Schools of Economic Thought


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

Classical economics
A school of economic thought, exemplified by Adam Smith's writings in the 18th century, that states that a change in supply will eventually be matched by a change in demand - so that the economy is always moving towards equilibrium.
Overtaken first by neo-classical economics in the early 20th century, it was then overtaken by Keynesian thought in the 1920s and 1930s. The re-emergence in the late 20th century of policies aimed at minimising government intervention in the economy, including efforts towards free trade, was backed to some extent by principles related to classical economics. 
The term classical economics was first used by Karl Marx (1818 – 1883) to describe early economists like Adam Smith (1723 – 1790), David Ricardo (1772 – 1823), John Stuart Mill (1806 – 1873) and Thomas Robert Malthus (1766 – 1834). Most important is Smith’s work An Inquiry into the Nature and Causes of the Wealth of Nations (1776) because it marks the starting point of economics as a science.
Still today, Smith’s concept of the ‘invisible hand’ shapes our understanding of the market economy. It is interpreted as the work of the price mechanism bringing together supply and demand in a market. The result is that the market economy simultaneously maximises the benefits for consumers and firms.
Furthermore, his promotion of the ‘laissez-faire’ concept – where economic performance is optimised when there is limited government interference – opened the door for free trade and a proper role for governments. In terms of trade, the concept means no protectionism. In terms of the role of the government, the ‘laissez-faire’ approach advocates setting up and enforcing a legal system that protects free markets and competition.
Example
David Ricardo’s concept of comparative advantage between countries in international trade, for example, is one theory from classical economics that is still applied today. It states that a country should produce for export goods and services whose production costs are lower than that of other goods.
Ricardo makes his famous example of England and Portugal both producing wine and cloth, but at lower costs in Portugal than in England. Consequently, Portugal has an absolute advantage in trade. However, it makes sense for both countries to trade.
England should focus on the production of cloth and Portugal on wine, because these are the products where both countries have a comparative advantage. That is, Portugal’s production cost for wine is lower than for cloth and in England it is the other way around. For example, with the wine produced, Portugal can buy more cloth through trade than if it used its resources to produce the cloth. The same is true for England . It will get more wine in exchange for cloth, compared to a situation in which it produces its own wine.
Liberal Economics
Another term for the classical theories of economics emphasising the concept of the free market and laissez-faire policies, with the government's role limited to providing support services.
Neo-classical Economics
School of economic thought that gained prominence at Cambridge University in the late 19th Century. It gave analytical depth to the ideas of the classical economists, developing the theories of equilibrium, elasticity and monopoly. Supplanted by Keynesian economics after the Second World War but came back into fashion with the monetarism of the late 20th Century.
Chicago School
Important strand of economic thought originating at the University of Chicago and focussed on the influence of money supply on the economy. The Chicago School's philosophy, as articulated in particular by Milton Friedman and F.A. Hayek, forms the backbone of monetarist policies, which normally emphasise non-interference by government, free competition, and the need to keep inflation low. This diverges substantially from the Keynesian philosophy of fiscal policy as the key stimulus.
Keynesian economics
Relating to the ideas of John Maynard Keynes, who believed that, in a recession, the economy can be made to grow and unemployment reduced by increasing government spending and making reductions in interest rates. 
Theory based on the ideas of economist John Maynard Keynes that optimum economic performance could be achieved by influencing aggregate demand through government fiscal (public spending and taxation) policy, not through the free market philosophy characterised by the classical and neo-classical schools.
Austrian Economics
School of economic thought originating in Austria in the late nineteenth century which focuses on the concept of opportunity cost. 
In economic theory, the term Austrian School stands for liberalism and laissez-faire-economics (where economic performance is optimised when there is limited government interference).
The Austrian School of economics has its original roots in the work of Carl Menger from the University of Vienna . References to the topic were first published in 1871. Well-known followers of Menger included Eugen von Böhm-Bawerk (1851 – 1914), Ludwig von Mises (1881 – 1973) and, perhaps most important, Friedrich A. Hayek (1899 – 1929).
Hayek, for example, strongly rejected any intervention by the state in the economy. For him, markets work perfectly in the sense that the market price balances supply and demand.  A perfect market is one characterised by easy access to information, no barriers to entry and with prices controlled by all participants.
Due to the global financial crisis of 2007 and 2008, the popularity of the Austrian School of economics has experienced a boost in recent times because it had predicted, a long time ago, that too much debt – due to too low interest rates – would trigger investment bubbles followed by a crisis after these bubbles burst.  For example, look at Ireland’s property bubble, which was fuelled by reckless lending by banks to property developers.
Example
In contrast to Keynesianism, the Austrian School of thought holds that the business cycle is driven by the supply side of the economy, not demand. If interest rates are too low, we will have over-investment. This may lead to over-production, which may trigger a crisis. During the crisis, supply declines until it is once again equal to overall demand. Then a new cycle starts.
For the Austrian school, the main challenge is not inflation, but over-investment in the face of too much money, or too-low interest rates that can lead to a crisis.  Too much money means that the growth of money supply is much higher than the growth of goods and services in an economy. This leads to inflation, which is an increase in the average prices of all goods because there is more money available.
This means that the right level of the interest rate, called the ‘natural rate of interest’, is crucial to prevent a crisis. This type of interest rate attracts enough investment to ensure full employment and no inflation. If the actual rate is equal to the natural rate, there is no inflation
Laissez-faire
The view, backed by supporters of the free market, that economic performance is optimised when there is no government interference. One of the basic tenets of classical economics.
Invisible Hand
Economic theory, posited by Scottish economist Adam Smith, that participants in a free market act out of self-interest and that their interaction with other participants will automatically produce the most favourable outcome for all concerned (i.e. the most productive and efficient exchange of goods and services).
                                                                                                                                       Source: Financial Express
 


Thursday, 03rd Sep 2015, 10:14:04 AM

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