CLASSICAL ECONOMICS

Classical economics is a school of economic thought that emerged in the 18th century
and was dominant in the 19th century. It is associated with influential economists like
Adam Smith, David Ricardo, and John Stuart Mill. Classical economics laid the
foundation for many of the ideas that still shape modern economic thinking. Here are
some key principles and ideas associated with classical economics:

1. Laissez-Faire: Classical economists believed in the idea of laissez-faire,

which means "let it be" in French. They argued that markets should be left to
operate without government interference. They believed that, in a free market,
competition and self-interest would lead to the most efficient allocation of
resources.
2. Invisible Hand: Adam Smith, often considered the father of classical
economics, introduced the concept of the "invisible hand." This idea suggests
that individuals pursuing their self-interest in a free market unintentionally
promote the well-being of society as a whole. In other words, self-interest can
lead to socially optimal outcomes.
3. Division of Labor: Adam Smith emphasized the importance of the division of
labor. He argued that when individuals specialize in specific tasks or
industries, it leads to greater productivity and economic growth. This
specialization is a key driver of economic development.
4. Labor Theory of Value: Classical economists, particularly David Ricardo,
subscribed to the labor theory of value. This theory states that the value of a
good or service is determined by the amount of labor required to produce it.
This theory has been largely replaced by the subjective theory of value in
modern economics.
5. Theory of Comparative Advantage: David Ricardo also introduced the theory
of comparative advantage, which demonstrates the benefits of international
trade. According to this theory, even if one country is less efficient at producing
all goods compared to another country, both countries can still benefit from
 trade by specializing in the production of goods where they have a
comparative advantage.
6. Say's Law: Jean-Baptiste Say's law, often associated with classical
economics, states that supply creates its own demand. In other words, the act
of producing goods and services generates income, which, in turn, provides
the means to purchase other goods and services. This idea has been debated
and modified over time.
7. Classical Macroeconomics: Classical economists had a different view of
macroeconomic issues than modern economists. They believed in the idea of
"full employment equilibrium," where the economy would naturally tend toward
full employment without the need for government intervention. They also had a
strong belief in the quantity theory of money, which related changes in the
money supply to changes in the price level.

NEOCLASSICAL ECONOMICS

Neoclassical economics is a dominant school of economic thought that developed in the

late 19th and early 20th centuries as a response to classical economics and the
marginal revolution. It remains a foundational framework in contemporary economics.
Neoclassical economics builds upon classical economics but introduces several key
innovations and ideas. Here are some of the fundamental aspects of neoclassical
economics thought:

1. Marginal Utility: Neoclassical economists introduced the concept of marginal

utility, which suggests that the value of a good or service is not solely determined
by the amount of labor required to produce it (as in classical economics) but by
the additional satisfaction or benefit (utility) an individual derives from consuming
one more unit of that good. The marginal utility of a good decreases as a person
consumes more of it, reflecting the principle of diminishing marginal utility.
2. Supply and Demand: Neoclassical economics places great emphasis on the
interaction of supply and demand in determining prices and resource allocation.
 Prices are seen as the equilibrium point where the quantity of a good that
consumers want (demand) equals the quantity producers are willing to supply.
3. Rational Choice and Maximization: Neoclassical economists assume that
individuals are rational decision-makers who aim to maximize their utility, subject
to their budget constraints. This rational choice framework is a fundamental
assumption in microeconomic models.
4. Utility Maximization and Consumer Behavior: Neoclassical economics models
consumer behavior by analyzing how consumers allocate their incomes to
maximize their utility, given price constraints. This analysis leads to the derivation
of demand curves for goods and services.
5. Firm Behavior and Profit Maximization: Firms in neoclassical economics are
assumed to be profit-maximizing entities. They make decisions about production,
pricing, and resource allocation with the goal of maximizing their profits. The
neoclassical model of firm behavior incorporates concepts like marginal cost and
marginal revenue.
6. Perfect Competition: The neoclassical model often assumes perfect
competition in markets, where there are many buyers and sellers, homogeneous
products, perfect information, and no barriers to entry. This idealized market
structure helps analyze market equilibrium and efficiency.
7. Efficiency and Pareto Optimality: Neoclassical economics places a strong
emphasis on allocative efficiency, where resources are allocated in a way that
maximizes overall societal welfare. A situation is considered Pareto optimal if no
one can be made better off without making someone else worse off.
8. Utility and Welfare Economics: Neoclassical economics introduced welfare
economics, which assesses policies and market outcomes based on their impact
on individual and societal welfare. Concepts like consumer surplus and producer
surplus are used to measure economic welfare.
9. Subjective Value: Neoclassical economics acknowledges that value is
subjective and varies from person to person. This subjective theory of value
contrasts with the classical labor theory of value.
 KEYNESIAN MACROECONOMICS

