History of economic thought

Economics is a social science. It studies the production, distribution, and consumption of goods and services. The word 'economics' means "rules of the house"; it comes from the Greek for οἶκος (oikos: house) and νόμος (nomos: custom or law).

Origin of Economics takes its roots in the natural propensity of human beings to barter, to exchange or trade goods. Whilst there are no records of dogs ever having bartered bones, men has 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 the Nations. .

This article will focus on Economics since it became an independent science from politics. The study of the authors who previously contributed to Economics and finally led to the development of The Wealth of the Nations is done in the article History of Ancient Economics.

Before Smith, Economics was a chapter in political science, the art of managing a State. The list of acceptable definitions for Economics is enourmous. Economics is the study of those activities which, with or without money, involve exchange transactions among people. Economics is also the study of wealth. Several other definitions are acceptable

Paul Samuelson, in his famous book Economics - An Introductory Analysis, defines Economics as:"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"

Definition of Economics

Even the definition of economics is subject to controversy. The textbook definition talks about making choices in the face of scarcity. Many, if not most, 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. It is repeated in most economics texts.

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."

One can play with definitions, but a favourite remains the one proposed by a Canadian economist, Jacob Viner, as "Economics is what economists do".

Introduction

The "Classical" period of economic thought begins on 1776 with the publication of Adam Smith's Wealth of the Nations . Written during the gentle era of Enlightenment, the laissez-faire policies of Adam Smith did not antecipate the economic and social upheavals that the industrial era was about to unleash. Only 13 years after its publication the French court was bankrupt, the French people took to the streets and beheaded their king; it was the French Revolution.

Among the economists who tried to understand the new phenomena three were outstanding: Jean-Baptiste Say , Thomas Robert Malthus and David Ricardo. 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 that would become the mainstream economy thought for the whole of the XIX century

Thomas Robert Malthus (1766-1834) is most famous for his "Essay on the Principle of Population" where he formulated the theory that population expanded at a geometric rate (or exponentially) while food production could only increase arithmetically. At a certain point, the population increase would outrun the food supply, and result in general misery. 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 (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.

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

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

Karl Marx is the most famous of Ricardo's followers (in pure economic theory he is a follower of Ricardo - or in Samuelson's words, a "minor Ricardian" - and had little impact on the development of the discipline). 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 , a Marxian school of economics emerged under the leadership of Marx's inner circle of companions and co-writers, notably Friedrich Engels and Karl Kautsky , both of whom were German.

The marginalist revolution

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

Alfred Marshall (1900-1920) was responsible for the combination of "demand" and "supply" ,where demand was based on "marginal utility". He was responsible for developing numerous concepts still used in economics, including: demand and supply curves or schedules and their equilibrium, "elasticity of demand" , consumer surplus, the distinction between short- and long-period, etc. Modern microeconomics , the study of individual economic agents and individual markets, is a continuation and elaboration of his work.

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

The Great Depression and Keynesianism

However, the edifice of neo-classical economics suffered a severe blow with the Great Depression of the 1930's. In competitive markets, unemployment is not supposed to occur. It can only be due to monopolistic forces preventing the demand and supply of labour from reaching equilibrium. This was clearly not the case in the 1930's.

Marshall's most famous disciple and pupil, John Maynard Keynes, attacked the neo-classical system with the publication of the General Theory of Employment, Interest and Money 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.

Microeconomics 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.

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 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.

The monetarist "counterrevolution"

While the Keynesian-neo-classical synthesis took over the profession, an unregenerate rearguard of neo-classical economists centred at the University of Chicago continued 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 to include even education and family formation.

With the perceived failure of Keynesian economics to explain and do anything about 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.

Economics today and the Keynesian revival

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 (New Keynesian economics).

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: Marxists, Neo-Ricardians, “Post Autistic”, Post Keynesians, New Keynesians, 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 Marxists to complete libertarian laissez-faire for the Rational Expectationists.

However, a new dominant school or mainstream seems to be emerging: the "New Keynesians". 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 microeconomic 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 economists is Joseph Stiglitz, who won the The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001 a.k.a., imprecisely, Nobel in Economics.

The Classicals

"The classical economists" was a name invented by Marx to cover Ricardo and James Mill and their predecessors - the founders of the theory which culminated in the Ricardian economics. Keynes would include in "The Classical School" the followers of Ricardo, those who adopted and perfected the theory of the Ricardian economics, including (for example), John Stuart Mill, Alfred Marshall, Edgeworth and Prof. Pigou.

Adam Smith

Adam Smith published on 1776 An Inquiry into the Nature and Causes of the Wealth of Nations, the famous book that established economics as an autonomous subject and launched the economic doctrine of free enterprise.

In his book Smith examined in detail the consequences of economic freedom. It covered such concepts as the role of self-interest, the division of labor, the function of markets, and the international implications of a laissez-faire economy, with public welfare, on his view, coming as a by-product.

