists in other universities. It is best known for its advocacy of [[monetarism]] but its economists have also made contributions on a wide range of other topics, including international trade, rational expectations and institutional economics. Their methodology embodies an approach, which philosophers term [[instrumentalism|instrumentalist]], that gives the predictive value of a theory priority over the representativeness of its assumptions <ref>Milton Friedman ''The Methodology of Positive Economics''</ref>


However, the basic prescription of monetarism failed when it was attempted in the late 1970s and early 1980s. For some this meant moving to even more radical free market positions (Rational Expectations and Real Business Cycle theories), while others attempted to put Keynesian economics on a more sound microeconomic foundation such as the ''[[New Keynesian|New Keynesian economics]]'' <ref name=NEWKEYNESHET>[http://cepa.newschool.edu/het/schools/newk.htm '''"New Keynesians"''']</ref>.
===Monetarism===
The [[Monetarism#The monetary equation|quantity theory]] of money, which is often attributed to the economist [[Irving  Fisher]], but which  undoubtedly had earlier origins, equated  the volume of money in circulation multiplied by a notional "velocity of circulation". to the volume of physical output multiplied by its unit price (usually written as MV = PT). If the velocity of circulation were roughly constant, that would imply an association between [[inflation]] and growth in the [[money supply]]. Milton Friedman found that to have been the case during various periods in United States history <ref> Friedman and Meiselman The relative stability of monetary velocity and the Investment Multiplier in the United States 1897-1958 in ''Stabilisation Policies, CMC Research Papers'' p165  Prentice-Hall 1964</ref>, and that periods of monetary expansion had been followed by periods of inflation, although with long and variable time-lags. That led him to argue that Keynesian demand management would be ineffective in the long run because it would be accompanied by a damaging rise in the money supply; and that stability of demand and prices could better be achieved by control of the money supply. The controversy that followed  was mainly concerned with the nature of the [[Monetarism#The transmission mechanism|transmission mechanism]] (the question whether an excess of money would bid up the prices of goods, or whether it would be invested in interest-bearing [[bond]]s without affecting the prices of goods).


Economics today is in a state of crisis, with a number of contending schools and a whole lot of economists in between. The schools that can be distinguished include. from left to right: [[Marxist Socialism|Marxists]], Neo-Ricardians, Post Autistic, Post Keynesians, [[New Keynesian|New Keynesians]] <ref name=PRIZELECT>[http://nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-lecture.html    STIGLITZ, Joseph E. '''''Prize Lecture: Information and the Change in the Paradigm in Economics.''''' <small>Joseph E. Stiglitz held his Prize Lecture December 8, 2001, at Aula Magna, Stockholm University. He was presented by Lars E.O. Svensson, Chairman of the Prize Committee.</small>]</ref>, various degrees of Neo-classical-Keynesians, various degrees of Monetarists, Real Business Cycle, Rational Expectationist. They differ fundamentally about the amount and level of government intervention in the economy, ranging from almost total control for [[Marxist Socialism|Marxists]] to complete libertarian ''[[laissez-faire]]'' for the Rational Expectationists.
A theory connecting the [[money supply]] and the [[balance of payments]] had previously been put forward  by Harry Johnson when he was a professor of economics at Manchester University. The conventional view had been that the [[exchange rate]] is determined by the balance between the supply and demand  of exports and imports, but  Harry Johnson treated it as the relative price of the moneys in circulation in the two countries <ref>[http://www.questia.com/library/book/international-trade-and-economic-growth-studies-in-pure-theory-by-harry-g-johnson.jsp Harry G Johnson ''International Trade and Economic Growth'' Chapter 6 Harvard UP 1958]</ref>. One of the implications of his theory  is that if the [[exchange rate]] is fixed, the money supply cannot be controlled - which was a consideration that influenced the Chicago School's campaign to put an end to the system of fixed exchange rates then in operation. Another is that if the money supply is held constant, the [[balance of payments]] is self-correcting.


However, a new dominant school or mainstream seems to be emerging: the [[New Keynesian economics|''"New Keynesians]]"'' <ref name=NEWKEYNESHET>[http://cepa.newschool.edu/het/schools/newk.htm '''"New-keynesians"''']</ref>. They reject the simplistic ''[[laissez-faire]]'' of the monetarists, but recognize many of their criticisms as valid and see some limitations to the ability of governments to act to cure all economic ills. They are particularly preoccupied with creating a proper [[Microeconomics|microeconomic]] <ref name=MICRO_EXERCISES>[http://www.msu.edu/course/ec/201/brown/pim/ '''''MICROECONOMICS: Most important concepts explained in detail'''''. Text and workable problems. <small>'''WARNING: Internet Explorer will not work!''' Get "Firefox" or "Netscape" for free. Requires "Adobe Acrobat Reader" as a helper to your web browser. You will need "Excel 97" or higher running on your computer to use the spreadsheets.</small>]</ref> foundation for Keynesian economics. They focus mainly on rigidities, market imperfections, and the economics of information, which result in the need for some kinds of government intervention, but without the unbridled faith in the ability of government to solve all problems that Keynesians had in the 1950's and 60's. One of the leading new-keynesian <ref name=PRIZELECT>[http://nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-lecture.html    STIGLITZ, Joseph E. '''''Prize Lecture: Information and the Change in the Paradigm in Economics.''''' <small>Joseph E. Stiglitz held his Prize Lecture December 8, 2001, at Aula Magna, Stockholm University. He was presented by Lars E.O. Svensson, Chairman of the Prize Committee.</small>]</ref> economists is [[Joseph E. Stiglitz]] <ref name=STIGLITZ>[http://cepa.newschool.edu/het/profiles/stiglitz.htm Joseph Stiglitz]</ref>, who won the ''The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001'' <ref name=NOBEL2001>[http://nobelprize.org/nobel_prizes/economics/laureates/2001/press.html ''The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001'']</ref> (a.k.a., imprecisely, ''Nobel in Economics'').
===Expectations===
{{main|Neoclassical Schools (1871-today)}}
Milton Friedman also attacked the thinking behind the [[Phillips curve]] (which had reflected the observation that [[inflation]] tended to fall when there was a rise in [[unemployment]]) on the grounds that it failed to take account of expectations. He proposed its replacement by the [[expectations-augmented Phillips curve]] <ref> Edmund  Phelps ''Money wage dynamics and labor market equilibrium''. Journal of Political Economy 1968</ref>, and used that construction to  counter fears that a reduction in growth of the money supply would lead to a sustained increase in unemployment. To do so, he introduced the concept  of the [[non-accelerating-inflation rate of unemployment]] (NAIRU), which is usually referred to as its [[natural rate of unemployment|natural rate]], and which is the unemployment rate at which the expected inflation rate is the same as its actual rate. He argued that if a reduction in money supply growth caused unemployment to rise above its natural rate, the expected inflation rate would fall, setting in motion a sequence of events that would cause unemployment to revert to its natural rate. Conversely, a reduction in unemployment accompanying an increase in the money supply would cause an increase in expected inflation, prompting wage demands which would lead to an increase in actual inflation - a process which could continue indefinitely.
{{main|Joseph E. Stiglitz}}


==Alternative schools==
Applying the concept of "rational expectations"<ref> John Muth "Rational Expectations and the Theory of Price Movements" Econometrica, Vol. 29, No. 3, July 961)</ref>
formulated by his former colleague, John Muth, to the operation of economic policy, Robert Lucas  of the Chicago School put forward what has become known as the ''Lucas Critique''<ref> Robert Lucas ''Econometric Policy Evaluation: A Critique.'' Carnegie-Rochester Conference Series on Public Policy 1: 19–46 1976</ref> . He argued that policy actions tend to change people's expectations so that the same policy action could have future consequences that differ from the consequences that it had in the past. That possibility has fundamental implications for the construction of forecasting models, and the Lucas critique  also raises the possibility that public reactions could frustrate the achievement of policy objectives.


The schools of economic thought which differ from the mainstream [[Neoclassical]] tradition are called ''"Heterodox"''. Among them one of the most important are the [[Keynesians]] (and their sub-divisions)
===Policy implications and outcomes===
The Chicago School's prescription for stabilisation problem was confined  to the control the [[money supply]], and its prescription for the reduction of unemployment was to take measures to improve wage - and [[price flexibility]]. Concern for rising [[inflation]], and the failure of attempts to control it by wage restraint, led to the widespread adoption of the first of those prescriptions in the late 1970s. In the United States, the Congress passed The Full Employment and Balanced Growth Act  (known as the Humphrey-Hawkins Act) which required the [[Federal Reserve System|Federal Reserve Bank]] to set one-year target ranges for money supply growth twice a year and to report the targets to Congress. In the United Kingdom, the Callaghan administration adopted a specific money supply objective: a practice that was enthusiastically adopted by its successor Thatcher administration. In both countries, attempts to keep the growth of the money supply within pre-set limits were generally unsuccessful (and in the United Kingdom,  money supply growth actually increased <ref> Nick Gardner ''Decade of Discontent'' p207 Basil Blackwell 1987 </ref>) and were eventually abandoned. Some central bankers have said that they take account of long-term money supply trends, but none consider control of the money supply to be a practicable instrument of stabilisation policy. Consensus monetary policy since the late 1980s  uses interest rates as a means of stabilising both prices and output<ref> [http://www.bankofengland.co.uk/publications/other/monetary/bean070413.pdf Charles Bean ''Is There a Consensus in Monetary Policy?'']</ref>, and the median inflation rate in 13 industrialised countries has fallen from around 15 per cent in the mid 1970s and early 1980s to around 2 per cent in 2005<ref> Kenneth Kuttner and Adam Posen ''Do Markets Care Who Chairs the Central Bank'' NBER Working Paper 13101 02007</ref>.


