1. Economics for the 21 st Century Major Schools of Economic Thought Henry B. Stobbs, MFA

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3. John Maynard Keynes said… “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 to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

4. The History of Modern Economic Thought Times change, but the problem remains the same: –How do we decide what to produce with our limited resources? –How do we ensure stable prices and full employment of our resources? –How do we provide a rising standard of living for ourselves and for the generations that follow us?

5. Mercantilism 16 th Century Seville

6. Mercantilism Dominant economic philosophy of the late 15 th,16 th,and 17 th centuries (and still with us!) Core beliefs: –A nation’s wealth comes primarily from the accumulation of gold and silver. –Nations without mines can obtain wealth only by selling more goods than they purchase from abroad or, by finding external sources of gold and silver.

7. Mercantilists Typical Policies: –Intervene in import markets by imposing tariffs. –Build extensive maritime and military fleets. –Grant subsidies to improve export prospects for domestic goods. –Establish colonies to extract local resources and establish markets for domestic goods. –Engage other nations in fierce competition for access to scarce resources.

8. Physiocrats

9. Physiocrats 18 th century French philosophers who developed the circular flow model of income and output. –Opposed mercantilism in favor of agriculture as a source of wealth. –Advocated laissez-faire policies of minimal government interference in the economy.

10. Classical School 1776 – Adam Smith’s The Wealth of Nations.

11. Land, labor and capital are the factors of production and major contributors to a nation’s wealth. The ideal economy is self-regulating. The market mechanism works like an “invisible hand” that guides individuals. Individuals are motivated by “self- interest, rightly understood” to produce the greatest good for society as a whole. Accepts laissez-faire, rejects emphasis on agriculture.

12. Classical School David Ricardo: 1772 – 1823

13. Classical School –Focused on the distribution of income among landowners, workers, and capitalists –Saw conflict between landowners on one side and labor and capital on the other. –Posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits. –Developed theory of comparative advantage.

14. Classical School Thomas Robert Malthus (1766 – 1834)

15. Classical School –Theory of diminishing returns explains low living standards and wages. –Populations increase geometrically, outstripping the production of food. –Rapidly growing populations diminish returns to labor, leading to chronically low wages and low standards of living. –Questioned the automaticity of full employment – too much savings leads to unemployment.

16. Classical School John Stuart Mill (1806 – 1873)

17. The market has two distinct roles: –Allocation of resources –Distribution of income Because the market is efficient at allocating resources but inefficient at distributing income, society must intervene.

18. Marginalists Whereas classicists theorized that the costs of production determine prices, marginalists emphasized that prices also depend on the level of demand. The level of demand depends on consumer satisfaction provided by individual goods and services. In a free market economy, the factors of production receive returns equal to their contributions to production. Invented basic analytic tools and mathematical framework for the science of modern macroeconomics.

19. Alfred Marshall (1842 – 1924) Principles of Economics (pub. 1890) "(1) Use mathematics as shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This I do often."

20. Marxists Karl Marx (1818 – 1883) Das Kapital (Vol. 1 pub. 1867) Friedrich Engels (1820 – 1895) Ernest Mandel (1923 – 1995) Antonio Gramsci (1891 – 1937)

21. Marxists Capitalism is an evolutionary phase that will ultimately destroy itself to be replaced by a world free of private property. All production belongs to labor because workers produce all value in a society. Market systems allow capitalists to exploit workers by denying them a fair share of their production. Capitalism produces increasing misery for workers as the drive for profit leads to increased mechanization. The unemployed will rise up and seize the means of production.

22. Institutionalists Individual economic behavior is part of a social pattern influenced by current ways of living and modes of thought. Rejected the classical view that people are motivated by economic self-interest Opposed laissez-faire philosophies, called for government intervention to bring about equitable income distribution.

23. Keynesian Economics John Maynard Keynes (1883 – 1946) The General Theory of Employment, Interest and Money (1936)

24. Keynsians Classical assumption: In a recession, wages and prices will decline to restore full employment. Keynes maintained the opposite: Falling prices and wages, by depressing incomes, prevent a revival of spending. Direct government intervention is necessary to stabilize the economy – spend and decrease taxes when recession threatens; increase taxes when to ward off inflation. Keynes’ analytic framework remains the core of macroeconomic analysis.

25. Neo-Keynsians, Neo-Classic Synthesis John Hicks (1937 – 1989) attempted a mathematical explanation of Keynes’ arguments Paul Samuelson (1915 - ) most prominent of “neo- Keynsians” –In the short term, markets can be imperfect and fail to reach equilibrium due to wage rigidity and monopoly distortion –Government can intervene to correct failed markets; the Invisible Hand will then resume its proper function

26. Austrian School Carl Menger (1840 – 1921) – The Theory of value Grundsätze der Volkswirtschaftslehre (1871) “Man himself is the beginning and the end of every economy.“ “All things are subject to the law of cause and effect."

27. Austrian School Ludwig von Mises (1881 – 1973) "Economics deals with society's fundamental problems; it concerns everyone and belongs to all. It is the main and proper study of every citizen."

28. Austrian School De-emphasizes idealized mathematical models in favor of a social-science approach to economics. Economics is as a tool for understanding how people both cooperate and compete in the process of meeting needs, allocating resources, and discovering ways of building a prosperous social order. Entrepreneurship is a critical force in economic development. Private property is essential to an efficient use of resources. Government intervention in the market process is always and everywhere destructive.

29. Austrian School The expansion of free markets, the division of labor, and private capital investment is the only possible path to the prosperity and flourishing of the human race. Socialism is disastrous for a modern economy because the absence of private ownership of land and capital goods prevents any sort of rational pricing, or estimate of costs. Government intervention, in addition to hampering and crippling the market, is counter-productive and cumulative, leading inevitably to socialism unless the entire tissue of interventions is repealed.

30. Just a Few Other Theories Monetarism (Quantity Theory): reemphasizes the critical role of monetary growth as a fundamental prerequisite for a society’s material well-being. Rational Expectations Theory: Rationalizes limited government and argues that the market’s ability to anticipate government policy actions limits their effectiveness. Supply-side Economics: Economic growth is a fundamental pre- requisite for improving society’s well-being and emphasizes the need for incentives to save and invest if the economy is to grow. Islamic Economics: System of economics based in Quranic law and philosophy Christian Socialism: Combines Christian principles with socialism in a re-distribution and social equity construct New institutional Economics: focuses on the social and legal norms and rules that underlie economic activity.sociallegal norms

31. Summary Economic thinking constantly changes. There are as many economic theories as there are economists. No theory survives intact the next economic crisis. All theory reduces to a search for answers to the basic problem of every society…