Keynesian macroeconomics is a school of economic thought based on the ideas and

theories of John Maynard Keynes, a British economist who revolutionized the way we
understand and manage macroeconomic issues. Keynesian economics emerged in
response to the economic challenges of the Great Depression in the 1930s and has had
a significant impact on economic policy and theory. Here are some key principles and
ideas associated with Keynesian macroeconomics:

1. Aggregate Demand: A central concept in Keynesian economics is aggregate

demand, which represents the total demand for goods and services in an
economy. Keynes argued that fluctuations in aggregate demand play a crucial
role in driving economic fluctuations.
2. The Propensity to Consume: Keynes introduced the concept of the marginal
propensity to consume (MPC). He argued that households do not spend their
entire income but save a portion of it. The MPC represents the fraction of an
additional dollar of income that households will spend, and it plays a significant
role in determining aggregate demand.
3. The Multiplier Effect: The multiplier effect is a fundamental concept in
Keynesian economics. It explains how an initial change in spending, whether it's
by the government or private sector, can lead to a magnified impact on national
income and employment. The multiplier effect arises because an increase in
spending creates additional income, which, in turn, leads to more spending.
4. Underemployment Equilibrium: Keynes challenged the classical notion of full
employment equilibrium. He argued that in a market economy, there can be
situations where the economy operates at less than full employment due to
insufficient aggregate demand. In such cases, resources, including labor, remain
idle.
5. Role of Government: Keynes advocated for the active role of government in
managing the economy. He believed that during times of economic downturns,
the government should increase its spending and use fiscal policy to stimulate
 demand and create jobs. Conversely, during periods of inflation or economic
overheating, the government should reduce spending to curb inflation.
6. Countercyclical Policy: Keynesian economics supports countercyclical policy,
which involves using fiscal and monetary tools to counteract economic
fluctuations. For instance, during a recession, the government can increase
spending or cut taxes to boost demand, while during an economic boom, it can
reduce spending or raise taxes to cool the economy.
7. Liquidity Preference: Keynes introduced the theory of liquidity preference,
which explains how people hold money for transaction purposes and as a
precautionary measure against uncertainty. This theory is crucial for
understanding interest rates and the demand for money.
8. Critique of Classical Economics: Keynesian economics challenged the
classical view that markets would naturally self-adjust to full employment. Keynes
argued that market forces alone were insufficient to ensure full employment and
that government intervention was necessary to stabilize the economy.
9. Long-Run and Short-Run Analysis: Keynesian economics distinguishes
between the short run and long run. In the short run, prices and wages are not
fully flexible, and demand shocks can result in unemployment or inflation. In the
long run, prices and wages are more flexible, and the economy tends to gravitate
toward full employment.
 KEYNESIAN MACROECONOMICS

Keynesianism is a school of economic thought that emphasizes the role of government

intervention in the economy to promote economic stability and growth. Keynesians
believe that markets are inherently unstable and that the government needs to play a
more active role in the economy to ensure that economic output and employment
remain high.
Keynesian economics was developed by John Maynard Keynes in the 1930s in
response to the Great Depression. Keynes argued that the government could use fiscal
policy and monetary policy to manage aggregate demand and achieve full employment.
Fiscal policy refers to government spending and taxation. Keynesians believe that the
government can use fiscal policy to stimulate the economy during recessions and to
cool the economy during booms. For example, the government can increase spending
on infrastructure or cut taxes to stimulate the economy during a recession.
Monetary policy refers to the central bank's control of interest rates. Keynesians believe
that the central bank can use monetary policy to lower interest rates and make it easier
for businesses to borrow money and invest. This can lead to increased economic
activity and job creation.
Keynesian economics has been influential in shaping economic policy around the world.
Since the Great Depression, governments have used fiscal and monetary policy to
manage the economy and achieve desired economic outcomes.
Here are some of the key features of Keynesianism:
 Markets are inherently unstable. Keynesians believe that markets are prone to
booms and busts. This is because markets are driven by investor sentiment,
which can be irrational and volatile.
 Government intervention can be necessary to stabilize the economy.
Keynesians believe that the government can use fiscal and monetary policy to
manage aggregate demand and prevent recessions and depressions.
 The government should focus on achieving full employment and price
stability. Keynesians believe that the government should use fiscal and
monetary policy to achieve full employment, which is defined as the lowest
possible rate of unemployment without causing inflation.
  Government intervention should be temporary and targeted. Keynesians
believe that government intervention should be used to address specific
economic problems, such as recessions or high unemployment.