Smith laid an intellectual framework that explained the free market that still holds true today. His expression "the invisible hand,"' which he used to demonstrate how self-interest guides the most efficient use of resources in a nation's economy became world-wide known.

The Classical School ("Ricardians")

Written during the gentle era of the Enlightenment - and on the same year the Mercantilist economic policies of the British state had led to a rebelion in America, where the colonists established a home-grown liberal republican government more-or-less dedicated to the laissez-faire and free trade, in line with the Wealth of Nations - Smith's book could not possibly antecipate the economic and social upheavals that industrial era was about to unleash. Therefore it did not analyse those issues.

Only 13 years after its publication the French court was bankupt, the French people took to the streets, beheaded their king and approved a "Declaration of the Rights of Man". Napoleon would give Europe a bloodbath for the next 25 years. The French Revolution would change the World.

New explanations for the social phenomena taking place became necessary. Three names emerged to try and explain them: Jean-Baptiste Say, Robert Malthus and David Ricardo. They all had different visions for political economy after Smith. Say (1803) wanted to take it back towards the French-Italian demand-and-supply tradition. Malthus (1798, 1820) wanted to add a whole new emphasis, away from the obsessive intricacies of "value" and towards a more macroeconomic (and "dynamic") perspective. Ricardo (1817) wanted to do Smith all over again, but to do it properly this time.

David Ricardo turned out to be the most successful and influential. His 1817 treatise On the Principles of Political Economy and Taxation Ricardo took economics to a high degree of theoretical sophistication. Ricardo's theory, the most clearly and consistently formalized of them all, became the Classical system.

Many economists continued working in the Say tradition, notably Rau and the French Liberal School. Say's approach, disputing the labor theory of value and focusing on supply-and-demand instead, was also advocated by a small group of economists at Oxford and Dublin. The publication of John Stuart Mill The Principles of Political Economy: with some of their applications to social philosophy,(1848) textbook, restating the Ricardian Classical doctrines fully and explicitly settled the controversy. Ricardo's system, however, was improved very little by his followers. Perhaps only Karl Marx (1867-94) added insights of importance.

By 1860 the Classical School became under attack simultaneously by , Thomas Cliffe-Leslie the and English Historicists, accompanied, by the German Historical School. The Victorian "sages", Thomas Carlyle and John Ruskin, criticized the Classical economists in the popular press.

A major blow to the Classical Ricardian School came with the Marginalist Revolution led by William Stanley Jevons (1871), Carl Menger and Leon Walras (1874), which provided a clear alternative. The Classical Ricardian system did not last long beyond that. Some reconciliation between the two theories was discussed by Alfred Marshall (1890). Other more radical Marginalists, notably Edwin Cannan (1893), concluded that there was nothing in Classical political economy worth saving.

Neoclassical Schools (1871-today)

The Marginalist Revolution

Marginalist Revolution was the name given to a movement which took place (almost) simultaneouly and independently during the end of the XIX century led by a series of works which lay the foundation for a new concept of Economics and which contributed to transform it into an exact science.

This programatic goal -- to transform Economics into an exact science -- find in the books of Carl Menger (1871) William Stanley Jevons (1871) and Léon Walras (1874) its decisive moments and it is exactly to designate this multiple explosion the that name "Marginalist Revolution" has been coined.

History

Adam Smith (1776), David Ricardo (1817) and the Classicals (which adopted a cost of production theory of value) struggled to understand what came to be called the paradox of "value in use" versus "value in exchange", usually exemplified as the "paradox of diamond and water". Water is essential, diamonds are frivoulous. But the price of diamonds is far higher than that of water. Smith and the Classical School had failed to distinguish between "total utility" and "marginal utility" . The elaboration of this insight transformed economics in the late nineteenth century, and the fruits of the marginalist revolution continue to set the basic framework for contemporary microeconomics.

The creation of the Theory of Marginal Utility

The creation of the marginal utility's concept, which flourished during the end of the XIX century, brought the answer to the paradox and has been the theoretical basis for the economic analysis of demand.

The value of marginal utility is defined as "the additional utility perceived by the consumer by the addition of one extra unit of a good".

For example: a hungry consumer finds an enourmous utilitity by eating a first loaf of bread. This utility declines as he keeps eating more units. The 10th loaf of bread represents for him an utility far smaller than the first one. And the 100th loaf might represent no utility at all.

The creators of the concept

Demand analysis became possible by the theory of utility, the mathematical tools of which were first developed by Hermann Heinrich Gossen (1810-1858) in Germany. However, due to its abstract and mathematical nature, Gossen's work was dismissed by the all- powerful German Historical School; his work was only uncovered and graciously acknowledged by Jevons in 1878. Grossen is considered a pro-marginalist.

Almost simultaneously Carl Menger in Austria (1871), Léon Walras in France (1874-77) e William Stanley Jevons in England (1871) published their works and became the fathers of the Marginalist Revolution .