===Heterodox tradition===
==Institutional Economics==
===The Institutionalist School===
The term ''Institutionalist'' refers to economists who argue that economic activity cannot properly be understood except in the context of the public and social structure in which it takes place.  That approach to the can be traced back to the ''German Historical School'', which included Friedrich List and Max Weber, who is best known for his ''The Protestant Ethic and the Spirit of Capitalism''.  But the term is more commonly applied to the views of a pre-war group of American economists whose leading member was [[Thorstein Veblen]] - the man who coined the term ''conspicuous consumption'' - and whose lasting contributions were the collection of economic statistics and the study  of business cycles.


The strain of economic thought that begins with the Utopians and Socialists ([[Jean-Jacques Rousseau]], 1712-1788) and follows with The [[Fabian Socialists]],  Gustav Schmoller and the [[German Historical School]], [[The English Historical School]], [[The French Historical School]], [[Thorstein Veblen]] and the [[American Institutionalist School]], [[Joseph Schumpeter]] and Evolutionary Economics, The Soviet Planning Economists, The Neo-Marxians/Radical Political Economy and the [[New School for Social Research]] forms what is called the '''''[[Economic Heterodox Tradition|Heterodox Tradition]]''''' <ref>[http://l.web.umkc.edu/leefs/htn5.htm LEWIS, Paul. ''Transforming Economics, Perspectives on the Critical Realist Project''. London: Taylor and Francis(Routledge), 2004. ISBN 0415369673]</ref> <ref>[http://pdftohtml.spiritofanime.com/pdf2html.php?url=http://www.econ.uoa.gr/UA/files/1027030227..pdf LAWSON, Tony. ''Why Methodology?'' Faculty of Economics and Politics, Cambridge, 2003.]</ref> and will be subjetct of another article.
===Modern institutional economics===
{{main|Economic heterodox tradition}}
A major contributor to the theory of institutional economics has been Ronald Coase, who summarised his approach in his 1991 Nobel Prize lecture <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1991/coase-lecture.html Ronald Coase ''The Institutional Structure of Production'' The Nobel Prizes 1991, Nobel Foundation 1992]</ref>. Early in his career as an economist he had formulated what came to be known as the ''[[Coase Theorem]]'' which was the proposition  that economic efficiency will be achieved provided that property rights are fully allocated and can freely be traded; a proposition which he developed further in his 1960 paper ''The Problem of Social Cost'' <ref>[http://www.cerna.ensmp.fr/Enseignement/CoursEcoIndus/SupportsdeCours/COASE.pdf Ronald Coase The Problem of Social Cost ''Journal of Law and Economics'' October 1960]</ref>. The development of institutional economics by economists at the University of Chicago has taken them across the conventional borders of economics into the disciplines of law, sociology and politics. (An extreme example has been the publication of the best-selling ''Freakonomics'' that was jointly authored by the Chicago economist Steven Levitt and the New York journalist Stephen Dubner, and which applies economic thinking to such questions as cheating, drug dealing and the connection between crime and abortion.)


===Keynesians===
===Mechanism design theory===
A recent extension to institutional economics is concerned with how well  different institutions and allocation mechanisms achieve goals  such as  welfare and  private profit. Contributions to that subject by Leonid Hurwicz of the University of Minnesota, Eric Maskin of Princeton and Roger Myerson of Chicago earned them the 2007 Nobel Prize in Economics.


[[John Maynard Keynes]] <ref name=KEYNESHET>[http://cepa.newschool.edu/het/profiles/keynes.htm '''John Maynard Keynes''']</ref> is reputedly one the most important figures in the entire history of economics. He revolutionized economics with his classic book, ''The General Theory of Employment, Interest and Money'' <ref name=KEYNES1>[http://cepa.newschool.edu/het/texts/keynes/gtcont.htm KEYNES, John Maynard. ''The General Theory of Employment, Interest and Money''. London: Macmillan Press; New York: St. Martin's Press,; 1936]</ref> (1936).  This is generally regarded as probably the most influential social science treatise of the 20th Century. It permanently changed the way the world looked at the economy and the role of government in society.
===Public choice theory===
A different approach to the same questions <ref>[http://www.econlib.org/LIBRARY/Enc/PublicChoiceTheory.html Public Choice]</ref> had previously been put forward under the heading of [[public choice theory]], the principle contribution to which had been James Buchanan and Gordon Tullock's major treatise, ''The Calculus of Choice'' <ref>[http://www.econlib.org/LIBRARY/Buchanan/buchCv3Contents.html James Buchanan and Gordon Tullock ''The Calculus of Consent'']</ref>. However, Buchanan and Tullock are best known for their analysis of the behaviour of politicians, civil servants and voters on the assumption that they are mainly motivated by personal gain,  rather than a desire to serve the public interest.


[[Keynesianism]] was the mainstream economic thought from the publication of [[Keynes|Keynes's]] book  until the early 1970's, when economists became increasingly critical of traditional [[Keynesians|Keynesian's ]] ideas, partly because of their assumed lack of micro-foundations. However, the attempts to construct a new macroeconomics based on traditional microeconomics, with its assumptions of well functioning markets, was doomed to failure. Recessions and depressions, accompanied by massive unemployment, were symptomatic of massive market failures. The market for labor was clearly not clearing.
==International economics==


This problem led a large gropu economists, led by [[Stiglitz]], to research on other aspects of traditional neoclassical models to try to improve them. Those efforts gave rise to a new ''"Keynesian Revival"''.  
===The gains from trade===
{{main|Keynesians}}
David Ricardo's law of [[comparative advantage]] - and its implication that trade restrictions are damaging to the interests of the country that imposes them - was the starting-point of the historical  development  of trade theory <ref>Douglas  Irwin Against the Tide: ''An Intellectual History of Free Trade'' Princeton University Press 1997</ref>. The subsequent theoretical developments of "classical" trade theory have mainly been  attempts to create mathematical models of inter-country trade. The best-known of those was the Heckscher-Ohlin Theory <ref>
{{main|John Maynard Keynes}}
[http://mitpress.mit.edu/catalog/item/default.asp?tid=4723&ttype=2  Eli  Heckscher and Bertil Ohlin ''Heckscher-Ohlin'' Trade Theory  (Ed Harry Flam and . June Flanders) MIT Press]</ref>, which deduced from a range of highly restrictive assumptions that a country will export those commodities that are intensive in the factor of production in which it is most well-endowed. That theory was extended by Paul Samuelson to conclude that, in the absence of  productivity differences, trading between two countries would tend to equalise wages and capital costs in those countries. However, doubt was cast upon the relevance of the Heckscher-Ohlin theory by Wassily Leontief's discovery that the United States, which is the world's most capital-intensive country, had been exporting labour-intensive commodities and importing capital-intensive commodities. The general conclusion has been that international trade is mainly driven by factors other than labour-intensity and capital-intensity. "Modern" trade theory depends mainly upon the econometric analysis of international trade statistics,and has produced a range of findings concerning the influence of factors such as innovation and training.


==Thematic schools==
===Infant industries===
There was  opposition in the early nineteenth century to the proposition that trade restrictions reduce welfare  from a small group of economists, including Friedrich List of the German Historical School, who argued that free trade should not be permitted until the government had taken the measures necessary to establish the country's "productive powers". That was the precursor of  the argument for ''infant-industry protection'' that was politically influential in  the early twentieth century and which led to the introduction of the ''Smoot-Hartley'' system of industrial [[tariff]]s in the United States. It has been given recent expression in Ha-Joon Chang's book  ''Kicking Away the Ladder'' <ref>[http://www.paecon.net/PAEtexts/Chang1.htm Ha-Joon Chang ''Kicking Away the Ladder'']</ref> which suggests that industrial successes in Britain and the United States (and later in  creating an automobile industry in South Korea) were attributable to the fact that they were protected from overseas competition until they were large enough to benefit from [[economies of scale]]. The mainstream reaction among economists concedes that the case for free trade does not take account of the benefits of scale economies, and that welfare gains from temporary trade restrictions might in principle be possible if a government were sufficiently successful in "picking winners" but that tax incentives and [[subsidy|subsidies]] are more effective than tariffs <ref>Bhagwati  and Ramaswami. ''Domestic Distortions, Tariffs and the Theory of Optimum Subsidy  - Some Further Results''  Journal of Political Economy, 1969, vol. 77, issue 6, pages 1005-10' (1963)</ref> .


'''Thematic Schools''' refer to those schools of economic thought which concentrate on the study of some particluar aspect of economics. The most important themes studied by the ''Thematic Schools are: ''Business Cycle Theory'', ''Empirics and Econometrics'', ''Imperfect Competition'', ''Economic Development'', ''Uncertainty and Information'', ''Game Theory'' and ''Finance Theory''.  
===Globalisation===
{{main|Thematic schools}}
[[Globalization|Globalisation]] is seen by most economists as contributing to economic welfare by promoting competition and the division of labour. But there are exceptions. Professor Joseph Stiglitz <ref>[http://www2.gsb.columbia.edu/faculty/jstiglitz/ Joseph Stiglitz website]</ref> <ref>[http://www.cceia.org/resources/transcripts/101.html Interview with Joseph Stiglitz]</ref> of the Columbia Business School has advanced the infant industry case for [[protection]] in developing countries and criticised the conditions imposed for help by the International Monetary Fund <ref>Joseph Stiglitz ''Globalization and its Discontents" Norton 2002</ref>. And Professor Dani Rodrik of Harvard<ref>[http://rodrik.typepad.com Dani Rodrik's website]</ref> has noted that the  benefits of globalisation are unevenly spread, leading to income inequalities that, in his view, lead to damaging losses of [[social capital]], and to the migration of labour causing social stresses in receiving countries <ref>Dani Rodrik ''Has Globalization Gone Too Far?.'' Institute for International Economics 1997.  
</ref>


==Economics subdisciplines==
==Financial economics==
===Overview===
Economists and professional investors gave little attention to [[financial economics]] until the adoption in the 1970s of [[model (theory)|models]] based upon the [[financial economics#The efficient markets hypothesis|efficient markets hypothesis]]. That hypothesis was the basis of risk analysis using the assumption that price variations on the markets for financial [[asset (finance)|assets]] could be treated as random variations, which could be represented by established [[probability distribution]]s. The international financial industry made use of the models to select investments that were predicted to give the best return for a stipulated level of risk. It was not until the  [[crash of 2008| 2008 financial crisis]] that it was widely recognised that the efficient market hypothesis was no more than a statement of a general tendency, and that additional risks could  arise from statistically unpredictable patterns of investor conduct.


