Economic theory help


History of Economic Thought deals with the origin and development of economic idea, its interrelations and manifestations. It is the study of the heritage left by the writers on economic topics. A school of thought is a set or group of people who share common character of opinion or outlook regarding a philosophy, discipline, belief, social movement, cultural movement, art movement etc. It traces the historical change in attitude. Thus, history of economic thought deals with the economic problems and the approached to solve them. Economic thought is a sum of all the opinions and views on economic subjects.

Economists understanding about the economy and economic problems in different periods and settings allowed them to revive valuable theoretical insights. There was a formation of new economic thinking to the challenges faced in different periods and the main objective was to achieve society’s goals.

There have been various schools of economic thought since 1700s. Some schools of thought have emphasized on economic freedom and the value of private incentives for allocation of resources. However, others have supported the abolition of private property and profits for establishment of economic equity and justice. These schools of thought have evolved over time and made huge differences in the thinking as well as the approach to solve the economic problems.

Changes in economic thought can drive the change in economic policy. Economic thought has also studied on the aspects of human nature such as greed, selfishness etc. because these generally work against the good of all. On the other hand, economic behavior is self-regulating and works toward a common purpose.

There have been different schools of thought with different ideologies. Before the introduction of classical school of thought, Mercantilism dominated (1500-1776). It was largely concerned with accumulating wealth in the form of gold; this was done by maximizing exports and minimizing imports i.e. the goal was to maintain positive balance of trade. Nationalism, protectionism, and colonization are features of this economic school. Mercantilism was also a political movement, promoting the use of the state's defense power to ensure local markets and supply sources were protected.

The Physiocrats school of thought followed who believed that the wealth of a nation lies not in its stocks of gold and silver, but rather in the size of its net product. It was the beginning of the anti-mercantilism. They categorized the economy into three classes i.e. the "productive" class (agricultural laborers and farmers), the "sterile" class (industrial laborers, artisans, and merchants) and the "proprietor" class (who appropriated the net product as rents). They argued that when these income flows come to a state of balance i.e. no sector expanded or contracted then the economy is in its natural state. They promoted laissez faire system.


The Classical school is one of the first and most important school of economic thought and it was mainly given by economists like Adam Smith, Robert Malthus, and David Ricardo etc. This school of thought believed in free market economy i.e. markets should be left alone to work and this will generate economic development.

Adam Smith said that the price mechanism acts as a powerful “invisible hand” which allocates resources efficiently and it was productivity which caused the division of labor. The classical thought emphasized on the automatic self-adjustment mechanism and assumed that the economy will return to its full employment level. It is widely known that the Classical period lasted until 1870.

Classical Economists assumed that prices, wages and rates are flexible and markets always clear and growth depends upon the supply of production factors because there is no unemployment.

Robert Malthus studied about populations and he explored the relationship between population growth and inflation. He talked about the relationship between food supply, populations and economic rent theory. Population growth pushes production leading to less productive land, thus increasing land rent while keeping wages at a subsistence level. David Ricardo proposed the "labor theory of value," which is that the value of goods comes from the labor used to produce it. He also extended the theory of international trade with the concept of comparative advantage, showing how trade was mutually advantageous.

Jean-Baptiste Say was another economist who formulated the Say’s Law i.e. Supply creates its own demand. This also provided a justification that economy will move to full employment because any increase in output of goods and services (supply) will lead to an increase in expenditure to buy those goods and services (demand). There will be no shortage of demand and there will always be jobs for all workers and the economy will be at full employment level. The equilibrium will be restored even if there is unemployment because it is considered as temporary.

John Stuart Mill was another major classical economist who advocated the formation of democratic economy but also, credited the idea of free market. Mill talked about how socialism can be used for remedial measures to problems like labor unrest, continuing poverty etc.


Marxism is a school of economic thought which talked about socialist principles and committed to cause the downfall of capitalism and creation of a complete form of socialism called communism. It was originated in the mid-nineteenth century when German born Karl Marx teamed with English businessman Friedrich Engels to write The Communist Manifesto (1848). Here, they examined the nature of class conflict throughout history and through the critique of capitalism, he gave the best suitable alternative i.e. communism. Marx held that communism was unavoidable in the process of evolution that begins with feudalism and passes through capitalism and socialism.

This school of thought focuses on the labor theory of value and what Marx called to be the exploitation of labor by capital. The labor theory of value is a method for measuring the degree to which labor is exploited in a capitalist society, rather than simply calculating the price. Marx believed that revenues of production belonged to labor and the surplus value (profits) belonged to capitalist. Marxists continue to believe that the free market allocation process is many times flawed, inefficient and needs to be improved.

Neo-Classical School of Thought

The neo-classical school of economic thought presumes that people act independently on the basis of the information that they have. Modern economic theory has been evolved from neo-classical school of thought. Neo-classical economics believes that economic agents are rational in their decisions and consumers look to maximize their utility while producers look to maximize their profits. This school of thought tries to derive general rules about the behavior of firms and consumers scientifically. Neo-classical economics is associated with Leon Walras, William Jevons, and Alfred Marshall etc.

Alfred Marshall projected the idea that economics was a scientific discipline that required more mathematics and less philosophy. Jevons and Walras established the marginal utility theory and thus initiated a revolution in economic thought that converted most economists from classical to neoclassical analysis. Neo-classical theory used land in mathematical terms by treating it as part of capital.

