Friday, March 11, 2011

Classical economics

Widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill.

Adam Smith's The Wealth of Nations in 1776 is usually considered to mark the beginning of classical economics. The school was active into the mid 19th century and was followed byneoclassical economics 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 to refer to Ricardian economics – the economics of David Ricardo and James Mill and their predecessors – but usage was subsequently extended to include the followers of Ricardo.

There are three basic assumptions of Classical Economics theories. They are:

  • Flexible Prices: The prices of everything, the commodities, labor (wages), land (rent), etc. must be both upwardly and downwardly mobile. Unfortunately, in reality, it has been observed that these prices are not as readily flexible downwards as they are upwards, due a variety of market imperfections, like laws, unions, etc.
  • Say's Law: 'Supply creates its own demand'. The Say's law suggests that the aggregate production in an economy must generate an income enough to purchase all of the economy's output. In other words, if a good is produced, it has to be bought. Unfortunately, this assumption also does not hold good today, as most economies today are demand driven (production is based on demand. Demand is not based on production or supply).
  • Savings - Investment Equality: This assumption requires the household savings to equal the capital investment expenditures. Now it takes no genius to know, that this is rarely the case. Yet, should the savings not equal the investment, the 'flexible' interest rates should be able to restore the equilibrium.

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