Later Alfred Marshal in England, on his book Principles of Economics (1890), greatly extended the concept and recognized that prices are determined simultaneoulsy by factors of cost and factors of demand. Marshall's analysis also analyses the complexes phenomena ocurring in a price system, with various goods interacting among themselves and affecting each other's prices.

Carl Menger founded the Austrian School (a.k.a Viena School), which was later joined by Eugen von Böhm-Bawerk, Ludwig von Mises and Friedrich von Hayek; Léon Walras worked with the Lausanne School while William Stanley Jevons led the Anglo-American Marginalists.

Anglo-American Neoclassicism (1871-Today)

Anglo-American Marginalists ("Jevonians")

The Anglo-American Marginalists ("Jevonians") refer to early English and American writers between the 1870s and the 1930s who strayed from the Marshallian and Institutionalist schools. Many could thus be deemed "followers" of W.S. Jevons; they adopted the "mathematical" method of reasoning and/or the radical "subjectivism" inherent in Jevons's revolutionary marginalism.

Clark and the American Apologists

John Bates Clark (1847-1938) is best known for developing the "marginal productivity" concept and the "product exhaustion" thesis behind the Marginal Productivity Theory of Distribution, which he was the first to develop in 1889. He also developed the theory of marginal utility-based demand independently in 1885. As one of few American economists of the Marginalist school and a prominent apologist for the capitalist system, John Bates Clark was a great opponent of the Institutionalist School.

The "American Apologists" is the term used to describe late XIX Century and early XX Century American arch-conservative economists and social scientists. Theoretically they hoovered between Classical and Neoclassical economic theory; they distinguished themselves in their applied work and policy stance. The most important American Universities system were dominated by strict apologists for the status quo. Simon Newcomb at Johns Hopkins, John Bates Clark at Columbia, J. Laurence Laughlin at Chicago, Charles Dunbar and Frank Taussig at Harvard, Arthur T. Hadley and William Graham Sumner at Yale, all defendeded the new industrial age and condemn the unions and populist causes.

Alfred Marshall and The Cambridge Neoclassicals ("Marshallians")

The Marshalians was a group inspired on the work of Alfred Marshall which relied on practical, intuitive arguments rather than mathematical formalism, taking into account items such as historical time, institutional and industrial structure and real world phenomena, such as uncertainty, money and business cycles. Their main focus was on representative conditions. Their work emphasised partial market equilibrium, couching their arguments in terms of "representative" agents, firms, etc. rather than grand, idealized, multi-market general equilibrium systems.

London School of Economics (LSE) and Robbins

The London School of Economics and Political Science was set up as in 1895 by Sidney J. Webb and Beatrice Potter Webb, fabian socialists, but its early appointments were more conservative: W.A.S. Hewins (later a Tory MP) was its first director, Edwin Cannan, was to head the economics department, the technocratic Arthur L. Bowley headed statistics and liberal theorists L.T. Hobhouse headed sociology.

The L.S.E. from the very beginning aimed at being an academic teaching-and-research powerhouse. It was one of the group of "new universities" (like M.I.T., Johns Hopkins, Chicago, etc.) founded at the turn of century which eschewed the Oxbridge-Ivy League "gentlemanly education" approach in favor of a more serious academic and technical approach, akin to the Central European model. Like other "new universities", the L.S.E. was keen on raising its profile via academic research.

Lord Lionel C. Robbins, 1898-1984.

Lord Robbins was one Englishman who was not a Marshallian but rather a follower of Jevons and Wicksteed. He was one the few economists in England who cared to read the Continental European economists - Walras, Pareto, Böhm-Bawerk, Wieser and Wicksell. As a result of his Jevonian-Lausanne-Austrian-Swedish influence, Robbins helped to move Anglo-Saxon economics off its Marshallian rails and onto Continental ones.

His tools were the London School of Economics and a famous 1932 essay on economic methodology. He appointed Friedrich A. von Hayek, who in turn bred a new generation of English-speaking "continentals" such as Hicks, Lerner, Kaldor and Scitovsky.

The Chicago School and Knight

The "Chicago School" is perhaps one of the better known American "schools" of economics. The term "Chicago School" refers to the approach of the members of the Department of Economics at the University of Chicago (founded by the oil magnate John D. Rockfeller) over the past century. Also the term "Chicago School" may be associated with a brand of economics which adheres strictly to Neoclassical price theory in its economic analysis, "free market" libertarianism in much of its policy and a methodology relatively averse to much mathematical formalism. and willing to forego careful general equilibrium reasoning It favors results-oriented partial equilibrium analysis.

In recent years, the "Chicago School" has been associated with "economic imperialism", i.e. the application of economic reasoning to areas traditionally considered the prerogative of other fields such as political science, legal theory, history and sociology.

The "Chicago School" has had various phases with quite different characteristics. At present, under the term "Chicago School" we can identify various schools of thought: Monetarism in the 1960s, New Classical/Real Business Cycle macroeconomics from the 1970s until today, and more recently, the New Institutionalism, New Economic History and Law-and-Economics.