The idea of marginalism and maximizing marginal utility is endorsed by the neoclassical school and also, that economic agent’s act on the basis of rational expectations and this lead to the “Marginal Revolution”. In neoclassical thought, the value of goods derived is not from labor but from their marginal utility. And, in a competitive economy, people get what they had worked for. They believe that market is always in equilibrium.

Austrian School of Thought

Austrian school economists consider that human behavior is too peculiar to represent with mathematics and that minimal government intervention is ideal. The Austrian school of thought has added value and established useful theories and explanations on the business cycle, proposition of capital intensity, and the importance of time and opportunity costs in determining consumption and value.

Austrian thought underline the importance of formulating theory on individuals and their subjective values. Besides marginal analysis, Austrian theory talks about the spontaneous order of market processes, the uncertainty of the future, the importance of the heterogeneous aspects of capital and money creation, and the decentralized nature of knowledge.

In 1871, Carl Menger accepted that value and utility are totally subjective, independent of labor and other inputs. The value of land, labor, and capital goods are built on the values and utility people place on consumer goods. Menger's theory also incorporated marginal analysis, in which the value and market price of a good is based on the utility of the marginal or extra increment of the good obtained. This marginal utility diminishes with increasing amounts of the good i.e. diminishing marginal returns. He said trade is beneficial because people exchange goods of lower marginal utility for those of higher marginal utility. This analysis started the Austrian school of thought.

Austrians such as Hayek have further extended the theory of capital and claimed that socialism is required for central economic planning i.e. for efficient distribution of resources, and modern Austrians have initiated the theory and study of the history of free banking. Ludwig von Mises, another Austrian, believed that value is not intrinsic in things but in people i.e. it is the way in which man reacts to the conditions in the environment. Austrians also have a theory of the business cycle about the role of money creation and interest rates, mainly started by Murray Rothbard. Now, there are contemporary Austrians world-wide.

Keynesian School of Thought

The Keynesian school of economic thought known as the Keynesians provided the basics for greater government intervention to encourage economic growth and stability. Keynesian economics is derived from John Maynard Keynes, from his book, The General Theory of Employment, Interest and Money (1936). The book examined the determinants of national income, in the short run during a period of time when prices are relatively inflexible. Keynes argued against free market principles and stated that aggregate demand determines employment. He also suggested fiscal measures as to fix depressions and recessions. He believed that governmental intervention can boost demand. Also, as wages and prices are sticky, it can prevent the market clearing.

Keynesian economics is basically a theory of aggregate demand, and it is used to influence macro-economic policy. This school of thought believes that business cycle can be managed by active government intervention i.e. increasing demand during a depression by increasing the money supply, by increasing government spending, raising the money supply, and reducing taxes to increase private spending. During a boom, the government can reverse these policies to reduce inflation.

Policy considerations of Keynesian economics is that market economies are susceptible to business cycles and can create permanent unemployment and/or persistent inflation which it may be unable to fix by itself, thus government can and should influence aggregate demand to counter the business cycle, minimize unemployment and inflation. By the use of government fiscal policy (spending & taxation), central bank monetary policy (interest rate targeting) and use of treasury foreign exchange policy (exchange rate targeting), the economy can be stabilized.

The Keynesians led in a new era of economic thinking i.e. expanded government responsibilities in the economy. The Keynesians initiated new discussions and debates in the field of macroeconomics, especially problems related to economic growth, unemployment, and inflation.

However, critics believe that the Keynesian approach is interventionist because it works in the self interest and due to which it governs micro-economic behavior but this does not always lead to long run macro-economic development or short run macro-economic stability. Inflating the money supply eventually increases prices and stops raising output and thus creates distortion in prices and production. Also, these policies try to treat the effects of economic problems without analyzing the root causes.


The monetarist school of thought re-established the classical theory of money that focuses on the role of the quantity of money. In the long run, high money expansion will result in higher inflation rather than increase in output. The works of the monetarist school is mainly attributed to Milton Friedman. Monetarist economists consider that the role of government is important to control inflation and this happens through the control of money supply. Monetarists school of thought underline that markets do clear and participants have rational expectations i.e. people create judgments about future economic variables such as inflation using past information and avoid making systematic mistakes. This is also called as the New Classical school of thought.

Monetarists reveal that government does not have the understanding to react to every situation in the economy, so instead of discretionary policy, it is better to have some rules which the central banks will follow. Monetarism is not a complete macroeconomic theory but a school within macroeconomics, especially for monetary economics which advocates free markets.

According to Friedman, laissez-faire government policy is more advantageous than government intervention in the economy and governments should aim for a neutral monetary policy which focuses on long-run economic growth. The goal of monetarists is to keep the money supply growing at almost the same pace or a bit fast in the economy so that the general prices remain relatively stable.

Policy considerations of Monetarist school of thought is that governmental intervention is unnecessary; economy always stabilizes itself around the natural rate of unemployment. Government should focus more on inflation than on unemployment. Also, central banks should not target or adjust interest rates to stabilize economy but they should ignore the cycle and make sure only that the total money supply is adequate. Government should focus on maintaining fundamental things right like property rights, law and order, transparency, etc.

The world is in an era of globalization, thus the possible economic thoughts too have evolved over the years and now everything is closely connected i.e. inter-disciplinary. The evolution of economics will continue and this will surely play a major role in worldwide business, government, and society as a whole in the years to come.

Therefore, the future of economic thought may be able to discover and know the complex processes and means which guide economic transactions in human society.

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