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.
===The finance market===
The study of [[financial economics]] had its origin in a 1900 thesis entitled ''Theorie  de la Speculation'' by the French mathematician Louis Bachelier <ref> Jean-Michel Courtault, Yuri Kabarov And Bernard Bru: "Louis Bachelier and the Centenary of the Theorie de la Speculation",  ''Mathematical Finance'' Vol10 No3 July 2000</ref>, according to which price fluctuations in a speculative market are analogous to the Brownian Movement of physics (the [[random walk]] of statistics theory), such that there is no combination of prices that offer the prospect of a certain gain.  In 1933, the American economist Alfred Cowles<ref>[http://cowles.econ.yale.edu/archive/people/directors/cowles.htm Alfred Cowles]</ref>  developed a similar thesis, which he published in a  paper entitled ''Can Stock Market Forecasters Forecast?''.  According to Cowles' [[efficient market hypothesis]], all of the available information  that was relevant to an asset's prospects would already be embodied in its price (so that the answer to his question was "no"). The hypothesis depended upon the assumptions that most traders behave rationally, and that the activities of the others are mutually cancelling. Those assumptions were widely accepted, and on their basis, financial markets were taken to be essentially stable. Hyman Minsky's 
1986 [[Financial economics#The financial instability hypothesis|financial instability hypothesis]], which suggested that financial markets are apt to become unstable after a period of sustained economic growth, received little attention at the time.
A number of [[Financial economics/Tutorials|mathematical models of finance markets]] based upon the efficient markets hypothesis were developed in the course of the 20th century and were widely applied as guides to investment, but financial economics was then considered by most of the economics profession to be a specialised subject of little general interest, regarding the financial system as a collection of secondary markets whose internal characteristics do not affect the rest of the economy.


Some of the Economics subdisciplines do not fit neatly into those major divisions, reaching parts of both; they are the ''"Comprehensive subdisciplines"''.
===Portfolio and asset price theory===
A sequence of Nobel Prize-winning  advances concerning the problem of getting the best return from an investment without exceeding a chosen level of risk, occurred during the period from the 1950s to the 1970s. The sequence started in the late 1950s, when James Tobin <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1981/tobin-autobio.html James Tobin]</ref> and Harry Markowitz laid the foundations of modern portfolio management. In his  "Separation Theorem",  Tobin proposed a two-stage process in which the required risk ceiling could be maintained by mixing risky and riskless assets, and Markowitz demonstrated the benefits of a diversified portfolio in which the prices of it assets would not rise and fall together, using the statistical concept of [[covariance]]. In 1970, William Sharpe<ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1990/sharpe-autobio.html William Sharpe]</ref> applied that concept to the tendency of the price of an asset to rise and fall in concert with the all-share index, assigning the title "Beta" to its mathematical definition, and used it to derive a pricing method know as the [[Capital Asset Pricing Model]], and in 1973, Fischer Black <ref>[http://www.mayin.org/ajayshah/MEDIA/1995/black.html Fischer Black]</ref> and Myron Scholes <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1997/scholes-autobio.html Myron Scholes]</ref> developed the Black-Scholes model which made use of the fact that the expected volatility of an asset is reflected in its price in the options market, which led to the development by Robert Merton <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1997/merton-autobio.html Robert Merton]</ref> of the "Contingency Claims Analysis" method of pricing assets.


{{main|Economics subdisciplines}}
===Corporate finance===
During the same period there was a sequence of advances in the economics of corporate finance. It started with the demonstration by Franco Modigliani <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1997/merton-autobio.html Franco Modigliani]</ref> and Merton Miller <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1990/miller-autobio.html Merton Miller]</ref> that shareholders should be indifferent to the level of a corporation's debts provided that it was possible to repay them costlessly with money available at a riskless rate of interest. Other economists subsequently augmented the ''Modigliani-Miller'' theory with allowances for the effects of taxation and of [[information asymmetry]].


==External links==
==Recent developments ==
<div class="references-small" style="-moz-column-count:2; column-count:2;">
===The Greenspan era===
Divergences of view about economic management persisted into the early 21st century, but a consensus developed among those responsible for the management of the major economies, along the lines of a speech by the then United States [[Federal reserve system|Federal Reserve Board]] Chairman, [[Alan Greenspan]]<ref>[http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm  Alan Greenspan: ''The Challenge of Central Banking in a Democratic Society'', (lecture to The American Enterprise Institute for Public Policy Research, December 5, 1996, Federal Reserve Board 1996]</ref>. The use of [[Keynesian theory|Keynesian]] [[fiscal policy]] to regulate output was considered to have proved ineffective and inflationary, and [[Monetarism|monetarist]] attempts to control the [[money supply]] were seen to have been unsuccessful. The new rôle of fiscal policy was the  maintenance of [[fiscal stability]], responsibility for the management of the economy had become the exclusive function of [[monetary policy]], and monetary policy was confidently expected  to prevent serious interruption to economic growth  (the President of the American Economic Association had declared that "The central problem of depression-prevention [has] been solved, for all practical purposes"<ref>[http://home.uchicago.edu/~sogrodow/homepage/paddress03.pdf Robert E. Lucas, Jr: Presidential Address to the American Economic Association, January 10, 2003]</ref>). The [[financial system]] was considered to be essentially stable, making [[financial regulation]] unnecessary.


* [http://www.chass.utoronto.ca/~reak/eco100/contents.htm '''''ECONOMICS 100 ONLINE'''''. Department of Economics at the University of Toronto<small><copyright K.J. Rea, 2000-2003 all rights reserved>.</small>] ('''A great "primer" to understanding the basic principles of Economics''')
The conclusion of the era was marked by Alan Greenspan's 2008 congressional testimony:
<blockquote>
:"In recent decades, a vast risk management and pricing system has evolved combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology.  A Nobel prize was awarded for the discovery of the pricing model that underpins much of the advance in the derivatives markets.  This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year."<ref>[http://clipsandcomment.com/wp-content/uploads/2008/10/greenspan-testimony-20081023.pdf Testimony of Dr. Alan Greenspan before the Committee of Government Oversight and Reform October 23, 2008]</ref>
</blockquote>


* [http://www.msu.edu/course/ec/201/brown/pim/ '''''MICROECONOMICS: Most important concepts explained in detail'''''. Text and workable problems. <small>'''WARNING: Internet Explorer will not work!''' Get "Firefox" or "Netscape" for free. Requires "Adobe Acrobat Reader" as a helper to your web browser. You will need "Excel 97" or higher running on your computer to use the spreadsheets.</small>]
The shortcomings of economic theory in that respect have been held
<ref>for example by Professor Shin of Princeton University [http://www.voxeu.eu/index.php?q=node/3948 Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009]</ref> to have played a major role in the [[crash of 2008|the financial crisis of 2008]].


* [http://cepa.newschool.edu/het/ ''The History of Economic Thought Website'' <small><forever 'under construction'></small> ]]
===Post-Great Recession thinking===
The [[crash of 2008|financial crisis of 2008]] and the resulting [[Great Recession]] prompted much  re-thinking of economic theory.
Professor Shin of Princeton University  reported  that the "race is on" to  add a new perspective to [[macroeconomics]] by the incorporation into it of a new theory of  financial economics<ref>[http://www.voxeu.eu/index.php?q=node/3948 Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009]</ref>, and there was new thinking about the use of [[financial regulation]] to reduce the risk of fresh financial [[shock (economics)|shocks]]. A re-examination of the rôle of [[fiscal policy]] had been triggered  among economists and politicians by a 2008 proposal by Britain's  [[Gordon Brown]] for a coordinated [[fiscal stimulus]] to counter the expected recessionary effects of the financial crisis. The idea was dismissed as ineffective by some economists<ref>[http://www.dimensional.com/famafrench/2009/01/bailouts-and-stimulus-plans.html Eugene Fama: ''Bailouts and Stimulus Plans'' January 2009]</ref><ref>[http://www.iea.org.uk/record.jsp?type=pressArticle&ID=376 ''Keynesian over-spending won't rescue the economy'', Letter by IEA economists in the Sunday Telegraph, 26 October 2008]</ref>, and as inflationary by others
<ref>[http://www.nytimes.com/2009/05/04/opinion/04meltzer.html Allan Meltzer: ''Inflation Nation'', New York Times op-ed, 3rd May 2009]</ref>, and it  was rejected by Germany's [[Angela Merkel]]<ref>[http://www.time.com/time/world/article/0,8599,1865273,00.html Catherine Mayer: ''Behind a Merkel Snub, Euro Economic Discord'', Time, 9 December 2008]</ref> and ridiculed by her finance minister as "crass Keynesianism"<ref>[http://news.bbc.co.uk/1/hi/business/7780160.stm Tristana Moore: ''Steinbrueck 'shouldn't scare UK'''BBC News 12 December 2008]</ref>
Although fiscal stimulus packages were implemented during the [[recession of 2009]], they were not sustained by European governments to support the faltering recovery in  2010, and programmes of [[fiscal contraction]] were widely introduced in 2011. The main reason that was given for that reversal of fiscal policy was the fear that operators in the [[bond]] market would lose confidence in governments' ability to service the levels of [[public debt]] that their continuation would involve. The European Union's [[European Union/Addendum|Fiscal Compact]] (which  places mandatory restrictions upon the use of fiscal policy  by its signatories) may gain political approval, but its economic consequences are likely to remain a matter of  controversy. Unlike the European governments, the United States government has not introduced a major programme of fiscal contraction, and the  Congress  has not been able to agree on a plan for the reduction of the government's budget deficit<ref>[http://topics.nytimes.com/top/reference/timestopics/organizations/c/congress/joint_congressional_committee_on_deficit_reduction/index.html  ''Joint Select Committee on Deficit Reduction (Deficit "Super Committee")'', New York Times, 22 March, 2012]</ref>.  A controversy also remains unresolved concerning the merit of techniques known as [[quantitative easing]] by which [[central bank]]s seek to increase the [[money supply]] in order to relieve  [[credit crunch]]es and stimulate economic activity<ref>[http://www.cnbc.com/id/39775319/CEOs_Debate_the_Merits_of_QE2_%E2%80%A8%E2%80%A8 Lori Ann LaRocco: ''CEOs Debate the Merits of QE2'', CNBC News, 21 Oct 2010]</ref><ref>[http://economics21.org/commentary/e21s-open-letter-ben-bernanke ''Open Letter to Ben Bernanke'', 15 November 2010]</ref>.