Frank H. Knight, 1885-1972.

Frank H. Knight, the "Grand Old Man" of Chicago, (irreducibly Neoclassical) was one of the century's the deepest thinker and scholar American economics has produced. With Jacob Viner, Knight presided over the Department of Economics at the University of Chicago from the 1920s to the late 1940s.

His famous dissertation Risk, Uncertainty and Profit (1921), where he made made the distinction between "risk" (randomness with knowable probabilities) and "uncertainty" (randomness with unkowable probabilities)is one of the most interesting reads in economics even today.

The Monetarists and Milton Friedman

The "Chicago School", led by the influential economist Milton Friedman, a fierce opponent of the Keynesian economics, led the "Monetarist" movement against the Keynesian orthodoxy in the 1960s and early 1970s.

Friedman's criticisms of Keynesian theory began with his attack on the IS-LM dichotomy in his "restatement" of the Quantity Theory in 1956 -- effectively, reminding Keynesians that "money matters".

Friedman (1968) exposed the apparent breakdown of the "Phillips Curve" relationship in the 1970s, proposing to replace it with a "Natural Rate of Unemployment" (NRU) - a concept later formalized in more detail by the "New Classicals".

Friedman argued that government discretionary "fine-tuning" of the economy, as had been proposed by Keynesians, ought to be replaced with iron "rules" of policy - notably his famous "money supply growth" rule. He also wrote several books advocating laissez-faire.

New Classical Macroeconomics and Robert Lucas

The "New Classical school", the "modern" version of the Chicago School, is led by Robert Lucas based on the concept of "rational expectations" of the 1970s which helped to decisively bury the Neo-Keynesian orthodoxy and inaugurated a new era of macroeconomics relying on the Neoclassical concept of supply-determined equilibrium expalined in "Real Business Cycle" theory.

Lucas also became famous for the "Lucas Critique" (1976) of the use of econometric models for policy purposes.

The New Institutionalist Schools

The "New Institutionalist Schools" to refer to the schools of thought that seek to explain political, historical, economic and social institutions such as government, law, markets, firms, social conventions, the family, etc. in terms of Neoclassical economic theory. New Institutionalist schools can be thought of as the outcome of the Chicago School's "economic imperialism" -- i.e. using Neoclassical economics to explain areas of human society normally considered outside them.

Continental Neoclacissism

The Lausanne School and Léon Walras

The "Lausanne School", also called the Mathematical School or the Italian School refers to the Neoclassical school of thought led by the Frenchman Léon Walras (1834-1910) and the Italian Vilfredo Pareto (1848-1923). It developed the general equilibrium theory, generalizing and extending the applicability of the Neoclassical approach to economics.

One can distinguish between the early "Walrasian" and the later "Paretian" stages of the Lausanne School. The core of their theories were identical but their emphasis and mode of analysis were different.

Walras fundamental tool of analysis was a system of simultaneous market demand and supply equations. He was mainly interested in analyzing grand themes: the existence of an equilibrium solution to a this system, the stability of that equilibrium, the incorporation of capital and growth and the introduction of money.

Vilfredo Pareto, Enrico Barone and Giovanni Antonelli, his Italian disciples, were particularly interested in the "microfoundations" of general equilibrium systems, the relationship between decision-making households and firms and the resulting general equilibrium. Consequently, the research focus of the Lausanne School moved in a different direction.

As this new direction was announced most prominently in Vilfredo Pareto's Cours d'Économie politique (1896-7) and in his Manual of Political Economy (1906) this was the "Paretian" phase.

The Paretians saw the problem as one of ensuring the compatibility of the individual incentives and constraints of consumers and producers in equilibrium. Their tools were the differential calculus and Lagrangian multipliers. Using advanced mathematics, they constructed a rather grand "Paretian general equilibrium system", a system of equations, where the agent-theoretic microfoundations were starkly brought to the fore. They replaced all the grand themes of Walras with a single new one of their own: the efficiency and social optimality of equilibrium.

The Lausanne School evolved over time to a third phase which focused on the overlap of sociology and economics, along the lines of François Perroux.

The Austrian School and Carl Menger

The Austria School (a.k.a Viena School) emerged around the pioner of the Marginalist Revolution, Carl Menger, at the University of Vienna.

The "First" Generation of the Austrian School was composed by the Austrian professors Friedrich von Wieser and Eugen von Böhm-Bawerk. They spread the Austrian School theories throughout the Austro-Hungarian Empire and trained the next two generations which would count with their disciples Ludwig von Mises and Friedrich von Hayek. Joseph Schumpeter became a Walrasian. The Austrian School maintained its base in Vienna until the 1930s Before the second World War most of its members moved or were exiled to Great Britain and the United States.

Paul Samuelson, John Hicks and the Paretian Revival (1930-40)

The "Paretians" are the Neoclassical general equilibrium theorists of the period 1910-1950 who concentrated on the themes outlined by Vilfredo Pareto's Manual of Political Economy (1906): namely, the analysis of individual optimization, market efficiency and social optima via classical programming techniques (differentiable calculus, Lagrangian multipliers, etc.).