Here are some specific examples of how Keynesian economics has been used to
achieve desired economic outcomes:

 The Great Depression: Keynesian economics was used to justify government

intervention to stimulate the economy during the Great Depression. The
government increased spending on infrastructure and cut taxes to encourage
businesses to invest and hire workers. This helped to bring the economy out of
the recession and create jobs.

 The 2008 financial crisis: Keynesian economics was also used to justify
government intervention to stimulate the economy during the 2008 financial
crisis. The government increased spending on bailouts and stimulus packages to
prevent a deeper recession.

 Unemployment: Keynesian economics is often used to justify government

intervention to reduce unemployment. For example, the government can
increase spending on public works projects or provide tax breaks to businesses
that create jobs.

 Inflation: Keynesian economics can also be used to justify government

intervention to control inflation. For example, the government can raise interest
rates or reduce spending to cool the economy and reduce inflation.

NEO-KEYNESIANISM

Neo-Keynesianism is a school of economic thought that combines elements of

Keynesian economics with neoclassical economics. Neo-Keynesians believe that
markets are not always efficient and that government intervention may be necessary to
promote economic stability and growth.

Neo-Keynesians accept the neoclassical principle of marginalism, but they argue that
markets can fail to clear due to sticky prices and wages. Sticky prices and wages mean
that prices and wages do not adjust quickly to changes in supply and demand. This can
lead to unemployment and recessions.

Neo-Keynesians believe that the government can use fiscal and monetary policy to
stabilize the economy and promote growth. Fiscal policy refers to government spending
and taxation. Monetary policy refers to the central bank's control of interest rates.

Neo-Keynesians argue that the government can use fiscal policy to increase aggregate
demand and stimulate the economy. For example, the government can increase
spending on public goods or cut taxes. Neo-Keynesians also argue that the government
can use monetary policy to lower interest rates and make it easier for businesses to
borrow money and invest.

Here are some of the key features of neo-Keynesianism:

 Markets are not always efficient. Neo-Keynesians believe that markets can fail
to clear due to sticky prices and wages. This can lead to unemployment and
recessions.
 Government intervention can be necessary to stabilize the economy and
promote growth. Neo-Keynesians believe that the government can use fiscal
and monetary policy to increase aggregate demand and stimulate the economy.
 The government should focus on achieving full employment and price
stability. Neo-Keynesians believe that the government should use fiscal and
monetary policy to achieve full employment and price stability.
 Government intervention should be temporary and targeted. Neo-
Keynesians believe that government intervention should be used to address
specific economic problems, such as recessions or high unemployment.
 MONETARISM AND THE CHICAGO SCHOOL OF ECONOMICS

Monetarism and the Chicago School of Economics are two closely related schools of thought in
economics. Both schools emphasize the importance of free markets and limited government
intervention in the economy. However, there are some key differences between the two schools.

MONETARISM

Monetarists believe that the central bank can control the money supply and use this
control to manage aggregate demand and achieve full employment and price stability.
They argue that the central bank should target a steady rate of growth in the money
supply. This would help to stabilize the economy and prevent inflation and recessions.

Monetarism has been influential in shaping central bank policy around the world.
Central banks are now more likely to focus on achieving price stability and less likely to
be influenced by political pressure. Many central banks have also adopted inflation
targeting, a monetary policy framework in which the central bank targets a specific
inflation rate.

For example, the Federal Reserve System in the United States uses a variety of tools to
control the money supply, including:

 Setting interest rates: The Fed can raise or lower interest rates to make it more
or less expensive for banks to borrow money. This affects the amount of money
that banks lend to businesses and consumers, which in turn affects aggregate
demand.

 Open market operations: The Fed can buy or sell government bonds to
increase or decrease the money supply. When the Fed buys government bonds,
it injects money into the economy. When the Fed sells government bonds, it
removes money from the economy.
  Reserve requirements: The Fed can change the amount of reserves that banks
are required to hold. This affects the amount of money that banks can lend to
businesses and consumers.

THE CHICAGO SCHOOL

The Chicago School is a school of economic thought that emphasizes the importance of
free markets and limited government intervention in the economy. Chicago School
economists argue that free markets are generally more efficient than government
regulation. They also argue that government intervention often restricts innovation and
competition.