* [http://www.helsinki.fi/WebEc/ ''World Wide Web Resources in Economics''.  Center for Innovative Education, Helsinki School of Economics, Finland. (An excellent sorce of links to the various Economics subdisciplines)]
The history of economic thought has taken an unexpected turn, and a new consensus on economic management has not yet emerged.
 
* [http://ancienthistory.about.com/library/bl/bl_text_xenophon.htm Xenophon]
 
 
 
 
 
 
 
 
 
 
 
</div>
 
== See also ==
<div class="references-small" style="-moz-column-count:2;column-count:2;">
* [[Classical economy]]
* [[Econometrics]]
* [[Economic Theory]]
* [[Econophysics]]
* [[History of Ancient Economics]]
* [[Keynesians]]
* [[Macroeconomics]]
* [[Microeconomics]]
* [[Neoclassical Schools (1871-today)]]
* [[Neuroeconomics]]
* [[Supply and demand]]
</div>


==References==
==References==
<div class="references-small" style="-moz-column-count:2; column-count:2;">
{{reflist|2}}[[Category:Suggestion Bot Tag]]
<references /></div>
 
==Bibliography==
 
<div class="references-small" style="-moz-column-count:2; column-count:2;">
 
* [[Asimakopulos|ASIMAKOPULOS]], Athanasios; with CAIRNS, Robert D. and GREEN, Christopher.''Economic Theory, Welfare, and the State''. Montreal: McGill University Press, 1991. ISBN 0773508538.
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/beccaria/pubecon BECCARIA, Marquis Caesar Beccaria Bonesaria. ''A Discourse on Public Economy and Commerce''. Hamilton, Ontario: McMaster University.]
 
*[http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/bentham/usury BENTHAM, Jeremy. ''Defence of Usury''(1787). Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/cantillon/index.html CANTILLON, Richard. '' An Essay on Commerce in General''. Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/ferguson/civil.html FERGUSON, Adam. ''An Essay on the History of Civil Society''. Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/galiani/index.html GALIANI, Ferdinando. ''Della Moneta''. Hamilton, Ontario, McMaster Universisty]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/galiani/bleds.htm GALIANI, Ferdinando. ''Dialogues sur le commerce des bleds''. Hamilton, Ontario, McMaster Universisty]
 
* [http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=8361 GOSSEN, Hermann Heinrich. ''The Laws of Human Relations and the Rules of Human Action Derived Therefrom''.<small>Translated by Rudolph C. Blitz; introduction by Nicholas Georgescu-Roegen. Cambridge, MA: MIT Press, 1983.] ISBN 0262070901</small>
 
* [http://www.questia.com/PM.qst?a=o&d=97704533 HANEY, Lewis H., Ph.D. ''History of economic thought: a critical account of the origin and development of the economic theories of the leading thinkers in the leading nations''. New York: The Macmillan Company, 1920.]
 
* [http://www.constitution.org/dh/origcont.htm HUME, David. Of The Original Contract (1748), Edited and rendered into HTML by Jon Roland, in: www.constitution.org.]
 
* [http://www.constitution.org/dh/hume.htm HUME, David. ''Selected Essays'' (1748).in: www.constitution.org.]
 
* [http://www.constitution.org/dh/perfcomw.htm HUME, David. Idea Of A Perfect Commonwealth'' (1754). Edited and rendered into HTML by Jon Roland. in: www.constitution.org.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/hume/interest.txt HUME, David. ''Of Interest''. Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/hume/trade.txt HUME, David. ''Of the Balance of Trade''. Hamilton, Ontario: McMaster University.]
 
* [http://www.constitution.org/jk/jk_000.htm KENT, James. ''Commentaries on American Law'' (in four volumes). New York: Published by O. Halstead, 15th edition, 1826. Edited by Jon Roland, 1997-2002. in: www.constitution.org.]
 
* KEYNES, John Maynard. ''Treatise on Money, A''. New York: Harcourt, Brace and Co.; 1st American edition; 1930
 
* [http://cepa.newschool.edu/het/texts/keynes/gtcont.htm KEYNES, John Maynard. ''General Theory of Employment, Interest and Money, The''. London: Macmillan Press; New York: St. Martin's Press; 1936]
* LEIJOHNUFVUD, Axel. ''On Keynesian economics and the economics of Keynes : a study in monetary theory''. New York: Oxford University Press, 1968.
 
* LERNER, Abba. ''The Economics of Control: Principles of Welfare Economics''. New York: MacMillan, 1960. <small>First published in 1944</small>
 
*PARETO, Vilfredo. ''Cours d'Economie Politique''. F.Rouge, Lausanne, 1896.
 
* PARETO, Vilfredo. ''Manual of Political Economy''; Translated By Ann S. Schwier; Edited By Ann S. Schwier and Alfred N. Page Pareto; Publisher: Augustus M. Kelley; 1971.
 
* [http://www.taieb.net/auteurs/Quesnay/tableau.html QUESNAY, François (1694-1774). ''Analyse de la formule arithmétique du TABLEAU ÉCONOMIQUE de la distribution des dépenses annuelles d'une Nation agricole''. <small> Courtesy of Mme Paulette Taieb, Université de Paris</small>]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/ricardo/prin/index.html RICARDO, David. ''The Principles of Political Economy and Taxation''. 1815 (third ed. 1821). Hamilton, Ontario: McMaster University.]
 
* [http://www.constitution.org/jjr/polecon.htm ROSSEAU, Jean Jacques. ''A Discourse On Political Economy''(1755). in: www.constitution.org.]
 
* [http://arielrubinstein.tau.ac.il/Rubinstein-revision.pdf RUBINSTEIN, Ariel. ''Lecture notes in microeconomic theory : the economic agent''. Princeton: Princeton University Press, 2006.]
 
* [http://www.constitution.org/cm/sol.htm SECONDAT,Charles de, Baron de Montesquieu. ''The Spirit Of The Laws''. Translated by Thomas Nugent, revised by J. V. Prichard, Based on an public domain edition published in 1914 by G. Bell &  Sons, Ltd., London.]
 
* [http://www.econlib.org/library/Smith/smWN.html SMITH, Adam (1723-1790). ''An Inquiry into the Nature and Causes of the Wealth of Nations''. London: Methuen and Co., Ltd., ed. Edwin Cannan, 1904. Fifth edition. <small>(Downloadable)</small>]
 
* [http://nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-lecture.html    STIGLITZ, Joseph E. '''''Prize Lecture: Information and the Change in the Paradigm in Economics.''''' <small>Joseph E. Stiglitz held his Prize Lecture December 8, 2001, at Aula Magna, Stockholm University. He was presented by Lars E.O. Svensson, Chairman of the Prize Committee.</small>]
 
* [http://pdfdownload.bofd.net/pdf2html.php?url=http://www2.gsb.columbia.edu/faculty/jstiglitz/download/2006_Samuelson.pdf STIGLITZ, Joseph E. ''Samuelson and the Factor Bias of Technological Change: Toward a Unified Theory of Growth and Unemployment''. in: 17; Szenberg; Chap16; 13/07/06 03:35 PM; pp. 235-251.]
 
* [http://pdftohtml.markoer.org/pdf2html.php?url=http://www2.gsb.columbia.edu/faculty/jstiglitz/download/2006_Infant_Economies_AER.pdf STIGLITZ, Joseph E. and GREENWALD, Bruce. ''Helping Infant Economies Grow: Foundations of Trade Policies for Developing Countries''. New Developments in Macroeconomics, in:American Economic Review, Volume 96, Number 2 (May 2006), pp. 141-146.]
 
* STIGLITZ, Joseph E. and GREENWALD, Bruce. ''Towards a New Paradigm in Monetary Economics''. Cambridge University Press, 2003. ISBN 0521810345
*STIGLITZ, Joseph E. ''Making Globalization Work'', W.W. Norton, September, 2006. ISBN 0393061221
 
* [http://www.ccel.org/a/aquinas/summa/home.html THOMAS AQUINAS, Saint (1225?-1274).''The Summa Theologica''. Benziger Bros. edition, 1947. Translated by Fathers of the English Dominican Province.<small>Acknowledgement: This digital file was produced through the kindness of Sandra K. Perry, Perrysburg, Ohio.</small>]
 
* [http://www.constitution.org/tb/tb-0000.htm TUCKER, St. George.''Blackstone's Commentaries: with notes of reference to the Constitution and Laws of the Federal Government of the United States; and of the Commonwealth of Virginia''. in: www.constitution.org.]
* [http://www.taieb.net/auteurs/Turgot/ref1788/r88_69.html TURGOT, Anne-Robert-Jacques Turgot, Baron de l'Aulne (1727-1781).''Réflexions sur la formation et la distribution des richesses'', Paris, 1788. <small> Courtesy of Mme Paulette Taieb, Université de Paris</small>]
 
* [http://www.econlib.org/Library/Essays/trgRfl1.html TURGOT, Anne-Robert-Jacques Turgot, Baron de l'Aulne (1727-1781).''Reflections on the Formation and Distribution of Wealth''. London: Printed by E. Spragg, 1793. Translated from the French. First published 1774.]
 
* WALRAS, Léon. ''Eléments d'économie politique pure, ou Théorie de la richesse sociale''. Lausanne: F.Rouge, Paris Guillaumin; Paris: Guillaumin & Cie [etc.], et al.; 1889.
 
