Classical economics

Classical economics

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Classical economics is widely regarded as the first modern school of economic thought
History of economic thought
The history of economic thought deals with different thinkers and theories in the subject that became political economy and economics from the ancient world to the present day...

. Its major developers include Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

, Jean-Baptiste Say
Jean-Baptiste Say
Jean-Baptiste Say was a French economist and businessman. He had classically liberal views and argued in favor of competition, free trade, and lifting restraints on business...

, David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

, Thomas Malthus
Thomas Malthus
The Reverend Thomas Robert Malthus FRS was an English scholar, influential in political economy and demography. Malthus popularized the economic theory of rent....

 and John Stuart Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...

.

Adam Smith's The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

in 1776 is usually considered to mark the beginning of classical economics. The school was active into the mid 19th century and was followed by neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 in Britain beginning around 1870, or, in Marx's definition by "vulgar political economy" from the 1830s. The definition of classical economics is debated, particularly the period 1830–70 and the connection to neoclassical economics. The term "classical economics" was coined by Karl Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...

 to refer to Ricardian economics
Ricardian economics
David Ricardo was born in 1772 and made a fortune as a stockbroker and loan broker. At the age of 27, he read An Inquiry into the Nature and Causes of Wealth of Nations by Adam Smith and was energized by the theories of economics. His main economic ideas are contained in Principles of Political...

 – the economics of David Ricardo and James Mill
James Mill
James Mill was a Scottish historian, economist, political theorist, and philosopher. He was a founder of classical economics, together with David Ricardo, and the father of influential philosopher of classical liberalism, John Stuart Mill.-Life:Mill was born at Northwater Bridge, in the parish of...

 and their predecessors – but usage was subsequently extended to include the followers of Ricardo.

History


The classical economists produced their "magnificent dynamics" during a period in which capitalism
Capitalism
Capitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...

 was emerging from feudalism
Feudalism
Feudalism was a set of legal and military customs in medieval Europe that flourished between the 9th and 15th centuries, which, broadly defined, was a system for ordering society around relationships derived from the holding of land in exchange for service or labour.Although derived from the...

 and in which the industrial revolution
Industrial Revolution
The Industrial Revolution was a period from the 18th to the 19th century where major changes in agriculture, manufacturing, mining, transportation, and technology had a profound effect on the social, economic and cultural conditions of the times...

 was leading to vast changes in society. These changes raised the question of how a society could be organized around a system in which every individual sought his or her own (monetary) gain. Classical political economy is popularly associated with the idea that free markets can regulate themselves.

Classical economists and their immediate predecessors reoriented economics away from an analysis of the ruler's personal interests to broader national interests. Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

, and also physiocrat Francois Quesnay
François Quesnay
François Quesnay was a French economist of the Physiocratic school. He is known for publishing the "Tableau économique" in 1758, which provided the foundations of the ideas of the Physiocrats...

, for example, identified the wealth of a nation
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

 with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labour, land, and capital. With property rights to land and capital held by individuals, the national income is divided up between labourers, landlords, and capitalists in the form of wages, rent
Economic rent
Economic rent is typically defined by economists as payment for goods and services beyond the amount needed to bring the required factors of production into a production process and sustain supply. A recipient of economic rent is a rentier....

, and interest or profits.

Modern legacy


Classical economics is generally agreed (but see section 5 below) to have developed into neoclassical economics – as the name suggests – or to at least be most closely represented in the modern age by neoclassical economics, and many of its ideas remain fundamental in economics. Other ideas, however, have either disappeared from neoclassical discourse or been replaced by Keynesian economics
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...

 in the Keynesian revolution
Keynesian Revolution
The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the then orthodox economic framework: neoclassical economics....

 and neoclassical synthesis
Neoclassical synthesis
Neoclassical synthesis is a postwar academic movement in economics that attempts to absorb the macroeconomic thought of John Maynard Keynes into the thought of neoclassical economics...

. Some classical ideas are represented in various schools of heterodox economics
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...

, notably Marxian economics
Marxian economics
Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Adherents of Marxian economics, particularly in academia, distinguish it from Marxism as a political ideology and sociological theory, arguing that Marx's approach to understanding the...

 – Marx being a contemporary of the classical economists and their immediate successors – and Austrian economics, which split from neoclassical economics in the late 19th century.

Classical theories of growth and development


Analyzing the growth in the wealth of nations and advocating policies to promote such growth was a major focus of classical economists. John Hicks
John Hicks
Sir John Richard Hicks was a British economist and one of the most important and influential economists of the twentieth century. The most familiar of his many contributions in the field of economics were his statement of consumer demand theory in microeconomics, and the IS/LM model , which...

 & Samuel Hollander
Samuel Hollander
Samuel Hollander, OC, FRSC is a British/Canadian/Israeli economist.Born in London, he received a B.Sc. in economics from the London School of Economics in 1959. In 1961 he received an AM and a Ph.D. in 1963 from Princeton University...

, Nicholas Kaldor
Nicholas Kaldor
Nicholas Kaldor, Baron Kaldor was one of the foremost Cambridge economists in the post-war period...