The Chicago School has had a significant impact on deregulation policy. Many countries
have deregulated their economies in recent decades, which has led to increased
competition and innovation in many industries. For example, the deregulation of the
financial industry in the United States in the 1980s led to the rise of new financial
products and services, such as hedge funds and derivatives.

Examples of economic policies influenced by monetarism and the Chicago School

Here are some specific examples of economic policies that have been influenced by
monetarism and the Chicago School:

 Inflation targeting: Inflation targeting is a monetary policy framework in which

the central bank targets a specific inflation rate. Inflation targeting has been
adopted by many central banks around the world, including the Federal Reserve
System in the United States.

 Deregulation: Deregulation is the process of reducing or eliminating government

regulation of businesses and industries. Deregulation has been implemented in
many countries around the world, including the United States, the United
Kingdom, and New Zealand.
 Privatization: Privatization is the process of transferring ownership of state-
owned enterprises to the private sector. Privatization has been implemented in
many countries around the world, including the United Kingdom, France, and
Germany.

 Trade liberalization: Trade liberalization is the process of reducing or

eliminating tariffs and other trade barriers. Trade liberalization has been
implemented in many countries around the world through trade agreements,
such as the North American Free Trade Agreement (NAFTA) and the General
Agreement on Tariffs and Trade (GATT).
 NEW DEVELOPMENTS

THE GREENSPAN ERA

The Greenspan era refers to the period from 1987 to 2006 during which Alan
Greenspan served as chairman of the Federal Reserve System. Greenspan was a
strong proponent of monetarism and inflation targeting. He believed that the central
bank could control inflation by keeping the growth of the money supply in line with the
growth of the economy.

 Monetary policy:

o Focus on low inflation: Greenspan believed that the central bank could
control inflation by keeping the growth of the money supply in line with the
growth of the economy. He used a variety of tools to control the money
supply, including interest rates, open market operations, and reserve
requirements.

o Use of tools to control money supply: Greenspan was generally

successful in keeping inflation low during his tenure. The inflation rate
averaged around 2% per year during the Greenspan era. However, some
economists argue that Greenspan's focus on low inflation led him to
overlook other risks in the economy, such as the growth of subprime
lending.

 Economic prosperity:

o Longest period of economic expansion in American history:

Greenspan is credited with helping to create the longest period of
economic expansion in American history. During his tenure, the
unemployment rate fell to its lowest level in decades and the stock market
experienced a prolonged bull market.

o Contributions to prosperity: Greenspan's monetary policy helped to

keep inflation low and interest rates stable, which created a favorable
 environment for economic growth. He also supported deregulation of the
financial industry, which led to increased competition and innovation.

 Financial crisis:

o Collapse of subprime mortgage market: The financial crisis of 2008

was a major turning point for Greenspan's legacy. The crisis was caused
by a number of factors, including the collapse of the subprime mortgage
market and the failure of major financial institutions.

o Failure of major financial institutions: Greenspan's critics argue that his

focus on low inflation and deregulation contributed to the crisis. They
argue that his policies led to a housing bubble and made the financial
system more fragile.

POST GREAT RECESSION ERA

The Great Recession of 2008 was a major turning point in economic thinking. The crisis
exposed a number of weaknesses in the financial system and led to a reassessment of
the role of government in the economy.

Some of the key changes in economic thinking that have emerged since the Great
Recession include:

 Increased focus on financial stability: Prior to the Great Recession, there was
a widespread belief that the financial system was self-regulating and that the
government should not interfere. However, the crisis showed that the financial
system was not as stable as previously thought and that government intervention
may be necessary to prevent future crises.
 Increased skepticism of deregulation: The Great Recession also led to
increased skepticism of deregulation. Many economists now believe that
deregulation of the financial industry contributed to the crisis.
 Increased emphasis on risk management: The Great Recession also led to
increased emphasis on risk management. Financial institutions are now more
aware of the risks they face and are taking steps to mitigate those risks.
 Increased role of government: The Great Recession led to an increased role
for government in the economy. The government used a variety of tools to
stabilize the economy and prevent a deeper recession.
 New economic theories. Two of the most notable new theories are behavioral
economics and post-Keynesian economics.
o Behavioral economics argues that people do not always make rational
decisions and that this can lead to market failures. For example, people may
be overconfident in their abilities, which can lead to them taking on too much
risk.
o Post-Keynesian economics argues that the government can play a more
active role in the economy to promote economic stability and growth. For
example, the government can use fiscal policy and monetary policy to
manage aggregate demand.