* [http://www.taieb.net/auteurs/Walras/mech_gf.pdf WALRAS, Léon.''Economique e Mecanique''. (1909). Bulletin de la Société Vaudoise de Sciences Naturelles, Vol. 45, p.313-325. Suivie d'une lettre de Henri Poincaré (1901), et avec une note introductive de G.H. Bousquet (1960). <small>Transcription par Gonçalo L. Fonseca (History of the Economic Thought Website), Courtesy of Mme Paulette Taieb, Université de Paris</small>]
 
 
[[Category:CZ Live]]
[[Category:Economics Workgroup]]

Latest revision as of 11:00, 28 August 2024

This article has a Citable Version.
 Main Article
 Discussion
Related Articles  [?]
Bibliography  [?]
External Links  [?]
Citable Version  [?]
Timelines [?]
 
https://en.citizendium.org/wiki/index.php?title=History_of_economic_thought&printable=yes
This editable Main Article has an approved citable version (see its Citable Version subpage). While we have done conscientious work, we cannot guarantee that this Main Article, or its citable version, is wholly free of mistakes. By helping to improve this editable Main Article, you will help the process of generating a new, improved citable version.

This article is intended to be of interest to students of economics at all levels.
It is also intended to be accessible to all who take an informed interest in accounts of economic developments in the media.

Modern economic thought is generally considered to have originated in the late eighteenth century with the work of David Hume and Adam Smith, the founders of classical economics. The nineteenth and twentieth centuries saw major developments in the methodology and scope of economic theory; and the early twenty-first century has seen a rethinking of some previously accepted tenets.

Nineteenth- and early twentieth-century economists applied deductive reasoning to axioms considered to be self-evident and simplified 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 advantage. An understanding of the relationships governing transactions between consumers and producers was considered to provide all that was necessary to explain the behaviour of the economic system.

The development, in the latter half of the 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. By that time, the concept had emerged of the national economy as a complex interactive system, and analysis of that concept provided explanations of recessions, unemployment and inflation that were not previously available. The application of empirical data and inductive reasoning enabled those theories to be refined, and led to the development of forecasting models that could be used as tools of economic management.

The development of economic thought in the early 21st century has been stimulated by the financial crisis and Great Recession, and the questions that these events raised concerning the functioning of the global financial system and the part that it plays in the functioning of the economic system generally.

The search for understanding continues.

Overview: categories of economic thought

Historians categorise economic thought into “periods” and “schools”, and tend to attribute each innovation to one individual. This categorisation is helpful for the purpose of exposition, but the reality has been a story of interwoven intellectual threads in which advances attributed to particular individuals or schools have often prompted the work of others. For example, the quantity theory of money, which achieved prominence in the twentieth century and is associated with Milton Friedman, was first formulated at least three centuries earlier. Many of those threads, that have permeated the categories referred to as "Classical economics" and "Neoclassical economics", had earlier origins. "Classical", in economics, denotes the adoption in the late eighteenth century of an approach that was inspired by the enlightenment and the methodology of the physical sciences, and that had abandoned previous examinations of economics in terms of ethics, religion and politics. Preoccupation with those threads was overshadowed in the twentieth century by the responses of Keynesianism and monetarism to the problems of unemployment and inflation, but the development of neoclassical economics started before that time, and has continued thereafter. The introduction of new tools of exploration has since led to the vigorous development of that, and other, threads, and an expansion in the scope of economics into many new directions.

Classical Economics

David Hume

The Scottish philosopher David Hume was an early exponent of what was later known as monetary economics, and was an opponent of "mercantilism". Mercanilist policy at the time, regulated trade in ways that subsidised exports so as to promote inflows of gold and silver, and restricted imports in order to discourage outflows. Hume contested the mercantilist thesis, partly on the grounds that an inflow of money would cause inflation, and partly on the grounds that nations would benefit from the international specialisation that would result from the introduction of free trade. More generally, Hume argued that all government intervention in commerce tended to obstruct economic progress.[1].

Adam Smith

A major advance in the development of economics occurred with the publication in 1776 of Adam Smith's An Inquiry into the Nature and Causes of The Wealth of Nations.[2]. Smith wrote a comprehensive treatment of the subject, using deductive logic in a manner similar to its use in the physical sciences. His main purpose was to recommend changes of economic policy in the interests of economic growth. He argued that the division of labour was the main cause of economic growth. His famous maxim was that the extent of the market is determined by the division of labour. To thus expand markets, required that they should not be impeded by governmental policies. He therefore opposed government intervention in commerce (as in mercantilist trade regulation). But he did not oppose all governmental intervention into the economy. He advocated government spending upon what are now termed public goods such as defence, law enforcement, infrastructure, and education of the children of people who could not afford it. He identified what he considered to be the economic drawbacks of all forms of taxation (except the taxation of land values) and of public expenditure. He examined the relation of price to value and concluded that the price of a product tends to equality with its cost of production, which he termed its "natural price". He reasoned that "when the quantity brought to market is just sufficient to supply the effectual demand and no more, the market price naturally comes to be either exactly, or as nearly as can be judged of, the same with the natural price" - an outcome which he took to be the normal result of market bargaining.

Jean-Baptiste Say

Jean-Baptiste Say[3] was an influential advocate of Adam Smith's teaching in French government circles, but his best-known contribution was what came to be known as "Say's Law of Markets." Later paraphrased as "supply creates its own demand," Say's law stated that, although there could be an imbalance between the supply and the demand for particular products, no such imbalance could exist in the economy as a whole. It was based upon the postulate that money plays no part in the functioning of the economy beyond its role as a medium of exchange. (The claim that money is nothing but a medium of exchange, is another way of saying that people use money only for buying things (including stocks and bonds). Say justified that postulate by arguing that it would be foolish to hold money out of circulation because that would mean needlessly going without things (or without dividends or interest). Say's Law remained part of mainstream classical economics until John Maynard Keynes drew attention to the speculative and precautionary motives for holding money.

Thomas Malthus

In his influential Essay on the Principle of Population, Thomas Malthus postulated that the population would grow at a geometric rate (2, 4, 8, 16...) while food production could only increase arithmetically (1, 2, 3, 4 ....) and concluded that the food supply would eventually be insufficient to support the population.[4] This theory led him to oppose the introduction of the UK's Poor Law, and to advocate the protection of agriculture. In other respects, he followed Adam Smith in opposing government intervention in commerce. Evidence in support of his postulates was lacking at the time, and they have since been found to be mistaken[5], mainly because they took no account of the benefits of technical change.

David Ricardo

With minor reservations, David Ricardo accepted and extended Adam Smith’s economics. In his major work,The Principles of Political Economy and Taxation, he accepted the concept of a value-determined “natural price”, although he considered value to be determined by labour value added, rather than cost.[6] Following Adam Smith’s lead, he also developed the wage fund concept that the amount available for the payment of wages is fixed at any particular level of capital investment, so that an increase in the supply of labour would lead to a reduction in wage rates. He pioneered a definition of rent as the difference between the produce of a unit of labour on the land in question, and its produce on the least productive land in use. In a further extension to Adam Smith’s work, he explored the incidence of taxation on wages, profits, houses, and rent, identifying in each case (but with the exception of rent) its harm to the economy. Probably his most influential contribution, however, was his development of his "Law of Comparative advantage" that challenged the belief that the trading of a product is possible only with those with a lesser ability to produce it. Ricardo produced a logical demonstration that there can be mutually beneficial trade between two countries, one of which is better able than the other to produce all of the commodities that are traded.

Karl Marx

Karl Marx[7] adapted Ricardo's concept of labour value and put it to an entirely different use. In his analysis, as in Ricardo's, labour consumption determines value. This, Marx termed exchange value. But Marx regarded each labourer as a product, whose exchange value is determined by the labour inputs required to feed, clothe, and train him. He reasoned that what the employer receives is the labourer's use value, which is determined by the utility of his products. Marx noted that a labourer's use value normally exceeds his exchange value, and he termed the difference surplus value, which was the employer's profit. Like Adam Smith and his classical predecessors, Marx was preoccupied with the subject of economic growth but, unlike them, he saw technical progress as a major contributor.

Marx was probably the first economist to make a systematic attempt to explain the fluctuations in economic activity known as the business cycle. He considered that if technical progress were to slow down, the only way to maintain growth would be to invest more and more in machinery and buildings, as a result of which the rate of profit on new investment would fall, leading to a further reduction in growth. Also, in his view, any departure from the conditions necessary for steady growth would lead to the accumulation of unwanted stocks of goods, producing a downturn in economic activity - until price-cutting, in order to get rid of surpluses, put the process into reverse.

In his major work, Das Kapital[8] Marx puts his findings in an historical, concludes that economic conditions shape history, and forecasts a breakdown of the capitalist system and its replacement by socialism.

Other contributors

Among the many lesser contributors to classical economic theory, the best-known was John Stuart Mill. His Principles of Political Economy[9], although intended by the author merely to bring together the works of others, offered some fresh insights into increasing returns to scale and their consequences for the development of monopolies, and anticipated (though not in these terms) the neoclassical concepts of elasticity and the determination of price by the interaction of supply and demand.

Written during the classical period, but without recognition at the time, was the Theory of the Firm by the French economist and mathematician Antoine Augustin Cournot. Cournot used differential calculus to demonstrate the profit-maximising requirement of equality between marginal cost and marginal revenue, thus anticipating some of the more important developments of neoclassical economics.

Neoclassical Economics

The neoclassical approach

The term "neoclassical" is commonly applied to all of the continuing developments in economic thinking that followed the replacement of value-based concepts by the concept of markets that are governed by the interaction of supply and demand. In that sense, the term denotes a period rather than a consistent approach - although it is a period that overlaps the competing approaches of Keynesianism and monetarism. It is nevertheless a period in which most economists have deduced their findings from the same hypothetical postulates - including the assumption of competitive markets in which consumers maximise utility and producers maximise profits. Within that framework of postulates, neoclassical economists have explored a variety of aspects of economic activity in a variety of different ways.