The Paretian Revival reached its apex during the 1930s and 1940s. John Hicks, Paul Samuelson, Abba Lerner, Oskar Lange, Maurice Allais, Harold Hotelling led the way.

The Paretian Revival represents the first time that the work of the "Lausanne School" began breaking the English-language barrier.

The Vienna Colloquium

The "Vienna Colloquium" was a symposium run by the mathematician Karl Menger (son of the economist Carl Menger) in the 1930s to bring together many different minds from mathematics but also the physical sciences, philosophy, statistics and economics, that set in motion modern general equilibrium theory from its early roots in the Lausanne School.

Among the participants in the Colloquium, besides Karl Menger, was the banker Karl Schlesing Oskar Morgenstern, the polymath John von Neumann and the statistician Abraham Wald. Other participants included assorted Viennese physicists and mathematicians like Kurt G�del.

During the 1930s Menger collected and published the proceedings of the Colloquium as the "Ergebnisse eines mathematischen Kolloquiums"

Tjalling Koopmans and the Cowles Commission

With the motto "Science is Measurement" the "Cowles Commission for Research in Economics" was dedicated to the pursuit of linking economic theory to mathematics and statistics. Its main contributions to economics lie in its "creation" and consolidation of two important fields: general equilibrium theory and econometrics.

The Dutch-born Tjalling Koopmans was the director of the Cowles Comission from 1948 to 1954, a position he woud alternate with James Tobin

Kenneth Arrow, Gérard Debreu and the Neo-Walrasian General Equilibrium School

"Neo-Walrasian" economics refers to the "general equilibrium theory" (often referred to by its acronyms, G.E. or G.E.T.) that emerged in the post-war period. Rooted in the Lausanne School of Léon Walras and Vilfredo Pareto; it re-emerged in two forms in 1930s, one more "Walrasian", advanced by the Vienna Colloquium, and another more "Paretian" that was championed particularly at the L.S.E., Chicago and Harvard.

The Cowles Commission merged these two traditions and endowed it with a new mathematical apparatus of axomatic reasoning and convex structures (notably the "separating hyperplane theorem"), creating the "Neo-Walrasian" school in the 1940s and 1950s.

Kenneth Arrow (1951) and Gérard Debreau (1951. 1954) recast the Paretian theories of the consumer, production and the welfare theorems.

Robert Aumann and the Edgeworthian Revival

The "Edgeworthian revival" refers to the efforts to study the relationship between a Walrasian competitive equilibrium and the solutions obtained via alternative exchange process (notably those from game theory). The mathematical tools of choice that were introduced in this effort in the 1960s and 1970s (measure theory and non-standard analysis) -- were substantially more complex than the tools economists had been using.

The main goal of this group of economists was to try and prove the "Edgeworth's conjecture".

Robert Aumann proved (1964) the equivalence of the Edgeworthian core and the Walrasian equilibria when we have a continuum (uncountably infinite number) of agents. This "new" definition of "perfect competition" brought measure theory -- notably Lyapunov's Theorem -- into economics.

Alternative Schools

Heterodox Tradition

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 Heterodox Tradition and will be subjetct of another article.

Keynesians

John Maynard Keynes (1883-1946)

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. Keynes, 1936.

John Maynard Keynes reputedly made one of the the most important contributions for the science of Economics. His classic book, The General Theory of Employment, Interest and Money (1936) , Keynes's famous treatise, revolutionized both economics and the political science, bringing what is generally regarded as the most influential social science treatise of the XX Century. This single book permanently changed the way the world looked at the economy and the role of government in society.

After a brief period in the British civil service, Keynes returned to his alma mater Cambridge in 1909 where he published his Treatise on Probability (1921), which dismantled the classical theory of probability, launching what has since become known as the "logical-relationist" theory of probability.

In 1930 Keynes published his first major work on economics, the heavy two-volume A Treatise on Money which set out his Wicksellian theory of the credit cycle. In it, the rudiments of a liquidity preference theory of interest are laid out. Friedrich von Hayek, the laissez-faire advocate, reviewed the Treatise so harshly that Keynes decided to ask Sraffa to review Heyek's own competing work and condemn it no less harshly. The Keynes-Hayek conflict initiated a battle in the Cambridge-L.S.E. whose effects continue to the present day.

In the General Theory , Keynes developed a theory that could explain the determination of aggregate output - and as a consequence, employment. He explained how the determining factor to be aggregate demand. Among the revolutionary concepts initiated by Keynes was the concept of a demand-determined equilibrium wherein unemployment is possible, the ineffectiveness of price flexibility to cure unemployment, a unique theory of money based on "liquidity preference", the introduction of radical uncertainty and expectations, the marginal efficiency of investment schedule breaking Say's Law (and thus reversing the savings-investment causation), the possibility of using government fiscal and monetary policy to help eliminate recessions and control economic booms. Indeed, with this book, he almost single-handedly constructed the fundamental relationships and ideas behind what became known as "macroeconomics".

