MODULE 1.

5 - A BRIEF HISTORY OF ECONOMIC THOUGHT

18th CENTURY

Adam Smith & laissez faire

Adam Smith (1723 - 1790), often called the father of modern economics, introduced foundational
concepts in "The Wealth of Nations" (1776). He argued that individuals pursuing their self-interest
inadvertently contribute to economic prosperity through the invisible hand of the market. Smith
advocated for a laissez-faire economy, where minimal government intervention allows markets to
function freely. He opposed mercantilism, which emphasised state control over trade. However, Smith
acknowledged essential government roles in defense, justice, and infrastructure, providing public goods
that markets cannot efficiently supply. Smith emphasised the division of labour, which enhances
productivity and economic growth, and warned against monopolies that could restrict competition.
Smith's ideas were influenced by the Enlightenment and the broader intellectual movement towards
understanding natural laws.

19th CENTURY

Utility Theory in Classical Microeconomics

Jeremy Bentham and John Stuart Mill developed utilitarianism, which posits that actions are right if they
promote the greatest happiness for the greatest number. This concept became central to utility theory
in classical microeconomics, examining how consumers make choices to maximise satisfaction (i.e.
utility). The principle of marginal utility, introduced by William Stanley Jevons, Carl Menger, and Léon
Walras, explains how prices are determined by the additional satisfaction consumers gain from
consuming extra units of goods. Bentham and Mill also integrated considerations of individual rights and
welfare into their utilitarian framework. The marginal revolution shifted economic thought from classical
labour theories of value to the subjective theory of value based on utility, laying the groundwork for
modern microeconomic theory.

Say’s Law in Classical Microeconomics

Say's Law, named after Jean-Baptiste Say, asserts that supply creates its own demand. Classical
economists believed that production inherently generates enough demand to purchase all goods
produced, ensuring full employment. The Great Depression was a critical turning point that
demonstrated the limitations of Say’s Law and classical macroeconomic thought, leading to the rise of
Keynesian economics.
The Marxist Critique of Classical Economics

Karl Marx critically analysed capitalism, focusing on labour exploitation and capitalism's inherent
instability. He argued that goods' value derives from labour, with surplus value representing worker
exploitation. Marx predicted capitalism's collapse due to internal contradictions, leading to class struggle
and communism. His works, including "Das Kapital," laid the foundation for Marxist economics,
emphasising class relations and capitalist production dynamics. Marx’s critique included a historical
materialist perspective, analysing the evolution of economic systems and class relations through history.
Marx's influence extended beyond economics to sociology, political science, and other social sciences,
highlighting his interdisciplinary impact.

20th CENTURY

The Keynesian Revolution

John Maynard Keynes revolutionised economic thought with "The General Theory of Employment,
Interest, and Money" (1936). He argued that total spending (i.e. aggregate demand) determines overall
economic activity and that insufficient demand can lead to prolonged high unemployment. Keynes
advocated for active government intervention to manage demand through fiscal and monetary policies,
addressing the shortcomings of classical economics during economic downturns. Keynes’ theories
introduced the concept of aggregate demand management and the importance of counter-cyclical fiscal
policies. Keynes’ ideas were instrumental in shaping post-World War II economic policies and the
establishment of institutions like the International Monetary Fund (IMF) and the World Bank.

The Emergence of Macroeconomic Policy

Keynes' ideas led to the development of macroeconomic policy as a distinct field, focusing on stabilising
the economy through government intervention. This included policies to manage inflation,
unemployment, and economic growth, becoming the dominant framework for mid-20th century
economic policy. The development of the Phillips Curve showed a trade-off between inflation and
unemployment, influencing macroeconomic policy.

Monetarism & New Classical Economics

In the 1970s, Monetarism, led by Milton Friedman, emphasised the money supply's role in influencing
economic activity. Monetarists argued for controlling the money supply to manage inflation. New
classical economics, associated with Robert Lucas, stressed rational expectations and minimal
government intervention, arguing that individuals base decisions on future economic policies. These
schools of thought inspired market-based supply-side policies and a return to the idea of automatic full
employment through free markets. Monetarism also brought attention to the long-term effects of
monetary policy on inflation and the importance of controlling the money supply to ensure price stability.
The Rational Expectations Hypothesis argued that individuals' expectations about future economic policy
could neutralise the effects of those policies.

21st CENTURY

Behavioural Economics

Behavioural economics integrates insights from psychology, challenging the assumption of rational
behaviour. It shows that individuals often make decisions deviating from traditional economic
predictions. Notable contributors like Daniel Kahneman, Robert Shiller, and Richard Thaler study how
cognitive biases, emotions, and social factors influence economic decisions, leading to new approaches
in understanding consumer behaviour and market dynamics. Behavioural economics explores concepts
like bounded rationality, prospect theory, and heuristics, which challenge traditional models of rational
decision-making. Behavioural insights have been applied to various fields, including finance (behavioural
finance), public policy (nudges), and marketing.

Sustainable Economic Development

Modern economic thought increasingly recognises the interconnectedness of economic, social, and
environmental systems. This has led to a focus on sustainable development and the circular economy,
which aims to minimise waste and maximise resource use by redesigning production and consumption
systems. The circular economy contrasts with the traditional linear economy, emphasising the repair,
reuse, and recycling of products to create a more sustainable economic model. International agreements
and organizations, such as the United Nations Sustainable Development Goals (SDGs), promote
sustainable development. There is an increasing emphasis on Corporate Social Responsibility (CSR) and
Environmental, Social, and Governance (ESG) criteria in business practices.