Marginal analysis

The neoclassical period is also marked by an expansion in the number of people applying their minds to the problems of economics, as a result of which there have frequently been similar contributions from a number of different thinkers. That was true of the innovative concepts of marginal analysis, that are attributable to the contributions of William Stanley Jevons [10] , Carl Menger [11] and Léon Walras [12]. Their contributions have been brought together by Alfred Marshall in his Principles of Economics [13], which provides the reader with an accessible and readable (and non-mathematical) account of those and other contributions. The concept of utility, was given more prominence, and it was demonstrated logically (and mathematically) that a rational consumer would continue to buy additional units of a product until its marginal utility (the increase in utility obtainable from one additional unit of the product) became level with to its price; and that a rational supplier would continue to offer additional units of a product until its marginal cost became level with the marginal revenue that he would get from selling it. The American economist, John Bates Clark, subsequently applied the concept to a market in which a rational employer would continue to hire labour until its marginal product became level with the prevailing wage rate.

Equilibrium and the Price Mechanism

The concept of "market equilibrium" is central to the neoclassical model. Léon Walras[14] thought of it as the achievement of an imaginary auctioneer who adjusts a notional opening price in response to a succession of bids by buyers and sellers, and permits transactions to take place only when a price is reached at which buyers are willing to buy all that is offered for sale. That is the process of price determination by supply and demand which marks the abandonment of the concept of value-determined price, and which is examined in detail in Alfred Marshall's Economics and in Milton Friedman's Price Theory[15]. Walras, and subsequently the Italian economist Vilfredo Pareto [16], later developed the concept of a general equilibrium in which supply is equal to demand in every market in a closed economy. The normal assumption of neoclassical economics is that of a stable equilibrium to which the economy will automatically return after a disturbance. In such an economy, unemployment does not persist because any excess in the supply of labour, relative to its demand, is corrected by a reduction in wages.

Welfare and Efficiency

The most politically influential of the contributions of the neoclassical economists was probably their development of the concept of welfare. In accordance with the precepts of representative government, they assumed the criterion for the success of an economic system to be the welfare of the individual, and they introduced the concept of economic efficiency as a measure of that success. Vilfredo Pareto took the lead in defining efficiency as a state in which no-one could be made better off without making someone worse off. The three types of efficiency were identified as productive efficiency (the production of good at minimum cost), allocative efficiency (the provision of the mix of goods that consumers want) and distributive efficiency (the distribution of the goods in such a way as to maximise individual welfare). That work laid the foundations for the subsequent development of the theory of welfare economics by Sir John Hicks and others. (The subject of economic welfare is discussed extensively in Arthur Pigou's Economics of Welfare [17], and the theorems of welfare economics are summarised in William Baumol's Economic Theory and Operations Analysis [18])

Competition

The theorems of welfare economics establish a presumption that allocative efficiency - that is to say that resources will be optimally allocated as between the production of alternative products - will be achieved under the hypothetical conditions of perfect competition. (Those conditions include the requirement that for each product there is no supplier large enough to influence prices, that all producers supply identical products, and that all consumers are well informed and behave rationally.) Despite the unreasonableness of those requirements, most economists advocate a presumption that restrictions upon competition will result in a reduction in efficiency . Those theoretical developments were the foundation for antitrust and other forms of competition policy, the economics and politics of which have been developed by George Stigler .

The theory of the firm

The tools of welfare economics were also used to develop the theory of the firm by Nicholas Kaldor of the London School of Economics in his Equilibrium of the Firm [19] and Ronald Coase in his "The Nature of the Firm [20]. (Those theoretical developments have been summarised in William Baumol's Economic Theory and Operations Analysis [21]. An empirical study of the way firms actually behave is provided by Cyert and March's Behavioral Theory of the Firm [22])

Economic growth

There has been succession of attempts to create models of economic growth that identify the contributions of such factors as investment, productivity, innovation and institutional environment; and that explain the differences in growth experienced by different regions of the world. In the simple model proposed by Malthus in 1850, growth could not exceed population growth, but it was not long before it became evident that it was doing so. The Harrod-Domar model [23], and its successors, assume that there would be sufficient economic growth to enable some to go into growth-enhancing investments. In a later development, the 1956 Solow model [24] introduced the influence of the substitution of capital for labour that results from investment in improved capital equipment. Solow also pioneered the technique of growth accounting , which he used to estimate relative contributions to historical growth in the United States; and he identified an unexplained residual which he termed total factor productivity, the growth of which he attributed to technological change. Technological change was exogenous to the Solow model, in that it was not the consequence of factors that were represented in the model. As a result of subsequent research, notably that of Paul Romer [25] and Robert Lucas [26], some of the factors believed to influence technological change, such as expenditure on R&D and training, have since been embodied in the growth models, which are termed endogenous growth models. The most recent work on the subject has sought to identify the contributions to economic growth of institutional factors such as quality of governance, trust, and ethic diversity; and to explore its links with geographical factors and globalisation.

Keynesian macroeconomics

The contribution of John Maynard Keynes

The most important contribution to economic thought by John Maynard Keynes was his examination of the factors determining the levels of national income and employment, and the causes of economic fluctuations. His major (and hard to read) work, the General Theory of Employment, Interest and Money, contains a sustained attack on much of the thinking of classical economics - mainly on the grounds that their postulates were unrealistic. His first target was Say's law of markets with its denial of the possibility of a general deficiency of demand. He challenged its implicit assumption that money is no more than a medium of exchange by drawing attention to the speculative motive for holding money. Secondly, he attacked the classical economists' contention that it was the interest rate that reconciled savings plans with investment plans, claiming that the level of savings was largely determined by the level of national income. Thirdly, he rejected the classical economists' assumption that any tendency for unemployment to rise would be corrected by a reduction in the general level of wages, substituting the contention that "wages are sticky downward". Having substituted his assumptions for those of his predecessors, he advanced the thesis that a deficiency of demand could occur if there was an excess of planned savings over planned investment, because such an excess could be removed only by a reduction in national income. The implication of that thesis was that the economy could settle down into a condition of high unemployment, lacking the self-righting mechanism envisaged by the classical economists.

Neo-Keynesianism

Shortly after the publication of Keynes' General Theory, John Hicks published an article entitled "Mr Keynes and the Classics"[27], in which he produced a synthesis between the Keynesian and neoclassical models. Its main feature is the IS/LM diagram with its intersecting curves, one of which (Investment/Savings) relates the demand for savings to the interest rate, and the other (Liquidity/Money Supply) relates the demand for money to the interest rate - and in which the point of intersection of the two curves represents an equilibrium level of demand. (The IS/LM diagram subsequently came to be known as the Hicks-Hansen diagram in recognition of prior work by the American economist Alvin Hansen . The important feature of the synthesised model is that it can be made to depict behaviour in accordance with either the Keynesian model or the neoclassical model, depending upon what is assumed concerning the slopes of the two curves. In doing so it introduced a fundamental departure in the methodology of economics - a change from an exclusive reliance upon logical deduction from a priori postulates, to the increasing use of the inductive process of testing hypotheses against empirical evidence, that was made possible at the time by the comparatively recent practice of systematically collecting economic statistics. The work of a large body of economists was subsequently devoted to testing such hypotheses, using the mathematical technique known as "econometrics". That work does not appear to have resolved the controversy concerning the usefulness of the two models (except that some economists now acknowledge that one or the other seems to have worked better from time to time and in some countries' economies)

Policy Implications

A Keynesian consensus dominated the economic policies of the developed countries for two or three decades following the second world war. Keynesian stabilisation policy required governments to counter downturns in demand by cutting taxes or increasing public expenditure. Since it takes some years for such actions to take effect, their timing had to be based upon forecasts using computerised economic forecasting models, but forecasting errors and misguided attempts to stimulate growth often had destabilising consequences. Measures that unwittingly stimulated demand at a time when an economy was operating at its full capacity, frequently gave rise to rising inflation - for which the only remedy appeared to be wage restraint - and the situation was sometimes exacerbated by the operation of foreign exchange policies. Opposition to those policy actions came from economists of the Austrian School, and from economists of the Chicago School whose thinking is described below.

Monetarism and the Chicago School

The Chicago School

The University of Chicago School of Economics [28] has enjoyed a reputation for economic excellence since its foundation in 1892 However, the term Chicago School is usually taken to refer to the outlook and methodology of its economists during the period that started in the 1960s - including Milton Friedman, George Stigler, Ronald Coase, Robert Lucas, Cary Becker, Harry Johnson and Merton Miller, and to some like-minded economists in other universities. It is best known for its advocacy of monetarism but its economists have also made contributions on a wide range of other topics, including international trade, rational expectations and institutional economics. Their methodology embodies an approach, which philosophers term instrumentalist, that gives the predictive value of a theory priority over the representativeness of its assumptions [29]

Monetarism

The quantity theory of money, which is often attributed to the economist Irving Fisher, but which undoubtedly had earlier origins, equated the volume of money in circulation multiplied by a notional "velocity of circulation". to the volume of physical output multiplied by its unit price (usually written as MV = PT). If the velocity of circulation were roughly constant, that would imply an association between inflation and growth in the money supply. Milton Friedman found that to have been the case during various periods in United States history [30], and that periods of monetary expansion had been followed by periods of inflation, although with long and variable time-lags. That led him to argue that Keynesian demand management would be ineffective in the long run because it would be accompanied by a damaging rise in the money supply; and that stability of demand and prices could better be achieved by control of the money supply. The controversy that followed was mainly concerned with the nature of the transmission mechanism (the question whether an excess of money would bid up the prices of goods, or whether it would be invested in interest-bearing bonds without affecting the prices of goods).

A theory connecting the money supply and the balance of payments had previously been put forward by Harry Johnson when he was a professor of economics at Manchester University. The conventional view had been that the exchange rate is determined by the balance between the supply and demand of exports and imports, but Harry Johnson treated it as the relative price of the moneys in circulation in the two countries [31]. One of the implications of his theory is that if the exchange rate is fixed, the money supply cannot be controlled - which was a consideration that influenced the Chicago School's campaign to put an end to the system of fixed exchange rates then in operation. Another is that if the money supply is held constant, the balance of payments is self-correcting.