The General Theory set up the The Keynesian Revolution which split the economics world in two generations: the young lining up behind Keynes; the old ralling to condemn it. John Maynard Keynes responded to his critics -- Jacob Viner, Dennis Robertson and Bertil Ohlin -- in a series of 1937 articles, which expanded upon his theory. A densely-written and difficult book, it was followed up immediately by elucidatory publications by the members of Keynes's Circus, such as Joan Robinson, and young economists such as Roy Harrod and Abba Lerner.

Of particular importance was the 1937 article by John Hicks which introduced the "IS-LM" representation of Keynes's theory that launched the "Neoclassical-Keynesian Synthesis", which became the World's mainstream form of macroeconomics in the post-war era until the early 1970s.

Joan Robinson and the Cambridge Keynesians

"Cambridge Keynesians" refer to the unique group of British economists inspired by John Maynard Keynes's General Theory in a more "fundamentalist" way than the American Neo-Keynesians.

Their origin stems from the Keynes's "Circus" at Cambridge -- Joan Robinson, Richard Kahn, Piero Sraffa, Austin Robinson and James Meade. Commodities (1960). Although it followed upon Joan Robinson's original queries about capital aggregation (1954, 1956), Sraffa's "capital critique" set the radical "counter-revolutionary" tone of the Cambridge Capital Controversy that ensued with the American Neo-Keynesians.

The Robinson-Kaldor growth theory and the Cambridge Capital Controversy galvanized a new generation of "Cambridge Keynesians" -- such as Luigi Pasinetti, Piero Garegnani, John Eatwell, Geoff Harcourt -- to initiate the "Neo-Ricardian" research program, an attempt at an explicit marriage of Keynesian theory of effective demand and the Ricardian theory of value. In the course of their confrontation with Neo-Keynesian Synthesis, the Cambridge Keynesians found sympathizers in the American Post Keynesian school.

Franco Modigliani, James Tobin and the Neo-Keynesian Synthesis.

The "Neoclassical-Keynesian Synthesis" refers to the Keynesian Revolution, as interpreted by group of American economists in the early post-war period, which was centered in the IS-LM Model first introduced by John Hicks (1937) and then expanded upon by Franco Modigliani (1944).

However the IS-LM model was unable to obtain the Keynesian result of an "unemployment equilibrium". The model tended to yield the Neoclassical result of "full employment". To explain the results of this system of equations, the Neo-Keynesians appealed to rigid money wages, interest-inelastic investment demand, income-inelastic money demand or some other imperfection to this system. Thus it became a "synthesis" of Neoclassical and Keynesian theory.

Later on the money demand function was derived from utility-maximization by William J. Baumol (1952) and James Tobin (1956, 1958) and the Neo-Keynesians added the Phillips Curve (Phillips, 1958; Lipsey, 1960) to account for inflation. The international sector was incorporated into an extended IS-LM system known as the Mundell-Fleming model (Mundell, 1962) and

The Neoclassical-Keynesian Synthesis was wildly successful and dominated macroeconomics in the post-war period. For a long time, the Neo-Keynesian system was synonymous with the "Keynesian Revolution".

The Neo-Keynesian system came under attack in the late 1960s and early 1970s by Axel Leijonhufvud (1968). However, the Neo-Keynesian system only came into serious trouble in the early 1970s, when a sustained bout of inflation and unemployment in the OECD countries, which became known as "stagflation", could not be explained by their models. Milton Friedman (1968), the leader of the Monetarist School, proposed a "natural rate of unemployment hypothesis" that did seem consistent with the OECD experience. This natural rate hypothesis formed the basis of a "New Classical" macroeconomic theory, which has risen since the 1970s to replace Neo-Keynesianism as the new macroeconomic orthodoxy.

Abba Lerner and the American Post Keynesians

Abba P. Lerner was born in Russia, raised on the London East End and worked as a machinist, a capmaker, a Hebrew teacher, a Rabbinical student before enrolling in 1929 at the London School of Economics to which he was attracted by L.S.E.'s Fabian associations.

Lerner moved to the United States in 1937 where he taught at over a half-dozen universities, including the New School for Social Research. Lerner became of of the most important American Post Keynesians, along with Evsey Domar, Sidney Weintraub, Paul Davidson, Alfred S. Eichner, Hyman P. Minsky, Alain Barrère, Josef Steindl, Edward J. Nell and Athanasios Asimakopulos, the William Dow Professor of Political Economy in the Department of Economics at McGill University (Montreal), among others.

In 1934, Lerner wrote paper laying out the full Pareto-optimality conditions in a general equilibrium production economy, introducing the Paretian rule for efficiency, i.e. "that price equal marginal cost", P=MC .

His magnum opus,The Economics of Control: Principles of Welfare Economics (1944) synthesises his work on trade, welfare, socialism and Keynesian theory .

