Classical economics
Classical economics is a foundational economic theory that emphasizes the self-regulating nature of free markets and the idea of the "invisible hand," a concept introduced by philosopher Adam Smith in his pivotal work, *The Wealth of Nations* (1776). This school of thought advocates for minimal government intervention, suggesting that competition among rational consumers and producers leads to innovation and efficiency. Classical economics emerged as a critique of mercantilism, which prioritized government regulation and monopolistic practices, often resulting in market stagnation and reduced incentives for businesses to improve.
In this framework, prices are determined by the interactions between supply and demand, with the invisible hand guiding them to a balance that satisfies both consumers and producers. Prominent thinkers such as John Stuart Mill and David Ricardo expanded upon Smith's theories, reinforcing the notion that competitive markets foster economic growth. Over time, classical economics evolved into neoclassical economics and influenced the development of capitalist systems. However, it has faced challenges from other schools of thought, particularly Keynesian economics, which advocates for active government intervention during economic downturns. This ongoing dialogue highlights the complexity and diversity of economic perspectives in understanding market dynamics.
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Classical economics
Classical economics is the basis for a variety of modern economic schools of thought. It revolves around the self-correcting nature of the market and the "invisible hand." Classical economics advocates keeping the government as uninvolved with the free market as possible and theorizes that rational consumers will drive economic innovation. Classical theory was influential to the formation of the modern free market system.
Background
Classical economics can be traced back to the work of philosopher Adam Smith. Born in 1723, Smith was a professor at Edinburgh University. His work, The Wealth of Nations (1776), was one of the founding texts of classical economics. It was written in response to mercantilism, the prevailing economic theory from the sixteenth to the early eighteenth century. According to mercantilism, nations became successful by encouraging agriculture and manufacturing within their borders. With these crafts supported, nations could maximize exports while minimizing imports. Ideally, this philosophy would lead to nations selling more than they bought, allowing them to accrue large amounts of gold, precious metals, and other forms of international currency.
Initially, mercantilism was extremely successful. It allowed both England and France to secure large shares of the trade market and to weaken or break Dutch monopolies. Unfortunately, mercantilism gave rise to many smaller monopolies. The selling of privilege, or local monopolies, was an inherent feature of mercantilism. Governments would grant privileges to businesses, making competition illegal. This caused markets to stagnate and discouraged innovation. If a business was guaranteed customers, it had no motivation to improve upon its services.
Smith realized that mercantilism was harmful to the economy. The Wealth of Nations railed against the economic practices of the time. It advocated for free trade, the division of labor, and self-interest-driven competition as the means to a healthy economy. These ideas went on to become the foundation of classical economics.
Overview
Classical economics revolves around the free market. It argues that the private sector, meaning the sections of society owned by individual citizens, is best served by competition. If two or more companies are competing for the business of a limited number of consumers, they will be motivated to find ways to provide consumers with the best value possible. According to classical economics, rational consumers will always seek to get the most value for their money. This could mean getting the cheapest product of equivalent quality or getting the highest quality item for a set price. In this style of free market, only the most efficient businesses would survive.
When introduced to classical economic theory in the late eighteenth and early nineteenth centuries, many people did not understand how prices could stay at a level acceptable to the average consumer without government intervention. Smith argued that prices would be guided by a force that he called the "invisible hand." The invisible hand of the market was made up of an implicit arrangement between consumers and businesses. If prices rose too high, consumers would be unable or unwilling to purchase goods. They would find another way to acquire their chosen commodity or find a way to live without it. Lacking a steady stream of revenue from consumers, the businesses would die. However, if prices were too low, the businesses would be unable to sustain themselves on sales. Thus, the invisible hand of the market pushes prices toward the highest point at which consumers are willing to buy goods and the lowest point at which businesses are able to profit on goods. Eventually, the prices will drift to whatever point is most acceptable to both parties. As long as outside influences remain consistent, prices will remain at a point agreeable to both businesses and consumers. In an ideal economy, the invisible hand will be a consistent corrective force.
For the free market system to function properly, competition must be maintained. If one business in a market grows too powerful, it may be able to remove its competition, thus reducing its motivation to improve. If consumers have no alternative ways to acquire a commodity, the power of the invisible hand weakens. Competition may also be weakened by agreements among businesses. For example, if several businesses collectively decide not to lower their prices beyond a certain point, they are no longer competing in the way that proponents of classical economics believe is beneficial to an economy.
The classical theory of economics was actively promoted by prominent thinkers, such as John Stuart Mill, Robert Malthus, Jean-Baptiste Say, and David Ricardo, until the late nineteenth century. It proved extremely influential to later economic movements. The free market system proposed by classical economics would become the foundation of capitalism. The economic school slowly evolved into the neoclassical school. During this period, classical economic theories about the invisible hand and the conflicting interests of consumers and businesses evolved into modern supply and demand theory. In supply and demand, the ratio between the supply of a product available for sale and the consumer demand for the product affects its market price. If supply is higher than demand, prices are expected to fall. If demand is higher than supply, prices are expected to rise.
Classical economics saw a resurgence in the 1970s with new classical economics. New classical economics applied classical economic theories, which attempted to explain the interactions between businesses and consumers on a smaller scale, to macroeconomics, which attempted to explain massive, national-level economics.
Several economic theories doubt the basic tenets of classical economics. For instance, Keynesian economics, a school of thought based on the writings of John Maynard Keynes, doubts the idea that the free market will always move toward optimal employment conditions for the general populace. Instead, Keynesian economists advocate government intervention to stimulate the economy in times of recession and depression.
Bibliography
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