Asked in EconomicsHistory
What is the historical background of economics?
June 24, 2013 7:05PM
Economic writings date from earlier Mesopotamian, Greek, Roman, Indian subcontinent, Chinese, Persian, and Arab civilizations. Notable writers from antiquity through to the 14th century include Aristotle, Xenophon, Chanakya (also known as Kautilya), Qin Shi Huang, Thomas Aquinas, and Ibn Khaldun. The works of Aristotle had a profound influence on Aquinas, who in turn influenced the late scholastics of the 14th to 17th centuries. Joseph Schumpeter described the latter as "coming nearer than any other group to being the 'founders' of scientific economics" as to monetary, interest, and value theory within a natural-law perspective.
1638 painting of a French seaport during the heyday of mercantilism
Two groups, later called 'mercantilists' and 'physiocrats', more directly influenced the subsequent development of the subject. Both groups were associated with the rise of economic nationalism and modern capitalism in Europe. Mercantilism was an economic doctrine that flourished from the 16th to 18th century in a prolific pamphlet literature, whether of merchants or statesmen. It held that a nation's wealth depended on its accumulation of gold and silver. Nations without access to mines could obtain gold and silver from trade only by selling goods abroad and restricting imports other than of gold and silver. The doctrine called for importing cheap raw materials to be used in manufacturing goods, which could be exported, and for state regulation to impose protective tariffs on foreign manufactured goods and prohibit manufacturing in the colonies.
Physiocrats, a group of 18th century French thinkers and writers, developed the idea of the economy as a circular flow of income and output. Physiocrats believed that only agricultural production generated a clear surplus over cost, so that agriculture was the basis of all wealth. Thus, they opposed the mercantilist policy of promoting manufacturing and trade at the expense of agriculture, including import tariffs. Physiocrats advocated replacing administratively costly tax collections with a single tax on income of land owners. In reaction against copious mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal government intervention in the economy.
Modern economic analysis is customarily said to have begun with Adam Smith (1723-1790). Smith was harshly critical of the mercantilists but described the physiocratic system "with all its imperfections" as "perhaps the purest approximation to the truth that has yet been published" on the subject.
Publication of Adam Smith's The Wealth of Nations in 1776, has been described as "the effective birth of economics as a separate discipline." The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth.
Adam Smith wrote The Wealth of Nations
Smith discusses the benefits of the specialization by division of labour. His "theorem" that "the division of labor is limited by the extent of the market" has been described as the "core of a theory of the functions of firm and industry" and a "fundamental principle of economic organization." To Smith has also been ascribed "the most important substantive proposition in all of economics" and foundation of resource-allocation theory - that, under competition, owners of resources (labor, land, and capital) will use them most profitably, resulting in an equal rate of return in equilibrium for all uses (adjusted for apparent differences arising from such factors as training and unemployment).
In Smith's view, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace. He described the market mechanism as an "invisible hand" that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive.
In his famous invisible-hand analogy, Smith argued for the seemingly paradoxical notion that competitive markets tended to advance broader social interests, although driven by narrower self-interest. The general approach that Smith helped initiate was calledpolitical economy and later classical economics. It included such notables as Thomas Malthus, David Ricardo, and John Stuart Mill writing from about 1770 to 1870. The period from 1815 to 1845 was one of the richest in the history of economic thought.
While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent conflict between landowners on the one hand and labor and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits.
Malthus cautioned law makers on the effects of poverty reduction policies
Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Human population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.
Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s.
Coming at the end of the Classical tradition, John Stuart Mill parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market's two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene.
Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity. Other classical economists presented variations on Smith, termed the 'labour theory of value'. Classical economics focused on the tendency of markets to move to long-run equilibrium.
The Marxist school of economic thought comes from the work of German economistKarl Marx.
Marxist (later, Marxian) economics descends from classical economics. It derives from the work of Karl Marx. The first volume of Marx's major work, Das Kapital, was published in German in 1867. In it, Marx focused on the labour theory of value and what he considered to be the exploitation of labour by capital. The labour theory of value held that the value of an exchanged commodity was determined by the labor that went into its production.
A body of theory later termed 'neoclassical economics' or 'marginalism' formed from about 1870 to 1910. The term 'economics' was popularized by such neoclassical economists as Alfred Marshall as a concise synonym for 'economic science' and a substitute for the earlier, broader term 'political economy'. This corresponded to the influence on the subject of mathematical methods used in the natural sciences.
Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with thelabour theory of value inherited from classical economics in favor of a marginal utility theory of value on the demand side and a more general theory of costs on the supply side. In the 20th century, neoclassical theorists moved away from an earlier notion suggesting that total utility for a society could be measured in favor of ordinal utility, which hypothesizes merely behavior-based relations across persons.
In microeconomics, neoclassical economics represents incentives and costs as playing a pervasive role in shaping decision making. An immediate example of this is the consumer theory of individual demand, which isolates how prices (as costs) and income affect quantity demanded. In macroeconomics it is reflected in an early and lasting neoclassical synthesis with Keynesian macroeconomics.
Neoclassical economics is occasionally referred as orthodox economics whether by its critics or sympathizers. Modern mainstream economics builds on neoclassical economics but with many refinements that either supplement or generalize earlier analysis, such as econometrics, game theory, analysis of market failure and imperfect competition, and the neoclassical model of economic growth for analyzing long-run variables affecting national income.
John Maynard Keynes (right), was a key theorist in economics.
Keynesian economics derives from John Maynard Keynes, in particular his book The General Theory of Employment, Interest and Money (1936), which ushered in contemporary macroeconomics as a distinct field. The book focused on determinants of national income in the short run when prices are relatively inflexible. Keynes attempted to explain in broad theoretical detail why high labour-market unemployment might not be self-correcting due to low "effective demand" and why even price flexibility and monetary policy might be unavailing. Such terms as "revolutionary" have been applied to the book in its impact on economic analysis.
Keynesian economics has two successors. Post-Keynesian economics also concentrates on macroeconomic rigidities and adjustment processes. Research on micro foundations for their models is represented as based on real-life practices rather than simple optimizing models. It is generally associated with the University of Cambridge and the work of Joan Robinson.
New-Keynesian economics is also associated with developments in the Keynesian fashion. Within this group researchers tend to share with other economists the emphasis on models employing micro foundations and optimizing behavior but with a narrower focus on standard Keynesian themes such as price and wage rigidity. These are usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style ones.
The Chicago School of economics is best known for its free market advocacy and monetarist ideas. According to Milton Friedman and monetarists, market economies are inherently stable if left to themselves and depressions result only from government intervention. Friedman, for example, argued that the Great Depression was result of a contraction of the money supply, controlled by the Federal Reserve, and not by the lack of investment as Keynes had argued. Ben Bernanke, current Chairman of the Federal Reserve, is among the economists today generally accepting Friedman's analysis of the causes of the Great Depression.
Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the classical economists and modernized them. One example of this is his article in the September 1970 issue of The New York Times Magazine, where he claims that the social responsibility of business should be "to use its resources and engage in activities designed to increase its profits...(through) open and free competition without deception or fraud."