, Luigi L. Pasinetti
Luigi Pasinetti
Luigi L. Pasinetti is an Italian economist of the Post-Keynesians school. Pasinetti is considered the heir of the "Cambridge Keynesians" and a student of Piero Sraffa and Richard Kahn. Along with them, as well as Joan Robinson, he was one of the prominent members on the "Cambridge, UK" side of the...

, and Paul A. Samuelson have presented formal models as part of their respective interpretations of classical political economy.

Value theory


Classical economists developed a theory of value, or price, to investigate economic dynamics. William Petty
William Petty
Sir William Petty FRS was an English economist, scientist and philosopher. He first became prominent serving Oliver Cromwell and Commonwealth in Ireland. He developed efficient methods to survey the land that was to be confiscated and given to Cromwell's soldiers...

 introduced a fundamental distinction between market price
Market price
In economics, market price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics...

 and natural price to facilitate the portrayal of regularities in prices. Market prices are jostled by many transient influences that are difficult to theorize about at any abstract level. Natural prices, according to Petty, Smith, and Ricardo, for example, capture systematic and persistent forces operating at a point in time. Market prices always tend toward natural prices in a process that Smith described as somewhat similar to gravitational attraction.

The theory of what determined natural prices varied within the Classical school. Petty tried to develop a par between land and labour and had what might be called a land-and-labour theory of value. Smith confined the labour theory of value to a mythical pre-capitalist past. Others may interpret Smith believed in value as derived from labour. He stated that natural prices were the sum of natural rates of wages, profits (including interest on capital and wages of superintendence) and rent. Ricardo also had what might be described as a cost of production theory of value. He criticized Smith for describing rent as price-determining, instead of price-determined, and saw the labour theory of value as a good approximation.

Some historians of economic thought, in particular, Sraffian
Piero Sraffa
Piero Sraffa was an influential Italian economist whose book Production of Commodities by Means of Commodities is taken as founding the Neo-Ricardian school of Economics.- Early life :...

 economists, see the classical theory of prices as determined from three givens:
  1. The level of outputs at the level of Smith's "effectual demand",
  2. technology, and
  3. wages.

From these givens, one can rigorously derive a theory of value. But neither Ricardo nor Marx, the most rigorous investigators of the theory of value during the Classical period, developed this theory fully. Those who reconstruct the theory of value in this manner see the determinants of natural prices as being explained by the Classical economists from within the theory of economics, albeit at a lower level of abstraction. For example, the theory of wages was closely connected to the theory of population. The Classical economists took the theory of the determinants of the level and growth of population as part of Political Economy. Since then, the theory of population has been seen as part of Demography
Demography
Demography is the statistical study of human population. It can be a very general science that can be applied to any kind of dynamic human population, that is, one that changes over time or space...

. In contrast to the Classical theory, the determinants of the neoclassical theory value:
  1. tastes
  2. technology, and
  3. endowments

are seen as exogenous to neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

.

Classical economics tended to stress the benefits of trade
Free trade
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...

. Its theory of value was largely displaced by marginalist schools of thought which sees "use value" as deriving from the marginal utility
Marginal utility
In economics, the marginal utility of a good or service is the utility gained from an increase in the consumption of that good or service...

 that consumers finds in a good, and "exchange value" (i.e. natural price) as determined by the marginal opportunity
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

- or disutility-cost of the inputs that make up the product. Ironically, considering the attachment of many classical economists to the free market, the largest school of economic thought that still adheres to classical form is the Marxian school.

Monetary theory


British classical economists in the 19th century had a well-developed controversy between the
Banking
British Banking School
The British Banking School was a major part of British history. They were created to oppose the British Currency School; they argued that currency issue could be naturally restricted by the desire of bank depositors to redeem their notes for gold....

 and the Currency school. This parallels recent debates between proponents of the theory of endogeneous money, such as Nicholas Kaldor
Nicholas Kaldor
Nicholas Kaldor, Baron Kaldor was one of the foremost Cambridge economists in the post-war period...

, and monetarists, such as Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...

. Monetarists and members of the currency school argued that banks can and should control the supply of money. According to their theories, inflation is caused by banks issuing an excessive supply of money. According to proponents of the theory of endogenous money
Endogenous money
In economics, endogenous money refers to the theory that money comes into existence driven by the requirements of the real economy and that banking system reserves expand or contract as needed to accommodate loan demand at prevailing interest rates. It forms part of Post-Keynesian economics...

, the supply of money automatically adjusts to the demand, and banks can only control the terms (e.g., the rate of interest) on which loans are made.

Debates on the definition of classical economics


The theory of value
Theory of value (economics)
"Theory of value" is a generic term which encompasses all the theories within economics that attempt to explain the exchange value or price of goods and services...

 is currently a contested subject. One issue is whether classical economics is a forerunner of neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 or a school of thought that had a distinct theory of value, distribution, and growth.

