Schools of Economic Thought Chapter 1

Introduction The word "economics" is derived from oikonomikos, which means skilled in household management. The word "economics" is derived from oikonomikos, which means skilled in household management. Why? Why? Modern economic thought emerged in the 17th and 18th centuries as the western Modern economic thought emerged in the 17th and 18th centuries as the western world began its transformation from world began its transformation from a farming to an industrial society. a farming to an industrial society.

Introduction Theories try to answer basic Economic Questions How do we decide what to produce with our limited resources? How do we decide what to produce with our limited resources? How do we decide who gets goods & services? How do we decide who gets goods & services? How are we going to produce those goods & services? How are we going to produce those goods & services?

Mercantalism Merchants and Statesmen Merchants and Statesmen 16th and 17th centuries. 16th and 17th centuries. Mercantilists believed that a nation's wealth came from its accumulation of gold and silver. Mercantilists believed that a nation's wealth came from its accumulation of gold and silver. High interest in exportation of goods High interest in exportation of goods Importation restricted with high tariffs = Protectionism Importation restricted with high tariffs = Protectionism Brought politics and economics together Brought politics and economics together

Physiocrats 18th century French philosophers 18th century French philosophers Idea of the economy as a circular flow of income and output. Idea of the economy as a circular flow of income and output. They opposed the Mercantilist policy of promoting exportation They opposed the Mercantilist policy of promoting exportation Believed agriculture was the sole source of wealth in an economy. Believed agriculture was the sole source of wealth in an economy. Physiocrats advocated a policy of laissez- Physiocrats advocated a policy of laissez- faire, which called for minimal faire, which called for minimal government interference in the economy. government interference in the economy.

Classical Began with the publication in 1776 of Adam Smith's The Wealth of Nations. Began with the publication in 1776 of Adam Smith's The Wealth of Nations. Identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth Identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth Ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace. Ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace. "invisible hand" that leads all individuals "invisible hand" that leads all individuals

David Ricardo- Classical focused on the distribution of income among landowners, workers, and capitalists. focused on the distribution of income among landowners, workers, and capitalists. Conflict between landowners and labor and capital. (Have vs. Have-Nots) Conflict between landowners and labor and capital. (Have vs. Have-Nots) Quickly growing population makes increased competition for jobs, pushes wages down Quickly growing population makes increased competition for jobs, pushes wages down

Thomas Malthus- Classical Diminishing returns explain low living standards Diminishing returns explain low living standards Population increases, outstripping the production of food. Population increases, outstripping the production of food. A rapidly growing population against a limited amount of land meant diminishing returns to labor. A rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.

Keynesian School John Maybard Keynes John Maybard Keynes 1930s, reaction to great depression 1930s, reaction to great depression Theory: People/Business Owners tend to save too much causing unemployment Theory: People/Business Owners tend to save too much causing unemployment Unemployment = poverty = low standard of living Unemployment = poverty = low standard of living Spending = job creation = employment = increase in personal wealth = increase personal spending = economic growth!! Spending = job creation = employment = increase in personal wealth = increase personal spending = economic growth!! Insisted that direct government intervention was necessary to increase total spending. Insisted that direct government intervention was necessary to increase total spending.

Summary Economic theories are constantly changing. Economic theories are constantly changing. Monetarism (value of $ predicts inflation) Monetarism (value of $ predicts inflation) Rational Expectations Theory (limited government intervention- people predict government actions minimizing affects)) Rational Expectations Theory (limited government intervention- people predict government actions minimizing affects)) Supply-Side Economics (incentives to save & invest to create economic growth) Supply-Side Economics (incentives to save & invest to create economic growth) All theories created to answer the 3 basic Economics questions All theories created to answer the 3 basic Economics questions

Question Why do you think so many people have such differing views on how to handle economic problems? Why do you think so many people have such differing views on how to handle economic problems? Personal socio-economic standing Personal socio-economic standing Political Preferences Political Preferences Personal Beliefs Personal Beliefs Government Government