Expectations

Milton Friedman also attacked the thinking behind the Phillips curve (which had reflected the observation that inflation tended to fall when there was a rise in unemployment) on the grounds that it failed to take account of expectations. He proposed its replacement by the expectations-augmented Phillips curve [32], and used that construction to counter fears that a reduction in growth of the money supply would lead to a sustained increase in unemployment. To do so, he introduced the concept of the non-accelerating-inflation rate of unemployment (NAIRU), which is usually referred to as its natural rate, and which is the unemployment rate at which the expected inflation rate is the same as its actual rate. He argued that if a reduction in money supply growth caused unemployment to rise above its natural rate, the expected inflation rate would fall, setting in motion a sequence of events that would cause unemployment to revert to its natural rate. Conversely, a reduction in unemployment accompanying an increase in the money supply would cause an increase in expected inflation, prompting wage demands which would lead to an increase in actual inflation - a process which could continue indefinitely.

Applying the concept of "rational expectations"[33] formulated by his former colleague, John Muth, to the operation of economic policy, Robert Lucas of the Chicago School put forward what has become known as the Lucas Critique[34] . He argued that policy actions tend to change people's expectations so that the same policy action could have future consequences that differ from the consequences that it had in the past. That possibility has fundamental implications for the construction of forecasting models, and the Lucas critique also raises the possibility that public reactions could frustrate the achievement of policy objectives.

Policy implications and outcomes

The Chicago School's prescription for stabilisation problem was confined to the control the money supply, and its prescription for the reduction of unemployment was to take measures to improve wage - and price flexibility. Concern for rising inflation, and the failure of attempts to control it by wage restraint, led to the widespread adoption of the first of those prescriptions in the late 1970s. In the United States, the Congress passed The Full Employment and Balanced Growth Act (known as the Humphrey-Hawkins Act) which required the Federal Reserve Bank to set one-year target ranges for money supply growth twice a year and to report the targets to Congress. In the United Kingdom, the Callaghan administration adopted a specific money supply objective: a practice that was enthusiastically adopted by its successor Thatcher administration. In both countries, attempts to keep the growth of the money supply within pre-set limits were generally unsuccessful (and in the United Kingdom, money supply growth actually increased [35]) and were eventually abandoned. Some central bankers have said that they take account of long-term money supply trends, but none consider control of the money supply to be a practicable instrument of stabilisation policy. Consensus monetary policy since the late 1980s uses interest rates as a means of stabilising both prices and output[36], and the median inflation rate in 13 industrialised countries has fallen from around 15 per cent in the mid 1970s and early 1980s to around 2 per cent in 2005[37].

Institutional Economics

The Institutionalist School

The term Institutionalist refers to economists who argue that economic activity cannot properly be understood except in the context of the public and social structure in which it takes place. That approach to the can be traced back to the German Historical School, which included Friedrich List and Max Weber, who is best known for his The Protestant Ethic and the Spirit of Capitalism. But the term is more commonly applied to the views of a pre-war group of American economists whose leading member was Thorstein Veblen - the man who coined the term conspicuous consumption - and whose lasting contributions were the collection of economic statistics and the study of business cycles.

Modern institutional economics

A major contributor to the theory of institutional economics has been Ronald Coase, who summarised his approach in his 1991 Nobel Prize lecture [38]. Early in his career as an economist he had formulated what came to be known as the Coase Theorem which was the proposition that economic efficiency will be achieved provided that property rights are fully allocated and can freely be traded; a proposition which he developed further in his 1960 paper The Problem of Social Cost [39]. The development of institutional economics by economists at the University of Chicago has taken them across the conventional borders of economics into the disciplines of law, sociology and politics. (An extreme example has been the publication of the best-selling Freakonomics that was jointly authored by the Chicago economist Steven Levitt and the New York journalist Stephen Dubner, and which applies economic thinking to such questions as cheating, drug dealing and the connection between crime and abortion.)

Mechanism design theory

A recent extension to institutional economics is concerned with how well different institutions and allocation mechanisms achieve goals such as welfare and private profit. Contributions to that subject by Leonid Hurwicz of the University of Minnesota, Eric Maskin of Princeton and Roger Myerson of Chicago earned them the 2007 Nobel Prize in Economics.

Public choice theory

A different approach to the same questions [40] had previously been put forward under the heading of public choice theory, the principle contribution to which had been James Buchanan and Gordon Tullock's major treatise, The Calculus of Choice [41]. However, Buchanan and Tullock are best known for their analysis of the behaviour of politicians, civil servants and voters on the assumption that they are mainly motivated by personal gain, rather than a desire to serve the public interest.

International economics

The gains from trade

David Ricardo's law of comparative advantage - and its implication that trade restrictions are damaging to the interests of the country that imposes them - was the starting-point of the historical development of trade theory [42]. The subsequent theoretical developments of "classical" trade theory have mainly been attempts to create mathematical models of inter-country trade. The best-known of those was the Heckscher-Ohlin Theory [43], which deduced from a range of highly restrictive assumptions that a country will export those commodities that are intensive in the factor of production in which it is most well-endowed. That theory was extended by Paul Samuelson to conclude that, in the absence of productivity differences, trading between two countries would tend to equalise wages and capital costs in those countries. However, doubt was cast upon the relevance of the Heckscher-Ohlin theory by Wassily Leontief's discovery that the United States, which is the world's most capital-intensive country, had been exporting labour-intensive commodities and importing capital-intensive commodities. The general conclusion has been that international trade is mainly driven by factors other than labour-intensity and capital-intensity. "Modern" trade theory depends mainly upon the econometric analysis of international trade statistics,and has produced a range of findings concerning the influence of factors such as innovation and training.

Infant industries

There was opposition in the early nineteenth century to the proposition that trade restrictions reduce welfare from a small group of economists, including Friedrich List of the German Historical School, who argued that free trade should not be permitted until the government had taken the measures necessary to establish the country's "productive powers". That was the precursor of the argument for infant-industry protection that was politically influential in the early twentieth century and which led to the introduction of the Smoot-Hartley system of industrial tariffs in the United States. It has been given recent expression in Ha-Joon Chang's book Kicking Away the Ladder [44] which suggests that industrial successes in Britain and the United States (and later in creating an automobile industry in South Korea) were attributable to the fact that they were protected from overseas competition until they were large enough to benefit from economies of scale. The mainstream reaction among economists concedes that the case for free trade does not take account of the benefits of scale economies, and that welfare gains from temporary trade restrictions might in principle be possible if a government were sufficiently successful in "picking winners" but that tax incentives and subsidies are more effective than tariffs [45] .

Globalisation

Globalisation is seen by most economists as contributing to economic welfare by promoting competition and the division of labour. But there are exceptions. Professor Joseph Stiglitz [46] [47] of the Columbia Business School has advanced the infant industry case for protection in developing countries and criticised the conditions imposed for help by the International Monetary Fund [48]. And Professor Dani Rodrik of Harvard[49] has noted that the benefits of globalisation are unevenly spread, leading to income inequalities that, in his view, lead to damaging losses of social capital, and to the migration of labour causing social stresses in receiving countries [50]

Financial economics

Overview

Economists and professional investors gave little attention to financial economics until the adoption in the 1970s of models based upon the efficient markets hypothesis. That hypothesis was the basis of risk analysis using the assumption that price variations on the markets for financial assets could be treated as random variations, which could be represented by established probability distributions. The international financial industry made use of the models to select investments that were predicted to give the best return for a stipulated level of risk. It was not until the 2008 financial crisis that it was widely recognised that the efficient market hypothesis was no more than a statement of a general tendency, and that additional risks could arise from statistically unpredictable patterns of investor conduct.

The finance market

The study of financial economics had its origin in a 1900 thesis entitled Theorie de la Speculation by the French mathematician Louis Bachelier [51], according to which price fluctuations in a speculative market are analogous to the Brownian Movement of physics (the random walk of statistics theory), such that there is no combination of prices that offer the prospect of a certain gain. In 1933, the American economist Alfred Cowles[52] developed a similar thesis, which he published in a paper entitled Can Stock Market Forecasters Forecast?. According to Cowles' efficient market hypothesis, all of the available information that was relevant to an asset's prospects would already be embodied in its price (so that the answer to his question was "no"). The hypothesis depended upon the assumptions that most traders behave rationally, and that the activities of the others are mutually cancelling. Those assumptions were widely accepted, and on their basis, financial markets were taken to be essentially stable. Hyman Minsky's 1986 financial instability hypothesis, which suggested that financial markets are apt to become unstable after a period of sustained economic growth, received little attention at the time. A number of mathematical models of finance markets based upon the efficient markets hypothesis were developed in the course of the 20th century and were widely applied as guides to investment, but financial economics was then considered by most of the economics profession to be a specialised subject of little general interest, regarding the financial system as a collection of secondary markets whose internal characteristics do not affect the rest of the economy.

Portfolio and asset price theory

A sequence of Nobel Prize-winning advances concerning the problem of getting the best return from an investment without exceeding a chosen level of risk, occurred during the period from the 1950s to the 1970s. The sequence started in the late 1950s, when James Tobin [53] and Harry Markowitz laid the foundations of modern portfolio management. In his "Separation Theorem", Tobin proposed a two-stage process in which the required risk ceiling could be maintained by mixing risky and riskless assets, and Markowitz demonstrated the benefits of a diversified portfolio in which the prices of it assets would not rise and fall together, using the statistical concept of covariance. In 1970, William Sharpe[54] applied that concept to the tendency of the price of an asset to rise and fall in concert with the all-share index, assigning the title "Beta" to its mathematical definition, and used it to derive a pricing method know as the Capital Asset Pricing Model, and in 1973, Fischer Black [55] and Myron Scholes [56] developed the Black-Scholes model which made use of the fact that the expected volatility of an asset is reflected in its price in the options market, which led to the development by Robert Merton [57] of the "Contingency Claims Analysis" method of pricing assets.

