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ClassicalNeoclassicalEconomics-Arya

The document discusses the evolution of classical and neoclassical economics, highlighting key concepts such as the law of Say, Fischer's quantitative theory of money, and the principle of marginal utility. It explains how classical economics emphasizes the importance of a free and competitive market for aligning personal and national interests, while neoclassical economics introduces the idea of rational expectations and self-adjusting markets. The text also critiques the Phillips curve and outlines the implications of technology changes on economic productivity and relative prices.

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16 views

ClassicalNeoclassicalEconomics-Arya

The document discusses the evolution of classical and neoclassical economics, highlighting key concepts such as the law of Say, Fischer's quantitative theory of money, and the principle of marginal utility. It explains how classical economics emphasizes the importance of a free and competitive market for aligning personal and national interests, while neoclassical economics introduces the idea of rational expectations and self-adjusting markets. The text also critiques the Phillips curve and outlines the implications of technology changes on economic productivity and relative prices.

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biskrasami4
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CLASSICAL & NEOCLASSICAL ECONOMICS

Presentation · February 2020

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Kiumars Arya
Islamic Azad University North Tehran Branch
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CLASSICAL & NEOCLASSICAL ECONOMICS

Classical economics, according to Adam Smith (1776), led to the emergence of a distinctive school
in comparison with the economic thinking of mercantilism and feudalism. Classical economics
concluded that supporting and safeguarding personal (individual) interests in a 'free and
competitive' economy would increase collective interests, that is, national interests. The
convergence of personal and national interests required two essential conditions: First, a free
economy is an environment in which the state does not interfere in economic affairs except to
ensure that the principles of a free economy are implemented to improve market performance.
The free economy has characteristics such as legality, effective monetary and financial rules, size
of government, responsibility and free trade. Secondly, the convergence of personal and national
interests is possible under competitive market conditions. The 'perfect competition market'
eliminates monopoly, unhealthy competition and other economic (customs tariff) and non-
economic (collusion) restrictions. From the classical school perspective, important economic
indicators, such as price, wages, interest rates and investment, are able to grow national income
and full employment because of 'flexibility'. If the economy goes out of balance due to stagnation
and unemployment, a nominal decline in bank interest rates and wages will increase investment
incentives, which will drive economic activity toward higher production and employment. Also,
classical economics involves the law of Say and Fischer's quantitative theory.

The law of Say


supply makes its own demand: The total supply of goods and services is necessarily equal to the
aggregate demand, as products are exchanged for products, in which money plays a neutral role.
If part of the national income is not dedicated to the purchase of goods and services, the surplus
of supply will force firms to adjust against demand. The decline in output is always accompanied
by an increase in unemployment. The recession and rising unemployment reflect the fact that
savings are increasing, consumption and investment are decreasing.

Fischer's quantitative theory of money


According to Fischer's quantitative theory, the nominal sector of the economy (prices, wages and
interest rates) cannot influence the real sector of the economy (production, employment and
consumption) and money only plays a neutral role (classical dichotomy). Any increase in the
volume of money will result in higher prices, not production. Increasing the volume of money is
aimed at lowering bank interest rates and reducing savings incentives. If steady income is
assumed, the decline in savings is always accompanied by an increase in consumer demand, a
factor that is important for increasing investment, production, and employment.

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CLASSICAL & NEOCLASSICAL ECONOMICS

The theory of classical economics evolved in the twentieth century with the advent of the
international economic and the political developments and led to the emergence of the new
classical school. The New-Classical School of Economics developed from two basic perspectives
the classics: one the Principle of marginal utility and the other of business cycle theory.

The Principle of Marginal Utility


Man has many needs, individual and social needs. Providing human needs (pleasure) is costly
(suffering). To increase the level of desirability, it is essential that each person make maximum
use of 'time' and 'income' to meet their basic needs. In analyzing consumer (worker, employee
and wage) utility and producer utility (employer, organization and government), the value of
labor and the value of goods and services are taken into account. William Stanley Jones (1911)
distinguishes the subjective value of the commodity from the trade value of commodity. It is the
consumption of goods and services that actually makes one feel happy and determines the
subjective value, the 'value of use' of the commodity. Strictly speaking, assuming rational
behavior, the marginal utility of consuming an additional unit of a given commodity is the use
value of that commodity. The utility is not an intrinsic property of the commodity and depends
on the degree of satisfaction of the individuals. Utility is a relative phenomenon because people
have different tastes and preferences and do not have the same mental value for consuming
goods and services. 'Work' cannot be a good criterion for the measuring price. The value of work
varies in quantity and quality. Followers of the neoclassical school believe that price, that is, the
subjective value of the commodity, determines the value of labor. In fact, the price is determined
by the marginal utility.

The Business Cycle Theory


After World War II, the efficiency of the Phillips curve was questioned by economists, Friedman
& Phelps (1960). Economic events in some industrialized countries confirm the empirical fall of
the Phillips curve that there is no relationship between inflation and employment even in the
short run. In this period, Economists' disagreement on how to benefit from monetary and fiscal
policies and the use of interventionist policies to increase output and employment is more
evident than ever.
Robert Lucas (1973) took an important step in macroeconomic analysis of neoclassic by
presenting the theory of business cycle. Lucas, endorsing the rational expectations hypothesis
(John Muth, 1961), concluded that households and firms have rational behavior in shaping their
future expectations because individuals make the most use of existing information and are not
influenced by predictable policies. For
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CLASSICAL & NEOCLASSICAL ECONOMICS

example, coordinated monetary policy cannot reduce unemployment and will only increase
inflation, as increasing money supply in past experiences will raise the inflationary expectations
of individuals. As businesses are not affected by predictable policies and no change in investment,
the level of real output does not increase.
The economy is always faced with two different flows, at the same time, important for the
stability of markets. At the heart of the economy is the flow of goods and services that determine
the amount of output and employment. The nominal part of the economy is the cash flow that
provides the funding for the applicants. According to the neoclassic, markets are self-adjustment,
and such a process is accompanied by recession and boom. In the general equilibrium of the
economy, the total supply of production depends not on effective demand (John Maynard
Keynes) but on relative prices. According to the theory of real business cycle (Keydland &
Prescott, 1982), technology changes affect the productivity of economic resources (such as labor
and capital) and cause relative price changes. The relative change in prices also affects
consumption, investment and production. New classical economic principles include the
following:

• Individuals are able to optimize.


• Markets are always self-adjustment.
• Expectations act rationally and thwart predicted economic policies.
• Technology changes are always accompanied by changes in relative prices, productivity
of production factors, and the amount of production.

Kiumars Arya
12. February 2020

[3]

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