Lerner discovered the factor price equalization theorem (1947), but never published it. It was rediscovered in 1948 by Paul Samuelson and published in 1952.

Lerner was the first to recognize the importance of accounting for inflation in Neo-Keynesian theory and laid out his analysis in a remarkable series of articles and books (1944, 1947, 1949, 1951, 1972). In particular, he introduced the concept of "seller's inflation", a form of cost-push inflation which was to become central to Sideny Weintraub and Post Keynesian economics. In his analysis of inflation, Lerner was quite ahead of his time: he recognized the possibility of "stagflation", the unemployment-inflation trade-off of the Phillips Curve, what he called "high full employment" (a predecessor of the Friedman's NARU - natural rate of unemployment), the differential effects of expected and unexpected inflation and the theory of implicit contracts long before any of these concepts were discussed elsewhere.

Robert Clower, Axel Leijonhufvud and Disequilibrium Keynesianism

On an scholarly study On Keynesian economics and the economics of Keynes : a study in monetary theory (1968) Leijonhufvud differentiated between "Keynesian Economics" (Hicks-Samuelson type of synthesis) and "Economics of Keynes" (the work of J.M. Keynes) and essentially demonstrated that the two had little in common. He joined Clower in calling for a dynamic, "microfounded" formulation of Keynesian theory which explained underemployment equilibrium rather than merely referring to it as an imperfection. In particular, Leijonhufvud relies on differing speeds of quantity and price adjustments to create the coordination failures which yield protracted unemployment.

His later work in the 1970s and 1980s still mirrored this quest. In the 1990s, Clower and Leijonhufvud identified the fast-growing evolutionary theory and computational economics as moving in the right direction and founded a fledgling school, "Post Walrasian", intent on harnessing macroeconomics to it.

Joseph E. Stiglitz and the New Keynesians

Introduction

Joseph E. Stiglitz is one of the most important leaders of the New Keynesians. In 2001 he shared the The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001 (a.k.a. Nobel in Economics) with George A. Akerlof and A. Michael Spence "for their analyses of markets with asymmetric information". His career began at Yale, where he became a tenured professor at the age of 27. Stiglitz has also been a faculty member at Princeton, Oxford and Stanford universities. At the age of 29, he became a Fellow of the Econometric Society and is a member of the National Academy of Science. Stiglitz is also the recipient of the prestigious John Bates Clark Medal, awarded every two years to the American economist under the age of 40 who has made the most significant contributions to the subject.

Stiglitz has also become influential in the making and evaluation of economic policy in the last decade. He served on President Clinton's Council of Economic Advisers – first as a member and later as chairmanwith cabinet rank. He was later named chief economist of the World Bank. Since January 2000, Stiglitz has been a visiting professor at Columbia's Graduate School of Business and Department of Economics in the Graduate School of Arts and Sciences.

Noting that many of the major political debates over the past two decades have centered around one key issue: "the efficiency of the market economy", and the appropriate relationship between the market and the government, and based on his lifelong experiences, Stilglitz became to question the argument of Adam Smith (1776) that free markets led to efficient outcomes, "as if by an invisible hand", which has played a central role in these debates: it suggested that we could, by and large, rely on markets without government intervention. There was, at best, a limited role for government.

However his childhood told him otherwise. When he began the study of economics over forty years ago, Stiglitz was struck by the incongruity between the models that he was taught and the world that he had seen growing up, in Gary Indiana, a city whose rise and fall paralleled the rise and fall of the industrial economy. Founded in 1906 by U.S. Steel, and named after its Chairman of the Board, by the end of the century it had declined to but a shadow of its former self. But even in its heyday, it was marred by poverty, periodic unemployment, and massive racial discrimination. Yet the theories that Stiglitz was taught paid little attention to poverty, said that all markets "cleared" ­ including the labor market, so unemployment must be nothing more than a "phantasm", and that the profit motive ensured that there could not be economic discrimination. The central theorems argued that the economy was Pareto efficient and that, ino some sense,­ he had been living in the best of all possible worlds. It seemed to Stiglitz that he should be striving to create a different world. As a graduate student, he set out to try to create models with assumptions ­ and conclusions ­ closer to those that accorded with the real world he saw, with all of its imperfections.

Stiglitz contributions to Economics

Stiglitz helped create a new branch of economics, "The Economics of Information" exploring the consequences of information asymmetries and pioneering such concepts as adverse selection and moral hazard, which have now become standard tools not only of theorists, but of policy analysts. He has made major contributions to macro-economics and monetary theory, to development economics and trade theory, to public and corporate finance, to the theories of industrial organization and rural organization, and to the theories of welfare economics and of income and wealth distribution. In the 1980s, he helped revive interest in the economics of R&D.

His work has helped explain the circumstances in which markets do not work well, and how selective government intervention can improve their performance.

For Stiglitz there is no such a thing as Adam Smith's "invisible hand": "Adam Smith's invisible hand - the idea that free markets lead to efficiency as if guided by unseen forces - is invisible, at least in part, because it is not there".