Corporate finance

During the same period there was a sequence of advances in the economics of corporate finance. It started with the demonstration by Franco Modigliani [58] and Merton Miller [59] that shareholders should be indifferent to the level of a corporation's debts provided that it was possible to repay them costlessly with money available at a riskless rate of interest. Other economists subsequently augmented the Modigliani-Miller theory with allowances for the effects of taxation and of information asymmetry.

Recent developments

The Greenspan era

Divergences of view about economic management persisted into the early 21st century, but a consensus developed among those responsible for the management of the major economies, along the lines of a speech by the then United States Federal Reserve Board Chairman, Alan Greenspan[60]. The use of Keynesian fiscal policy to regulate output was considered to have proved ineffective and inflationary, and monetarist attempts to control the money supply were seen to have been unsuccessful. The new rôle of fiscal policy was the maintenance of fiscal stability, responsibility for the management of the economy had become the exclusive function of monetary policy, and monetary policy was confidently expected to prevent serious interruption to economic growth (the President of the American Economic Association had declared that "The central problem of depression-prevention [has] been solved, for all practical purposes"[61]). The financial system was considered to be essentially stable, making financial regulation unnecessary.

The conclusion of the era was marked by Alan Greenspan's 2008 congressional testimony:

"In recent decades, a vast risk management and pricing system has evolved combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel prize was awarded for the discovery of the pricing model that underpins much of the advance in the derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year."[62]

The shortcomings of economic theory in that respect have been held [63] to have played a major role in the the financial crisis of 2008.

Post-Great Recession thinking

The financial crisis of 2008 and the resulting Great Recession prompted much re-thinking of economic theory. Professor Shin of Princeton University reported that the "race is on" to add a new perspective to macroeconomics by the incorporation into it of a new theory of financial economics[64], and there was new thinking about the use of financial regulation to reduce the risk of fresh financial shocks. A re-examination of the rôle of fiscal policy had been triggered among economists and politicians by a 2008 proposal by Britain's Gordon Brown for a coordinated fiscal stimulus to counter the expected recessionary effects of the financial crisis. The idea was dismissed as ineffective by some economists[65][66], and as inflationary by others [67], and it was rejected by Germany's Angela Merkel[68] and ridiculed by her finance minister as "crass Keynesianism"[69] Although fiscal stimulus packages were implemented during the recession of 2009, they were not sustained by European governments to support the faltering recovery in 2010, and programmes of fiscal contraction were widely introduced in 2011. The main reason that was given for that reversal of fiscal policy was the fear that operators in the bond market would lose confidence in governments' ability to service the levels of public debt that their continuation would involve. The European Union's Fiscal Compact (which places mandatory restrictions upon the use of fiscal policy by its signatories) may gain political approval, but its economic consequences are likely to remain a matter of controversy. Unlike the European governments, the United States government has not introduced a major programme of fiscal contraction, and the Congress has not been able to agree on a plan for the reduction of the government's budget deficit[70]. A controversy also remains unresolved concerning the merit of techniques known as quantitative easing by which central banks seek to increase the money supply in order to relieve credit crunches and stimulate economic activity[71][72].

The history of economic thought has taken an unexpected turn, and a new consensus on economic management has not yet emerged.

References

  1. ↑ David Hume David Hume Essays, Moral and Political, 1742, Vol 2 "Of the Balance of Trade" (published by Liberty Fund, 1985).
  2. ↑ Adam Smith, The Wealth of the Nations (Modern Library, 2000).
  3. ↑ Jean-Baptiste Say
  4. ↑ Thomas Malthus, Essay on the Principle of Population.
  5. ↑ Nicolas Wade Why Malthus Was Mistaken, New York Times, September 19, 1999
  6. ↑ David Ricardo, The Principles of Political Economy and Taxation (John Murray, 1821).
  7. ↑ Karl Marx
  8. ↑ Karl Marx, Das Kapital (abridged).
  9. ↑ John Stuart Mill, Principles of Political Economy, (Longmans Green, 1926.
  10. ↑ William Stanley Jevons, 1835-1882
  11. ↑ Carl Menger, 1841-1921
  12. ↑ Marie Esprit Léon Walras (1834-1910)
  13. ↑ Alfred Marshall Principles of Economics Macmillan 1890
  14. ↑ Léon Walras
  15. ↑ Milton Friedman: Price Theory, Transaction Publishers, 2007
  16. ↑ Vilfredo Pareto
  17. ↑ Arthur C Pigou The Economics of Welfare Macmillan 1920,
  18. ↑ William Baumol Economic Theory and Operations Analysis Chapter 13, Prentice-Hall 1961
  19. ↑ Nicholas Kaldor The Equilibrium of the Firm the Economic Journal 1934
  20. ↑ Ronald Coase: The Nature of the Firm, Economica, November 1937
  21. ↑ William Baumol Economic Theory and Operations Analysis Chapters 9 and 10, Prentice-Hall 1961
  22. ↑ Richard Cyert and James G March The Behavioral Theory of the Firm Prentice-Hall 1963
  23. ↑ Roy Harrod An essay in dynamic theory Economic Journal March 1939
  24. ↑ Robert Solow A Contribution to the Theory of Economic Growth Quarterly Journal of Economics 70 1956
  25. ↑ Paul Romer Endogenous Technological Change Journal of Political Economy October 1986
  26. ↑ Robert Lucas Jr On the Mechanics of Economic Development Journal of Monetary Economics July 1988
  27. ↑ John Hicks Mr Keynes and the Classics(Econometrica, April 1937)
  28. ↑ The University of Chicago Department of Economics
  29. ↑ Milton Friedman The Methodology of Positive Economics
  30. ↑ Friedman and Meiselman The relative stability of monetary velocity and the Investment Multiplier in the United States 1897-1958 in Stabilisation Policies, CMC Research Papers p165 Prentice-Hall 1964
  31. ↑ Harry G Johnson International Trade and Economic Growth Chapter 6 Harvard UP 1958
  32. ↑ Edmund Phelps Money wage dynamics and labor market equilibrium. Journal of Political Economy 1968
  33. ↑ John Muth "Rational Expectations and the Theory of Price Movements" Econometrica, Vol. 29, No. 3, July 961)
  34. ↑ Robert Lucas Econometric Policy Evaluation: A Critique. Carnegie-Rochester Conference Series on Public Policy 1: 19–46 1976
  35. ↑ Nick Gardner Decade of Discontent p207 Basil Blackwell 1987
  36. ↑ Charles Bean Is There a Consensus in Monetary Policy?
  37. ↑ Kenneth Kuttner and Adam Posen Do Markets Care Who Chairs the Central Bank NBER Working Paper 13101 02007
  38. ↑ Ronald Coase The Institutional Structure of Production The Nobel Prizes 1991, Nobel Foundation 1992
  39. ↑ Ronald Coase The Problem of Social Cost Journal of Law and Economics October 1960
  40. ↑ Public Choice
  41. ↑ James Buchanan and Gordon Tullock The Calculus of Consent
  42. ↑ Douglas Irwin Against the Tide: An Intellectual History of Free Trade Princeton University Press 1997
  43. ↑ Eli Heckscher and Bertil Ohlin Heckscher-Ohlin Trade Theory (Ed Harry Flam and . June Flanders) MIT Press
  44. ↑ Ha-Joon Chang Kicking Away the Ladder
  45. ↑ Bhagwati and Ramaswami. Domestic Distortions, Tariffs and the Theory of Optimum Subsidy - Some Further Results Journal of Political Economy, 1969, vol. 77, issue 6, pages 1005-10' (1963)
  46. ↑ Joseph Stiglitz website
  47. ↑ Interview with Joseph Stiglitz
  48. ↑ Joseph Stiglitz Globalization and its Discontents" Norton 2002
  49. ↑ Dani Rodrik's website
  50. ↑ Dani Rodrik Has Globalization Gone Too Far?. Institute for International Economics 1997.
  51. ↑ Jean-Michel Courtault, Yuri Kabarov And Bernard Bru: "Louis Bachelier and the Centenary of the Theorie de la Speculation", Mathematical Finance Vol10 No3 July 2000
  52. ↑ Alfred Cowles
  53. ↑ James Tobin
  54. ↑ William Sharpe
  55. ↑ Fischer Black
  56. ↑ Myron Scholes
  57. ↑ Robert Merton
  58. ↑ Franco Modigliani
  59. ↑ Merton Miller
  60. ↑ Alan Greenspan: The Challenge of Central Banking in a Democratic Society, (lecture to The American Enterprise Institute for Public Policy Research, December 5, 1996, Federal Reserve Board 1996
  61. ↑ Robert E. Lucas, Jr: Presidential Address to the American Economic Association, January 10, 2003
  62. ↑ Testimony of Dr. Alan Greenspan before the Committee of Government Oversight and Reform October 23, 2008
  63. ↑ for example by Professor Shin of Princeton University Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009
  64. ↑ Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009
  65. ↑ Eugene Fama: Bailouts and Stimulus Plans January 2009
  66. ↑ Keynesian over-spending won't rescue the economy, Letter by IEA economists in the Sunday Telegraph, 26 October 2008
  67. ↑ Allan Meltzer: Inflation Nation, New York Times op-ed, 3rd May 2009
  68. ↑ Catherine Mayer: Behind a Merkel Snub, Euro Economic Discord, Time, 9 December 2008
  69. ↑ Tristana Moore: Steinbrueck 'shouldn't scare UK'BBC News 12 December 2008
  70. ↑ Joint Select Committee on Deficit Reduction (Deficit "Super Committee"), New York Times, 22 March, 2012
  71. ↑ Lori Ann LaRocco: CEOs Debate the Merits of QE2, CNBC News, 21 Oct 2010
  72. ↑ Open Letter to Ben Bernanke, 15 November 2010
Retrieved from "https://citizendium.org/wiki/index.php?title=History_of_economic_thought&oldid=974921"