Schools of economic thought

Classical School
The Classical school, which is regarded as the first school of economic thought, is associated with the 18th
Century Scottish economist Adam Smith, and those British economists that followed, such as Robert Malthus
and David Ricardo.
The main idea of the Classical school was that markets work best when they are left alone, and that there is
nothing but the smallest role for government. The approach is firmly one of laissez-faire and a strong belief in
the efficiency of free markets to generate economic development. Markets should be left to work because
the price mechanism acts as a powerful 'invisible hand' to allocate resources to where they are best employed.
In terms of explaining value, the focus of classical thinking was that it was determined mainly by scarcity and
costs of production.
In terms of the macro-economy, the Classical economists assumed that the economy would always return to
full-employment level of real output through an automatical self-adjustment mechanism.
It is widely recognised that the Classical period lasted until 1870.
Neo-classical
The neo-classical school of economic thought is a wide ranging school of ideas from which modern economic
theory evolved. The method is clearly scientific, with assumptions, and hypothesis and attempts to derived
general rules or principles about the behaviour of firms and consumers.
For example, neo-classical economics assumes that economic agents are rational in their behaviour, and that
consumers look to maximise utility and firms look to maximise profits. The contrasting objectives of
maximising utility and profits forms the basis of demand and supply theory. Another important contribution of
neo-classical economics was a focus on marginal values, such as marginal cost and marginal utility.
Neo-classical economics is associated with the work of William Jevons, Carl Menger and Leon Walras.
New classical
New classical macro-economics dates from the 1970s, and is an attempt to explain macro-economic problems
and issues using micro-economic concepts like rational behaviour, and rational expectations. New classical
economics is associated with the work of Chicago economist, Robert Lucas.
Keynesian economics
Keynesian economists broadly follow the main macro-economic ideas of British economist John Maynard
Keynes. Keynes is widely regarded as the most important economist of the 20th Century, despite falling out of
favour during the 1970s and 1980s following the rise of new classical economics.
In essence, Keynesian economists are sceptical that, if left alone, free markets will inevitably move towards
a full employment equilibrium.
They Keynesian approach is interventionist, coming from a belief that the self interest which governs micro-
economic behaviour does not always lead to long run macro-economic development or short run macro-
economic stability. Keynesian economics is essentially a theory of aggregate demand, and how best best to
manipulate it through macro-economic policy.

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. [1]
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 Smiths 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, Smiths 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 Ricardos 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, Portugals 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
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. [1]
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.
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.