Economics subdisciplines

Economic Theory

Microeconomics

Microeconomics examines the economic behaviour of individual actors such as businesses, households, and individuals, with a view to understand decision making in the face of scarcity and the allocation consequences of these decisions.

Managerial economics

Managerial economics (also called business economics), is the branch of economics that applies microeconomic analysis to specific business decisions. As such, it bridges economic theory and economics in practice. It draws heavily from quantitative techniques such as regression and correlation, Lagrangian calculus, linear programming, decision theory, and game theory. It is similar to operations research in this regard, and indeed uses operations research techniques.

Urban Economics

Urban Economics is a branch of Microeconomics that studies the location of households and firms. While other forms of economics do not account for spatial relationships between individuals and organizations, urban economics focuses on these spatial relationships to understand the economic motivations underlying the formation, functioning, and development of cities.

It develops economic theoretical models for cities that account for factors such as utility gains from lower average land rents and increasing (or constant returns) due to economies of agglomeration.

Macroeconomics

Macroeconomics examines an economy as a whole with a view to understanding the interaction between economic aggregates such as national income, employment and inflation, as well as economic performance measures, economic growth, and international economics. Note that general equilibrium theory combines concepts of a macro-economic view of the economy, but does so from a strictly constructed microeconomic viewpoint.

Development economics

Development economics is a branch of macroeconomics that deals with the study of the causes of long term economic growth, especially in developing countries. This may involve using mathematical methods from dynamical systems like differential equations and inter-temporal optimization, or it may involve a mixture of quantitative and qualitative methods.

Development economics also includes topics such as Third World debt, and the functions of such organisations as the IMF and World Bank. Many economists in this field are interested in ways of promoting stable and sustainable growth in poor countries and areas, by promoting self reliance and education in some of the lowest income countries in the world. Where economic issues merge with social and political ones, it is referred to as Development Studies.

Abrangent subdisciplines

The follwing subdisciplines do not fit neatly under the major division of micro or macroeconomics, abranging both fields.

Econometrics

Studies the application of statistical and mathematical methods in the field of economics to describe the numerical relationships between key economic forces such as capital, interest rates, and labor.

Econophysics

Econophysics and the closely-related field of sociophysics are areas of interdisciplinary research using methods and techniques from physics to model economic and other social phenomena respectively.

International economics

International economics is the branch of economics relating to ideas such as International trade, Foreign Direct Investment (FDI), and the exchange rate and how they influence one another.

Labour economics

Labour economics analyses the functioning of the market for labour analysing its supply (workers) and demand (employers) and attempts to understand the resulting pattern of wages, employment, and income.

Welfare economics

Welfare economics is the branch of economics that uses microeconomic techniques to simultaneously determine the allocational efficiency of a macroeconomy and the income distribution consequences associated with it. It attempts to "maximize the level of social welfare" by examining the economic activities of the individuals that comprise society.

Neuroeconomics

Neuroeconomics is a branch of economics which studies the neural mechanisms of decision-making and their economic significance.

Information economics

Information economics studies how "Information" affects economic decisions exploring the consequences of information asymmetries and such concepts as adverse selection and moral hazard. Joseph E. Stiglitz is one who greatly contibuted to the creation of this new branch in Economics.

Resource economics

Resource economics is a branch of Economics which includes the study of environmental economics, agricultural production and marketing, bioeconomics, community economic development, Resource utilization, and environmental policy.

Environmental economics

Environmental Economics undertakes theoretical or empirical studies of the economic effects of national or local environmental policies around the world. Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming.

Financial economics

Financial economics is the branch of economics concerned with the workings of financial markets, such as the stock market, and the financing of companies. The questions addressed are typically framed in terms of "time, uncertainty, options and information"

Economic geography

Economic geography is the study of the widely varying Economic conditions across the earth which analyses the economic impact of factors such as climate, geology, and socio-political factors.

Behavioural economics

Behavioural economics is the study of how the nature and causes of human Social behavior affects Economic decisions. In early-modern Social science theory, John Stuart Mill, Comte, and others, laid the foundation for Social psychology by asserting that human Social cognition and behavior could and should be studied scientifically like any other natural science.

Experimental economics

Experimental Economics is the use of experimental methods to evaluate theoretical predictions of economic behaviour. Historically most economics experiments were conducted in the laboratory, but recently interest in economics field experiments has grown. Economics experiments can be loosely classified into the following topics: Market Games, Bargaining, Auctions, Social Preferences, Learning, Matching, and Field Experiments.

External Links

• ARISTOTLE. Politics

• ARISTOTLE. Nicomachean Ethics

• MICROECONOMICS: Most important concepts explained in detail. Text and workable problems. 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.

• The History of Economic Thought Website <forever 'under construction'> ]

• 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)

• Xenophon

See also

History of Ancient Economics - Economic Theory - Macroeconomics- Microeconomics - Econometrics - Econophysics - Neuroeconomics

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