Sraffians
Neo-Ricardianism
The neo-Ricardian school is an economic schoolthat derives from the close reading and interpretation of David Ricardo by Piero Sraffa, and from Sraffa's critique of Neoclassical economics as presented in his The Production of Commodities by Means of Commodities, and further developed by the...

, who emphasize the discontinuity thesis,
see classical economics as extending from Petty's work in the 17th century to the break-up of the Ricardian system around 1830. The period between 1830 and the 1870s would then be dominated by "vulgar political economy", as Karl Marx characterized it. Sraffians argue that: the wages fund theory; Senior's abstinence theory of interest
Abstinence theory of interest
Abstinence Theory of Interest asserts that the money used for lending purposes is the money not used for consumption - which means, earning interest by abstaining from spending makes the funds possible and available for borrowers....

, which puts the return to capital on the same level as returns to land and labour; the explanation of equilibrium prices by well-behaved supply and demand functions; and Say's law
Say's law
Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...

, are not necessary or essential elements of the classical theory of value and distribution.

Perhaps Schumpeter's view that John Stuart Mill put forth a half-way house between classical and neoclassical economics is consistent with this view.

Sraffians generally see Marx as having rediscovered and restated the logic of classical economics, albeit for his own purposes. Others, such as Schumpeter, think of Marx as a follower of Ricardo. Even Samuel Hollander
Samuel Hollander
Samuel Hollander, OC, FRSC is a British/Canadian/Israeli economist.Born in London, he received a B.Sc. in economics from the London School of Economics in 1959. In 1961 he received an AM and a Ph.D. in 1963 from Princeton University...

 has recently explained that there is a textual basis in the classical economists for Marx's reading, although he does argue that it is an extremely narrow set of texts.

Another position is that neoclassical economics is essentially continuous with classical economics. To scholars promoting this view, there is no hard and fast line between classical and neoclassical economics. There may be shifts of emphasis, such as between the long run and the short run and between supply and demand, but the neoclassical concepts are to be found confused or in embryo in classical economics. To these economists, there is only one theory of value and distribution. Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

 is a well-known promoter of this view. Samuel Hollander
Samuel Hollander
Samuel Hollander, OC, FRSC is a British/Canadian/Israeli economist.Born in London, he received a B.Sc. in economics from the London School of Economics in 1959. In 1961 he received an AM and a Ph.D. in 1963 from Princeton University...

 is probably its best current proponent.

Still another position sees two threads simultaneously being developed in classical economics. In this view, neoclassical economics is a development of certain exoteric (popular) views in Adam Smith. Ricardo was a sport, developing certain esoteric (known by only the select) views in Adam Smith. This view can be found in W. Stanley Jevons, who referred to Ricardo as something like "that able, but wrong-headed man" who put economics on the "wrong track". One can also find this view in Maurice Dobb's Theories of Value and Distribution Since Adam Smith: Ideology and Economic Theory (1973), as well as in Karl Marx's Theories of Surplus Value.

The above does not exhaust the possibilities. John Maynard Keynes thought of classical economics as starting with Ricardo and being ended by the publication of Keynes' General Theory of Employment Interest and Money. The defining criterion of classical economics, on this view, is Say's law.

One difficulty in these debates is that the participants are frequently arguing about whether there is a non-neoclassical theory that should be reconstructed and applied today to describe capitalist economies. Some, such as Terry Peach, see classical economics as of antiquarian interest.

Sometimes the definition of classical economics is expanded to include the earlier 17th century English economist William Petty
William Petty
Sir William Petty FRS was an English economist, scientist and philosopher. He first became prominent serving Oliver Cromwell and Commonwealth in Ireland. He developed efficient methods to survey the land that was to be confiscated and given to Cromwell's soldiers...

 and the contemporary early 19th century German economist Johann Heinrich von Thünen
Johann Heinrich von Thünen
Johann Heinrich von Thünen was a prominent nineteenth century economist. Von Thünen was a Mecklenburg landowner, who in the first volume of his treatise, The Isolated State , developed the first serious treatment of spatial economics, connecting it with the theory of rent...

.

See also

  • Classical general equilibrium model
    Classical general equilibrium model
    The classical general equilibrium model aims to describe the economy by aggregating the behavior of individuals and firms. Note that the classical general equilibrium model is unrelated to classical economics, and was instead developed within neoclassical economics beginning in the late 19th...

  • Neoclassical economics
    Neoclassical economics
    Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

  • Classical liberalism
    Classical liberalism
    Classical liberalism is the philosophy committed to the ideal of limited government, constitutionalism, rule of law, due process, and liberty of individuals including freedom of religion, speech, press, assembly, and free markets....

  • Constitutional economics
    Constitutional economics
    Constitutional economics is a research program in economics and constitutionalism that has been described as extending beyond the definition of 'the economic analysis of constitutional law' in explaining the choice "of alternative sets of legal-institutional-constitutional rules that constrain the...

  • Perspectives on Capitalism
    Perspectives on capitalism
    Throughout modern history, a variety of influential perspectives on capitalism have shaped modern economic thought. Adam Smith was one of the first influential writers on the topic, with his book The Wealth of Nations, which is generally considered to be the start of classical economics which...


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