Classical economics

Classical economics is widely regarded as the first modern school of economic thought. It is associated with the idea that free markets can regulate themselves.^[1]Its major developers include Adam Smith, David Ricardo, Thomas Malthus and John Stuart Mill. Sometimes the definition of classical economics is expanded to include William Petty and Johann Heinrich von Thünen.

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 by neoclassical economics in Britain beginning around 1870.

They produced their "magnificent dynamics" during a period in which capitalism was emerging from a past feudal society and in which the industrial revolution was leading to vast changes in society. These changes also raised the question of how a society could be organized around a system in which every individual sought his or her own (monetary) gain.

Classical economists and their immediate predecessor reoriented economics away from an analysis of the ruler's personal interests to broader national interests. Physiocrat Francois Quesnay and Adam Smith, for example, identified the wealth of a nation with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labour, land, and capital equipment. With property rights to land and capital by individuals, the national income is divided up between labourers, landlords, and capitalists in the form of wages, rent, and interest or profits.

Value Theory

Classical economists developed a theory of value, or price, to investigate economic dynamics. Petty introduced a fundamental distinction between market price and natural price to facilitate the portrayal of regularities in prices. Market prices are jostled by many transient influences that are difficult to theorize about at any abstract level. Natural prices, according to Petty, Smith, and Ricardo, for example, capture systematic and persistent forces operating at a point in time. Market prices always tend toward natural prices in a process that Smith described as somewhat similar to gravitational attraction.

The theory of what determined natural prices varied within the Classical school. Petty tried to develop a par between land and labour and had what might be called a land-and-labour theory of value. Smith confined the labour theory of value to a mythical pre-capitalist past. He stated that natural prices were the sum of natural rates of wages, profits (including interest on capital and wages of superintendence) and rent. Ricardo also had what might be described as a cost of production theory of value. He criticized Smith for describing rent as price-determining, instead of price-determined, and saw the labour theory of value as a good approximation.

Some historians of economic thought, in particular, Sraffian economists^[2][3], see the classical theory of prices as determined from three givens:

1. The level of outputs at the level of Smith's "effectual demand",
2. technology, and
3. wages.

From these givens, one can rigorously derive a theory of value. But neither Ricardo nor Marx, the most rigorous investigators of the theory of value during the Classical period, developed this theory fully. Those who reconstruct the theory of value in this manner see the determinants of natural prices as being explained by the Classical economists from within the theory of economics, albeit at a lower level of abstraction. For example, the theory of wages was closely connected to the theory of population. The Classical economists took the theory of the determinants of the level and growth of population as part of Political Economy. Since then, the theory of population has been seen as part of some other discipline than economics. In contrast to the Classical theory, the determinants of the neoclassical theory value:

1. tastes
2. technology, and
3. endowments

are seen as exogenous to neoclassical economics.

Classical economics tended to stress the benefits of trade. Its theory of value was largely displaced by marginalist schools of thought which sees "use value" as deriving from the marginal utility that consumers finds in a good, and "exchange value" (i.e. natural price) as determined by the marginal opportunity- or disutility-cost of the inputs that make up the product. Ironically, considering the attachment of many classical economists to the free market, the largest school of economic thought that still adheres to classical form is the Marxian school.

Monetary Theory

British classical economists in the 19th century had a well-developed controversy between the Banking and the Currency school. This parallels recent debates between proponents of the theory of endogeneous money, such as Nicholas Kaldor, and monetarists, such as Milton Friedman. Monetarists and members of the currency school argued that banks can and should control the supply of money. According to their theories, inflation is caused by banks issuing an excessive supply of money. According to proponents of the theory of endogenous money, the supply of money automatically adjusts to the demand, and banks can only control the terms (e.g., the rate of interest) on which loans are made.

Debates on the definition of Classical Economics

The theory of value is currently a contested subject. One issue is whether classical economics is a forerunner of neoclassical economics or a school of thought that had a distinct theory of value, distribution, and growth.

Sraffians, who emphasize the discontinuity thesis, see classical economics as extending from Willam Petty's work in the 17th century to the break-up of the Ricardian system around 1830. The period between 1830 and the 1870s would then be dominated by "vulgar political economy", as Karl Marx characterized it. Sraffians argue that: the wages fund theory; Senior's abstinence theory of interest, which puts the return to capital on the same level as returns to land and labour; the explanation of equilibrium prices by well-behaved supply and demand functions; and Say's law, are not necessary or essential elements of the classical theory of value and distribution.

Perhaps Schumpeter's view that John Stuart Mill put forth a half-way house between classical and neoclassical economics is consistent with this view.

Sraffians generally see Marx as having rediscovered and restated the logic of classical economics, albeit for his own purposes. Others, such as Schumpeter, think of Marx as a follower of Ricardo. Even Samuel Hollander^[4] has recently explained that there is a textual basis in the classical economists for Marx's reading, although he does argue that it is an extremely narrow set of texts.

The first position is that neoclassical economics is essentially continuous with classical economics. To scholars promoting this view, there is no hard and fast line between classical and neoclassical economics. There may be shifts of emphasis, such as between the long run and the short run and between supply and demand, but the neoclassical concepts are to be found confused or in embryo in classical economics. To these economists, there is only one theory of value and distribution. Alfred Marshall is a well-known promoter of this view. Samuel Hollander is probably its best current proponent.

A second position sees two threads simultaneously being developed in classical economics. In this view, neoclassical economics is a development of certain exoteric (popular) views in Adam Smith. Ricardo was a sport, developing certain esoteric (known by only the select) views in Adam Smith. This view can be found in W. Stanley Jevons, who referred to Ricardo as something like "that able, but wrong-headed man" who put economics on the "wrong track". One can also find this view in Maurice Dobb's Theories of Value and Distribution Since Adam Smith: Ideology and Economic Theory (1973), as well as in Karl Marx's Theories of Surplus Value.

The above does not exhaust the possibilities. John Maynard Keynes thought of classical economics as starting with Ricardo and being ended by the publication of Keynes' General Theory of Employment Interest and Money. The defining criterion of classical economics, on this view, is Say's law.

One difficulty in these debates is that the participants are frequently arguing about whether there is a non-neoclassical theories that should be reconstructed and applied today to describe capitalist economies. Some, such as Terry Peach^[5], see classical economics as of antiquarian interest.

See also

• Classical general equilibrium model
• Neoclassical economics
• Classical liberalism

Notes

External links

• Classical economics, Encyclopædia Britannica

References

• Mark Blaug (1987). "classical economics," The New Palgrave Dictionary of Economics, v. 1, pp. 414-45.
• _____ (2008). "British classical economics," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
• Samuel Hollander (1987)). Classical Economics. Oxford: Blackwell,